Wall Street Compensation Will Never Be Solved

So many people dumbfounded and angry that after all the carnage on Wall Street, all the bailouts and all the lessons (not) learned, bankers that are employed are still getting huge salaries.

TARP overseer Elizabeth Warren wants Wall Street to “wake up” and realise that the world has changed. Big paydays just don’t fly anymore. Others are seeing the light as well, like Judge Richard Posner, a conservative judge and a born-again regulator. Nassim Taleb says limiting pay is critical to reducing systemic risk. Ben Bernanke is talking about the issue of pay today.

Here’s the problem: It’s an impossible problem to fix. Sure, you can play around at the edges. You can make compensation more in stock, or lock it up for a few years to try ensuring that you’re not just paying employees to pick up pennies in front of steamrollers.

But high pay is a product of big profits. Period. To “fix” pay, you need to come up with a system in which an employee is incapable of delivering your firm a big profit. You have to come up with a way to make sure that a trader can not possibly have a fantastic year. Or you need to make it impossible for a banker to arrange a huge deal for which they’re entitled to a big fee.

Now if you can do all that — make it impossible for an employee to deliver a big profit for your firm — then it may be possible. This may be what people are thinking who advocate the super-buzzy “make banks more like water utilities” ideas. In other words, the idea is to make banks so boring that human agency and judgment barely comes into it.

But in the end, humans and managers don’t set wages. Markets do. There’s a reason that capital-strapped Citigroup (C) wants out from the TARP limitations. They can’t pay market wages. Sorry, there is still competition for human capital. We see it every day. And it’s not just Wall Street culture, either. There are plenty of industries where people would love to pay their chums million dollar bonuses. But the market just doesn’t let it happen.

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