There is a lot of talk about how to fix Wall Street and prevent another melt down. Most of the talk has been about strengthening the oversight bodies, to allow the government to identify and interdict early on to prevent another bubble and crisis. However, this is attacking the symptoms, not the root cause of the problem. The real issue is greed. To some degree it's a curious aspect of human nature. After all, common sense says that once you're in a position where you have enough to feed your family and surround yourself with all the creature comforts you could want, there would be no more incentive to continue to work for more money. Yet, most people do. They use money then as a score card, and the competitive nature and a will to win drives us to earn more. If we didn't have this competitive nature, this greed if you will, mankind would likely be much worse off. It’s this drive to continue to succeed that keeps the best and brightest continuing to contribute to society. Imagine if Henry Ford had been content with one small factory, or the railroad barons were happy with a local track between two small cities. Certainly, thinking big and taking on large projects, and seeing them through has helped society, as well as hurt it.

So the question isn't necessarily to have more rules and more people overseeing the rules of the game - because someone, somewhere, will try to find loopholes in the rules to gain advantage. Rather we need to build in an inherent braking mechanism that causes the bankers to police themselves.

Ironically, there was such a mechanism until recently. The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999, repealed many aspects of the 1933 Glass-Steagall Act which had separated insurance, investment, and banking activities. The walls began to come down long before 1999 when exceptions in the separation were made - such as Citibank being allowed to merge with Travelers Group in 1998. After chipping away at the wall, the argument from Wall Street was "with all the exceptions and modifications, Glass-Steagall no longer really existed anyway, so why not just make it official and end it?" Prior to this, investment firms such as Lehman Brothers, Goldman Sachs, and Bear Sterns were all partnerships. In a partnership, like a law firm, at the end of the year they would divvy up the profits earned over that year. In theory, if a firm lost money, there could be a capital call, and each partner would have to make payments out of their own pocket to cover the losses. This created a natural breaking system. Since every partner or division is really gambling with the paychecks of all the other partners, the desire, or greed, of each partner to protect their bonus meant that everyone was looking over the other partners' shoulders to ensure they didn't take on too much risk.

With the repeal of Gramm-Leach-Bliley, these firms could merge with public companies or go public themselves. This shifted the risk from the partners (which became employees and managers of these public companies) to the shareholders. If a public company were to lose money, it would have to raise capital through additional share offerings. Since a company needs to raise money under duress, the selling of shares at a low price means dilution for the rest of the shareholders. If something really bad happened, and the firm were to go bankrupt, the first people wiped out are the common shareholders. We see three major negative trends that have occurred after these companies went public.

First, in this new structure the managers argued (successfully) that they individual bonuses should be dependent on the success of their individual contribution rather than the overall success of firm as a whole. Which is how we end up with a situation like the one at Citigroup, where Andrew Hall, who heads Citigroup-s energy-trading unit called Phibro LLC, could be in position to earn a $100 million bonus while tax payers had to bailout Citigroup as company. (Ed. Note: Because of this bonus issue and how it might play in Washington, DC, Citigroup sold Phibro to Occidental Petroleum Corporation in early October.) This change meant that every manager was now swinging for the fences every day, and there was no one looking over their shoulder and questioning the risk each manager was taking on. If they succeeded, they got huge bonuses, if they failed, so what? It was just company money. And if you were lucky the failures wouldn't be apparent until well after your bonus check cleared.

Secondly, one would think that with risk comes return. Since the shareholders are assuming the risk for these firms, they would be getting the return. But taking a look at Goldman Sachs, by all accounts one of the better investment houses on Wall Street, we see that Goldman Sachs is being run by managers for managers. It has been reported that they are setting aside $3.4b for bonuses for 2009. Meanwhile, Yahoo Finance is reporting a $1.40 estimated dividend, and $1.52 trailing dividend four quarters - which means approximately $750 million in dividends. So for every dollar earned for the shareholders, the real owners of the company, management is planning to award themselves $4.50. The logical conclusion is that anyone who is a shareholder in Goldman Sachs, or any of these other financial powerhouses, is a sucker. Shareholders are taking all the risk and very little of the reward.

The third trend is that nothing has changed. Wall Street will always find a way to manipulate the rules and make a quick buck. For example, the latest scandal involves high frequency trading. Originally, a stock offer was announced in a pit to be traded. Meaning the members of that stock exchange had inside information on what price people are willing to pay for a specific stock. By the time the information was sent back to non-members off the floor the information was stale. Having knowledge before others allows for front-running a stock (buying or selling before others in anticipation of a trend). When the pits were abolished and the marketplace was run by computers, it was assumed that the days of front running were over. But, they're back. So called "flash" orders give the high frequency traders, which co-locate their systems with the exchange's own computers, a few milliseconds head start. By seeing if the next order is going up or down, they have information others don't. They can also issue and then cancel an order practically simultaneously to flush out the intent of other traders. Although they are only making fractions of a cent off each trade, they are rumored to account for almost half of all trade volume that occurs. And they are doing at the expense of a fair, open markets and the regular guy on the street. Sure the government needs to put rules in place and have better enforcement mechanisms, however, this game of cat-and-mouse will go on forever.

Our suggestion is to make insurance companies (like AIG) go back to insurance. It never should have had a "financial products" division that was trading in credit default swaps. In addition, separate the boring commercial banking from investment banking. And make hedge funds and investment houses to remain private concerns. Investment banking is risky business, and shouldn't ever be at risk of bringing down your local neighborhood bank. On the public front, we need to strengthen shareholder rights. Allow the real owners to have real say in their companies. Rather than having non-binding shareholder resolutions, and boards handpicked by management, we need real shareholder say in who runs public companies and how much they get paid.

Until we get back to the basics - separating the important pillars of our economy: investment banking, commercial banking, and insurance - America will be venerable. Since these institutions are so critical to our economy, we now have institutions that are "too big to fail". Separating these industries will create smaller, less interlocking companies that will be lessen the risk in the banking and insurance companies, and concentrate it in the investment banking houses and hedge funds. Confidence is the name of the game in banks and insurance companies - after all if people don't believe these institutions will be around to return your money or pay out on a claim, people will no longer put money in these institutions - yet it is precisely these institutions that make available the capital for companies that have made America's economy the largest in the world. Meanwhile, we dither with half-measures and additional regulations and oversight - hoping that bankers with PhDs won’t be able to outwit a bunch of government bureaucrats. Good luck with that.