Friday, February 6, 2009

What to Do About Wall Street's Bonus Problem?

Populist fury over bonus payments awarded after taxpayer-funded bank bailouts has finally caused our lawmakers to wake up and take action.  Sadly, much like the curbs on mortgage lending that Congress pushed through four years too late to serve any purpose, the recent pay caps, while symbolic, fail to address the issue of misaligned compensation schemes at banks.  The reality remains that many people were paid outrageous sums to take extraordinary risks with other people's money and caused a calamity so great that the government was forced to intervene to halt a full blown collapse.  A $500,000 pay cap on future executive compensation at firms that take significant money from the government is perfectly reasonable in my view.  Critics of the plan pull out the old "but the talent will leave to go work somewhere else" card.  These institutions will be stripped of the smartest people, the thinking goes, and the government-owned institutions will wind up with all the deadbeats who won't be able to compete with all of the brilliant competition from better firms.  I'm left wondering why that's so bad.  

First of all, maybe we need the really talented people to go out and start their own firms and hire other talented people.  The economy needs new companies and new jobs.  Let the brilliant launch their own firms, with their own capital.  It's hard managing your own money and taking risk that you must personally bear.  The Wall Street Journal has a great article today that illuminates the hazards of hiring incredibly brilliant people to take tremendous risks with the firm's capital.  The article details the "fall" of Boaz Weinstein, a 35 year-old star trader, who made $1.5 billion in profits for Deusche Bank in 2006 and 2007, only to lose $1.8 billion in the fourth quarter of 2008.  For this amazing round-trip zero-sum game, accomplished by tying up billions of Deutsche Bank's precious capital, Mr. Weinstein was paid $40 million a year.  The article is filled with anecdotes about how brilliant Mr. Weinstein is, how he's a chess master, an accomplished blackjack player, etc.  I don't dispute his brilliance at all, much like I've never disputed the brilliance of any of the folks, some with Nobel prizes, who sunk Long Term Capital.  I just think he was paid far too much in the past two years for adding no value.  Mr. Weinstein has been let go from Deutsche and is starting his own hedge fund.  I wish him luck.  Maybe he can take a few of the other geniuses that helped him wipe out Deutsche Bank's prop desk.  They can go on the road, try to raise money, and make another go of it.  If he's successful, then at least there will be somewhere for all of the other talented but underpaid to go when they feel hemmed in by the $500,000 pay cap.            

Clearly, the problem with Wall Street's old business model is that it made it too easy to take significant risks, get paid gobs of cash in the short run, and then just jump ship when the losses or lawsuits hit.  The only downside was that your career might be cut short in the next downturn if you didn't survive the layoffs, but if you made millions, you were still better off financially than in any other pursuit.  Even if you crossed the line ethically, it didn't matter because typically the firm would pay a large settlement and then move on to the next money-making borderline-fraudulent activity.  It's precisely why there is a scandal roughly every 5-8 years on Wall Street.  The guys who are usually in charge when the scandal is uncovered are not the same guys who committed the acts.  So the new management can pay the fine, blame the old management, and move on.  This cycle, however, has come to a screeching halt.  Wall Street finally did something worse than pumping internet stocks, pushing crappy Enron off-balance sheet partnerships, and selling worthless Worldcom bonds.  It committed the ultimate crime:  It finally blew itself out and turned to the government for money.  

Apparently UBS is having problems with the bonus issue, according to the Wall Street Journal.  The bank eliminated cash bonuses for executive directors and managing directors of its investment bank.  The move came amid heavy pressure from the Swiss government, which lopped off one billion francs from UBS's initial proposal of three billion francs in bonus payments.  The article goes on about how this move has triggered questions about the firm's commitment to investment banking and that there are concerns that top bankers will flee.  One of the heads of investment banking expressed frustration and claimed that top executives needed to convince bankers that there is "a plan to properly pay employees in the future."  Somehow it is still hard to swallow the fact that the number one concern of highly compensated executives at a bank that punted $47 billion and required a $60 billion government injection, is the banks plan to pay employees "properly" in the future.  Maybe the truth is that they were just paid improperly in the past?  What if the bankers were told "in light of all of the political scrutiny and the lack of funds, we just can't afford to pay you any more than this small sum.  Feel free to pursue other, better opportunities."  Then what if nobody left?  

Perhaps a little perspective is in order?  Certainly it is difficult for anyone who is used to a certain lifestyle to adjust to new compensation expectations.  But the cycle will eventually turn, and banks will one day make money again.  Banking employees will once again be highly rewarded, although hopefully compensation will be adjusted to reflect risk assumed by the institution.  It is still far more lucrative to have a "low paying" banking job than a high paying job in almost any other industry, or to be unemployed in this economy.  In this economic environment, if you still have a job, maybe it's wise to just keep your mouth shut, work hard and wait for the next bubble.