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<DIV class=timestamp>December 18, 2008</DIV>
<DIV class=kicker><NYT_KICKER>The Reckoning</NYT_KICKER></DIV>
<H1><NYT_HEADLINE type=" " version="1.0">On Wall Street, Bonuses, Not Profits,
Were Real </NYT_HEADLINE></H1><NYT_BYLINE type=" " version="1.0">
<DIV class=byline>By LOUISE STORY</DIV></NYT_BYLINE><NYT_TEXT>
<DIV id=articleBody>
<P><SPAN class=italic>“As a result of the extraordinary growth at Merrill during
my tenure as C.E.O., the board saw fit to increase my compensation each
year.”</SPAN> </P>
<P>— <A title="More articles about E. Stanley O'Neal"
href="http://topics.nytimes.com/top/reference/timestopics/people/o/e_stanley_oneal/index.html?inline=nyt-per">E.
Stanley O’Neal</A>, the former chief executive of <A
title="More information about Merrill Lynch & Co"
href="http://topics.nytimes.com/top/news/business/companies/merrill_lynch_and_company/index.html?inline=nyt-org">Merrill
Lynch</A>, March 2008 </P>
<P><STRONG><FONT color=#ff0000>For Dow Kim, 2006 was a very good year. While his
salary at Merrill Lynch was $350,000, his total compensation was 100 times that
— $35 million.</FONT></STRONG></P>
<P>The difference between the two amounts was his bonus, a rich reward for the
robust earnings made by the traders he oversaw in Merrill’s mortgage business.
</P>
<P>Mr. Kim’s colleagues, not only at his level, but far down the ranks, also
pocketed large paychecks. In all, Merrill handed out $5 billion to $6 billion in
bonuses that year. A 20-something analyst with a base salary of $130,000
collected a bonus of $250,000. And a 30-something trader with a $180,000 salary
got $5 million.</P>
<P><STRONG><FONT color=#ff0000>But Merrill’s record earnings in 2006 — $7.5
billion — turned out to be a mirage. The company has since lost three times that
amount, largely because the mortgage investments that supposedly had powered
some of those profits plunged in value.</FONT></STRONG></P>
<P>Unlike the earnings, however, the bonuses have not been reversed.</P>
<P>As regulators and shareholders sift through the rubble of the financial
crisis, questions are being asked about what role lavish bonuses played in the
debacle. Scrutiny over pay is intensifying as banks like Merrill prepare to dole
out bonuses even after they have had to be propped up with billions of dollars
of taxpayers’ money. While bonuses are expected to be half of what they were a
year ago, some bankers could still collect millions of dollars.</P>
<P>Critics say bonuses never should have been so big in the first place, because
they were based on ephemeral earnings. These people contend that Wall Street’s
pay structure, in which bonuses are based on short-term profits, encouraged
employees to act like gamblers at a casino — and let them collect their winnings
while the roulette wheel was still spinning. </P>
<P>“Compensation was flawed top to bottom,” said Lucian A. Bebchuk, a professor
at <A title="More articles about Harvard University."
href="http://topics.nytimes.com/top/reference/timestopics/organizations/h/harvard_university/index.html?inline=nyt-org">Harvard</A>
Law School and an expert on compensation. “The whole organization was responding
to distorted incentives.”</P>
<P>Even Wall Streeters concede they were dazzled by the money. To earn bigger
bonuses, many traders ignored or played down the risks they took until their
bonuses were paid. Their bosses often turned a blind eye because it was in their
interest as well.</P>
<P>“That’s a call that senior management or risk management should question, but
of course their pay was tied to it too,” said Brian Lin, a former mortgage
trader at Merrill Lynch.</P>
<P>The highest-ranking executives at four firms have agreed under pressure to go
without their bonuses, including <A title="More articles about John A. Thain."
href="http://topics.nytimes.com/top/reference/timestopics/people/t/john_a_thain/index.html?inline=nyt-per">John
A. Thain</A>, who initially wanted a bonus this year since he joined Merrill
Lynch as chief executive after its ill-fated mortgage bets were made. And four
former executives at one hard-hit bank, <A
title="More information about UBS AG."
href="http://topics.nytimes.com/top/news/business/companies/ubs_ag/index.html?inline=nyt-org">UBS</A>
of Switzerland, recently volunteered to return some of the bonuses they were
paid before the financial crisis. But few think others on Wall Street will
follow that lead.</P>
<P>For now, most banks are looking forward rather than backward. <A
title="More information about Morgan Stanley"
href="http://topics.nytimes.com/top/news/business/companies/morgan_stanley/index.html?inline=nyt-org">Morgan
Stanley</A> and UBS are attaching new strings to bonuses, allowing them to pull
back part of workers’ payouts if they turn out to have been based on illusory
profits. Those policies, had they been in place in recent years, might have
clawed back hundreds of millions of dollars of compensation paid out in 2006 to
employees at all levels, including senior executives who are still at those
banks.</P>
<P><SPAN class=bold>A Bonus Bonanza</SPAN></P>
<P>For Wall Street, much of this decade represented a new Gilded Age. Salaries
were merely play money — a pittance compared to bonuses. Bonus season became an
annual celebration of the riches to be had in the markets. That was especially
so in the New York area, where nearly $1 out of every $4 that companies paid
employees last year went to someone in the financial industry. Bankers
celebrated with five-figure dinners, vied to outspend each other at charity
auctions and spent their newfound fortunes on new homes, cars and art. </P>
<P>The bonanza redefined success for an entire generation. Graduates of top
universities sought their fortunes in banking, rather than in careers like
medicine, engineering or teaching. Wall Street worked its rookies hard, but it
held out the promise of rich rewards. In college dorms, tales of 30-year-olds
pulling down $5 million a year were legion. </P>
<P>While top executives received the biggest bonuses, what is striking is how
many employees throughout the ranks took home large paychecks. On Wall Street,
the first goal was to make “a buck” — a million dollars. More than 100 people in
Merrill’s bond unit alone broke the million-dollar mark in 2006. <A
title="More information about Goldman Sachs Group Incorporated"
href="http://topics.nytimes.com/top/news/business/companies/goldman_sachs_group_inc/index.html?inline=nyt-org">Goldman
Sachs</A> paid more than $20 million apiece to more than 50 people that year,
according to a person familiar with the matter. Goldman declined to comment.</P>
<P>Pay was tied to profit, and profit to the easy, borrowed money that could be
invested in markets like mortgage securities. As the financial industry’s role
in the economy grew, workers’ pay ballooned, leaping sixfold since 1975, nearly
twice as much as the increase in pay for the average American worker. </P>
<P>“The financial services industry was in a bubble," said Mark Zandi, chief
economist at <A title="More information about Moody's Corporation"
href="http://topics.nytimes.com/top/news/business/companies/moodys_corporation/index.html?inline=nyt-org">Moody’s</A>
<A href="http://economy.com/" target=_>Economy.com</A>. “The industry got a
bigger share of the economic pie.” </P>
<P><SPAN class=bold>A Money Machine</SPAN></P>
<P>Dow Kim stepped into this milieu in the mid-1980s, fresh from the Wharton
School at the <A title="More articles about University of Pennsylvania"
href="http://topics.nytimes.com/top/reference/timestopics/organizations/u/university_of_pennsylvania/index.html?inline=nyt-org">University
of Pennsylvania</A>. Born in Seoul and raised there and in Singapore, Mr. Kim
moved to the United States at 16 to attend Phillips Academy in Andover, Mass. A
quiet workaholic in an industry of workaholics, he seemed to rise through the
ranks by sheer will. After a stint trading bonds in Tokyo, he moved to New York
to oversee Merrill’s fixed-income business in 2001. Two years later, he became
co-president.</P>
<P>Even as tremors began to reverberate through the housing market and his own
company, Mr. Kim exuded optimism. </P>
<P>After several of his key deputies left the firm in the summer of 2006, he
appointed a former colleague from Asia, Osman Semerci, as his deputy, and
beneath Mr. Semerci he installed Dale M. Lattanzio and Douglas J. Mallach. Mr.
Lattanzio promptly purchased a $5 million home, as well as oceanfront property
in Mantoloking, a wealthy enclave in New Jersey, according to county
records.</P>
<P>Merrill and the executives in this article declined to comment or say whether
they would return past bonuses. Mr. Mallach did not return telephone calls. </P>
<P>Mr. Semerci, Mr. Lattanzio and Mr. Mallach joined Mr. Kim as Merrill entered
a new phase in its mortgage buildup. That September, the bank spent $1.3 billion
to buy the <A title="More information about First Franklin Corporation"
href="http://topics.nytimes.com/top/news/business/companies/first-franklin-corporation/index.html?inline=nyt-org">First
Franklin</A> Financial Corporation, a mortgage lender in California, in part so
it could bundle its mortgages into lucrative bonds. </P>
<P>Yet Mr. Kim was growing restless. That same month, he told E. Stanley O’Neal,
Merrill’s chief executive, that he was considering starting his own hedge fund.
His traders were stunned. But Mr. O’Neal persuaded Mr. Kim to stay, assuring him
that the future was bright for Merrill’s mortgage business, and, by extension,
for Mr. Kim.</P>
<P>Mr. Kim stepped to the lectern on the bond trading floor and told his anxious
traders that he was not going anywhere, and that business was looking up,
according to four former employees who were there. The traders erupted in
applause. </P>
<P>“No one wanted to stop this thing,” said former mortgage analyst at Merrill.
“It was a machine, and we all knew it was going to be a very, very good
year.”</P>
<P>Merrill Lynch celebrated its success even before the year was over. In
November, the company hosted a three-day golf tournament at Pebble Beach,
Calif.</P>
<P>Mr. Kim, an avid golfer, played alongside <A
title="More articles about William H. Gross."
href="http://topics.nytimes.com/top/reference/timestopics/people/g/william_h_gross/index.html?inline=nyt-per">William
H. Gross</A>, a founder of Pimco, the big bond house; and Ralph R. Cioffi, who
oversaw two <A title="More information about Bear Stearns Cos"
href="http://topics.nytimes.com/top/news/business/companies/bear_stearns_companies/index.html?inline=nyt-org">Bear
Stearns</A> hedge funds whose subsequent collapse in 2007 would send shock waves
through the financial world.</P>
<P>“There didn’t seem to be an end in sight,” said a person who attended the
tournament. </P>
<P>Back in New York, Mr. Kim’s team was eagerly bundling risky home mortgages
into bonds. One of the last deals they put together that year was called “Costa
Bella,” or beautiful coast — a name that recalls Pebble Beach. The $500 million
bundle of loans, a type of investment known as a collateralized debt obligation,
was managed by Mr. Gross’s Pimco.</P>
<P>Merrill Lynch collected about $5 million in fees for concocting Costa Bella,
which included mortgages originated by First Franklin.</P>
<P>But Costa Bella, like so many other C.D.O.’s, was filled with loans that
borrowers could not repay. Initially part of it was rated AAA, but Costa Bella
is now deeply troubled. The losses on the investment far exceed the money
Merrill collected for putting the deal together. </P>
<P><SPAN class=bold>So Much for So Few</SPAN></P>
<P>By the time Costa Bella ran into trouble, the Merrill bankers who had devised
it had collected their bonuses for 2006. Mr. Kim’s fixed-income unit generated
more than half of Merrill’s revenue that year, according to people with direct
knowledge of the matter. As a reward, Mr. O’Neal and Mr. Kim paid nearly a third
of Merrill’s $5 billion to $6 billion bonus pool to the 2,000 professionals in
the division. </P>
<P>Mr. O’Neal himself was paid $46 million, according to Equilar, an <A
title="More articles about executive pay."
href="http://topics.nytimes.com/top/reference/timestopics/subjects/e/executive_pay/index.html?inline=nyt-classifier">executive
compensation</A> research firm and data provider in California. Mr. Kim received
$35 million. About 57 percent of their pay was in stock, which would lose much
of its value over the next two years, but even the cash portions of their bonus
were generous: $18.5 million for Mr. O’Neal, and $14.5 million for Mr. Kim,
according to Equilar.</P>
<P>Mr. Kim and his deputies were given wide discretion about how to dole out
their pot of money. Mr. Semerci was among the highest earners in 2006, at more
than $20 million. Below him, Mr. Mallach and Mr. Lattanzio each earned more than
$10 million. They were among just over 100 people who accounted for some $500
million of the pool, according to people with direct knowledge of the matter.
</P>
<P>After that blowout, Merrill pushed even deeper into the mortgage business,
despite growing signs that the housing bubble was starting to burst. That
decision proved disastrous. As the problems in the subprime mortgage market
exploded into a full-blown crisis, the value of Merrill’s investments plummeted.
The firm has since written down its investments by more than $54 billion,
selling some of them for pennies on the dollar. </P>
<P>Mr. Lin, the former Merrill trader, arrived late to the party. He was one of
the last people hired onto Merrill’s mortgage desk, in the summer of 2007. Even
then, Merrill guaranteed Mr. Lin a bonus if he joined the firm. Mr. Lin would
not disclose his bonus, but such payouts were often in the seven figures. </P>
<P>Mr. Lin said he quickly noticed that traders across Wall Street were
reluctant to admit what now seems so obvious: Their mortgage investments were
worth far less than they had thought. </P>
<P></P>
<P>“It’s always human nature,” said Mr. Lin, who lost his job at Merrill last
summer and now works at RRMS Advisors, a consulting firm that advises investors
in troubled mortgage investments. “You want to pull for the market to do well
because you’re vested.”</P>
<P>But critics question why Wall Street embraced the risky deals even as the
housing and mortgage markets began to weaken. </P>
<P>“What happened to their investments was of no interest to them, because they
would already be paid,” said Paul Hodgson, senior research associate at the
Corporate Library, a shareholder activist group. Some Wall Street executives
argue that paying a larger portion of bonuses in the form of stock, rather than
in cash, might keep employees from making short-sighted decision. But Mr.
Hodgson contended that would not go far enough, in part because the cash rewards
alone were so high. Mr. Kim, for example, was paid a total of $116.6 million in
cash and stock from 2001 to 2007. Of that, $55 million was in cash, according to
Equilar. </P>
<P><SPAN class=bold>Leaving the Scene</SPAN></P>
<P>As the damage at Merrill became clear in 2007, Mr. Kim, his deputies and
finally Mr. O’Neal left the firm. Mr. Kim opened a hedge fund, but it quickly
closed. Mr. Semerci and Mr. Lattanzio landed at a hedge fund in London. </P>
<P>All three departed without collecting bonuses in 2007. Mr. O’Neal, however,
got even richer by leaving Merrill Lynch. He was awarded an exit package worth
$161 million. </P>
<P>Clawing back the 2006 bonuses at Merrill would not come close to making up
for the company’s losses, which exceed all the profits that the firm earned over
the previous 20 years. This fall, the once-proud firm was sold to <A
title="More information about Bank of America Corp"
href="http://topics.nytimes.com/top/news/business/companies/bank_of_america_corporation/index.html?inline=nyt-org">Bank
of America</A>, ending its 94-year history as an independent firm.</P>
<P>Mr. Bebchuk of Harvard Law School said investment banks like Merrill were
brought to their knees because their employees chased after the rich rewards
that executives promised them. </P>
<P>“They were trying to get as much of this or that paper, they were doing it
with excitement and vigor, and that was because they knew they would be making
huge amounts of money by the end of the year,” he said. </P><NYT_AUTHOR_ID>
<DIV id=authorId>
<P>Ben White contributed
reporting.</P></DIV></NYT_AUTHOR_ID></DIV></NYT_TEXT></DIV></BODY></HTML>