Bank on It: Wall Street Pay is Risky Business

(MoneyWatch)  One of the big lies being told in the debate over Wall Street pay is that the link between bankers' compensation and their tendency to throw caution to the winds is poorly understood. Here's top M&A lawyer Bob Profusek of law firm Jones Day in an interview last week with the WSJ:

Everybody says "excessive compensation" and "excessive risk" are inexorably linked, but nobody has taken the time to really examine that, to prove out the premise. . . . The assumption, I suppose, is that they will push the risk envelope to make even more money.

There's nothing shocking about a prominent corporate lawyer making such a statement. After all, Jones Day, like most white-shoe law firms, lists among its clients many large financial companies, including Bank of America, Citigroup, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Lehman Brothers and Morgan Stanley.

It also goes without saying that attorneys, as any Law & Order fan will attest, are paid to channel the interests of their clients. It's no coincidence that Profusek's interview appeared a day after government pay czar Ken Feinberg laid down the law for seven large companies on the public dole.

That said, Profusek may want to fine-tune his pitch. Because the truth is that the link between how bankers are paid and their proclivity for risk-taking has been thoroughly examined. And confirmed.

"Standard pay arrangements reward executives for short-term results even when these results as subsequently reversed," said Harvard professor Lucian Bebchuk, perhaps the foremost expert on such matters, in congressional testimony this summer. "The ability to take a large amount of compensation based on short-term results off the table provides executives with powerful incentives to seek short-term gains even when they come at the expense of long-term value, say, by creating latent risks of implosion later on."

This isn't idle speculation. It's not even some pet theory that, while seemingly well-grounded, requires revision in the face of contradictory evidence. It's an unimpeachable fact. Bebchuk's research and reams of other studies all point to the same conclusion: Bankers take chances with other people's money because they don't bear the risk of losing it.

So the assumption that this axiom is poorly understood is, I suppose, false. Profusek is on safer ground in speculating over what's behind all the bleating over banker pay. His hypothesis is that it's motivated by "populist politics" and a thirst for revenge:

I thought we were past the retribution phase. Retribution is not a good foundation on which to erect policy.

Such claims are more defensible -- because they're right. Good thing, too. Profusek seeks to disparage public concerns about the impact of Wall Street bonuses on, say, folks' 401k balances by conjuring up images of hirsute, torch-bearing villagers combing the forest in pursuit of the monsters that lurk there. Such is democracy. Some beasties really do go bump in the night.

Meanwhile, what's wrong with "retribution"? Profusek is perhaps referring to the spiritual perils of seeking vengeance, which is better left to the Lord. But the term also means "justly deserved penalty," and "something given or exacted in recompense."

These principles, which as a lawyer Profusek knows are deeply embedded within the law, are excellent foundations for policy. Self-serving spin, not so much.

Now pass me that torch.