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Got Outrage? More Fodder To Feed Your Inner Populist

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A lot has been said and written in the last year about government bailouts of Wall Street. I'll state my opinion up front: Nobody has yet offered persuasive evidence that we would have been better off by letting the financial industry implode - and let's not kid ourselves: the American financial system was teetering of the edge following the meltdown at Lehman Brothers.

That's not to say the haphazard rescue plan was a model of elegant forethought and skillful execution. Earlier this year Phillip Swagel of the Brookings Institution published "The Financial Crisis: An Inside View," which should be must=reading for anyone attempting to understand the government's response to last year's financial crisis.)

Now along come Lucian Bebchuk, Alma Cohen and Holger Spamann, three writers affiliated with Harvard Law School's corporate governance program, with a paper they aptly named "The Wages of Failure."

It's fodder to fuel another year's worth of tea parties.

"The standard narrative of the meltdown of Bear Stearns and Lehman Brothers assumes that the wealth of the top executives of these firms was largely wiped out along with their firms. In the ongoing debate about regulatory responses to the financial crisis, commentators have used this assumed fact as a basis for dismissing both the role of compensation structures in inducing fact as a basis for dismissing both the role of compensation structures in inducing risk-taking and the potential value of reforming such structures."

Spoiler alert: The fat cats who nearly wrecked the world waltzed away, each with a veritable king's ransom, and lived (presumably) happily ever after. To be sure, their take was a lot less than it might have been had Bear Stearns and Lehman not been brought low. So instead of new Lamborghinis each year, they have to make do with Mercedes-Benz. Everyone must make sacrifices now and then.

Between 2000 and 2008, the top-five executive teams - meaning the CEO, CFO and the next three most highly-paid officials - operating at Bear and Lehman cashed out bonus compensation - that remains beyond the reach of any claw-back attempt by Uncle Sam - as well as stock sales. Even though they wound up making incredibly risky - and ultimately stupid - decisions, they did not pay any financial price for their folly. The paper estimates that these executives at the two companies received $1.4 billion and $1 billion, respectively, from cash bonuses and equity sales during the period under review. (The individual compensation numbers obviously varied but if you divide the pie into ten pieces, it comes out to a neat $120 million apiece. Not bad for screwing up on a monumental scale.)

But at this point, what's the use of spilling more bile? The question is whether this data will inform the debate now underway about how to reform the financial system. Again, from Bebchuk, Cohen and Spamann:

"The analysis indicates that the design of the firms' performance-based compensation did not produce a tight alignment of executives' interests with long-term shareholder value. Rather, the design provided executives with substantial opportunities (of which they made considerable use) to take large amounts of compensation based on short-term gains off the table and retain it even after the drastic reversal of the two companies' fortunes. Such a design provides executives with incentives to seek improvements in short-term results even at the cost of maintaining an excessively elevated risk of an implosion at some point down the road."

In other words, the system was rigged to reward these nimrods for making bets that got wilder and wilder. We know how the story turned out but Bebchuk, Cohen and Spamann want to make sure this doesn't happen again.
Still, some in Congress seem ready to protect a system predicated on rewarding executives with bonuses and equity-based compensation don't for short-term results. Where the legislative powers-that-be will go with is remains anyone's guess. But at least they now have reliable data to consider - or ignore.

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