Wall Street Adrift and the Scourge of Financial Engineering

    Corporations vs. Their Own Employees

    “Wall Street sort of lost its way, in that investment banking has become a function not of allocating capital properly, but levering capital and levering the returns on capital as opposed to transferring capital to productive industries.”

                                                                                –Bill Gross, CEO, PIMCO, as reported by Reuters,

    Bill Gross’ astute comments were aimed at a number of issues involving the separation of investment banking into two separate activities: speculation and banking.  However, his comments also help explain the nation’s huge income disparity and how a large portion of the top 1% became billionaires.

    What’s omitted from the national discussion about “class warfare” and income disparities is that many of the top 1% did not actually earn their money in the traditional sense, but they earned it through financial engineering.  This would include their access to large options, as well as other stockholder-propelled incentives, combined with the huge leverage available through lucrative executive options plans.  This feature of options is lost to most sophisticated investors, who don’t realize that options, especially those out-of-the-money, offer more leverage than futures, the trading vehicle most often associated with leverage. 

    In the executive suite, these programs include the award of options upon hiring and at various other trigger points inside the executive’s contract or as the company reach certain financial milestones.  At these points, stock options are awarded and executive management can then manage the company’s financial performance, which is distinct from its actual workplace and physical output, so that the options are triggered to award top management.  The vast majority of workers are excluded from these programs.  The exception is early stage start-ups, especially in the high-tech sector. . 

    The Focus on Short-Term Performance

    Socially responsible or shareholder-activist institutional investors, have long recognized this and criticized certain companies for their focus on the short-term financial performance.  It is thisfocus on short-term results which triggers huge paydays for top CEOs.  Meanwhile, the disparity between executives and their own workforce continues to expand.  The AFL-CIO, which tracks this disparity, now says that: 

    “2010 was another good year to make lots of money—if you were a CEO. CEOs of the largest companies received, on average, $11.4 million in total compensation last year, according to the AFL-CIO analysis of 299 companies in the S&P 500 Index. Overall, CEOs of the 299 companies in the AFL-CIO Executive PayWatch database received a combined total of $3.4 billion in pay in 2010, enough to support 102,325 jobs paying the median wages for all workers.”   

    Source:  AFL-CIO

    So when commentators talk about “class warfare” and income disparities, the discussion has to consider the mechanics and abuses of financial engineering, and the fact that the vast majority of American workers never have access to these lucrative and exclusive programs.   This also means that people working for the same company are practicing an insidious form of class warfare against their own employees.

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    Chuck Epstein has managed marketing communications and public relations departments for major global financial institutions and participated in the launch of industry-changing financial products. He also has written by-lined articles for over 50 publications, five books and served as editor and publisher of nation’s first newsletter on the topic of using the PC for personal investing and trading. (“Investing Online, 1994-1999). He also is a marketing consultant, writer and speaker on topics related to investor protection and opportunities in the very dynamic cannabis industry. He has held senior-level marketing, PR and communications positions at the New York Futures Exchange, Chicago Mercantile Exchange, Lind-Waldock, Zacks Investment Research, Russell Investments and Principal Financial. He has won national awards from the Mutual Fund Education Alliance (MFEA) and his web site, www.mutualfundreform.com, was named best small blog in 2009 by the Society of American Business Editors and Writers (SABEW).


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