Plus ça change, plus c'est la même chose

A investment banker with a very good take on the problems with the Wall Street bonus system. Note that it was written in 1988.Sounds familiar:

The headlines now are filled with stories of Wall Street's woes. Thousands are losing their jobs. Once powerful firms are being humbled by their own increasing debt and management problems. Many firms are turning to management consultants, a sure sign of widespread turmoil and desperation, for answers. How did an industry that could boast the highest returns, the brightest talent and the greatest compensation get to be in such trouble?

Part of the answer rests in the compensation system that fueled the explosive growth of investment banking. The bonus system — the annual ritual of money and merit. It is at bonus time that bankers, traders and salesmen look to getting their rewards. This is the time when the legendary endless hours, extraordinary creativity and plain hard work get the big payoff... for the year's work.

And, that is it. The bonus was simply for a year's work; but more importantly, the entire focus of the year's work was the bonus.

Does this short-term system serve the long-term best interests of clients and Wall Street firms themselves, particularly now? The bonus system has had an insidious effect on the economy, Wall Street's clients and ourselves as investment bankers. It directly skewed the structure of many Wall Street firms and, thereby, the national economy. It guided the energy of many of our society's best and brightest members, making their perspective short and their attitudes increasingly arrogant. It often undermined and diluted traditional standards of excellence.

But, the Wall Street bonus system reflects a larger societal problem, not simple greed as many believe, but the almost insatiable desire to have everything now. Bonuses are simple and logical. There is nothing wrong with the concept. But, the amounts involved on Wall Street, in practice, are enormous, almost unreal. And, now in the midst of extraordinary turmoil perhaps the way we pay ourselves must be challenged.

PSA on Banker Pay

Following up on a recent post by Tyler Cowen, Matt Yglesias says today that the empirical evidence that banker pay played a role in the crisis is "quite weak". He concludes:

All that said, what I think people really need to do is confront the fact that obscene banker compensation is really a social justice issue rather than a financial regulation issue. Which is to say the sky-high pay seems wrong just as such rather than because there’s a specific bad incentives issue that needs to be corrected.

But Ygelsias's comments miss a key point about the both the study and the structure of investment banks--the problem is not with the CEOs* (which the study measures). Rather, it's the traders swapping complex derivatives, bankers packaging shady mortgages, and salesman foisting these crappy products on customers we have to worry about. These people very clearly have incentives to think about the short-term gains rather than the long-term losses. The pay structure encourages bank employees to gamble with shareholders' money in a way that gives the bankers huge rewards if they win, while sticking them with little of the downside.

True, there probably aren't many, if any, studies that could empirically prove this. But that's because it's impossible to get actually get data on this to measure. CEO pay has to be reported to the SEC, but the numbers for non-top management employees are closely guarded. Banks are reluctant to turn them over to federal law enforcement agents when asked. Do you think they're going to hand them over to academics for research that will mostly be used to criticize their practices?

*Most of the CEOs of these banks were bond traders or salesman in a time when finance was much less complicated. I highly doubt the really understood what was going in many of the more complex areas of the bank, which is why the overly relied on measures like Value at Risk.

What Do They Get Paid For Again?

All the hubbub over the Freep's big Michigan story has inspired me to make my glorious (although likely short-lived) return to the blogosphere. I don't want to rehash many of the issues that have been discussed in detail (although I imagine I'm in the minority of Michigan fans on this one), but I did want to point something out I haven't seen anywhere else.

There has been a lot of discussion about how the Free Press failed to get both sides of the story. I'm not sure this is true.

The Freep DID seek out both sides of the story. Unfortunately, in typical fashion for a large entity (whether it be a school, company, etc.), the athletic department chose to give out a boiler plate response from all the parties involved. If it's true that the University isn't breaking any rules, shouldn't the PR department get some of the blame for not explaining to the journalists why Michigan's program falls within the established bounds? It's kind of tough to give both sides of the story equal treatment when one side refuses to talk you. Should the Free Press be required to make Michigan's argument for them if Michigan won't make that argument itself?

Somebody really need to explain to me what PR departments do. It seems like Michigan is working from the same playbook as the investment banks. Isn't their goal to head off stories like this one?