Banks Buy Toxic Assets

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The PAF, of which the bonus portion was about $650 million, pays interest to the employees for eight years. It has fairly high leverage, with a debt-to-­equity ratio of more than five to one, so if the assets recover by 15 percent, employees will double their money. They also share some risk if its asset values fall. “It cannily reverses the phenomenon of paying bonuses on profits that later vanish. They are now paying bonuses on profits that only materialize over the long term,” says Robert Salwen, a compensation lawyer and consultant. “It gives the employees a real-world incentive to bring these assets back.”

Setting up the PAF raised some fascinating issues. Top managers made sure that the team that devised the PAF didn’t participate in the bonus plan, to prevent them from cherry-picking good assets for their own bonus packages.

The structure is almost the Platonic ideal, the one that Wall Street bankers might have created for all those toxic securities if they knew they were going to own them in the end. No single asset makes up more than 5 percent of the PAF’s portfolio, which includes corporate and leveraged loans and commercial-mortgage-backed debt. They come from the Americas, Europe, and Asia. Credit Suisse is financing the vehicle, so it has what’s known as patient capital—nobody will demand that the PAF pony up more collateral if the assets plunge in value. The bank has also contemplated selling interests to outside investors. Indeed, Geithner’s plan—for private investors to purchase toxic assets from banks—has strikingly similar leverage and financing.

Some employees initially objected to getting saddled with toxic assets, arguing they should be going only to those who created them. Paul Calello, head of Credit Suisse’s investment bank, decided everyone would participate “because we all share the responsibility for the performance of the division.” Good times had raised their boats; now they would share in the bad.

What a novel concept. Credit Suisse officials told me they are wondering why no other banks have followed their example. But is Credit Suisse’s approach a solution to the problem of excessive pay on Wall Street—and excess boardroom pay in general? Not really. Even with the PAF, the employees don’t suffer the whole pain; the bank has taken the bulk of the hit. “This is very different from looking back and trying to give them something that reflects their past performance,” says Lucian Bebchuk, a specialist in executive-compensation issues at Harvard Law School. To have done that, the assets would have to have been given out at their original value.

Pay is going down now on Wall Street. That simply reflects losses and, more recently, public outrage and media pressure. Companies and financial firms will “do something to placate those pressures” but will most likely lose interest. “The problems will reemerge,” Bebchuk says.

The compensation problem is not going to correct itself. Sure, the Obama administration and Congress have implemented some constraints on the pay of bankers whose firms received government aid. But the administration’s plans were toothless, and Wall Street immediately set to work evading the congressional restrictions. Taxing bonuses at 90 percent is simply a bad idea. Ad hoc and emotional responses to outrages, however legitimate, usually fail.

Britain’s Financial Services Authority is threatening to regulate pay in general. So should the U.S. government. It should mandate permanent, serious regulation of banker pay, and not just for firms receiving equity injections from the state. The government’s lending saved the financial system; it can require changes. That means restricting compensation—not just some portion but the entire package—in order to tie it to long-term performance, not just of the company but of each individual’s product. The way to do that is through changes to the tax structure, but ones that are carefully thought out. Without such changes, Wall Street bankers will continue to give them­selves what they think they deserve. And they never think they deserve less.

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