Wall Street Too Blind For Incentive Compensation

An excerpt from Why It's Not Really So Bad That We Won't Fix Wall Street Pay by John Carney. His premise is that Wall Street employees cannot recognize the riskiness of their activities and incentive compensation will not make them change their behavior.

The compensation theory requires bankers to have known the they were making risky investments when they bought triple-A rated securities but acted imprudently because the personal rewards were great and the personal losses were small. That's just not what happened in the years leading up to our crisis.

What really led to our crisis was that so many bankers were wrong. Take Ralph Cioffi, the Bear Stearns money manager who ran the two hedge funds that blew up in the early months of this crisis. He was just about the most knowledgeable banker in the world when it came to mortgage backed securities, especially one built from subprime mortgages. Bear Stearns originated the very first subprime, CRA securitization. If anyone was in a position to know that he was taking undue risks it would have been Cioffi.

But the evidence indicates the Cioffi didn't know. He wasn't engaged in risky investments in pursuit of bonuses. He actually believed that the hedge funds, which were 90% invested in AAA or AA securities, were safe. Even after the subprime meltdown began, his faith didn't waiver.

Read the complete article here.