Let's finally pop the Wall Street bonus bubble

Wall Street has a tough public relations problem. It is hard for rank and file Americans to feel much sympathy for an elite group tucked away in a remote nook of Manhattan who are mostly young and mostly overpaid. The events of 2008 only magnify the problem demonstrating clearly that Wall Street is a world apart from the place the rest of us inhabit. The bonus debacle is a clear case in point.

With all the carnage in the financial markets and the need for massive government bailouts, how is it that Wall Street can justify paying $32.9 billion in bonuses? The Merrill Lynch/Bank of America case was particularly egregious, paying out $5 billion in bonuses in December and then asking for $20 billion more in government money in January. There is no justification for it - only rationalizations based on self-serving assumptions and a broken compensation scheme that rewards short term thinking and inordinate risk taking.

Among the self-serving assumptions is the notion that these firms have to pay these kinds of bonuses to attract and retain top talent. I simply don't believe it. While there are "Michael Jordans" in every industry--talent so unique and compelling that it commands top-dollar wages--the sorry fact is that most of the really highly paid people on Wall Street are just normal (albeit, ambitious) folks who happen to be in the right place at the right time. They are the winners of the social lottery. They are the lucky few.

I don't begrudge them that fact and I certainly don't subscribe to the notion that we should regulate their wages lower. However, Wall Street would do well to take a closer look at how they structure compensation to drive more of what they really want: solid returns and tightly managed risks. Wall Street has paid lip service to this idea for a long time, but, as we discovered in 2008, this has been more mantra than operating practice.

Wall Street says it pays for performance. The more a trader or broker or M&A specialist performs (i.e., generates profits or revenues), the more she gets paid. Consequently, she spends a lot of energy worrying about the profit side of things and less time thinking about the way those profits are made. This reasoning is faulty. In fact, it matters a lot how the profits are made.

In the book Fooled by Randomness, author Taleb Nassim highlights this point with a hypothetical situation. Suppose an eccentric billionaire proposes to pay you $10 million to play a round of Russian roulette. Chances are, you will walk away with $10 million. Under Wall Street's rules, you would be deemed a hero (and you would earn a big bonus.) However, if you play that game enough times, you will probably die young. (This maybe why the average Wall Street trader is only 32 years old.)

As this situation illustrates, it makes a huge difference if the trader is lucky or smart. Wall Street gets in trouble because it doesn't distinguish between the two and pays the same regardless. As we learned in 2008, this can have devastating consequences. Isn't it time for Wall Street to wake up and realize they need to change the way they view the world? Isn't it time to finally pop the Wall Street bonus bubble and bring these guys back down to earth--where the rest of us live?