Sunday, March 1, 2009

How To Compensate Financial Executives

First, let us think what a financial institution is before we bother with the executives that run it or how they can be compensated. It has been suggested and often repeated that a financial institution is a utility. As such, it is too important to fail thus, when one falters, it must be bailed out because if not, the failure will trigger the domino effect and cause the other institutions to fail also. This will cause the economy to collapse and will put an end to Civilization as we know it.

Okay, we are persuaded by the argument and shall proceed with the discussion based on the points brought to the fore by it. So then, what are the responsibilities of the executives who run these financial utilities? Well, it is clear from the argument that the first responsibility of the executives is to see to it that the utilities do not court danger which is something they can easily do by not taking unnecessary risks.

And there are two kinds of risk. There is the risk of giving out imprudent loans which, as an act of contrition, the executives have publicly resolved never to do again. And they displayed both the contrition and the resolve as they responded to the near collapse of the financial system, a happening they readily admitted they were instrumental in causing.

And there is the risk of experimenting with new products, a concern that the executives have not yet addressed. We must therefore address the concern ourselves which we can do by giving the financial executives the following instructions: Stay away from experimenting. When you run a utility, whether it is a private one or a public one, you do not experiment. Period.

What flows from this is that we now have a definition for the executive of a financial institution. In simple words, he or she is a technician not an innovator, a boring accountant, albeit a glorified one who never gets bored doing the same thing day in and day out. These executives do the work assigned to them like the disciplined soldiers who never dream of dabbling in something as sexy as derivatives whether the latter look plain and little exciting or they look exotic and very much enticing.

So then, how do you compensate these people? Well, you give them a boring salary that rises from time to time in relation to the rise in both the cost of living and the productivity of the economy as a whole. In fact, this is how things used to be until someone in America decided to follow the European model and combine Commercial Banking with Investment Banking but run the operation in the style of Cowboy Capitalism.

Thus, while the Europeans managed to run their operations for decades without taking the world near to a catastrophic collapse, it took the Americans less than two decades to copy the model and abuse it so badly as to change it from being a useful tool serving the economy to a weapon of financial mass destruction that almost destroyed the world economy and with it any hope of convincing humanity that America is anything but a one nation wrecking crew.

But we are here now and we recognize that it will not do much good to draw parallels between the old European model, the old American model and the developing Global model that is emerging from the wreckage of the events which jolted the world and still threaten it. What is important is that we debate the situation as we find it and try to think of ways to put together a system that cannot be utilized to push the world close to another catastrophic failure.

To this end, we must be cognizant of the following points:

First, a financial act is not a product that has an intrinsic economic value. Rather it is an act of logistical support designed to facilitate the making of goods and services which are the products that have an actual intrinsic value. As such, finance does not in itself add to the wealth of nations even though it has the effect of swelling the GDP. The people who misuse the system of finance do so by inflating into a bubble the work of someone else whence they take an unusually big cut for themselves, or they swindle the public by transferring wealth from the account of their clients to their own account and to those of their collaborators.

Second, financial workers can be viewed as pilots who navigate known waters most of the time but also uncharted waters some of the time. They go on their daily journeys with tried and proven methods, and follow strict rules using detailed maps and calibrated instruments. They are instructed not to deviate from a preordained route unless they encounter an emergency but if they deviate and fail to explain the emergency, society must become suspicious of their intention and take steps to protect the system by dismissing the offending individuals.

Third, the executive of a financial utility does not necessarily have to follow a given course as if it were a railroad or a subway track. The course can look like a bus route with a certain amount of discretion given to the conductor. But what the latter must remember is that he or she is not on a safari with unlimited discretion to fellow their hunches. A safari is an adventure and you do not take the people’s money or the economy of a nation onto an adventure.

Fourth, in financial matters you do not invent a product and create a need for it; you wait for the need to arise and work out a solution. As you do, you custom-make the solution to exactly fit the needs of a specific client rather than make the solution so universal that you can sell it without modification to other clients.

Fifth, to say that you are creative in financial matters when you practice cowboy capitalism often means that you are prone to putting together a swindle such as a ponzi scheme. It is therefore useful to be constantly reminded that financial services are essential and that they are regulated like a utility. Consequently, steps must be taken by the authorities on a routine basis to audit the financial institutions and to make sure they are not deviating from the course previously set for them. And this should be done even when there is not a whiff of scandal floating in the air.

Given all of that, the people in charge of selecting officers to run a financial institution must remember that you do not appoint a compulsive gambler to head the Lottery and Gaming Commission. You do not appoint a pyromaniac to head the Fire Department. You do not appoint Dracula to head the blood bank. You do not appoint Jack the Ripper to run a house for recovered prostitutes. By the same token, you do not appoint financial innovators to run an institution such as a bank, an insurance company or any weighty financial institution.

And you certainly do not reward a financial innovator for his invention anymore than you would the gambler, the pyromaniac, Dracula or Jack the Ripper for the deeds they commit. Those who want to innovate should stay away from the banks and perhaps get into the hedge fund business where they will deal with their own money and be more careful with it rather than handle the other people’s money and be as careless as a cowboy banker. However, this does not mean that hedge funds can escape regulation; they should be regulated if only because a large fund that goes down can take the economy with it.

You must also keep this in mind: A financial worker who asks to be paid a high salary and who threatens to leave and go work for the competition if not spoiled like a rotten child should be treated with a kick in the rear end and paid to go work for the competition, preferably your worst enemy. Financial workers that are powered by this kind of mentality are phony like a three dollar bill because when they talk like this they admit they want to use your institution to inflate bubbles and to erect ponzi schemes. And these, my friend, are the seeds of a crime in search of a fertile ground on which to sprout. Do not hand your institution over to them.

There was a time when young "geniuses" who could whip up a computer virus were admired for their talent but no more. In a similar sort of way, the time has come to treat the financial "geniuses" who can whip up a shady scheme like the pariahs that they are. And if they don’t like the dough you are offering them in banking, they can go and eat cake somewhere else, maybe a place they should call the Marie Antoinette Hedge Fund for the rich but still hungry suckers. These geniuses do not deserve our admiration; they deserve our contempt.

In any case, talk has now surfaced to the effect that some of these people are looking to set up their "boutique" operations so as to compete with the firms that refuse to pay them outrageous salaries. Well, as the saying goes, the more the merrier. Let them multiply like rabbits and give a grand display of their unique abilities. When all is said and done, those that obey the law will become a cherished asset of the capitalist system because they will have enriched it. And those that violate their fiduciary duties will be dealt with in a manner that will deter them from offending again.