Putting an end to Wall Street’s ‘I’ll be gone, you’ll be gone’ bonuses

Consider:

— Lehman Brothers Chairman and CEO Richard Fuld Jr. made nearly a half-billion — $490 million — from selling Lehman stock in the years before it filed for Chapter 11 bankruptcy.

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— Countrywide Financial (now owned by Bank of America) founder and CEO Angelo Mozilo cashed in $122 million in stock options in 2007; His total take is estimated at more than $400 million dollars.

— Stanley O’Neal, who steered Merrill Lynch into financial collapse before it was taken over in a shotgun wedding with Bank of America in 2008, was given a package of $160 million when he retired.

— Bear Stearns former chairman Jimmy Cayne, rescued by a $29 billion Fed shotgun wedding to JPMorgan Chase, received $60 million when he was replaced;

— Fannie Mae CEO Daniel Mudd received $11.6 million in 2007. His counterpart at Freddie Mac, Richard Syron, brought in $18 million. In 2008, the two were forced into government conservatorship.

Add to this list Washington Mutual, Wachovia, IndyMac and other bankrupted firms whose senior management took a boatload of money and ran.

Nice work if you can get it — and still live with yourself.

Blame game

How did this happen? Some people blame excessive greed; others say crony capitalism is at fault. I believe we can sum it up in one word: liability.

In recent years, there was no legal liability for extreme recklessness. Take a healthy company, roll the dice and if it comes up snake eyes, all you lose are your unvested stock options. Most management does not have significant capital at risk.

The cost for pushing a healthy firm into insolvency by excessive risk-taking is some snickering at the golf course. In terms of lost monies, it is minimal.

You might be surprised to learn that it was not always this way. Before these firms went public in the 1970s and 1980s, bank management had full liability for their firm’s losses. During the era of Wall Street partnerships, if employees were so reckless as to lose billions of dollars, the partners were on the hook for the full amount. This meant that after the firm was liquidated to pay its debts, the partners’ personal assets were next on the auction block: Houses, cars, boats, even watches were sold to satisfy the debt.

Not surprisingly, partnership liability worked wonders in focusing attention on taking appropriate risks.

Once a bank or investment firm went public, this liability shifted from management to the company’s stockholders and creditors (namely, the bond holders). Add to this the rise of stock-option compensation, and you have a recipe for extreme short-termism.

In his book “The Accidental Investment Banker,” Jonathan Knee described this mercenary attitude with the phrase “IBGYBG.” As bankers signed off on increasingly risky deals, IBGYBG meant “I’ll be gone, you’ll be gone” by the time the really messy stuff hit the fan. Call it what you will — smash and grab, take the money and run. Without partnership liability or clawback terms, IBGYBG was perfectly legal.

The simple solution to IBGYBG is legal liability.

How this works: There must be a civil liability for recklessness that caused a collapse or loss. Liability for loss accrues when a trader knew and disregarded the risk or, failing that, should have been aware of the risks they were taking.

The ability to clawback past gains in the event of a subsequent collapse should accrue to the board of directors, the shareholders and the SEC.

It is too late to force the big banks and investment houses to go private and become partnerships again. However, we can return the liability for their recklessness back to where it belongs — on the traders, fund managers and executives who profited from extreme risk-taking.

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture.