New York Times editorial agrees it's time to change bankers' pay

Posted Sep 19th 2008 10:48AM by Peter Cohan

The New York Times editorializes that it is time to change the way bankers get paid. It suggests that one way to curb their risk-taking would be for "banks to hold a big chunk of bankers' pay in escrow, to be doled out over several years." Now that sounds like a great idea!

I starting posting about this in July 2007. Since then I discussed it here, here, and here. I think it's a great idea because people respond to incentives. If you pay them enormous amounts of money to close big deals then they will find the biggest deals around and close them. That's what motivated the creation of what amounted to a $1.3 trillion market to issue mortgages to people who couldn't pay them back. The name of that market? Subprime.

Bankers made huge bonuses by taking that $1.3 trillion in mortgages, bundling them and selling the bundles to investors. In all, mortgage-backed securities (MBSs) totaled $6.9 trillion. Such incentives also motivated the creation of the $6.1 trillion market for Collateralized Debt Obligations (CDOs). Both markets produced securities that it turns out aren't worth much. So the U.S. is now talking about using $500 billion of taxpayer money to foot the bill for these securities.

How much of these banker's bonuses is going into the $500 billion fund? Nothing -- the taxpayers will pick up the tab. But if bankers had an incentive to calculate the potential losses into their deals, they might take more care to close deals with a good chance of being profitable. When I first proposed this idea, the political winds were blowing hard against it. But now, perhaps there is a shift in the weather. Let's see whether Washington picks up on it.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

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