A Good One From Last November

This gives the correct history of how the problem started organizationally. Partnerships, not public corporations, assurred that Wall Street would be careful.Law firms are partnerships.


Op-Ed ContributorOur Risk, Wall Street’s Rewardnew_york_times:http://www.nytimes.com/2008/11/16/opinion/16cohan.html

By WILLIAM D. COHAN
Published: November 16, 2008

AFTER nearly 18 months spent doing triage on one of the worst financial crises in our nation’s history, there is now a shred of hope that those who are in a position to do something about the root cause of the problem — Wall Street’s bloated and ineffective compensation system — just might act.Late last month, first Representative Henry Waxman, chairman of the House Committee on Oversight and Government Reform, and then Andrew Cuomo, New York’s attorney general, demanded from the surviving Wall Street chief executives reams of data about their bankers and traders who were paid more than $250,000 in the past few years. The two politicians also asked for information on bonuses this year, which is destined to be one of the least-profitable ever on Wall Street.The impetus for the requests was the $125 billion these firms just received from the Troubled Asset Relief Program and the genuine concern that part of that money would be used to pay 2008 bonuses rather than to shore up firms’ capital or to begin to thaw the frozen credit markets.Whether Wall Street will come to its senses on its own about the way it pays and motivates its people, or will be forced to do so, remains to be seen. But there is no question that compensation reform in the securities industry is desperately overdue.Once upon a time on Wall Street (where I worked for nearly two decades), firms were smaller, less capital intensive partnerships. The beauty of the partnership agreement was the collective liability clause it contained.For instance, at Lazard, where I spent six years when it was a privately held partnership, the partners moved forward into the marketplace like a school of fish. When the partnership as a whole made money, partners (and some non-partners like me) shared in those profits based upon a point system that our patriarch, Michel David-Weill, established at the beginning of every year. When partners messed up — as a few did in the firm’s municipal finance department in the 1990s, forcing the firm to pay $100 million in fines, restitution and legal fees — the burden of the mistake was also shared by all, through a reduction in the pre-tax profits of the firm.The punishment for that misadventure was ruthless: not only did the partners involved get fired but Mr. David-Weill quickly shuttered the whole department. This is because the status of the firm was held very important — so much so that senior partners would often reject a particular assignment solely because of the risk that the firm’s image might suffer from the deal. The formula worked magnificently, if the preponderance of satisfied clients — and the Fifth Avenue and Hamptons addresses among the partners — was indicative of anything.But this quaint system began changing a generation ago when one venerable partnership after another decided to grab the riches available by selling shares to the public. What started with Donaldson, Lufkin & Jenrette in 1969 became a Wall Street stampede that eventually included Merrill Lynch, Morgan Stanley, Goldman Sachs and even 157-year-old Lazard, in May 2005.The result has been calamitous. The collective liability clause honored by partners was replaced with a system where bankers and traders were encouraged to take short-term risks with shareholders’ money. Gone, too was the idea of being held responsible for your actions (short of outright fraud). Managers at publicly traded banks constantly exhorted their traders to do bigger and bigger deals and to take increasing amounts of risk, and then rewarded them with millions of dollars in compensation — money that belonged to shareholders. Reputations were made not by turning down imprudent business but by seeing how much business could be done.The fallout of 25 years under this compensation system is strewn everywhere; the inevitable consequences of encouraging smart people to take risks, free of accountability, with other people’s money are easy to fathom. As innovative products emerged on Wall Street, the compensation system pushed bankers and traders to sell them, to inevitable and disastrous extremes.
1
2 Next Page »

William D. Cohan is the author of “The Last Tycoons: The Secret History of Lazard Frères” and the forthcoming “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street.”