Bankers are going to make lots of money, with or without bonuses, and loading all that cash into guaranteed salaries might make matters even worse
The news cycle must be slowing down, because the New York Times is recycling the flawed argument that banker bonuses are the cause of all of the economy's ills in an op-ed today. This time, the claim is made by Nassim Taleb, author of The Black Swan, risk engineering professor, and hedge fund investor. While some reforms of the system in place before the financial crisis were warranted, getting rid of bonuses altogether won't solve anything -- and could actually make the situation worse.
Ending Bonuses Won't End Lavish Banker Compensation
To determine whether or not ending bonuses could help to reduce risk, we need to first think about how a ending bonuses would change the situation. For starters, the amount of compensation that bankers are provided would not change significantly. These pay levels are based on the market value of the services that they provide. Instead of making lots of money with fat bonuses, these bankers and traders would make lots of money with giant salaries.
Not only does economic theory assert that this is true, but we have seen it in practice. A few years ago when banks came under fire for big bonuses, they began to shrink bonuses a bit and plow the difference into larger salaries. Taleb does not appear to dispute that compensation levels would remain very high for bankers, but instead argues that incentives would change. He's right about that, but they may change for the worse.
What Is Your Incentive With a Salary?
Based on my experience working with and knowing a fairly large number of bankers, I can make one very safe assumption: those who work on Wall Street like money. If they didn't want to make lots of money, many of them would have chosen other career paths. They want to make as much money as they possibly can -- that is their central motivation. In some cases, it may be their only motivation.
With that assumption in mind, how would they make more money if they only had a salary? Remember, they'll still want to get as big a raise as possible each year. What do they do? They take the same risk they did before. In fact, they may take even more risk.
Under the bonus system, if they had a year when business was bad, then their bonuses would decline. Proof of this is clear enough in today's news -- after a rough 2011, banker bonuses are expected to be down 20 to 30%. But if they just get a salary instead, then there is no downside.
Think about it: if trades go bad, then shareholders will suffer by seeing dividends cut or shares diluted when more capital must be acquired. But every time banks have a good year, bankers will get a nice salary bump -- and that amount will be guaranteed even in bad years. Remember those guaranteed bonuses everybody was angry about a few years ago? If you were to pay a guaranteed bonus out over the course of a year in semimonthly installments, you could call it something else: a "salary."