The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Re: Pay-for-Performance


Reihan recently called attention to Mike Konczal’s discussion of the relationship between pay-for-performance and the financial crisis. Here are my thoughts on Konczal’s thesis:

The problem with Wall Street is not that people are paid for performance, the problem is that not enough people are paid for performance. The ones who are paid for performance are the good guys. On the other hand, there are plenty of people in the business who got to where they are for reasons other than economic productivity, and are able to benefit from the performance of others. Having said that, Wall Street is much more meritocratic today than it was 50 years ago, and it is getting better on this score over time.

As Reihan points out via the e21 crew, when the banks moved from the private partnership model to the publicly traded model, the prinicipals became less worried about systemic risk, because they were more insulated from it financially than they previously had been. (It is important to note that most banks do compensate their employees at least in part with stock, and many of those who worked for Bear Stearns and Lehman Brothers, when those banks collapsed, lost their life savings.)

There are two big problems with how the political class, both left and right, talk about “Wall Street.”

First, “Wall Street” is not a monolith, just as there’s no monolith called the “food business” – there are farmers, seed producers, farming equipment manufacturers, grocers, restaurants, etc. etc. Wall Street is a complex ecosystem, in which various people play different roles. The part of Wall Street that crashed had to do with the part that was heavily invested in the housing bubble. The percentage of Wall Street employees who were involved in those matters is a tiny minority. Bankers for airline companies are not responsible for the collapse of the banking system. Traders of U.S. treasury bonds aren’t. Neither are investors in technology companies. If people are going to advocate dramatic changes in the way our financial system works, they should at least have the humility to make the effort to understand how it works today.

Second, for all this talk of Wall Street’s misdeeds, nobody seems to talk of the primary cause of the housing bubble and crash: irresponsible borrowing practices by many ordinary Americans. These individuals took out mortgages they couldn’t afford, and because of quirks in our mortgage system, were strategically incentivized to default on their loans when things went bad. As a result, mortgage securities held by banks that seemed stable turned out not to be, leaving banks with substantial financial losses.

From a policy standpoint, Washington has been making these problems worse, by subsidizing those who default on their mortgages at the expense of those who don’t. More problematic, however, is how the rhetorical demonization of Wall Street by our political class has let individuals off the hook for their own irresponsible behavior. We talk about ending bailouts for banks – but we aren’t even talking about the bigger challenge of ending bailouts for binge-spending individuals (or Congressmen). Indeed, by blaming the banks for our economic crisis, we are encouraging more defaults and more bad loans.

The people who have a right to be mad are the people who have been responsible borrowers, paying their mortgages on time, and living within their means. Irresponsible borrowers, and the mandarins in Washington who continue to abet them, are the appropriate target of their outrage.


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