The WSJ is on fire today. What more can you really say? This is exactly right.
Bankers and traders get their big bonus checks every 12 months. But the risks created by their work are spread over a longer time frame. By the time the risks are revealed, be they bad loans or bad deals, it's too late for real accountability. The checks have been cashed, and the charters booked for Nantucket.
Overreaching is an American pastime, and virtually a Wall Street birthright. And that's fine, given that ambition drives innovation. But this current credit mess -- or "equilibrium-finding" as the hopeful put it -- dredges up an issue the Street has yet to solve: just how to pay short-term for long-term performance.
Last year, bankers were praying for the deals market to "just hold on" until bonus season. They got their wish, passing around the biggest pot of fees in history, some $79 billion split among the investment banks, 20% higher than during 2005.
The prayers were even more fervent this summer as the deal business was reaching a record-setting crescendo. Only now are the gambles becoming embarrassingly evident, with the Street scrambling to finance some $220 billion worth of leveraged buyout deals.
Some bankers talk publicly as if the inventory will vanish after a few weeks of vacation. In private, though, the mood has gone from Nantucket holiday to Bataan Death March. As one top merger banker put it on Friday: "I'm underwater on every single loan on my book." Translation: He's stuck with deteriorating loans that he was supposed to sell to others.
Despite the fallout, both bank and hedge-fund investors are willing to pay upfront money without seeing back-end results. The consequence is a free-rider's paradise, where individuals can stack up the short-term benefits for themselves, while letting the institution bear the brunt of their actions.
The result is a banker getting handsomely rewarded in January for making a loan that blows up in August. The hedge-fund manager, meanwhile, is able to buy up billions in suspect subprime real-estate loans and derivatives, clipping a 2% management fee along the way.
There is a market trade-off to these high rewards. Bad decision-makers can get yanked from their jobs at a moment's notice. But this can have the effect of creating still more incentive to land the big score.
Given the dollar amounts in play, that's getting increasingly possible, says Alan Johnson, managing director of Johnson Associates, which advises Wall Street firms about compensation. "The sums are getting bigger and bigger," Mr. Johnson says. "You've got young people doing aggressive things that have never been done before. What if it turns out really badly? It's what keeps CEOs up at night."