Bonuses, Risk, Crash

Posted July 19, 2009, at 6:48 p.m.

Record second-quarter profits by Goldman Sachs and J.P. Morgan Chase brought a stock market surge but raised worries about the future: Are we headed for another boom such as the one that led to the current bust?

One cause of the latest bubble and the present mess was the banking culture of huge and unrecognized risks, outlandish profits and enormous bonuses at the end of the year, in a seemingly perpetual uphill tide of prosperity.

Now comes the Goldman report that it has posted its richest quarterly profit in its 140-year history and has set aside $11.36 billion so far for its workers’ compensation and benefits during the first half of this year. As The Wall Street Journal put it, the profits came from the “churning of huge trading gains by revving up risk-taking.”

The planned Goldman payout is enough to give each employee $386,420 for the half-year, for an average of about $770,000 this year if the trend continues. These are averages; top executives stand to get many times as much. Early reports said nothing about Morgan’s payout plans.

Spokesmen for Goldman and other big financial firms say that high pay and bonuses are essential to keep their people from straying to other companies.

There is some truth in that, but the trouble is that rewarding quick profits from risky bets helped bring on the present deep recession. And the Goldman largess may tempt the other remaining big banking firms to return to a high-risk pattern. They are already lobbying against regulation of derivatives, the investment products based often on risky mortgages and other debt that figured in the meltdown.

The Journal reported that Goldman increased its risk-taking and by the end of the quarter had raised its “value at risk” by 33 percent from a year ago to $245 million.

This measure, known as VAR, is an estimate of how much the company could lose in a single day.

What to do about it? The Bush administration ruled that corporations could deduct no more than $500,000 from their taxes for total payouts to a senior executive.

Now the Obama Treasury has sent to Congress proposed legislation that would require independence of members of compensation committees and their consultants and legal counsel. Another proposal would require an annual nonbinding shareholder vote for all publicly owned companies on compensation packages including retirement plans and any golden parachutes.

Avoiding actual pay caps is probably wise, but simply leaving the question of executive compensation to the shareholders may not be sufficient to cut back the explosive growth of executive salaries, bonuses, retirement packages, golden parachutes and other benefits.

Bolstering shareholder supervision of executive pay should benefit most shareholders, but in the case of giants such as Goldman and Morgan, it isn’t just their shareholders who need help. When a firm deemed too big to fail collapses through greed and risky bets, the whole economy suffers. That should not happen again.

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