| world is flat is very also a nice book. below is news on wall streets. ---------------------------------------------------------------------------------------------------------------------- Wall Street's stratospheric compensation packages are a recipe for economic disaster Robert Samuelson Jan 24, 2008 Amid the mayhem on world financial markets, it is becoming clear that capitalism's most dangerous enemies are capitalists. No one can have watched the subprime mortgage debacle without noticing the absurd contrast between the magnitude of the failure and the lavish rewards heaped on those who presided over it. At Merrill Lynch and Citigroup, large losses on subprime securities cost chief executives their jobs - and they left with multimillion-dollar pay packages. Stanley O'Neal, the former head of Merrill, received an estimated US$161 million. Everyday Americans will conclude (rightly) that this brand of capitalism is rigged in favour of the privileged few. It will be said in their defence that these packages reflected years of service, often highly successful. So? It's not as if these chief executives weren't compensated in all those years. If you leave your company in a shambles - with losses to be absorbed by lower-level employees, some of whom will be fired, and shareholders - do you deserve a gold-plated send-off? Still, the more serious problem transcends the high pay itself and goes to the wider consequences for the economy. Wall Street's pay practices perversely encourage extreme risk-taking that can destabilise 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. On Tuesday, the Federal Reserve cut its key overnight interest rate from 4.25 per cent to 3.5 per cent - 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. Last year, Lloyd Blankfein, chief executive of Goldman Sachs, received compensation estimated at US$68 million. But pay is also heavily skewed towards 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 are in their 40s. Here are estimates for 2007: Investment banker: US$2.1 million, consisting of US$275,000 in base pay plus US$1.2 million in cash bonus and US$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: US$1.525 million, with US$240,000 in base pay, US$975,000 in cash bonus and US$310,000 in long-term bonus. Hedge-fund manager: US$1.85 million, split between a salary of US$265,000 and US$1.585 million bonus. Just why investment bankers and traders out-earn, say, doctors or computer engineers is a question I've never heard convincingly answered. Are they smarter? Unlikely. Do they contribute more to the economy? Questionable. True, Wall Street often performs a vital function. It channels savings into productive investments. It helps provide access to capital and credit. In 2006, US companies raised nearly US$4 trillion through new stocks and bonds. Many financial innovations, including mortgage-backed securities, have benefited individuals and companies. But Wall Street also frequently misallocates capital and credit. The "tech bubble" of the late 1990s was one episode. Now we have subprime mortgages. Why? Well, the herd mentality of financial crazes has a long history. But compensation practices skewed so heavily towards bonuses based on annual profits make matters worse. "People self-select for careers. On Wall Street, they self-select for the money," says pay consultant Alan Johnson. "Wall Street is a sales business - they sell bonds, securities, transactions, ideas... They're not paid to be long-term, philosophical, reflective." The pressure is to do the next merger, sell more stocks and bonds, do more trading - whatever boosts current profits and bonuses, the long-term consequences be damned. "These are my MBA [masters of business administration] students, not just mine but MBAs from Harvard, Stanford, Pennsylvania," says economist Allan Meltzer of Carnegie-Mellon University. "They were buying and selling this garbage [subprime mortgages securities]. Are they so stupid? They got compensated for doing it. If they didn't do it, they'd lose their jobs." To be fair, the property bubble had many causes, including low interest rates, the political popularity of home ownership and the (mistaken) belief that housing prices could never fall. This may explain why, so far, the backlash against Wall Street has been muted. But if the subprime failure turns out to be a preamble to a larger financial breakdown, flowing from the creation of new securities that offered short-term trading possibilities - but whose long-term risks were underestimated - then the mood could turn uglier. Indeed, many may conclude that capitalism has run amok. Robert Samuelson is a Washington Post columnist |
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