Not all of them abused the system, but Wall Street bankers and traders could earn Croesus-like compensation packages in the past years by piling full-throttle into whatever was hot -- subprime, CDOs, commodities, whatever -- and collect an enormous bonus before the shoddiness of their creations became apparent. You know it's coming … "That's the way we do it. Get your money for nothing and your chicks for free."
Take former Merrill Lynch (NYSE:MER) CEO Stan O'Neal. You think he gives a hoot about mother Merrill's plunge in the past year? He rode off into the sunset with a $160 million golden parachute before things hit the fan. Same goes for an AIG (NYSE:AIG) derivatives executive, who was allegedly paid $1 million a month for consulting even after his division imploded. As Thomas Friedman put it, Wall Street rode on the I.B.G. Principle: I'll be gone before the bill comes due.
Credit Suisse Group (NYSE:CS) found an ingenious way to solve this problem: It's paying yearly bonuses to some of its top bankers not with cash, but with the same leveraged loans and commercial mortgage-backed debt that have crushed the financial system. If the securities plunge in value more than they already have … eh, that's their problem. They created them; they're responsible for the outcome. You break it, you buy it.
While the idea might not stick, it seems devilishly smart in terms of aligning bankers' and traders' interest with the products they peddle. With banks like Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) relying on an outsized chunk of profits from internal investing and trading, it doesn't seem crazy to demand that employees who're paid like gods put a little long-term skin in the game.
I really hope this style of compensation starts to take hold. One of the biggest reasons we're in this mess is the result of a ludicrous compensation system that praised anyone with the gall to take stupendous amounts of risk without any consideration to the consequences of that risk. After a while, it became what was probably the most extreme case of moral hazard in history. Fix the compensation problem alone, and you'd do more to overhaul a broken financial system than any number of bailouts could do.
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Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. The Motley Fool is investors writing for investors.