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Getting Past the Rage Stage

First came the shock over how badly our financial system messed up. Now comes the outrage over how well it got paid for doing so. We've always known that Wall Street bankers got paid too much. Now we know a lot more about how much. Thanks to New York State Attorney General Andrew Cuomo, we have a count of the million-plus earners at the big banks: 953 at Goldman Sachs last year, more than 1,600 at JPMorgan Chase , and 738 at Citigroup , the country's biggest recipient of government disability aid.

Bank of America branch, New York City.
Oliver Quillia for cnbc.com
Bank of America branch, New York City.

Bonus rage is a natural reaction to hearing just how out of sync with ordinary life Wall Street salaries are. It's freighted, understandably, with huge political symbolism. Unfortunately, it's also a major distraction from a lot of the real problems of the banking system. The rhetoric of bonus rage says that we can fix the financial system by cutting mega-paychecks and going back to basic principles of moderation. That sounds great. But look more closely and some of the very companies that are now being lauded for their relative frugality, such as Bank of America, are among the worst actors on the financial stage—costly to the government, dangerous to financial stability, and poisonous to consumers.

A spate of stories, such as this in the New York Times Dealbook blog or this one on the finance site Breaking Views, have talked about how hard it will be to integrate Merrill Lynch's well-paid "Thundering Herd" of brokers into Bank of America's "culture of thrift." At first glance the numbers in the Cuomo report seem to back this notion of Charlotte, N.C.-based Bank of America as a thrifty institution, a stark contrast to its profligate New York cousins. JPMorgan Chase paid out $1 million or more to 1,626 of its employees in 2008. Bank of America has slightly more workers in total but kept the number of million-dollar earners down to 172. Surely this "culture of thrift" and relatively moderate compensation must be a good thing, right?

Well, for Bank of America's customers, no. BofA has long been the pacesetter in consumer-bashing bank practices. Take any metric you like. The first bank to raise ATM charges to $3? Check. Minimum payments structured so that credit card borrowers unwittingly exceed their limits and get hit with interest rate boosts to 30 percent? Check. Arbitrary credit card rate increases to sky-high rates? Check. (Though when I "opted out" of the preposterous rate increase on my own Bank of America credit card, at least their customer service rep had the good grace to good-naturedly say that I was doing the right thing. Give 'em citizenship points for that.) The pièce de résistance is loan modification. While JPMorgan Chase has begun making modifications for 20 percent of its mortgages and Citi for 15 percent, Bank of America has moved to adjust only a meager 4 percent of its loans.

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You would imagine that Bank of America, so careful with its salaries and so stingy with its customers, would have to have done stunningly well for shareholders. Again, no. At least, unlike some other institutions, Bank of America remains in business. But its share price is now not just much lower than it was at the height of the bank bubble (no surprise there), but less than half of what it was 13 years ago, in 1996. Incredibly, even at its inflated share price of about $50 at the peak of the bank boom, Bank of America had underperformed the market for a decade. Driven by Ken Lewis' still unsated mania for acquisition, BofA has grown bigger, but investors sure didn't benefit. And so, in sum, the poster child for bank industry thrift has managed to achieve the trifecta of a) punishing its customers, b) punishing its investors, and c) still requiring a massive federal bailout.

Since the collapse of Bear Stearns and Lehman Bros. and the beginning of the financial crisis, the country's leading commercial bankers have tried mightily to spin the collapse of the financial system as the doing of a small coterie of highly paid Wall Street investment bankers. After then-Treasury Secretary Hank Paulson's hashing out of a rescue plan with bank leaders, Wells Fargo's Dick Kovacevich loudly complained that stable, well-capitalized banks such as his shouldn't be tarred with the same brush as failing institutions. Bank of America CEO Ken Lewis missed no chance to express his utter shock at the enormous bonuses he had somehow, mysteriously inherited in buying Merrill Lynch.

In fact, the commercial bankers' protests have been revealed as some of the most baldfaced lies in business history. Wells Fargo continues to owe the government $25 billion in TARP funds-money that it's not at all close to repaying. The Treasury's stress tests showed it was not nearly as well-capitalized as Kovacevich insisted. Meanwhile, Bank of America just paid $33 million to the Securities and Exchange Commission to settle charges that Lewis misled investors with his bogus claims of having had nothing to do with the Merrill payouts.

The bonus brouhaha has given many people the idea that the primary beneficiaries of federal bailout funds have been "Wall Street" and the heavily bonused investment bankers. That is emphatically untrue. It is true that the problems at Citigroup—the largest recipient of government aid, and the most troubled of the big banks—came from the investment-banking side. But the problems of Bank of America and Wells Fargo , as well as the rest of the banking industry, did not. They came from bad loans driven by years of bad decisions by the people who are now getting a free pass amid the Sturm und Drang of the bonus outcry.

Does Wall Street compensation need to be restructured? The story of salary reform in general is an awful study in being careful what we wish for. An irony of the bonus debate is that one of the reasons so much of investment banking compensation is given in the form of "bonuses" is that since 1993, corporations have had to pay additional taxes on "salaries" of more than a million dollars. The product of a backlash against inflated paychecks, the rules led to a corresponding inflation in compensation that could vaguely be called "performance based," from cash bonuses on Wall Street to stock options in the rest of the business world. Having tried to shoehorn what are effectively salaries into the performance-based bonuses to stay within the tax guidelines, investment bankers are now to some extent reaping the rewards of their semantic sleight of hand—if you're going to call the money you pay a "bonus," you can't blame folks for asking, "What for?"

If indeed there are changes in how Wall Street bankers are paid, they are likely to be largely cosmetic. A careful look at the Cuomo report reveals a surprisingly simple rule of thumb for Wall Street compensation. Look at the investment-banking houses in Cuomo's list—Morgan Stanley , Goldman Sachs, and Merrill Lynch—and you find that generally in most years they pay roughly half their revenue out in compensation. In a few cases, as with Morgan Stanley, whose compensation hit 59 percent of revenues in 2007, they get out of whack for a year, and in a very few cases (Merrill in 2007), a huge drop in revenue makes everything go topsy-turvy.

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Is this too much? It's not really something that investors in Goldman Sachs, Morgan Stanley, or JPMorgan Chase—who can fend fine for themselves—are crying about. Merrill, now part of Bank of America, and the investment-banking side of Citi are different: Effectively, the government is a major investor in these and so certainly has an interest in knowing where the money is going. We'll see whether the government can pressure them to come up with a better ratio. When all is said and done, it doesn't seem likely: The 50 percent rule seems surprisingly resilient.

The more important question, however, is whether imposing a culture of frugality on Wall Street will solve the most pressing problems of the banking industry. To this, the answer, bluntly, is that it will not. The unfortunate reality of bonus rage is that, understandable—and in some cases, even justified—as it is, it's ultimately a distraction from the real business of remaking the banks. Investment banks will always attract public outrage because they employ a fairly small number of people at outrageous salaries to do jobs that very few people will really understand. But the outcry over the excessive salaries of a few has created the false sense that the ills of the banking business lie mainly with sky-high pay.

They don't. You can hate JPMorgan Chase and Goldman Sachs for having the most millionaires on their payroll. But if you really want a better deal for consumers, the culture that has to change most isn't the bonus culture of Wall Street. It's in places like Bank of America, which might be less generous to their employees but more toxic to the public interest.