Bloated CEO compensation wasn’t the cause of the economic collapse according to a study cited by Floyd Norris in the NYT. Maybe not, but giant bonuses for incompetent management and dangerous traders make people really angry, especially when it comes out of our wallets.

The paper, which is surprisingly clear, was written by two European professors at Ohio State, René M. Stulz, and Rüdiger Fahlenbrach (abstract here, download available ), to test the hypothesis that the compensation to CEOs was not aligned with the interests of shareholders, and encouraged excessive risk-taking. It concludes that the compensation packages at banks were heavy on stock and option grants, and that the CEOs held a substantial amount of the outstanding stock of their institutions. As a result, their interests were aligned with shareholders.

Norris draws this conclusion:

… there is plenty of evidence that no one who counted — traders, chief executives or regulators — understood the risks that were being taken.

The professors identify this problem (p.1):

A plausible explanation for these findings is that CEOs focused on the interests of their shareholders in the build-up to the crisis and took actions that they believed the market would welcome.

Citizen rage was not related to alignment with shareholder interests. It is caused by the horrifying results, and the blindingly obvious incompetence that caused the debacle. CEOs and traders didn’t comprehend the risks they were running. Traders tried to game the system. CEOs were ignorant and incompetent in letting them do it without understanding what they were doing. Worse, CEOs were managing their institutions to please the market. That market consists of their peers in the stock-trading business, in other words, people just as ignorant and arrogant as they were.

People understand compensation for good results. What they can’t understand and won’t forgive is pouring money into the pockets of failures like the Wall Streeters. They got rich at our expense, what with the likes of Enron and the phony California power crisis, WorldCom with Citigroup’s Smith Barney cheerleading all the way into bankruptcy, asset bubbles in housing, fake trading in stocks and commodities and all the rest. When it became clear that it was all a mirage, the anger exploded, and while the occasional bright shiny object distracted the media, the hostility seethed below, enough to influence a Congress normally in the pockets of Wall Street. The recent report by Andrew Cuomo, Attorney General of New York, was enough to push something through Congress.

The House passed a law Friday that according to the NYT

…gives the Securities and Exchange Commission, among other federal regulators, nine months to propose rules for regulating compensation packages at institutions whose assets total more than $1 billion.

When TARP passed, a lot of angry people complained about the failure to control compensation at these large banks, because it only dealt with a few top executives. This bill has the potential to defuse the entire situation by limiting all compensation to all of the market participants, including the greedheads at Goldman Sachs, whose bonus pools dwarf the payouts to shareholders whose money is at risk of their trades.

Norris is right to point out that regulations won’t do the job, and that the Professor’s solutions aren’t likely to work either:

I asked Professor Stulz what he thought of the bill. “It is hard to believe that regulators will be better at devising compensation plans with proper incentives,” he said. “Properly designed capital requirements are a much more efficient approach to regulate the risk of financial institutions than fiddling with compensation.”

Indeed, much of the financial “innovation” of recent years consisted of bankers coming up with ways to evade capital requirements. The regulators are now trying to deal with that, but their efforts are handicapped by bankers warning that they will maker fewer loans if capital rules are tightened.

Blackmail, much? There is a great way to control these perverse practices. Taxes. Tax the company and tax the income of the trader. Taxes will discourage pointless paper transactions and high frequency trading. It won’t be perfect, but at least it will cut the deficit, and help with the enormous problem inflicted on this country by the financial elites.

Congress could characterize it as reparations in the class war.