We must ratchet back bankers' pay
The Washington Post, July 1, 2010
If Sen. Scott Brown (R-Mass.) can manage to get last-minute tweaks into the financial reform bill, can't we still get something in that fixes banker compensation? Without changing the incentives facing the wizards who rule American finance, three thousand executives on Wall Street will leave the other 300 million of us holding the bag again before long.
The way pay is rigged at publicly owned Wall Street firms creates incentives for casino-style gambling, because bankers reap all the upside and stick shareholders or taxpayers with the losses. When their big bets go bad, in other words, top bankers walk away rich anyway. This is not how capitalism is supposed to work.
The most mind-bending example of this phenomenon was Howie Hubler, a star bond trader at Morgan Stanley whose story was told by Michael Lewis in "The Big Short." As the housing bubble surged between 2004 and 2006, Hubler made roughly $25 million a year on mortgage-related bets that were fated to implode. Then, when it all hit the fan in 2007, Hubler's positions incurred a staggering $9 billion loss—the biggest trading loss ever on Wall Street. The brass at Morgan Stanley hadn't even understood the firm's exposure.
Yet Howie Hubler retired a very wealthy man.
Golf courses across the New York suburbs are dotted with less extreme but still shocking versions of the Hubler effect. And that's before we get to the banks' bosses, many of whom walked away with $100 million—or more—as their firms came to ruin. Kerry Killinger of Washington Mutual. Charles Prince of Citigroup. Stanley O'Neal of Merrill Lynch.
To be sure, Wall Street's rigged compensation is part of the broader problem of executive pay. In my book The Tyranny of Dead Ideas, I noted several instances of rewards that were obscenely disconnected from performance. Among them: Carly Fiorina, now the Republican candidate for California senator, made a mess of Hewlett-Packard—and then departed with $100 million. And, even more shocking, Gerald Levin earned $600 million after engineering the failed Time Warner-AOL merger. (Not long ago Levin said that, in retrospect, he was sorry, though not sorry enough to accompany his regret with a check to shareholders for his ill-gotten gains.)
It wasn't always like this. There was a time when CEOs and boards of directors operated with at least some understanding of proportion and restraint. In the book I cite George Romney (father of Mitt) as perhaps the most interesting example of this lost species. Romney voluntarily turned down $268,000 over five years, about 20 percent of his earnings, when he was CEO of American Motors. "In 1960, for example," The New York Times noted, "he refused a $100,000 bonus. Mr. Romney had previously told the company's board that no executive needed to make more than $225,000 (about $1.4 million in today's dollars), a spokesman for American Motors explained at the time, and the bonus would have put him above that threshold."
It's hard to imagine any Wall Street leaders adopting that mind-set today.
Still, if we know such pay schemes are corrosive for capitalism—and, in banking's case, potentially devastating for taxpayers—the question remains: what to do?
The answer is to re-create some version of the old private Wall Street partnership structure, in which every partner bore full personal liability for the firm's losses. When your entire net worth is on the line, "this has the effect of focusing the minds of management on exactly what the worst-case scenario of the behavior can wreak," writes investor and financial blogger Barry Ritholtz.
How might we get from here to there? Finance gurus tell me the major firms can never revert to private ownership structures because of the vast sums of capital now required to compete in global markets. That means boards of directors must act. Activist shareholders, including big pension funds, should pressure boards to revamp compensation programs to mimic the prudence-inspiring effects of the classic private partnerships. Government should craft incentives for boards to do just that.
There's still time before the vote to inject such critical reforms into the financial reform bill (or at least to demand they be studied, with recommendations due in six months). Remember, fixing Wall Street's pay racket isn't some liberal cry or populist peeve. It's essential for saving capitalism from phony capitalists whose perverse insistence on outsized rewards with little risk threatens the entire economy.
The Washington Post, July 1, 2010
If Sen. Scott Brown (R-Mass.) can manage to get last-minute tweaks into the financial reform bill, can't we still get something in that fixes banker compensation? Without changing the incentives facing the wizards who rule American finance, three thousand executives on Wall Street will leave the other 300 million of us holding the bag again before long.
The way pay is rigged at publicly owned Wall Street firms creates incentives for casino-style gambling, because bankers reap all the upside and stick shareholders or taxpayers with the losses. When their big bets go bad, in other words, top bankers walk away rich anyway. This is not how capitalism is supposed to work.
The most mind-bending example of this phenomenon was Howie Hubler, a star bond trader at Morgan Stanley whose story was told by Michael Lewis in "The Big Short." As the housing bubble surged between 2004 and 2006, Hubler made roughly $25 million a year on mortgage-related bets that were fated to implode. Then, when it all hit the fan in 2007, Hubler's positions incurred a staggering $9 billion loss—the biggest trading loss ever on Wall Street. The brass at Morgan Stanley hadn't even understood the firm's exposure.
Yet Howie Hubler retired a very wealthy man.
Golf courses across the New York suburbs are dotted with less extreme but still shocking versions of the Hubler effect. And that's before we get to the banks' bosses, many of whom walked away with $100 million—or more—as their firms came to ruin. Kerry Killinger of Washington Mutual. Charles Prince of Citigroup. Stanley O'Neal of Merrill Lynch.
To be sure, Wall Street's rigged compensation is part of the broader problem of executive pay. In my book The Tyranny of Dead Ideas, I noted several instances of rewards that were obscenely disconnected from performance. Among them: Carly Fiorina, now the Republican candidate for California senator, made a mess of Hewlett-Packard—and then departed with $100 million. And, even more shocking, Gerald Levin earned $600 million after engineering the failed Time Warner-AOL merger. (Not long ago Levin said that, in retrospect, he was sorry, though not sorry enough to accompany his regret with a check to shareholders for his ill-gotten gains.)
It wasn't always like this. There was a time when CEOs and boards of directors operated with at least some understanding of proportion and restraint. In the book I cite George Romney (father of Mitt) as perhaps the most interesting example of this lost species. Romney voluntarily turned down $268,000 over five years, about 20 percent of his earnings, when he was CEO of American Motors. "In 1960, for example," The New York Times noted, "he refused a $100,000 bonus. Mr. Romney had previously told the company's board that no executive needed to make more than $225,000 (about $1.4 million in today's dollars), a spokesman for American Motors explained at the time, and the bonus would have put him above that threshold."
It's hard to imagine any Wall Street leaders adopting that mind-set today.
Still, if we know such pay schemes are corrosive for capitalism—and, in banking's case, potentially devastating for taxpayers—the question remains: what to do?
The answer is to re-create some version of the old private Wall Street partnership structure, in which every partner bore full personal liability for the firm's losses. When your entire net worth is on the line, "this has the effect of focusing the minds of management on exactly what the worst-case scenario of the behavior can wreak," writes investor and financial blogger Barry Ritholtz.
How might we get from here to there? Finance gurus tell me the major firms can never revert to private ownership structures because of the vast sums of capital now required to compete in global markets. That means boards of directors must act. Activist shareholders, including big pension funds, should pressure boards to revamp compensation programs to mimic the prudence-inspiring effects of the classic private partnerships. Government should craft incentives for boards to do just that.
There's still time before the vote to inject such critical reforms into the financial reform bill (or at least to demand they be studied, with recommendations due in six months). Remember, fixing Wall Street's pay racket isn't some liberal cry or populist peeve. It's essential for saving capitalism from phony capitalists whose perverse insistence on outsized rewards with little risk threatens the entire economy.