One reason why some bankers acted so recklessly in recent years, jeopardizing the global economy, was that they were paid to. Pay scales that lavishly rewarded short-term profits, with little regard for risk, are now seen as a major factor contributing to the financial meltdown.
Leaders at Thursday's Group of 20 meeting say one way to stabilize the financial system is to change the way banks pay their employees. The bankers' challenge is similar to one playing out on the basketball court.
Parallels Between Wall Street, Hoops
A few weeks ago, business and sportswriter Michael Lewis published a story in The New York Times Magazine about Houston Rockets forward Shane Battier.
What makes Battier special isn't captured on any highlight reel. His individual stats — points, rebounds and the like — are unremarkable, but he has an uncanny ability to help his team win.
The point of Lewis's article is that those individual stats, while easy to measure and reward, are not what is really important. In fact, if a player's bonuses are tied too closely to individual stats, they can actually end up rewarding actions that hurt the team in the long run.
To University of San Diego law professor Frank Partnoy, that sounds a lot like Wall Street.
"I think there are a lot of parallels between the NBA and the MBA," Partnoy says. "These are markets where the superstars are going to take home the highest compensation and they are going to feel like they are worth it."
Partnoy says just like a ballplayer who gambles on a bad shot instead of passing to an open teammate, Wall Street bankers face a constant temptation to pad their own stats, and bonuses, even at the expense of their team.
"Maybe juice up their returns for a year, take on excess risks for a year, make that big bonus over the short term, and have their team suffer or their bank suffer in the long term," he says.
A Way To Keep Score
Partnoy, a former derivatives trader on Wall Street, says bankers view the size of their annual bonuses as a critical way of keeping score.
"These folks are as close to rational economic actors as you can possibly get," he says. "If you give them an incentive, if you ring the bell, if you put a plate of food in front of them, they are going to respond.
"And that's why it's so important to make sure that the incentives are structured in a way to have them think not just about their own bottom line, month by month, but the long-term viability of the bank."
The long-term viability of banks is pretty important. Selfish basketball players can cost their team a shot at the playoffs. Bankers who play for themselves can put the whole economy at risk.
Acknowledging Role In Crisis
Bankers themselves have come to realize this. In a survey released this week by the Institute of International Finance, 98 percent of bankers agreed the structure of their compensation may have contributed to the economic crisis. The institute's George Abed says bankers were handsomely rewarded for actions that goosed profits even if those gains were only temporary.
"There was a headline in The New York Times a few weeks back: Banks' profits were illusory, but the bonuses were real," Abed notes.
Regulators say there is no one-size-fits-all solution, but bank bonuses should be adjusted to reflect the risk that a banker is taking on. If the outcome of the risk won't be known for several years, then a chunk of the bonus should be postponed as well.
In the past, banks were reluctant to make such changes for fear of losing employees to the competition. But Abed says with so many bankers out of work these days, it is a good time to rethink the way that work is rewarded.
"We will definitely reduce the risk of reckless behavior, and we will reduce the risk of systematic instability arising from mismanaged or badly managed incentive systems," he says. "Every crisis provides an opportunity to learn and an opportunity to correct, and I think definitely this is one" of those opportunities.
So far, much of the anger in the U.S. has focused on the size of executive bonuses. President Obama, however, also wants to take a look at what bankers are rewarded for. He wants to change what he calls "a culture of narrow self-interest and short-term gain at the expense of everything else."
"We're going to take a look at broader reforms," Obama said, "so executives are compensated for sound risk-management and rewarded for growth measured over years — not just days or weeks."
And that means celebrating not the short-sighted superstars but the less obvious and more long-lasting winners.