Open for the same risky business

Employees who can take low risks and make large profits should be rewarded. Compensation schemes in the past have inappropriately incentivized employees to bet the farm using the firm’s money. For the health of these companies and the economy, this practice must be stopped.

The argument used by banks is that top salaries attract top talent and keep us competitive. This logic is flawed. Risk-focused compensation schemes caused the demise of many companies and harmed the economy. And while many executives walked away from the wreck with millions, shareholders were left with billions of losses.

Banks and excessive compensation schemes are an old story. It is disturbing to see that as banks begin to regain their financial footing, they feel it is appropriate again to pay out oversized bonuses. It is estimated that compensation levels for many of the nation’s major financial institutions could top $140 billion this year, an increase of 20 percent and higher than pre-crisis 2007.

This recession, which has given pink slips to almost 10 percent of the workforce, was driven, in part, by excessive compensation schemes that promoted excessive risk-taking. Some financial institutions - such as Bank of America and Citibank - were ultimately propped up by the government because they overdosed on risky mortgages.

Commercial banks serve an important role in citizens’ daily lives and in the overall financial health of the economy. An economy can only be as strong as its banks, so keeping banks strong, healthy, and out of trouble is paramount. In banking, oversized compensation schemes should be viewed as public enemy No. 1. Such excessive payments are in direct conflict with the public good.

Bank of America and Citibank are examples of financial institutions that need to reduce their risk-taking appetite. As these institutions rake in more profits, they should be plowing these earnings back into their companies and rebuilding the very capital base that has been eroded over the last few years. To pay out greater bonuses now is short-sighted and financially irresponsible to shareholders, the economy, and the many citizens who depend on banks and have lost jobs.

Other risk-taking banks - including Goldman Sachs and Morgan Stanley - are now under the regulatory power of the Federal Reserve Bank. They received government assistance in their time of need and now it is time for them to behave as better corporate citizens and rein in excessive pay packages.

The solution is simple: Banks that are too big to fail, and which have received the government protection that goes along with this designation, should be required to reduce excessive risk-taking activities. The first place to start is to downsize compensation packages. Smaller banks not deemed too big to fail can take greater risk but also know that they do so at their own peril and government help is not an option.

Banks such as Goldman Sachs and Bank of America have rushed to repay government TARP support as a sign that they are now strong again and can be left to their old risk-taking ways. The banks that continue to push for the same old oversized compensation schemes fail to realize that the rule of the game have changed.

Bankers need to realize that their role is to stay healthy, earn a respectable profit, and not bet the farm.

Mark T. Williams, a former Federal Reserve Bank examiner who teaches finance at the Boston University School of Management, is writing a book on the fall of Lehman Brothers.