Contrarian View: HR 1586 (T.A.R.P. Surtax Bill) will Create Millionaires

This is  just a  few quick thoughts, but I believe, in a few years, we’ll be able to take this bill and place it’s effects high on the list of unintended consequences. Let’s wonder what a reasonable firm would do in order to protect it’s people as much as possible from this legislation… I would put forth the proposal that a firm would give it’s employees the most “bang for the buck.” This seems to clearly be by paying in options. Now, I don’t know all the technical details behind how finance companies have to account for and value options given as compensation, but, using the CBOE option pricer and volatility from Morningstar, I get around $0.50 as the option price for a strike of $2.50 at the time Citi was giving bonuses out, around the time it was at $1.00. Or, if we use $2.50 for the equity price and the strike price, we get $1.62 option price.

Since those prices are per share for lots of 100 option, we get anywhere between 500,000 and 155,000 options, depending on when Citi’s rules would require it to re-cast it’s payments to employees. That’s obviously a huge range. However, for some context, when Citi was trading at $50 / share, having 500,000 shares would have meant you had $25 million in the bank. And 155,000 shares would have meant you had $7.75 million in the bank. However, let’s look at some more likely scenarios. Citi is currently trading at $3.00. As these options are longer dated (I believe the prices quoted above were for 3 year options), could one see a world where Citi is at $10, $15, or even $20 3 years in the future? I think so. So, 155,000 options would be worth between $1.55 million and $3.1 million.The other option is some combination of cash and restricted stock. As we see above, the total shares one would get, if merely receiving restricted stock (at the current trading level) is approximately half to two-thirds.

Now, obviously there are risks. Citi might not be around in three or more years–that is anyone’s guess! This assumes share price increases quite a bit (although the numbers look good even for more modest scenarios). However, all of these would be issues with restricted shares as well–which Wall St. heavily relies upon for compensation. Also, this is just for Citi, which is clearly in a more precarious position than some of it’s peers. For a firm like Goldman, Morgan Stanley, or even Merrill/BofA, the probability of defaulting is way lower. And, for those firms, volatility is lower, making options less valuable, and increasing the ratio of options to restricted shares. the purposes of comparison, Goldman is currently trading at approximately $100 and it’s two year volatility is around 60%. This yields an option price of around $39, or 3x as many options as restricted shares. So, for every $20 Goldman’s shares go up, one would make 3x as much if they had options.

You see where I’m going with this? Now, I don’t know the specific rules surrounding a firm’s ability to re-cast their payments once they’ve been made, or how they compute strike prices, restricted share award prices, or other details. But, I would bet that these firms go back to their employees and let them re-think some of their options (no pun intended).

Fun Super Irony Fact: HR 1586, in the 110th congress was the “The Death Tax Repeal Act of 2007”!!!

Here’s Some Advice, Pre-Salted

Having been recruiting and interviewing people for a few years now, I get constant questions asking about careers on Wall Street. For the lucky few who find their way into the right career, right industry, and the right job, then it’s not something they probably ever ask about. However, for the students and others looking, it’s a daunting task to sort out the options. What are the differences in working environment? What are the things I should be considering? Large firm or Small firm? Trading, Sales, Investment Banking, or Private Equity? These are all personal questions, but here is some advice I think will be useful regardless of what you seek.

1. The people are important. Your work environment will depend on the people found within it. Your entire group and the people with whom you interact are all integral parts of the equation. You don’t have to love everyone you work with, but you have to feel that they understand your position, are worthy of your respect and will treat you fairly, and that they are motivated on a personal level to see you do well. Obviously, since the only way to know these things for sure is to work with them, it’s difficult to know these ex-ante.

2. Be a team player. There are far, far too many examples of people building walled gardens in the world of finance. The thought process is, “If I know everything, and other people don’t, then I’m the most valuable person.” Let me tell you how the story usually ends: someone senior figures it out and the person hoarding information is usually pushed aside, fired, or moved. Not only that, but when the person is doing everything critical, they become a bottleneck, and urgent matters crush them personally and professionally. Show everyone from the start you are a team player. Involve people more junior than you and solicit input and feedback from people at or above your level. Offer to help and ask for help. It’ll get you a long way personally and professionally.

3. Never stop learning. Don’t just learn how to do what you’ve been doing well and stagnate. There is a constant evolution in the world of finance. Do you know what happened to all the people who were working with sub-prime mortgages and only knew their end of the business? Nothing good. You can’t evolve in your job if you don’t learn anything new. As innovations occur, understand them, the motivation behind them, and what they mean for the market/industry/system. Once you start to understand why people improve on existing structures, techniques, or financial technologies you’ll be in a position to innovate yourself when you see an opportunity.

4. Keep in touch with people and go out of your way to meet new people. This one is tough because it’s largely a personality issue, some people are comfortable with this and some people aren’t. Almost every hedge fund and every private equity firm was started up by a handful of people, deciding to cast their lots with each other. Now, these mega-success stories aren’t representative, but it also shows that one never really knows which relationships and ties will be most vital and beneficial to one’s future. Also, it’s hard to point to any example in my experience where knowing or meeting someone was a bad thing.

5. Don’t take any magic advice. There isn’t any. Everything that leads to success is slow and common sense, when stated plainly enough. Look for magic bullet somewhere else. Every story about someone who made a billion dollars in three years has an element of luck that is spun into certainty by good story telling. If you keep trying to be in the right place at the right time you’ll miss out. A strong knowledge base, solid work ethic, and a deep understanding of what’s going on around you and why is the best way to anticipate the next need. Keep in mind, as well, that the selection bias in the stories you are told obviously favor the success stories.

6. Have a backup plan. This business is both cyclical and fickle–the people you need in a boom aren’t the same people you need in a bust. Quarterly reporting means that sometimes things are rushed. Political and irrational concerns play into personnel decisions, resource decisions, and decisions on business focus. Any one of these changing can mean an adverse event and a sudden turn for your career. Headhunters are your friend but the firm‘s enemy (in general, some aren’t anyone’s friend)–talk to the good ones and keep in touch.

7. Know and demonstrate your value. When it comes time for recognition, promotions, or compensation you should know the facts going in. Take notes of what you’ve done. Inform your boss of what you’ve contributed, don’t assume others will do it for you (keep it appropriate and infrequent, but better to tell him something he knows than have it go unsaid). Obviously your mileage will vary and this is a series of personality assessments, but the principle is a constant. You lose your right to complain about something if the right people don’t know about it (vague, but meant to be general–think of it as not voting and complaining who won the election, you can’t).

9. Know what’s going on with your peers. Guess what a big theme on the street is? Comps (comparables). Guess what you get from the company you work for and your boss? Whatever they have to give you to be happy, and no more than suits them–it’s not personal, it’s a business. You should be talking to your peers to know if they are progressing faster than you, slower than you, or differently. Learn about how they handle problems and what works for them. It’s collective experience, and it gathers much faster than individual experience.

10. Get your foot in the door. I have only seen one person get hired for a non-support role on the Street that where the person wasn’t of college or from another firm on the Street. This person was one year out of college, at a major technology company, and even then was second guessed. Entry level jobs have a profile that recruiters look for, and some places have policies against taking people that have work experience into these entry-level jobs (obviously not including people graduating with M.B.A.’s who have prior work experience). I also haven’t seen a job listing that doesn’t call for relevant work experience. Even jumping between disciplines within finance is really difficult (P.E. to trading, or sales to banking, etc.). Unfortunately, this is the reality.

11. Know your priorities–prioritize money, career, and lifestyle early and often. This probably should have been #1 or #, but that’s life. If you wan to get paid and be a mercenary, then do that. If you want to be career oriented, then take that path. Either way the more you let it be known what your priorities are, people will associate those with you. If your priority is money, people will come at you with guarentees and higher risk positions. If your priotity is career, people will keep you in mind to take leadership opportunities and advance (with a higher potential for failure and a career setback). Keep in mind that mercenaries get paid more, but their high compensation paints a target on their back. Career-oriented employees can find themselves not being paid at the top tier, but with a bigger job. Tradeoffs all around. Whatever your focus, though, ensure that you’re good at what you do and advancement (up the money ladder or the corporate ladder) will come (with varying degrees, for maximum benefit add a few ounces of luck too).