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

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Monday, March 14, 2011; 7:42 PM

Want to reform Wall Street bonuses? Try clawbacks.

That's right. We need to make executives personally liable for their reckless bets if we want to remove the risk for taxpayers. That means giving shareholders, boards of directors and regulators the ability to "clawback" past gains when new speculations go horribly wrong.

The Federal Deposit Insurance Corp. and the Securities and Exchange Commission have floated proposals on performance-based compensation for traders and bankers. Firms that have more than $1 billion in assets would have to disclose incentive-based bonuses. The largest firms (those with more than $50 billion in assets) would have to pay at least half of their bonuses in compensation that is deferred for three years. The SEC could, in theory, deny plans that encourage excessive risk-taking or outrageous bonuses.

While this approach is well-intentioned, Wall Street has proven itself especially adept at circumventing compensation laws. Rules that seek to limit bonuses will likely shift compensation more to salary and commissions.

Private profit, public risk

Understand this: I do not care what shareholders and their boards pay the people who create enormous value. Whether it's a chief executive such as Steve Jobs of Apple or a hedge-fund manager such as Steve Cohen of SAC Capital, the people who are paid handsomely for creating incredible profit are not the problem.

On the other hand, many others received huge bonuses for bankrupting their firms and driving the economy into recession. Their job performance should be the subject of your ire and of regulators. They brought the world to the abyss of economic collapse because they had incentives to do so.

If that sounds unbelievable, consider:

- Subprime mortgage brokers who were paid based on the quantity - not the quality - of their mortgage writing. The loans lenders sold to Wall Street to be securitized carried a 90-day warranty. Hence, the brokers' jobs were to find people who would make the first three monthly payments of a 30-year loan. After that, it was no longer their concern.

- Derivative traders who knew that what they were buying was going to blow up. In 2007, I published an e-mail from one such trader who wrote, "We knew we were buying time bombs." The motivation was deal fees and bonuses. Once the derivative machinery was in motion, they had to "keep buying collateral, in order to keep issuing these transactions."

- Collateralized debt obligation managers whose job it was to assemble pools of mortgages, yet had little or no understanding of the underlying loans. The salespeople, traders and managers working in the mortgage sector had incentives that were upside down. The greater the risk they took, the more they were paid. But brunt of those risks was on third parties, never themselves. It was shareholders and taxpayers who shouldered them.

This is backward. The people who should bear the downside are the ones who have the upside. Instead, the system was perversely one of private profit but public risk.

Note that it wasn't merely the staff that engaged in this reckless risk-taking. At investment banks, senior managements were so reckless that they managed to destroy their firms. For this act of gross incompetency, they were rewarded with vast bonuses in cash and stock options. By the time their firms collapsed, they had cashed out hundreds of millions of dollars in legal booty.


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