Hobbling Goldman

By Felix Salmon
October 13, 2009
Andrew Ross Sorkin today picks up the Law of the Excluded Middle and runs with it, in a column headlined "Don’t Fail, or Reward Success":

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Andrew Ross Sorkin today picks up the Law of the Excluded Middle and runs with it, in a column headlined “Don’t Fail, or Reward Success”:

We can’t have it both ways, either. At one moment, many in the nation crossed their fingers hoping Goldman and the rest of Wall Street would be saved to halt the country’s downward spiral. But when the banks finally get up on their feet, we want them to fall flat again. Mr. Blankfein can’t win.

It’s true that we didn’t want Goldman Sachs to fail. But that’s got nothing to do with some kind of national wish for Lloyd Blankfein’s continued success, and everything to do with the fact that Goldman Sachs is too big to fail. Had the natural order of capitalism been allowed to work its course, then AIG and Morgan Stanley and Goldman Sachs and Citigroup and Bank of America and the rest of the financial system would have essentially imploded. Needless to say, that would not have been good for the economy as a whole. But just because we need these banks to exist does not mean that we want these banks to make enormous profits.

Sorkin does, eventually, arrive at the nub of the argument:

The bad news is the absolute number. It is far greater than any other bonus figure on Wall Street. Goldman says that its compensation program is based on pay for performance, and it is hard to argue that it has not performed well.

The company also says that it needs to pay these large sums to retain its best people or risk losing them to rivals. That may be true for a small percentage of its most senior executives, but some experts suggest it is a disingenuous argument…

Indeed, it is possible that Goldman’s bonus largess is creating a vicious circle: other, perhaps lesser firms, are probably going to pay even higher bonuses to try to compete with Goldman.

And therein lies the rub: While Goldman may have the Midas touch, the rest of Wall Street never seems to be able to keep up. And the only way for rival firms to compete with Goldman is take to outsize risk.

Believe it or not, there’s a simple (if not easy) solution to this problem: Goldman should just pay its employees less money, and have more left over for shareholders. That’s not asking Goldman to “fall flat”, it’s just asking that it not contribute in a harmful way to the culture of risk-taking that pervades Wall Street.

How should Goldman do this? One way would be by putting a cap on bonuses. Most people, in most jobs, don’t get any bonus at all. When there is a bonus, it’s generally small: maybe a thousand dollars here, 5% there — enough to buy some nice Christmas presents, perhaps, but not enough to buy a small Latin American nation.

It’s entirely conceivable that if Goldman started paying its bankers less money, the firm as a whole might become less profitable. From a public-policy point of view, that’s fine: the nation has no particular interest in Goldman making spectacular amounts of money every quarter. From a philosophical point of view, there’s a bit of a problem with artificial restraints on trade, but that’s something which goes hand in hand with too-big-to-fail status. If you’re a small investment-banking boutique, feel free to pay your people as much as you like. But if you have a trillion-dollar balance sheet and pose a major systemic risk to the economy, then you lose that freedom.

So the answer to the question Sorkin poses in the question is, essentially, “yes”: we don’t want Goldman to fail, and neither do we want Goldman to reward success in the way it has of late. What we do want is less excess and less systemic risk. Allowing a super-sized Goldman to pay out untold billions in bonuses every year — even if they’re cleverly structured in the form of slowly-vesting stock — achieves neither of those aims.

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