"The Rot At the Heart of Wall Street"

Real Clear Markets today gave this apt moniker to a fine piece by finance writer William D. Cohan, whose remedy for the rot is soooo simple:

What if every senior Wall Street executive had to worry that he could lose his entire net worth at any moment — including his mansions in Greenwich, Conn., and Palm Beach to say nothing of his job — if the revenue he was generating turned out to be unprofitable or excessively risky?

Does this loser-lose-all system sound impracticable today? Of course it does, given Wall Street's refusal to abandon the winner-take-all system that gave us the financial meltdown of 2007-2008. But as Cohan notes, Wall Street wasn't always addicted to risk: the Great Depression triggered a loser-lose-all system that worked just fine until 1970:

As with so many simple and obvious solutions, this one has the benefit of having a long track record of success. Once upon a time — not so long ago — this was how investment banking compensation worked. During the Golden Era of Wall Street, the years between the reforms of 1933 and, say, 1970, Wall Street was a series of small, private partnerships. If a firm made money in a given year, a partner would receive his share of the pre-tax profits. If the firm lost money, a partner was liable for his share of those losses up to and including his entire net worth. In those days, Wall Street stuck to prudent risk-taking.

Cohan's column then gives a nice overview of the risk-friendly corruptions than began in 1970 "when a small Wall Street partnership — Donaldson, Lufkin & Jenrette — decided to go public." His piece, modestly titled "Lehman’s Demise, Dissected" actually focuses on Anton Valukas' recent 2,200 page report documenting the off-balance sheet machinations of Dick Fuld (cropped to look evil, at right) and his crew at Lehman Brothers. Cohan's commentary on key passages of the report is here.