Cross-posted from New Deal 2.0
By Wallace C. Turbeville, the former CEO of VMAC LLC, and a former Vice President of Goldman, Sachs & Co.
The current system of trader compensation will continue to decay the heart of Wall Street.
Which is a greater threat to the nation — terrorism or the relentless decline of middle income families? Unless we abandon our core values out of unwarranted fear, terror cannot fundamentally change our way of life. The number of people affected by growing income disparity is vast. When I was a student, income disparity was indicative of an underdeveloped and unstable society.
The government appropriately devotes enormous resources to protect our lives and property from terrorism. It is unthinkable that a leader would display any weakness opposing this threat. Politicians have stiff backbones when it comes to terrorism.
In contrast, the government is timid and half-hearted in its approach to the system which perversely rewards a few Wall Street traders with billions of dollars of bonuses, yet allows the foundation to decay.
Kenneth Feinberg issued his report identifying outrageous Wall Street compensation of executives despite their role in the financial disaster and bail out. He proposed that the banks voluntarily adopt “brake provisions” that permit boards of directors to nullify bonuses in the event of a new financial crisis.
He might have more success asking the lions of the Serengeti to give the wildebeests a sporting chance of making an escape.
Over the last fifteen years, the financial sector’s percentage of GDP has increased dramatically. At the same time, the median family income stagnated and then declined. I do not believe that this is a coincidence.
The large banks have changed. They slice and dice the constituent elements of a stagnant economy, squeezing value out in ever more sophisticated ways. Wall Street has turned away from its roll as the financial backer of industry and commerce. In the short term, it is more profitable for them to use their capital for trading. Newfangled software and MIT “quants” allow the traders to “rip the faces off” of corporate counterparties and investors which were once trusted clients.
These young traders are simply doing what America has told them to do. They are allowed to earn obscene amounts of money using the advantageous information, technology and capital of their employers. Making money from less powerful counterparties is like shooting fish in a barrel. The banks make so much money that they have no problem shoveling it out to the traders.
The alternative careers for these talented young people offer upside which is modest by comparison. Besides, the trading world, in which the law of the jungle prevails, appeals to youthful aggressiveness. Michael Lewis expected that college students would be appalled by the amoral environment he described in “Liar’s Poker.” Instead, the overwhelming response he received from students was a desire to get in on the action. The draining of talented and energetic young professionals away from corporate America where they could help create jobs by the millions may be as damaging as the new allocation of wealth.
The government’s flaccid approach to Wall Street compensation, embodied in the Feinberg report, is appalling. Geithner and Bernake appear intimidated by Wall Street, yet intent on its approval. Why do they guilelessly buy into the notion that giant, multi-purpose banks dominated by trading are essential to America’s competitiveness in the world? Smaller, less risky institutions aligned with economic growth would seem to be a better idea for the vast majority of Americans.
Greenspan and his progeny, including Geithner and Bernake, are enthralled by financial innovation. Innovation, by itself, can be good or bad. Innovation does not fall into the “good” category if it corrupts the home mortgage market, siphons off business productivity and the jobs and wages of employees and unfairly enriches the few at the expense of the many. It is good if it creates jobs and enriches the public as a whole.
Trader compensation is at the heart of the problem. It encourages behavior that is inconsistent with Wall Street’s most important function: raising capital for industry and commerce. The banks and the government are afraid that the traders will desert the banks and move to hedge funds if their compensation is reduced. If they do jump ship, it is all the better for America. At least hedge funds can blow themselves up without crippling the US economy in the process.
Former traders now run most of the financial sector. They believe that the traders somehow deserve compensation at the prevailing levels. The system will not change unless it is forced to do so. The restrictions in the financial reform legislation only inhibit specific abuses. The banks will concoct new ways to trade risk. It is the only way to maintain their unconscionable profits (that is, until the next bubble bursts and we are in an even worse predicament). The only way to really change the system is to reduce short term incentives, that is to say limit bonuses. The government needs the kind of resolve it uses when fighting terrorism. After all, the stakes are actually higher.