New York Times
March 21, 2008
How can one feel sorry for James Cayne? The potential losses of the chairman and former chief executive of Bear Stearns must rank up there with the biggest in modern history. The value of his stake in Bear Stearns collapsed from about $1 billion a year ago to as little as $14 million at the price JPMorgan Chase offered for the teetering bank on Sunday.
Still, Mr. Cayne was paid some $40 million in cash between 2004 and 2006, the last year on record, as well as stocks and options. In the past few years, he has sold shares worth millions more. There should be financial accountability for the man who led Bear Stearns as it gorged on dubious subprime securities to boost its profits and share price, helping to set up one of the biggest financial collapses since the savings-and-loan crisis in the 1980s. Some might argue that he should have lost it all.
But thatís not how it works. The ongoing bailout of the financial system by the Federal Reserve underscores the extent to which financial barons socialize the costs of private bets gone bad. Not a week goes by that the Fed doesnít inaugurate a new way to provide liquidity ó meaning money ó to the financial system. Bear Stearns isnít enormous. It doesnít take deposits from the public. Yet the Fed believed that letting it implode could unleash a domino effect among other banks, and the Fed provided a $30 billion guarantee for JPMorgan to snap it up.
Compared to the cold shoulder given to struggling homeowners, the cash and attention lavished by the government on the nationís financial titans provides telling insight into the priorities of the Bush administration. Itís not simply a matter of fairness, though. The Fed is probably right to be doing all it can think of to avoid worse damage than the economy is already suffering. But if the objective is to encourage prudent banking and keep Wall Streetís wizards from periodically driving financial markets over the cliff, it is imperative to devise a remuneration system for bankers that puts more of their skin in the game.
Financiers, of course, dispute that they are being insufficiently penalized. ďI received no bonus for 2007, no severance pay, no golden parachute,Ē E. Stanley OíNeal, the former chief executive of Merrill Lynch, told a House committee recently. That doesnít seem like much of a blow to Mr. OíNeal, who was removed earlier this year following gargantuan subprime-related losses.
Indeed, the pain that is being inflicted on financial-industry executives as a result of their own actions and decisions is not proving much of an encouragement. Rather, the knuckle-rapping seems only to encourage bankers to make up for any losses they may suffer by finding another way to navigate their companies, the financial system and the economy into the next maelstrom ó from Internet stocks to what the industry calls zero-down, negative amortization, no-doc, adjustable-rate mortgages.
(Translation: derivatives based on incomprehensible mortgages with unpredictable interest rates given to people who have no reasonable chance of understanding them, let alone paying them back.)
Bankers operate under a system that provides stellar rewards when the investment strategies do well yet puts a floor on their losses when they go bad. They might have to forgo a bonus if investments turn sour. They might even be fired. Their equity might become worthless ó or not, if the Fed feels it must step in. But as a rule, they wonít have to return the money they made in the good days when they were making all the crazy bets that eventually took their banks down.
The costs of such a lopsided system of incentives are by now clear. Better regulation of mortgage markets would help avoid repeating current excesses. But more fundamental correctives are needed to curb financiersí appetite for walking a tightrope. Some economists have suggested making their remuneration contingent on the performance of their investments over several years ó releasing their compensation gradually.
Thatís an idea worth studying. Certainly, trying to put specific limits on bankersí salaries is a nonstarter. But until bankers face a real risk of losing their shirts, they will continue blithely ratcheting up the risks to collect the rewards while letting the rest of us carry the bag when their punts go bad.