Who's Paying for JPMorgan's Settlements?
It's sort of funny to read that JPMorgan "plans to keep overall compensation roughly flat this year from last year, in a sign that employees will feel at least some pain from the bank's recent legal settlements." Some quick stupid math:
- JPMorgan's recent legal settlements, if by "recent" you mean "within the last week," total to $17.5 billion.1
- That is just about equal to JPMorgan's estimated net income for the year.2
- JPMorgan's compensation and benefits bill last year was about $30 billion, so I guess this year it will be around $30 billion.
So settlements equal to around 100 percent of net income reduced compensation by about zero percent. "At least some pain," then, if you include "absence of increased pleasure" in your definition of pain. There is probably a Greek philosophy about that.
That is not a fair way to do the math, of course. Those $17.5 billion of settlements didn't drop from the sky on an unsuspecting JPMorgan; the bank has been reserving for them and their friends for years, smoothing the effect of the settlements both on net income and on compensation. Each of the past week's settlement announcements contained words to the effect of "we are already reserved for this stuff so don't worry," and no one did; JPMorgan's stock is higher today than it was before the settlement announcements.
Over the last five years JPMorgan has made about half a trillion dollars in net revenues. Of every dollar in revenues, about 5 cents went to legal expenses and reserves ($25.7 billion in all), 29 cents to employees, and 18 cents to shareholders.3 This year so far the litigation amount is above the five-year average (around 11 percent), and so is the employee amount (around 32 percent), while the shareholders are roughly in line with the average, though down from last year: Net income is 17 percent of revenues for the first nine months of the year (and down 19 percent from the same period last year), and estimated to be around 19 percent for the full year (down 14 percent):
Basically all of JPMorgan's main constituents -- its shareholders, its employees, and the people suing it4 -- have benefited from the bank's ability to cut non-compensation expense without hurting revenue. Which is perhaps clearer from this graph:
It's quite hard to use any of this though to answer the question that you might really be interested in, which is: Who pays for these settlements, between shareholders and employees? The fact that net income will be down around 14 percent this year, while comp will be flat, suggests that the answer is "mostly shareholders," but that is not especially rigorous; JPMorgan essentially prepaid a lot of these settlements by reserving in previous years, and anyway you don't know what comp would be if not for these expenses.5
Another way to think of it is that if someone just handed JPMorgan back that $17.5 billion tomorrow, the bank would split it up the way it usually splits its income after non-compensation expenses, roughly two-thirds to employees and one-third to shareholders. On that math, shareholders are paying roughly $5.5 billion of the latest batch of settlements, and employees are paying around $12 billion -- equal to about 40 percent of this year's total comp. (This is not especially rigorous either.6)
Now, "Jamie Dimon said this week that it would not be fair to penalize current employees for actions that occurred years ago, largely at banks that JPMorgan acquired in the heat of the crisis," which presumably means that first-year analysts will suffer less than, say, the guy who decided to buy Bear Stearns and WaMu.7 But while there is plenty of truth to that claim, it is not so far removed from, "it would not be fair to penalize current shareholders for actions that occurred years ago."
It is always weird to fine a company for the misdeeds of some of its employees, but that is not really what is going on here. The theory of corporate punishment -- shareholders will monitor employees to prevent them from doing stuff that could get the shareholders fined -- is questionable generally and sort of absurd when applied to a giant bank, but it's not worth worrying about here. The JPMorgan settlements aren't especially punitive, as you can tell from the fact that they're mostly tax deductible.
Mostly what is going on here is that JPMorgan and the companies it acquired made some money in part by doing some bad stuff, and had they not done the bad stuff they would have made less money, and these settlements soooooooort of put both shareholders and employees in that position. It's just that it's easier to think of shareholders as a uniform mass across time -- after all, the share price in 2007 discounted the possibility of fines in 2013, don'tcha know -- while it's a bit rougher to underpay 2013's employees to make up for overpaying 2007's. Though given that compensation will be flat to last year, I guess they're not getting underpaid too much.
1 Oh I mean you can complain about that math, feel free. But the headline numbers are $4.5 billion for private RMBS litigation last Friday and $13 billion for the big mortgage task force shebang this Tuesday. One particularly important falsehood in those headline numbers is that some of the consumer relief can come from modifying serviced mortgages, which means that investors, rather than JPMorgan, will be paying for it. This has investors understandably peeved.
2 JPM's net income for the first nine months of 2013 was $12.6 billion; Bloomberg shows an estimate of about $18.3 billion for the full year. Here is a Google Docs spreadsheet with an assortment of numbers and sources for those numbers.
3 In net income, I mean, not dividends or whatever.
4 Of course JPMorgan's main-est constituents are its clients, counterparties and creditors. But when I say "main constituents" in the text I mean something more like "plausible residual claimants." Orthodox theory says that shareholders are the residual claimants on a corporation -- they get what is left over after everyone else has been paid. It is fairly obvious that in banking the employees are at least as much residual claimants as the shareholders are; this is the result of highly variable compensation and employees with a lot of bargaining power. I have no particularly rigorous argument that the people and regulators suing JPMorgan for mortgage fraud are residual claimants in the same sense but it feels kind of right. (Thought experiment: Imagine JPMorgan had had a horrible last five years and had revenues that barely covered expenses. Would it still be paying a $13 billion fine?)
5 On the latter point, the other big banks have compensation and benefits expenses for the first nine months of 2013 that range from down 5 percent (Goldman Sachs) to up 5 percent (Wells Fargo), without much obvious correlation to changes in net income (e.g. Bank of America's net income is up 188 percent but its comp is down 2 percent). Compensation in the peer group overall is basically flat, though, suggesting that JPMorgan's settlements aren't hurting its comp any more than, y'know, every other bank's woes are hurting their comp. (See again that Google Docs spreadsheet.)
6 In that compensation is not strictly a percentage of revenue, or of revenue minus non-compensation expenses. (In theory it should be less variable than net income; a lot of bank tellers, etc., are on pretty fixed wages.) In particular employees probably have less of a claim on money-falling-from-the-sky than they do on money that they worked really hard for, etc., though this is empirically debatable.
7 You know who that guy is right? "It is unclear how Dimon's bonus will be affected by the settlements." I mean, it is clear that he'll make more than a first-year analyst.