Within the 662 pages of the report released last week by the Financial Crisis Inquiry Commission, based on information from more than 700 witnesses and millions of pages of documents, and including two separate dissents from the Republican members, there is one sentence that encompasses all of the majority's conclusions and refutes all of the dissenters' objections. Here it is:
Compensation systems--designed in an environment of cheap money, intense competition, and light regulation--too often rewarded the quick deal, the short-term gain--without proper consideration of long-term consequences.To be sure, there is plenty of blame to go around and the majority makes sure everyone gets a share -- especially the financial services companies, the ratings agencies, and the regulators. The report acknowledges that lax oversight by regulators was justified by a belief that the self-interest of the businesses involved would keep them from taking unreasonable risks.
Pay Was All Upside, No Downside
But a compensation plan with poorly designed incentives will distort self-interest toward the individual rather than the enterprise. Other than the regulators, who had no variable compensation to speak of, everyone, from the CEOs to the mortgage brokers to the designers and sellers of the derivatives to ratings agencies, was paid based on the quantity of transactions rather than the quality of transactions. This is the fault of the boards of directors for designing and approving them and the regulators, securities analysts, shareholders, and ratings agencies for failing to understand how devastating the impact would be. As a result, the upside was paid out in bonuses; the downside was externalized onto the taxpayers.
The Republican members of the FCIC, who attempt to make the entire meltdown seem like the fault of public policy and government programs favoring home ownership, should understand that if mortgage brokers had clawbacks for defaulted loans, they would not have pushed people into more than they could afford. And if the ratings agencies were paid by the users of their ratings rather than the companies they rate, they would be less likely to have to downgrade 83 percent of the triple-A ratings they gave out on derivative securities in 2006.
As Deep Throat said about the Watergate investigation, "follow the money." And as my mother says, "You get what you pay for, and sometimes you also have to pay for what you get."