Warren Buffett interview...calls for downside in compensation schemes... plus my rant

In an interview covering the payments industry, Warren Buffett today called for Wall Street to implement downside penalties into their compensation scheme. Thanks to New York Times' DealBook for bringing it to my attention. You can access the video interview here.

The compensation problem is not an easy problem to fix for two reasons.

First of all, shareholders of financial institutions have shown themselves to be happy with the current scheme. I mean, can anyone think of too many shareholders, even the majority shareholders who lost massive fortunes, of companies like Citigroup or AIG, complaining about compensation schemes? I have been following the markets a lot during the financial crisis and I haven't seen any strong calls for compensation reform. As far as I'm concerned, it is up to the owners, which means shareholders for public corporations, to control compensation. They are the ones that pay the employees and if they can't control their own compensation policies and the compensation consultants they hire, no one else can. Certainly the government can't control compensation (the govt also should not get involved too much or else you will end up a system where politicians will dictate business and we end up looking like a quasi-totalitarian state where the political class rules.)

Secondly, many financial institutions on Wall Street, especially the investment banking side, are more akin to casinos than a bank. These firms are run for their employees. That is how they have been historically; that is how they are now; and that is how they will be in the future. Investors in such firms are simply along for the ride. There is no way anyone, including Warren Buffett, can know what is going on in Goldman Sachs (Buffett was making a political bet and even said so himself—he said he wouldn't have invested if the government didn't backstop the company or provide literally unlimited low cost funding by allowing them to be a bank.) Neither could any shareholder have known what was going on in Bear Stearns. Or Lehman Brothers. Or Morgan Stanley. Or you-get-the-point. Some might argue the bears and short-sellers knew something but even that is not fully correct. Many who profitted off the collapse of some of these firms had no idea what was going on. Even short-sellers who are given credit, such as David Einhorn with Lehman Brothers or William Ackman with the monolines, completely misjudged the situation.

So, I think the two issues are intertwined. The reason, I believe, shareholders don't crack down on compensation for poor decisions is because they are 'in for the ride' and will lose their seat at the casino if they did. My impression is that the skewed bets are intrinsic to Wall Street and cannot be fixed. Investment banks and related businesses will always be run for the benefit of employees and, shareholders who wish to participate, need to shut up and watch. If things work out, shareholders make a killing—many financial firms had very high ROE in the 90's and 2000's—but if things blow up, well, shut up and walk away with your losses...


  1. The problem though is that it is more or less okay for shareholders to be along for the ride while employees grab all they can and get dynastically wealthy in a few years, shareholders at least have an "out" by selling. But now taxpayers are along for the ride as well.Banks, all of them, get massive subsidies. Turning right around and paying those subsidies out to employees amounts to looting the taxpayer directly. One way or another it has to stop. since the industry has made it crystal clear they will fight tooth and nail against any curbs crass government intervention seems inevitable.

  2. Sivaram VelauthapillaiOctober 22, 2009 at 7:59 PM

    Are you still bullish on the US$? Or more precisely, bearish on the Euro?

    I'm getting killed... most of my holdings are in US$-denominated stocks... I'm still bullish on the US$ but it's getting ugly...


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