A failure of risk management and not compensation polices caused bank failures

Rich Lowrey:

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Besides placating the aroused gods of anti-Wall Street populism, Feinberg's crackdown is motivated by the belief that out-of-control compensation rewarded recklessness and caused the financial crisis. It'd be nice if this were true. Then we could limit pay and derive not just psychic satisfaction from it -- take that, Masters of the Universe! -- but tell ourselves we're making the system sounder. Alas, it's not so simple.

By and large, executives didn't blow up their firms in the hopes of grabbing world-shaking bonuses and then leaving; they blew up their firms because they got caught up in the bubble mentality and thought their risks weren't as dangerous as they proved. Jeffrey Friedman, the editor of Critical Review, points out that bankers were usually compensated in stock as well as bonuses, and had no interest in seeing their stock wiped out. They managed to flush it anyway.

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My experience working with executives of financial institutions is that they are not into "bet your company" gambles. They try to carefully weigh the risk. The larger the transaction the more carefully they look at risks.

What happened in the pre meltdown era, was that the people they were relying on made some assumptions about risk that proved invalid. Those assumptions had a catastrophic and cascading effect that resulted in losses that were never tied to anyone's compensation.

As Lowrey points out, a good deal of that compensation was in stock that became worthless after the meltdown.