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The Wall Street Journal [subscription] reports that the way bankers get paid makes them do things that hurt the economy. They get paid based on closing deals -- e.g., sales volume -- not deal quality or profit.

Gary Becker, a Nobel Prize winning economist at the University of Chicago, achieved distinction for highlighting the ways that people respond to economic incentives. His insights have sensitized me to how incentives have skewed behavior in the recent securitization bubble, and I have posted on this topic for the last year and a half (for example, here, here, here, and here).

But the Journal provides details I had never seen until now. Here they are:

• Mortgage broker gets 0.5% to 3.0% of deal volume based on loan size, types, and terms
• Lender gets 0.5% to 2.5% of loan for selling the mortgage to an investment bank
• Bank/bond issuer gets 0.25% to 1.25% of Collateralized Debt Obligation (CDO) issue
• Ratings agency gets paid by bond issuer to give the highest rating
• Bank CEO gets big pay day even as he departs for making the bad loans

My suggestion is that bankers' compensation needs to change. Instead of paying them like sales people based on the volume of new business they close, pay them based on profits. One way to do that would be to give them a bonus based on sales volume and put that bonus into an escrow account that would be drawn down over five or ten years. If the deals that bankers originate end up losing money, the escrow account goes to paying off the losses. If not, the bankers get it all.

Some Wall Street firms are taking steps to tie compensation to longer-term performance. Senior traders at Credit Suisse set aside part of their compensation -- the firm declines to say how much -- for a number of years. That can be taken back to cover losses in future years. The Journal quotes CEO Brady Dougan as saying, "We have put in place compensation programs that ensure that our peoples' interests are directly aligned with our shareholders over a multiyear horizon."

I know bankers won't voluntarily agree to get their compensation clipped in this way. But if they did, I think they would be much more careful about bringing in bad business. You get what you pay for.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.