Some Thoughts About Wall Street Pay

Floyd Norris has an article in today’s New York Times, neatly summarized by the headline: “It May Be Outrageous, but Wall Street Pay Didn’t Cause This Crisis.”

Norris argues that: 
A) The crisis wasn’t caused by risk-taking behavior because Wall Streeters didn’t understand the risks that were being taken. 
B) Wall Street’s pay structure, with all its rewards for high profits now now now, couldn’t have caused risky behavior in the first place because banks run by CEOs who owned lots of stock did worse in the crisis than banks whose CEOs relied more on their salary.

I’m a fan of Norris’s blog, which is a good clearinghouse of current numbers as they come out, but these points are just silly. Still, Norris put some useful information in the article too–info that we can use.

As far as Norris’s first point goes, nobody’s arguing that Wall Streeters took calculated, well-understood risks that didn’t work out. They charged into situations that they didn’t understand. That’s exactly the problem.

The second point contradicts Norris’s thesis—banks run by CEOs who owned lots of stock (and thus stood to profit more in the short term) are in bad shape now because they took dumb risks back when things looked good. It’s true that some of these execs didn’t cash out in time and would have been better off in the long run by not taking these risks. Which, if you buy a certain brand of economics, means that these CEOs couldn’t possibly have been tempted by the prospect of huge immediate gains. You know, just like how the bad odds at casinos means that nobody goes to casinos, and how nobody ever drinks to excess because they know the hangover isn’t worth it.

The most interesting part of the article is near the end, a fact that I didn’t know—there was a 1970s reform that forbade companies from deducting pay in excess of $1 million as a business expense. This sounds good, but “performance-based” pay was excluded. Which is one reason Wall Streeters today get most of their pay in stock options and bonuses.

And yes, that pay structure does encourage risky behavior. When your pay is based on this year’s performance, it makes perfect sense to take wild risks with your company’s money—if the risk pays off, you’re set for life after a year. If it doesn’t, the money that was lost isn’t yours.

Norris seems to have brought up the 1970s reform to support the usual Washington attitude toward government actions (they’re fraught with unintended consequences, so every change should take years of study and debate and we probably shouldn’t even bother). But really, the fact that that law is on the books points our way toward a couple of easy, if minor, fixes.

First, we could close the loophole–no deducting pay of any kind past a given limit. There’s no reason taxpayers should subsidize the ridiculous pay that Wall Streeters get.

Second, “performance-based” my ass. If you get your bonus even when you run your company into the ground, it’s clearly not based on performance. Which means the worst and least defensible bonuses–the ones that are guaranteed no matter what–are already against the law. Well, at least deducting them as legitimate business expenses is against the law, and I seriously doubt that these companies refrained from doing that. Anyone for finding out?

Cross-posted at Dailykos.com, as some of the more political posts will be.

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