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Pining For The Days Of Wall Street Partnerships

Alan Blinder makes a good point in his Wall Street Journal op-ed today about executive compensation and the excessive risk-taking it tends to encourage:

[C]ompensation schemes exacerbate these natural tendencies by offering them [traders] the following sort of go-for-broke incentives when they place financial bets: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. ...

Not so very long ago, banks shied away from big gambles on securities and investment banks were organized as partnerships, not corporations. In a partnership, the firm's capital is the partners' own capital, which they safeguard with the care you'd expect when using MOM -- My Own Money. Back then, the upper echelons of Wall Street firms were not keen on giving a bunch of unruly 28-year-olds a lot of big coins to flip.

I'm not entirely sure what the upshot is, since you can't prevent a partnership from going public if it wants to, like Goldman et al have done in recent decades. But Blinder is exactly right that bonus-heavy compensation (with little penalty for placing bad bets) is a big part of what drives crazy risk-taking on Wall Street. You can regulate the risk-taking itself all you want, but until you figure out underlying compensation issues, you're probably not going to dent it much.

--Noam Scheiber