If You Reward Something… (Wall Street Edition)

That includes excessive risk-taking as Robert Samuelson’s column in the Washington Post observes:

Wall Street’s pay practices perversely encourage extreme risk-taking that can destabilize the economy. Subprime mortgage losses may simply be chapter one. Now there are signs of problems involving securities known as “credit default swaps.” Never mind the details. Concentrate on the possible fallout. If banks and investment houses sustain more losses, the nation’s credit system will be further wounded and so will the economy. The Federal Reserve cut its key overnight interest rate yesterday from 4.25 percent to 3.5 percent — a huge move — in part to shore up this wobbly credit system.

By “Wall Street,” I mean all the commercial banks, investment banks, mutual funds, hedge funds and the like that comprise the financial sector — but particularly investment banks. Pay is eye-popping. In 2007, Lloyd Blankfein, chief executive of Goldman Sachs, received compensation estimated at $68 million. But pay is also heavily skewed toward annual “bonuses” based on the profits that traders and bankers generate. I asked Johnson Associates, a compensation consulting firm, for typical Wall Street pay packages. The results describe “managing directors” based in New York with 10 or 15 years experience. Most would be in their 40s.

Here are estimates for 2007:

# Investment banker: $2.1 million, consisting of $275,000 in base pay plus $1.2 million in cash bonus and $625,000 in long-term bonus. (An investment banker helps firms raise capital by selling new stocks and bonds and also advises on mergers and acquisitions.)

# Bond trader: $1.5 million, with $240,000 in base pay, $975,000 in cash bonus and $310,000 in long-term bonus.

# Hedge fund manager: $1.8 million, split between a salary of $265,000 and $1.5 million bonus.

As long as this kind of jack is going to investment bankers, bond traders, and hedge fund managers, prudent Americans won’t study science or engineering. They’ll go after MBA’s.

That the rewards keep flowing in whether these guys actually make money for their companies isn’t just absurd, it’s obscene.

1 comment… add one
  • Oddly, in the old plain vanilla lending world, compensation schemes are explicitly tied to the performance of the credit portfolio of the lending officer over the life of the loan(s). Make bad bets, it pulls you down.

    Sadly, I-Bank world with its trader mentality hasn’t learned those lessons yet.

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