Investment banks are meant to be partnerships. When investment banks went public, this was a big step in the wrong direction for Wall Street. When public commercial banks – theretofore in the business of taking deposits and making loans – transformed into universal banks, this exacerbated the condition. If it is the case that the Wall Street model needs repair, as many nowadays believe, the issue at the root is this: The meaning of banking has changed, while the economic structure of banking hasn’t. The issue is one of mismatch and definition. To illustrate:

Let’s begin with an extreme scenario. We have a sole proprietorship, a lone financier, who risks solitary owner’s capital in trades, investments, loans, and assorted derivatives of these products. This solitary owner takes gains and losses as they come, and when underwriting or placing a financial instrument, the solitary owner whose own capital (and nobody else’s) is at risk, is paid a commission that is proportionate with the size of the underlying asset. Which is only fair.

Now let’s add partners to this franchise, but keep the business scope intact: trades, investments, loans, asset distribution, and sundry derivatives thereof. As partners multiply, as sources of capital are diversified, the at-risk position of each partner diminishes – if the aggregate capital pool is to stay constant – or, if alternatively individual at-risk amounts are constant then the total pool expands. Thus, greater trading volume, lending, underwriting, and asset distribution can be undertaken, or alternatively, individual risk is diminished through diversification. In either case the gains and losses taken, and the commissions paid, are proportionate to the capital risked by the partnership.

The difference between the sole proprietorship of the first case and the partnership of the second is relative, and strictly a matter of magnitude. In both cases, there is a self-contained organism that manages its own. Risk is measured, rewarded, tolerated, or reprimanded, by an owner or owners who are also the traders, underwriters, investors, principals – who, in short, are the business. Capital, after all, is fungible, and banking is operated by people.

But as this operation grows and we add public shareholders and other capital tiers to the original model, the premises begin to change. Firstly, the capital that is risked by the institution belongs largely to constituencies who are not decision makers in the business. Secondly, this outside capital leverages what is by comparison a tiny fraction of the partners’ own. We now see two opposing dynamics start to develop: As the investing, underwriting, lending, and trading power of the original franchise escalates, the ownership stake of each partner is diluted. On one hand, economic prowess is magnified, while on the other, the sense of ownership (and all that comes with this) diminishes. Taken to an extreme, and many Wall Street operations have reached extreme proportions, the sharp entrepreneurship that true ownership fosters, is endangered by distancing, perhaps a weaker focus, (a diminished loyalty?), more typically associated with hired staff. And this just as the stakes keep rising.

Which isn’t the worst of it. What’s worse, what aggravates the situation, is the put-on that the partnership is still intact. The economics, the decision-making, the style of operation, are all still predicated on the partner – or even sole proprietor – model previously described. To simplify this point and eliminate nuance: Commissions are still paid to individuals on the basis of at-risk capital as though that capital were the individual’s own. The model of risk-reward enterprise – rooted in centuries of partnership banking – disguises a reality that has become vastly different, that is based now on employment rather than ownership. There is no entrepreneurship per se, as much as advisory work. There is no personal risk, as much as consultative assistance. On countless levels, these differences cannot be understated.

The subject of the banking model is at the top of mind in a variety of professional circles and geopolitical strata today. Questions about the maximum size of banks and caps on compensation have taken a central place in the spotlight. These questions fall short, as does the debate, and the answers are necessarily incomplete. If the system is broken, this is not because of asset pools that are too big, accounting that is too vague, or compensation that is too breathtaking. Although it is quite possible that all of these characteristics are problematic, these are results, rather than causes. The root of the problem is more fundamental still, and is predicated on incorrect definition. Investment banking should be based on partnership, and it rarely is. We must revisit everything, from the beginning.