Let's Move Their Cheese

We can get better bank management for a fraction of the cost.

• By THOMAS FRANK

Incentives work, all right. Just look at the way our bankers come back to bonuses, finding in every occasion a good opportunity to cut themselves a slice of largess. Their determination is unrelenting, monomaniacal. It's like Republicans returning to tax cuts, the universal solution to every problem.

Some institutions, we read, are struggling to free themselves from the TARP, because of its exuberance-chilling compensation limits. Others have decimated their workforces, apparently so they might continue to shower money on the favored ones. Still other institutions have signaled that they would rather borrow at higher rates of interest than accept the compensation limits that come with cheaper federal loans. And certain banks are on track to return to pre-recession compensation levels this year, according to a story last week in the New York Times. Goldman Sachs, for example, set aside $4.7 billion for compensation in the first quarter alone.

Another way incentives work is this: They have kept the debate over incentives from getting off the dime for years. There is no amount of shame that will deter the bonus class from pressing their demand, no scandal that will put it off limits, no public outrage over AIG or Enron or really expensive Merrill Lynch trash cans that will silence the managers' monotonous warble: "Attract and retain top talent!"

And there is no possible objection to inflated compensation you can make that will not be instantly maligned as senseless populism.

In truth, however, the verdict has been in for years. Pay for performance systems, at least as they exist in many places, are a recipe for disaster.

What they have "incentivized" executives to do, in countless cases, is not to perform, but to game the system, to smooth the numbers, to take insane risks with other people's money, to do whatever had to be done to ring the bell and send the dollars coursing their way into the designated bank account.

It may well be true that those in our bonus class are geniuses, but in far too many cases their fantastic brain power is focused not on serving shareholders or guiding our economy but simply on getting that bonus.

One might say that events of the last year had proved this fairly conclusively.

Or one could quote the immortal words of Franklin Raines, the onetime CEO of Fannie Mae, as they were recorded by Business Week in 2003: "My experience is where there is a one-to-one relation between if I do X, money will hit my pocket, you tend to see people doing X a lot. You've got to be very careful about that. Don't just say: 'If you hit this revenue number, your bonus is going to be this.' It sets up an incentive that's overwhelming. You wave enough money in front of people, and good people will do bad things."

Will they ever. They might, for example, pull an accounting fraud of the kind Fannie Mae itself was accused of committing in 2004, in which earnings were allegedly manipulated to, ahem, hit certain revenue numbers and make the bonuses go bang.

They might rig the game to take the credit -- and reap the rewards -- when good luck befalls an entire industry. If they're bankers, they might even try to claim that their firm's recovery, made possible by TARP money and government guarantees, was actually a fruit of their personal ingenuity. Bring on the billions!

Of course, they will also threaten to leave if they don't get exactly what they want. Take last week's news story about the supersuccessful energy trading unit of Citibank, whose star trader scored $125 million in 2005, owns a castle in Germany, and collects Julian Schnabel paintings. This merry band of traders is apparently thinking about a white-collar walkout should the government refuse to lift its compensation restrictions.

At first one feels pity for Citi and its resident geniuses, brought to these straits by the interfering hand of government. But then it dawns on you: Should a company receiving billions of public dollars really be gambling on speculative energy trades? After all, the bank's ordinary, everyday deposits would have to be made good by you and me through the FDIC should one of their bright traders pull a Nick Leeson someday.

Besides, why is Citi so anxious to give in to these guys? It can't be that hard to "retain top talent" when New York is awash with unemployed bankers and traders who are no doubt anxious for a chance to prove their own brilliance.

Here's a Wall Street solution to Wall Street's problems: Let's offshore trading operations to lands where ethics are more highly esteemed -- Norway, for instance. And while we're at it, let's replace our gold-plated, Lear-jetting American CEOs with thrifty Europeans, who may not write management books but who will do the work better, and for a fraction of the cost.