Wall Street Compensation

The first paycheck you got on Wall Street -- how surprising or wonderful was that?

Well, relative to the previous paychecks that I had gotten, it was large. But it wasn't the kind of money that more senior people who had been around for a long time on Wall Street were making. But the comparison -- I was earning minimum wage, working at a golf course in Kansas. Then I was earning a very small salary working as a clerk to a judge. So I was making good money. …

But I think it's worth noting that in the mid-1990s, even the highest paid people weren't making anything close to what the top people on Wall Street are making now. The CEOs of these banks weren't making even 10 percent of what the CEOs are making today. So really, there's been a dramatic change in terms of compensation, how much people were making at the very, very top. …

Why do bankers make so much money?

Bankers make so much money because they're able to make that much money for their firms. The firms are very ruthless about money. They will not pay you unless you're generating something for the bottom line. So if you're not making any money for them, you lose your job. If you're making a lot of money for them, then you'll be paid well.

So really, the question about why bankers make so much money is why do banks make so much money? That's a very complicated question.

But essentially, what role banks have come to play in society is serving as financial intermediaries in a way that extracts much more money than they used to. … The more traditional role is matching borrowers and savers, people who have money with people who need money. Banks step into the middle there and they earn a fee, and no one objects to that function. That's a traditional function. It's been around for hundreds and hundreds of years.

The things that's changed is that banks and bankers now do things that are much more complicated than simply matching borrowers and savers. And those are the things that generate the big money. There are a couple of examples.

One is what is called regulatory arbitrage. This is a kind of esoteric term, but basically what it means is figuring out way to get around the law, figuring out a way to structure a transaction in a way that avoids taxes, that avoids accounting disclosure, that avoids some kind of regulatory or legal impact. It's a way to avoid the law. And Wall Street has become very good at regulatory arbitrage. They're very good at figuring out a complicated financial structure that achieves some objective that you couldn't achieve otherwise in a legal way.

So they do a bunch of stuff that is technically legal, but it's really to evade the law? Right?

Some people call this a-legal. It's not illegal, but it's beyond the capacity of the law to address. …

I presume that the bonuses make you want to take more risk. It's a little vicious cycle?

To some extent that's absolutely true. But don't forget, there are controls. The senior management, the board of directors and the bank shareholders want risk taking within certain limits, so there would be some level of control.

So we could take risks, but there were limits to it. But obviously if we could take the right risks and make more money, then there were immediately direct benefits for us.

But the other thing which is interesting about that process is it's a bit like setting up any sort of measurement metric. ... Very quickly we mastered the metrics. We knew how we were going to be measured, and so a game brewed up and got accelerated over time where people started to game the system. ...

Not only were we able to take the profits -- and some of those profits were legitimate -- but the system lent itself to a process whereby you could actually game it to recognize profits which may not have been real. And that process, to be very honest, accelerated in the late '90s, early 2000s, leading up to the problems of 2007, 2008. ...

Why are they doing this? For the money?

I think a lot of them did it because of the fact that that was the only jobs available. The second thing, of course, was the actual rewards in banking far outstripped the rewards in science. ...

This was one of the perversities, if you like, of banking. There was an absolute change in the way remuneration is structured. We now know that people get paid very large bonuses, very large incentive payments, but people assume that was the case always. In reality it wasn't. Until probably the early 1990s, banking was a well-rewarded profession, but not an egregiously rewarded profession. ...

We've just come through another year and seen bonus pools up, lots of compensation for bankers. People are bitter. They're not seeing any results on Main Street, but yet the bankers seem to be doing just fine and making huge bonuses. And those bonuses don't do anything to quell the risky behavior of the past.

... The major point is that in large part due to the banking agencies, but also due in some part to self-discipline, these bonuses now are much more closely tied to risk, and in particular clawback arrangements, whereby if it turns out that the bonuses were earned and the work turns out after a year or two or three, to have been less profitable or actually incurred losses, there can be clawbacks of the bonuses.

There is much more attention being paid to the relationship between the risk incurred and the size of the bonus. I'm sure it is far from perfect, but I think there are major efforts being made.

Why not have a compensation system that gets rid of bonuses and just ties people's income to their performance?

The irony here is that's the way it largely used to be, and Congress in its infinite wisdom decided that if you did it that way, it would be subject to a much higher tax level. That really is what led to the bonus system being a far greater component of total compensation. ...

The question of bonuses and compensation. This has a lot of people, rightly perhaps, very upset. How do bankers justify these bonuses in your view?

To some extent the bonuses are justified and can be justified if they reflect someone's contribution to the company.

The problem is with the incentive compensation schemes -- which I think the regulators have focused on like a laser beam in the last couple years -- which encourage immediate profitability without regard to longer-tail or even shorter-tail risk.

I would argue that the system was flawed in the sense of not tying compensation to risk and ... not having clawback provisions. ...

I'm going to take you back to March 27 [2009] now, the White House meeting [when] the CEOs came to town, the bonus stuff is all on the front pages. And so they're worried, because they don't know where this president is going. The message that comes out is, the administration is not going to force them to lend in ways that they don't agree to. It's not going to deal with compensation questions.

Well, that's not quite accurate.

But the president says, "Hey, we're the only ones between you and the pitchforks." It seems that the bankers come out of that meeting though thinking, "Well, yes, he slapped us on the wrists, but in the end it still our decision." And the critics say this was the period of time when you should have kicked their butts. This is the period of time you could have come down on them.

The one point I disagree there has to do with compensation. We actually had rules enabling us and Ken Feinberg to provide oversight to their compensation decisions.

But you have a point. With hindsight, I'd say we should have tried to extract more from the banks, particularly in terms of lending. It was frustrating to be providing them with the resources they need to stay alive, and yet they didn't seem to be lending into the economy in ways that would have helped pull forward the recovery.

So how angry did this make the president?

The president -- I'll tell you. The bonus and the compensation stuff made him more angry than I'd ever seen him. I mean, oftentimes with President Obama, if he was annoyed, you knew it because he would say, "I'm annoyed." When it came to the bonus -- I remember him, like, really standing up out of his chair in the Oval Office during the AIG bonus compensation stuff and just being really pretty livid.

One thing he would not stand for was the American people being played for as chumps by these banks. And that was something he just really didn't like.

Some people will say, yeah, he might have been mad, but nothing came out that sort of forced him to change.

I think it's an unfair claim on compensation. Because on compensation, we put a guy named Ken Feinberg, the compensation czar, in the Treasury, and the man had oversight over these banks' compensation packages. That's a very big move in a capitalist economy.

I think where you could criticize us was that we didn't ask enough out of the banks in terms of their taking some of those bailout funds that were helping to reflate their books and lending back into the economy.

Now, at the time, remember, it was leverage that got us into this mess. So there is a bit of the hair of the dog that bit you there. And you have to be mindful of that dynamic, too.

Was there a surprise that Wall Street didn't come around though, that it didn't listen to the message, it didn't listen to reason, that they had such a tin ear when it came to bonuses?

That did not surprise me. [laughter]

Did it surprise others in the administration? I mean, Obama comes into this thing saying, We're going to work together. I can bring anybody around a table with me and I can convince them that the better-for-all is the better for the individual.

… For those who were less familiar with the compensation practices of Wall Street -- and not everybody knows about that sort of thing and the kind of granularity that became important -- yeah, they were surprised that after we saved their bacon, they ate our lunch. [laughter] It just seemed crazy.

To me, it was like, well, you know, that's what they do.

And did we lose an opportunity? Did we lose the leverage to use the power, that the banks were up against the ropes and they knew that we were saving their butts.

I think this line of critique has been overplayed. Yes, we lost an opportunity in the sense that we should have insisted on more lending back into the economy as a contingency on getting some of those bailout funds. But that's actually a relatively small part of the puzzle.

What we got was financial reform. And what we should insist on going forward as that reform is still being crafted and implemented, is that it be a very serious and real level of oversight. The lessons of the financial meltdown of 2007 and 2008, it's not clear yet whether they've been learned or not. It's like what is the Mao saying about the French Revolution? It's too soon to tell. [laughter]

It's a matter of whether we come out of this with a level of oversight that is strong enough to contain the inherent instability in these financial markets. And we're fighting tooth and nail around the implementation of Dodd-Frank on those very issues.

Do you think that was widespread, and that was the abuse of derivatives, right?

There were abuses. In every market there are abuses. There were abuses in the derivative markets because of the opaqueness of derivatives. It was probably easier to abuse in some cases.

What does that say about the profession?

It obviously doesn't cover the profession in glory. And I think when you go through a period like we all did in the 1990s and the 2000s, where really large amounts of money were available to individuals on the condition that they performed well and performed honestly --

We're talking compensation.

We're talking bonuses. The incentive to cheat is very high. It's very high. And as a manager of those organizations, policing of prospective cheating becomes very difficult when there's huge amounts of money at stake. And there were cheaters.

I don't think the industry was full of cheaters. I don't think every firm was riddled with cheaters. In fact, I don't think most of the business that was done was cheating. I don't think most of the mistakes that were made can be chalked up to somebody cheating someplace. I think most of the mistakes that were made can be chalked up to incompetence. ...