The New Wall Street--Part II

It is clear nobody in government understands what drives Wall Street employees. Of course, the common thinking is it is greed and that is true. Sometimes such greed can lead to too much risk and large losses. That is what helped create the financial crisis in which we find our country. However, not everybody employs undue risk to make outsize profits.

Many successful Wall Street pros utilize sophisticated risk management techniques coupled with their intelligence to return high profits. The new administration and its congressional counterparts want to punish Wall Streeters for their previous misdeeds by limiting bonuses to $400,000. This may still seem like a lot of money and the government, who has saved many of the banks from demise with TARP funds, believe they have the right to set these policies.

We disagree as the brain drain from Wall Street will not only occur in droves but it will lead to reduced profitability at the banks and raise the risk of U.S. taxpayers losing TARP money. Here is why. Let's use a simplistic example. Suppose Wall Street Firm "A" has 2 employees. One employee is extremely bright who carefully manages risk while investing firm money. He generates $20 million in profits and deserves a bonus of 10-20% of these gains. The second employee takes excessive risk and loses $10 million. He deserves no bonus. Under this scenario, employee number 1 would get a bonus of $2-4 million whereas employee number 2 gets no bonus. The firm would have earned $10mm less employee 1's bonus resulting in net earnings of $6-8 million.

Now the government steps in and imposes a $400,000 maximum bonus on all employees at this TARP funded bank. Employee number 1 will be extremely upset as he knows his hard work and intelligence generated $20 million in profits for his firm. He also realizes he can either set up his own firm or move to another firm which doesn't have any bonus restrictions. Upon his exit, Wall Street Firm "A" is left with employee 2. The firm now would generate a loss of $10 million. Certainly such an adverse event will not lead to the payback of TARP money. In fact, such a result is likely to occur at all TARP funded banks and once again, the government will have tried to appease the general public but wind up losing taxpayer money as it weakens the banks that are already in financial distress.