Deal Fees Under Fire Amid Mortgage Crisis --- Guaranteed Rewards Of Bankers, Middlemen Are in the Spotlight
By Liam Pleven and Susanne Craig
The Wall Street Journal, January 17, 2008 (Copyright (c) 2008, Dow Jones & Company, Inc.)
To understand a root cause of the financial crisis shaking global markets, take a look at Kevin Schmidt's paycheck.
Mr. Schmidt arranges mortgages in Shreveport, La. He earns his money upfront, taking a percentage of each loan once papers are signed. "We don't get paid unless we can say YES" to loans, his firm's Web site says.
The problem, which Mr. Schmidt says he sees clearly: Brokers have little incentive to say "no" to someone seeking a loan. If a borrower defaults several months later -- as Americans increasingly are doing -- it's someone else's problem.
At every level of the financial system, key players -- from deal makers on Wall Street and in the City of London to local brokers like Mr. Schmidt -- often get a cut of what a transaction is supposed to be worth when first structured, not what it actually delivers in the long term. Now, as the bond market wobbles, takeover deals unravel and mortgages sour, the situation is spurring a re-examination of how financiers get paid and whether the incentives the pay structure creates need to be modified. This week, Congress asked three prominent executives to testify about their pay packages.
Upfront commissions and fees are well established on Wall Street. Investment banks get paid when billion-dollar mergers are inked. Firms that create complex new securities are paid a percentage off the top. Rating services assess the risk of a new bond in return for fees on the front end.
Critics argue this system can give people a vested interest in closing a deal, regardless of whether it turns out to be a good idea over time.
"It is not clear that existing compensation mechanisms