[ by Howard Haykin ] Goldman Sachs laid off senior personnel, including managing directors, last week - according to the firm's Monday announcement.  It will be interesting to see how Wall Street reacts.  CNBC Senior Editor John Carney, for one, thinks other firms have good reason to be rattled by the news  - since it may be the beginning of a new kind of deleveraging that will occur at every major Wall Street firm - i.e., a lightening up on debt and expenses. The fact that Wall Street has been forced by markets and regulators to delever following the 2008 financial crisis is common knowledge - and, for the most part, firms have carried out significant financial deleveraging, including: (i) reducing debt to capital ratios; (ii) reducing dependence on short-term debt; (iii) reducing compensation (esp. bonuses) to revenue ratios. Deleveraging Encounters of the Third Kind. Many Wall Street firms, especially Goldman Sachs, have engaged in another form of leverage that has persisted through the crisis but now seems ready to crack, according to Mr. Carney.  Despite being public companies seemingly dedicated to capitalism, many Wall Street firms remain as high-income workers collectives.  Regardless of the legal ownership structure, they are compensation machines for their employees. After all, those in Wall Street's "upper-middle tier" receive extremely generous compensation.  This category falls just below "senior managing directors" at most firms, and "partnership managing director" at Goldman.  It's also just above the junior VP and associate level.  At Goldman, MD's reportedly earn $500,000 in annual salary, and similar figures typically are found at most other big Wall Street institutions. The higher ups may be the rainmakers - winning new business, maintain client relationships, or construct trading strategies.  But when client business is running hot, its the MDs and VPs who execute the deals.  Nevertheless, when things are busy, firm revenue can soar into the stratosphere. But, slow cycles generate little revenue, and that's when the "upper-middle-ranks" are costly - given their high fixed costs.  SMD's, at such times, tend to hoard business for themselves, simply to keep busy.  If you haven't guessed, this is what Wall Street firms describe as “human capital.” Impact of Recent Changes in Wall Street Compensation. To address the swings between business cycles, and to mollify the public's outrage at the outsized compensation levels, many firms have moved away from, or are considering doing so, paying out higher fixed salaries in lieu of large annual bonuses.  Yet, because the lower ranking employees continue to pull in relatively high levels of compensation, there's less available to for senior executive compensation. All this has led to new personnel trends and developments - senior level managing directors are staying on longer - because they're not earning as much and are waiting for the "down" cycle to run its course.  This also has left fewer opportunities for middle ranks to move up - i.e., fewer incentives for them to become profit-centers rather than cost-centers. As a result, it's now much harder to reduce the compensation costs of the upper-middle ranks of an investment bank based on a firm’s annual performance.  Salaries have become much more akin to debt service. Another trend has been to use equity, rather than cash, as compensation.  And once this methodology began, firms have been increasingly going to the "equity well" much more.  This, too, has mollified the public, who see that Wall Streeters are playing with more "skin in the game." Yet, with Wall Street share prices at their current, underpriced levels, current compensation awards and granted options - now 'cheap' - will be more costly, if and when prices rise in the future.  And, to avoid diluting existing shareholders, firms may need to buy back stock when equity compensation grants vest.  This makes some firms think twice before funding compensation with costly equity.

[C-I Note: We refer you to 2 related stories:  (i) "Goldman to Name Fewer Partners", posted 6/7/ in WHO's News;  and, (ii) Goldman Makes High-Level Cuts," posted 6/5 in WHO's News.]

The Bottom Line, or Conclusion. When firms start letting managing directors and vice-presidents go, it is a form of "deleveraging."  Firms are reducing their exposure to the high-fixed costs of middle-ranks - although at a cost of outperforming in the "up" cycle years because the knowledgeable staffers are no longer on hand. Thus, as with financial deleveraging, personnel deleveraging has both benefits and costs for the returns that firms will be able to make.  It’s possible that personnel deleveraging could be a long-term cost to firms, and exacerbate the desire for middle-ranked executives to be "short-term greedy."  In order to preserve their jobs, they will feel pressure to increase their daily, weekly and quarterly profits.  Collaboration may decline and hoarding of business, strategies and client contacts increase. On the other hand, this could be a temporary phenomenon.  Goldman executive Gary Cohn recently said that this year’s class of summer associates at Goldman was so large that it had to be split into two - one group starting last week, the other this week.  Perhaps firms are trying to time the market: letting go of the middle-ranks now, while beefing up on the most junior employees who will be ready to play the role of human leverage when business picks up in the future. Wall Street always has a way of taking on complexities unlike any other industry.  Stay tuned, and try to hold onto your jobs. Click to access the referenced story:  [CNBC's NetNet, 6/5/12].