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."
Going Back to the Partnership Structure
Taleb suggests that investment banks go back to what they used to look like a few decades ago -- where they were partnerships instead of publicly traded companies. This idea does have some attractive features, as the employees all share in the losses. But that also makes it somewhat unattractive for certain employees: if one trading group has a miserable year, then everybody suffers.
Here's the problem: investors love financial firms. Taleb oddly points to the recent failure of MF Global as an example of the dangers of excessive risk-taking. But that situation actually demonstrates exactly what should happen. A financial firm took big risks that went bad, and it failed. Its investors lost money. No investor was coerced to put money into MF Global. If they didn't like risk taking, then they could have invested in a utility, a Dow component, or a U.S. Treasury. They knew what they were getting into and wanted a chance to reap the significant return that a company like MF Global offered.
The problem, however, is that some institutions are still probably "too big to fail," which means that they will get bailed out by taxpayers -- not just shareholders -- if they go bad. That is certainly a serious problem. But converting investment banks into partnerships won't help.
For example, if Lehman Brothers was a partnership back in 2008, would its failure have been any easier to handle? It's hard to see how. Instead, the employees -- and not shareholders -- would have taken all of the equity losses. Those equity losses didn't cause a financial crisis, however. The problems that caused the crisis stemmed from other firms having loaned it money and/or having derivatives exposure with the bank. Even if a bank is a partnership, its bailout may still be necessary if financial stability is threatened by its collapse.