Yesterday’s NY
Times Room For Debate commentary addressed Kenneth R. Feinberg’s pay plan,
which calls for significant
pay cuts (50 percent on average) from the 25 top earners at seven companies
that received exceptional bailout help — Citigroup, Bank of America, American
International Group, General Motors, Chrysler and the financing arms of the two
automakers. In addition to
reducing payment amounts, the plan alters the form of the pay in an attempt to
better-align incentives with long-term financial health, for example, by
shifting some cash compensation to restricted stock that cannot be sold for
several years.
It’s unlikely, though, that the plan will successfully
dampen popular outrage over high Wall Street bonuses at bailed-out
institutions. The pay
restrictions do not apply to firms that have already repaid their loans,
including Goldman Sachs, JPMorgan Chase, and Morgan Stanley, which received
tens of billions of dollars in government loans and loan guarantees and are
expected to make large bonus payments this year. Goldman Sachs raised
particular ire, when it reported record profits and bonuses (a pool
of nearly $23 billion, the highest ever).
The cuts will hit some firms harder than others. At AIG financial products division, for
example, no
top executive will receive more than $200,000 in total compensation.
As to banks not recipients of bailout money, the Federal
Reserve announced Thursday that it would crack down on pay packages that
encouraged bankers to take excessive risks. The proposal “will subject
executives, traders, deal makers and other employees of the biggest banks to
regulatory scrutiny of their compensation.”
Instead of pay limits, the Fed rules
are intended to tailor compensation packages to deter risky practices and
reward long-term performance. “The
Fed’s plan, which will take effect some time after a 30-day comment period,
will create a two-tier system of supervising pay, using different approaches
for the nation’s 28 biggest institutions and the thousands of smaller banks,
which would be subjected to a review with their regular bank examinations.”
According to Fed chairman, Ben S. Bernanke, “Compensation
practices at some banking organizations have led to misaligned incentives and
excessive risk-taking, contributing to bank losses and financial instability.” .
. . “The Federal Reserve is working to ensure that compensation packages
appropriately tie rewards to longer-term performance and do not create undue
risk for the firm or the financial system.”
The Room For Debate contributors are:
Lynn
A. Stout, law and economics professor, U.C.L.A.
Tyler
Cowen, economist, George Mason University
John
C. Coffee Jr., professor at Columbia Law School
Yves
Smith, financial analyst
Nicole
Gelinas, Manhattan Institute
In a recent
paper, I address the incentives (including, but not limited to, financial incentives)
for risk taking within financial institutions at levels that are not socially
optimal and pose dangers to the financial system. Although I particularly address the role of traders,
sales people, and their direct supervisors in risk-taking behavior, some of the
discussion is relevant for executives as well.
Sadly, I fear that the path to sound and strong financial
institutions will not be paved solely with compensation reform. Aligning
payment incentives with shareholders’ interests has proved difficult enough
over the years, without also having to account for the systemic well being of the
financial system.
Executive pay reform is likely to be little more than a band-aid, when
real systemic reform is what’s needed.
As Martin
Wolf recently noted in the FT:
A year ago, at the height of the financial panic, the world
yearned for a profitable and confident financial sector. It now has what it
wants, but hates it. As joblessness soars and the hopes of hundreds of millions
of people are blighted, the financial sector’s survivors are thriving. Even
bonuses are back. Policymakers have made a Faustian bargain.
Wolf continues by noting that trying to make financial
systems safer has made them more perilous. Today, the
market is more concentrated, many institutions have become too big or
systemically important to fail, and such institutions with an implicit bailout cushion
cannot be expected to prudently manage risk. As a result, according to Wolf, neither market discipline
nor regulation is effective.
There is a danger, therefore, that this rescue will lead to
still greater risk-taking and an even worse crisis at some point in the not too
distant future.
Either we impose a credible threat of bankruptcy, or
institutions we have to support are made safer, or, better, we have both of
these. Open-ended insurance of weakly regulated institutions that take complex
gambles is intolerable. We dare not return to business as usual. It is as
simple – and brutal – as that.
Prior related posts:
Supersize
Me: Too Big To Fail, and Getting Bigger
Becker
And Posner On The Pay Czar
What
Does Goldman’s VaR Mean?
Bank failure posts:
Failures, Funds, and the FDIC
Bank Failures and FDIC Fund Losses
Bank Failures Update and Future Problem Banks