Paying Bankers In Derivatives Worked Out So Well For Credit Suisse, Let’s All Do It

BreakingViews has a couple of posts up about one of my favorite things in the financial universe, Credit Suisse’s habit of paying its bankers in structured credit instruments that take pages to describe. How’s that going? Great:

Three years ago, around 2,000 employees were forced to take some $5 billion of the riskiest assets from the Swiss group’s balance sheet as their bonuses. Now, recipients are being offered the chance to buy more. What once seemed like a punishment has turned into something of a perk.

Investors in the “Partner Asset Facility” already sit on a paper profit of around 80 percent, thanks to a recovery in the value of the original portfolio. That gain is essentially safe, since most of the assets involved have been liquidated or sold down and the funds are sitting in low-risk, low-return investments. The snag is that beneficiaries can’t get to the payouts until 2016.

To ease the pain of waiting, Credit Suisse is giving participants another bite. They have a chance to plough some of their paper profits back in, buying up to $1 billion of risky assets, including mortgage securities, from the bank’s books. Over a third of participants opted in to a similar offer late last year. Some of the purchases are to be funded by leverage, leaving perhaps half to come from willing PAF holders.

Phrases like “risky assets, including mortgage securities,” are always a bit of a minefield, but the sense is clear enough, which is that a whole lot of senior people at Credit Suisse are pretty keen to take money that is basically theirs, which is currently held in the form of basically cash, and invest that on a ~2x levered basis in, er, “risky assets, including mortgage securities,” which let’s just stipulate have a higher risk and higher return than cash.

How would you describe those people?

Matt Yglesias has a theory, supported by JPMorgan’s possibly less than bulletproof risk management approach in its Chief Investment Office, that everyone employed in any revenue or revenue-adjacent capacity at a major bank is a testosterone-crazed gambling-addicted loon. Granting that for a sec, why would that be? One potential culprit is a comp model where banks offer (1) a livable but not-that-special base salary plus (2) a bonus that ranges from zero to ginormous depending on your skill, luck and charm and the skill, luck and charm of your co-workers. The people who take that offer will tend to be the ones who like a gamble every now and again and have a healthy confidence in their skill, luck and charm. If you want to minimize variability in your personal income, be a lawyer.

With that background it’s not surprising to see the CS people choosing a wide-dispersion outcome. This is part risk loving, part confidence: they or their peers chose these “toxic” assets to invest Credit Suisse’s money in, so they have some reason to believe that those assets will outperform market expectations. So they should value those assets more highly than the market does, and I guess that’s implicitly Credit Suisse’s conclusion in hiving off these assets to its managing directors rather than to the highest public bidder.

So what to do with those loons at JPMorgan? Here is BreakingViews’ Daniel Indiviglio:

One way to make JPMorgan executives eat their own cooking would be as follows. Once the size of the group’s 2012 bonus pool is determined, the bank could create a synthetic bond whose notional size mirrors the performance of the so-called Whale trade. The bonus pool essentially would buy the long side of that derivative and the resulting bonds would be delivered to employees in the form of bonuses.

This long-term compensation would be linked to the fate of the bad hedges. The bonds would mature when the trade does. Any losses in the securities doled out to bankers ultimately would benefit JPMorgan and its shareholders. Any gains would flow to the employees involved.

Such an arrangement has worked before. Credit Suisse pioneered the idea of paying banker bonuses with toxic securities. They didn’t love the idea in 2008. But those employees aren’t doing badly. Though it has several more years to maturity, Credit Suisse’s Partner Asset Facility is up by about 80 percent.

Now circumstances have changed, but if you’d offered the London Whale this trade a year ago, what would he have said? Some sort of series of grunts and whistles I suppose, but then he’d be all “yeah, sure, that sounds great.” Because – I don’t know if you know this – but he was loading up on a hundred billion dollars of long exposure to this trade. Leaving aside the possibility that he wanted to blow himself up, you’re left with the sense that he had a fair amount of confidence in his positions.*

Journalists and regulators like to propose schemes like this because they are journalists and regulators, have a stable paycheck that they enjoy getting, and think it would be terrible to have their entire comp for the year tied up in a gamble. Guys who tie up $100bn in a gamble like gambles and think they’re good at them. Give those guys the chance to put their own personal funds in that gamble – and, remember, Bruno Iksil probably couldn’t trade CDX.IG.NA.9 in his personal account, so he couldn’t put his own money in this trade by himself – and they’ll be thrilled.

Which is fine, I guess, in the short run: if the unwind of the Whale trade is still pretty risky, which seems likely, why not give some of it to people who want it rather than to shareholders who mostly don’t?** But in the long run I’m not so sure. People who worry about l’affaire Whaledemort mostly want banking to be simpler and less stuffed with opaque derivatives trades that sometimes fall into small deep holes; those people may like a comp structure that appears to punish the Whale, but they’ll be less thrilled if that comp structure encourages other whales. “If you do a trade that is creepy and attention-grabbing enough, we will give you gobs of equity in it” will deter the risk-averse, but it will let the risk-lovers’ imaginations run wild.

Incidentally, the gurus on this topic, Credit Suisse’s comp structurers, have their own doubts about paying bankers in first-loss slices of their own cooking. Their new 2011 vintage Partner Asset Facility, wittily named PAF2, is as intriguing as the first 2008 PAF, and at least as regulatory-capital-aggressive, but it is not as aggressive-aggressive. Instead, it is a fixed-income, mezz-tranched thing where bankers get limited upside, and also limited downside, in a portfolio of investment-grade, capital-intensive, structurally complex, but not all that risky credit exposure. The goal is to dampen the vol of their compensation, to align their incentives not with those of shareholders – who should like risk and leverage – but with those of the broader group of bank stakeholders including creditors, depositors and regulators. Getting paid in structurally complicated but investment grade 6.5% paper isn’t quite the lurid gamble that getting paid in circa-2008 toxic MBS was. If you want a lurid gamble, you’ll have to look elsewhere – which should, in equilibrium, reduce the risks run at Credit Suisse, and increase them wherever “elsewhere” ends up being.

Credit Suisse toxic bonus keeps giving [BreakingViews]
Hall of Shamu [BreakingViews]

* The same applies with slightly diminishing force to the layers of people, up to Jamie Dimon, who supervised him: they presumably have a fair amount of confidence in their underlings, since they delegated hundreds of billions of dollars of responsibility to them.

** Though, unless Jamie Dimon was expecting a multibillion-dollar bonus this year, the shareholders will be keeping most of it.

(hidden for your protection)
Show all comments

56 Responses to “Paying Bankers In Derivatives Worked Out So Well For Credit Suisse, Let’s All Do It”

  1. Disappointed says:

    You missed out on multiple opportunities for charts and graphs.

  2. Guest says:

    Derivatives? I'd settle for a pack of Trident Layers.

    – UBS MD

  3. lights on says:

    letting bank employees cherry pick assets off the banks balance sheet, huh? don't really see any potential conflict there.

    -guy who didn't read the whole article because he has better things to do. like post obnoxious comments.

  4. Issomeonerecordingthis? says:

    Matt – I have to say that this was a well thought out and somewhat elegant post. Um, well done.

  5. Gym says:

    I'll stick to getting paid in stock

    – VP, Orexigen Therapeutics

  6. We meet again Trebek says:

    I'll take neighbors in detriot for $10 please

  7. guest says:

    A European bank getting something right? I believe pigs are currently flying outside my window.

  8. guest says:

    The Whale would have responded "Thanks, but I never smoke what I deal."

  9. M.L. says:

    Very right with one modification… Why do these people at CS like to take these assets? Maybe you're right about the testocerone and risk loving tendencies or maybe they're thinking about the price they're buying at. After all, you say that if the price were too low, they would auction them off.. Well I ask what's better than buying at auction? Buying from someone who is more concerned with reducing exposure than value. I theorize that the Cs bankers believed they were getting a good deal. Seems to have turned out that way!

  10. guest says:


  11. Aubrey McClendon says:

    What is wrong with taking personal stakes in my company's "bets" ?!?

  12. g7DPta Very neat blog article.Really thank you! Awesome.

  13. Thanks-a-mundo for the post.

  14. buy Bowtrol says:

    Great, thanks for sharing this blog. Much obliged.

  15. Great post.Thanks Again. Great.

  16. Multi search says:

    Thank you ever so for you blog post.Really looking forward to read more.

  17. Thanks for sharing, this is a fantastic article. Really Cool.

  18. diamant says:

    Great, thanks for sharing this article post.Really looking forward to read more. Much obliged.

  19. nopal cactus says:

    wow, awesome post.Really looking forward to read more. Really Great.

  20. voiles says:

    wow, awesome article.Really thank you! Cool.

  21. Major thankies for the blog article.Much thanks again. Will read on…

  22. I think this is a real great blog article.Thanks Again. Want more.

  23. Really informative blog.Thanks Again. Keep writing.

  24. Enjoyed every bit of your blog.Really thank you! Keep writing.

  25. Very neat blog article.Really thank you! Really Cool.

  26. This is one awesome post.Really looking forward to read more. Want more.

  27. Great blog.Really thank you! Want more.

  28. I am so grateful for your article.Thanks Again. Awesome.

  29. Appreciate you sharing, great article.Thanks Again. Much obliged.

  30. BSdlbB A big thank you for your blog.Really thank you! Keep writing.

  31. shake table says:

    Im obliged for the blog.Thanks Again. Really Cool.

  32. hotel says:

    I am so grateful for your post.Really thank you! Much obliged.

  33. Fantastic article.Much thanks again. Cool.

  34. Thanks a lot for the blog. Really Great.

  35. Thanks for sharing, this is a fantastic blog article.Much thanks again. Will read on…

  36. karité says:

    Really appreciate you sharing this blog.Much thanks again. Really Great.

  37. Thanks-a-mundo for the article post. Really Great.

  38. Wow, great article.Really thank you! Awesome.

  39. I truly appreciate this blog post.Really thank you! Great.

  40. I think this is a real great blog article.Really thank you! Awesome.

  41. Thanks so much for the blog article.Thanks Again. Great.

  42. I am so grateful for your blog post.Really looking forward to read more. Awesome.

  43. foot rest says:

    Thanks for the post.Really looking forward to read more. Fantastic.

  44. cartridges says:

    A big thank you for your article post.Really thank you! Great.

  45. Really informative article post.Thanks Again. Cool.

  46. check says:

    Today, considering the fast way of life that everyone leads, credit cards have a huge demand throughout the market. Persons throughout every discipline are using credit card and people who aren’t using the credit card have lined up to apply for even one. Thanks for sharing your ideas on credit cards.

  47. kc inks says:

    Wow, great article post.Thanks Again. Will read on…

  48. Looking forward to reading more. Great blog post.Really looking forward to read more. Cool.

  49. Thanks so much for the blog article.Much thanks again. Keep writing.

  50. I do`t regret that spent a few of minutes for reading. Write more often, surely’ll come to read something new!…

  51. Youth rock band “Ranetki” says thank you for such a wonderful blog..!