03/22/2009 03:55 pm ET Updated May 25, 2011

Why are People Defending the Bonuses?

Ever since the AIG bonus fiasco, a surprisingly large group of observers in the media and elsewhere, with gravely sagacious overtones, have assured us that bonuses in themselves are at the heart of American capitalism. Being rewarded for a job well done -- and sometimes getting rich -- is as American as it gets.

Not the way Wall Street doled bonuses out, however.

In general, well before government bailouts, few if any of these giant bonuses had truly been deserved. And I think most Americans know that. They know their bosses are not that smart. And let's stop calling all these young impresarios "wizards" because they can do some arithmetic. None of them invented calculus.

First, the bonus system led to tragically bad decisions. There was no risk management on Wall Street. There was mostly excessive risk-taking. And it was largely due to outsized bonuses that rewarded risky banking and trading while penalizing anyone minimally for losses. Workers should not be paid this way. Economists even have a name for it: an agency problem. Too bad more of them didn't speak up and complain a lot sooner. (Thank goodness, Ben Bernanke is at last saying this publicly.)

Second, bonuses at the old levels were never deserved. They were paid as some percentage of profits, as if these magicians created these profits entirely themselves. This is nonsense. It's a bit like saying the president of the United States deserves ¼ percent of any rise in the GDP when he is in office because he made a few right decisions.

Profits can be created in the near term by any given trade. But that profitability is made possible because of the existence of an enormous financial infrastructure that has nothing to do with the efforts of today's bonus babies. A system of opportunity was created by the dint of effort of thousands who came before these rewardees and made enormous innovation in financial markets, communications and so on. The infrastructure was, as importantly, built with intensive government investment in peoples' educations, in transportation, in private property protections, in rules that make markets work, in insurance for savers, in protections against discrimination, and so on.

How many of these "wizard" MBAs got government loans to go to school? How many went to public high schools and state universities?

The industry is also a monopoly -- or an oligopoly, which is many firms acting like a monopoly. Otherwise, why are profits so high and rarely competed away? (Lack of open information and manipulation may also have big parts, of course.)

Oh, you say, what about those athletes' salaries? They, too, depend on an enormous infrastructure. The state even finances new stadiums. But the comparable bonuses on Wall Street went to many more people with, I dare say, less talent. Many on Wall Street made far more, as we know, than Alex Rodgriguez, but they are less indispensable. The profits to be shared are incomparably higher on Wall Street than in baseball, but they would have been made without the top one hundred or two hundred Wall Street earners.

We don't in America put a ceiling on what people make, even if they do so by exploiting a huge loophole in the nation's competitive economy. In other words, by taking a special seat at a monopoly table.

On the other hand, we have every right to limit those earnings if they lead to massive increases in systemic risk -- risk that can bring down a world economy. And this is what they did.

These bonuses are not deserved on the basis of talent or contributions to the economy, and they distort financial markets badly, which severely damages us all.