What Sunk the Ship?

Andy Kessler in today's Wall Street Journal makes the same basic point that we made in our last post about the futility of focusing on executive pay at banks. There is one philosophical difference that probably originates in the fact that Kessler is a former hedge fund manager. He says it wasn't excessive compensation schemes or excessive risk-taking that almost sunk the global financial system. Rather, he says it was the excessive use of leverage. He claims that Wall Street is good at managing their day-to-day risks. I have a hard time following this one.

Leverage is a decision variable that magnifies risk and returns, and so it is part and parcel of risk taking. So when Bear, Stearns or Lehman Brothers leveraged their portfolios at 35x, these were the accumulation of conscious decisions taken on their trading desks. It is the produce and distribute model for products that are as economically useful as carnival elixirs that needs to be changed and regulated. Unfortunately, there is no appetite to do this any more, as everyone is worn out by the minute-by-minute crisis watch over the past three quarters.

Just like SOX was a victory for accountants, consultants and lawyers with little impact on long-term shareholder value, so too will be the pursuit of executive compensation in banking. It's become so ridiculous that a local paper featured a story about a school board that rescinded performance pay bonuses for senior district administrators. Their performance measures, which included increasing enrollment in special programs, increases in minority performance and the like, were set a year ago; they seem clear, reasonable and measurable. The bonus amounts were a reasonable percentage of the base compensation. Now the administrators were told to give back their bonuses as contributions into special programs, "for the kids." It's not the fault of school administrators that Wall Street got the entire country into the crisis of the century!

Misguided populism is raising its head because the Administration and its Congressional lackeys don't have the guts or understanding to attack the problem at its roots because they are all running for their next campaigns. What a shame.