06/03/2009 05:12 am ET Updated May 25, 2011

Swine Flu Found on Wall Street

Let's face it. Many of us believe Wall Street bonuses give new meaning to "swine flu." AIG, Citigroup, and the firm formerly known as Merrill Lynch -- these struggling organizations have paid or are negotiating to pay sizable bonuses with taxpayer money.

What are they thinking?

It's tempting to pile on. Earlier this week I wrote about Citigroup and "retention bonuses." Demoralized employees at their Phibro subsidiary, including the division head who earned $100 million last year, are threatening to leave. Morale may be low there. But we're ready to storm the gates here.

There are no plans to pay "retention dividends," even though shareholders watched a 95 percent collapse in Citigroup's stock. Nor are there any "retention tax breaks." Perhaps US citizens should threaten to emigrate. We can all move to Andorra where there are no personal income taxes.

Forget Attica. Andorra. Andorra.

See what I mean? Wall Street bonuses are easy targets for our anger. It's comforting to cry "bloody murder" and scream for caps on banker compensation.

Not so fast.

I'm connecting a few dots here. And the picture isn't pretty. I'm afraid our anger will lead to unintended consequences. It will exacerbate the impact of uneven regulation among financial institutions -- an imbalance that undermines the long-term integrity of our capital markets.

Whoa! Where does that come from?

Here's my thinking: Through TARP, the government is regulating compensation at the banks. Top talent, as a consequence, is fleeing to hedge funds where there are no bonus caps. Just ask John Mack. But hedge funds -- with 20 percent profit participations and greater freedom than banks to concentrate or leverage bets -- are often unstable. One bad year, and investors pull their capital. A few bad "marks," and lenders make margin calls.

That's all she wrote.

There are plenty of examples. Peloton's ABS fund returned 87 percent in 2007. On the night of January 24, 2008, the founder accepted an award from EuroHedge. He attributed his fund's success to one bet, the "world coming to an end." Just over a month later, his fund came to an end when ABS succumbed to margin calls.

So here are my questions: Do we want Wall Street's best minds fleeing to Hedgistan? Where there are fewer rules and better pay structures? Where performance fees incentivize risk taking because there are no commensurate requirements to share losses?

Wait. There's more.

Do we want hedge funds, fragile and vulnerable as they are, to control the flow of capital into companies that make real products for a living? What happens when a good company's stock is crushed because a hedge fund was liquidated?

Still going.

By "piling on" and screaming about bankers' bonuses, aren't we sending our best minds to Hedgistan where there is a certain indifference to risk? Twenty percent of the upside. None of the downside. Isn't indifference to risk what created our economic mess in the first place?

Any ideas out there?