IT Employment

Wall Street's model is broken. It can be fixed.

Much of the agony created as a result of poor results in the stock market could have been prevented. John M McKee writes that human nature and poor system designs resulted in an outcome which was very avoidable.

At BusinessSuccessCoach.net, we believe that compensation programs - for employees, managers, and executives, often result in unintended consequences. People always figure out what's best for them personally. They'll do what is required to ensure they get maximum benefit.

That, in a nutshell, is one of the fundamental problems with the Wall Street Model. It rewards players for short-term actions. Even when the outcomes of those actions could be harmful to their own clients and potentially dangerous for the organization that employees them.

Execs at companies like AIG, Countrywide, Fannie Mae, and Lehman earned huge personal earnings making decisions that resulted in a poor outcome for their customers, their organizations, and the U.S. economy. Many would have known the danger. But they were playing by the established rules. Few in such a situation would resist taking advantage of the system. After all, how long can you watch others become wealthy for doing "what's expected" by management without finally starting to drink the same KoolAid?

When designing a new compensation program for an organization, I always attempt to balance the long- and short-term goals to ensure the results are consistent with the organization's values and aspirations. Before implementation, those at the company who have broad oversight are asked to review the new program. Revisions may be made as a result of that review. I believe this is a fundamental of good corporate governance. It ensures that immediate goals are balanced with the long term viability of the organization.

As the former leader of a billion dollar organization myself, I would never advocate increasing bureaucracy, because it slows down a company's ability to compete effectively, but I'm a strong proponent of a system with checks and balances. These reality checks force everyone involved to consider potential hassles in advance. Wall Street in total has no such effective oversight.

Mega companies in the financial sectors will be often be "saved" by the Feds. That's good news for millions of people with investments or insurance programs that will now remain in place. But it's very bad news for U.S. citizens who, through their taxes, are forced to finance private enterprises that cratered while employees and management became millionaires.

The current meltdown of Wall Street has many similarities to the horror story that was a precursor to The Great Depression. Hopefully, the U.S. Government, working with the central banks of the international community, has the capacity to ensure it doesn't reach a similar outcome which would tank the world economy for years.

But we need a new model. Now.

john

Leadership Coach

About

John M. McKee is the founder and CEO of BusinessSuccessCoach.net, an international consulting and coaching practice with subscribers in 43 countries. One of the founding senior executives of DIRECTV, his hands-on experience includes leading billion d...

12 comments
The 'G-Man.'
The 'G-Man.'

Get Burnt. This kind of thing is long overdue and was just waiting to happen. Until the sector can learn to behave and accept responsibility for their actions they are just digging their own graves. Whoever said that the financial sector was 'mature' was way off. Kids and playgrounds.

PCPTech
PCPTech

I totally agree with John on this one. I worked for a blue chip finacial organisation once and the one thing that struck me when I joined was the bonusses that were awarded to strategic leaders for archieving short term results. It made them concentrate on the now at the detriment of the future. So any investment that did not return immediate results was put off in favour of short term return investments. What happened the postponed investments had to be made at huge costs in the future.

redux
redux

Rather ambitious and naive premise, John. Compensation on Wall Street is rather straightforwardly based on sales, and Congress has been up in arms about the excessive compensation to those that have compensation based on longer term results, because they've made so much money. I'd say that 'dodell' is much more on point. Regulatory constraints that have been removed over the last 30 years now allow excessive leverage -- even to the absurd level of allowing insurance companies to invest in securities that they also insure. The result is simple, obvious, and time-tested: lots of leverage leads to big crashes during down cycles in the economy. No magic, and the fault of Democrats as much as Republicans -- the Clinton crowd loosened those constraints as much, or more, than anyone. The lessons of the 1987 housing crash were entirely ignored during the Clinton excesses, and Bush, the Republican Congress, and finally the Democrat Congress now "running" things did nothing to stop the run-away train. What's happening now is no different than the 1987 hit that housing and the Savings and Loan industry took. There is one difference, however. Instead of going to the insurance industry and telling them to clean up their own mess, the Fed is providing the money to them. Stupid as hell, but it has nothing at all to do with compensation structure.

daarka
daarka

Our economy and our leaders need to focus on the insidious situation and fix the internal problem of a broken system, instead of the outcome: the huge private gains, and socializing the losses. Those outcomes will only change when they are impossible.

JohnMcGrew
JohnMcGrew

I'm not convinced that it is "broken". After all, the market is now reacting to correct what is wrong. The only problem now is that it appears as though the government isn't going to allow anything to fail, so it's going to punish those who made rational investment decisions in the name of saving those who did not. That's "moral hazard", the real problem. Feddie & Fannie reaped great profits for its investors with practically zero risk for their investors since it was always implied that the taxpayers would be there to bail them out should they fail. Sure enough, they did. So what is the "fix"? To effectively nationalize mortgage financing. Does anyone honestly think the politicians who allowed Fannie & Freddie to get so out of control in the first place are going to manage it any better now that they've got direct implicit control? It will only be about 5 to 10 years before congress will be explicitly deciding what kind of house you will be buying with that federally backed mortgage. That's what you get when the "taxpayer" is footing the bill. 2nd culprit is the tax code, which encourages debt over income. (Obama's resdistribution rhetoric isn't helping any of this) Higher income and capital gains taxes are definitely a move in the wrong direction. I guess the lessons of Enron & Worldcom (Healthy companies pay dividends; paper companies play tax games and rely upon fluctuating stock price for "value") have already been forgotten.

Locrian_Lyric
Locrian_Lyric

and right on the money, no pun intended. I was in HS when the bank mess first started, and I recall discussing it in our current affairs class. Then, as now, the action that precipitated the mess was congress encouraging banks to lend money to 'emerging markets' in poor countries. Well, one after another defaulted and we the people had to bail the bastards out then, as now.

JohnMcGrew
JohnMcGrew

...was instead of encouraging lending to "emerging markets", back in the '90s, congress was berating the banking industry for not doing enough for "the poor" in this country. Hence, the "subprime" mortgage was born. Just wait a few years now they they have direct control over Fannie & Freddie; sooner or later they will be directed to write loans to "the poor" directly subsidized by their other paper. This will go on for 20 years or so until their books get lopsided and it all melts down again.

CareerCoach
CareerCoach

Do you agree that more governance could help fix this situation?

dodell
dodell

Over the last 30 years the safeguards that were put in place after the crash of '29 have been removed. The situation we are in now was the predictable result. Not all regulation is bad. You're right. People will generally act in their own short term best interest. We need regulations that guide us to move in the direction of greater good and long term gain for all.

TonytheTiger
TonytheTiger

[i]We need regulations that guide us to move in the direction of greater good and long term gain for all. [/i] Whose definition of "greater good" are you going to go with? What if it turns out to be wrong? Now you have a whole herd of cattle heading toward a cliff! I am not convinced that this bailout is the best thing. Bailing out those who have shown poor business practices (including consumers) is only going to perpetuate those practices. Failures are supposed to fail. Let them. It's the only way they'll learn.

RFink
RFink

As long as Wall Street is focused on quarterly earnings reports this will continue to happen. Wall Street thrives on stock movement. It doesn't matter if it goes up or down. People only make money if it moves. The more the merrier.