Pay politics continues for banks

Posted by Marc Hodak on December 24, 2010 under Politics, Reporting on pay | 2 Comments to Read

U.S. regulators are considering new or expanded curbs on bonuses in accordance with regulations created by Chris Dodd and Barney Frank to prevent another financial crisis (I will never get over the irony that).  The law generally prescribes that compensation plans should be designed so as to not encourage excessive risk taking.  One of the key design elements to implement that mandate is the deferral of bonuses. The nominal theory is that deferral of awards will create an incentive for the traders to think beyond current period performance, thus avoiding the “swing for the fences” bets that the comp critics insisted were central to the financial crisis.

The assumption that perverse incentives contributed to the financial crisis is reasonable.  It does not logically follow that changing those incentives is either necessary or sufficient to prevent another financial crisis, but seeing that would require understanding the root causes of the crisis which, perversely enough, neither Dodd nor Frank had any incentive to do.

But this law assumes two other things that challenge reason:

(1) that leaders in these banks, men and women whose personal fortunes are largely tied up in their company’s shares, lack either sufficient incentive or ability to monitor and impose reward systems that account for the risk they’re encouraging, and

(2) that the bureaucrats who write and enforce banking rules have those things.

To anyone who works with companies and regulators, such a premise seems insane, but the media has wholly accepted these premises, and their readership seems none the wiser. So, to that readership, I would address the following:

Think of yourself as the owner of a restaurant, having to sit down with a bureaucrat once a year, on their schedule, to go over the compensation plans for your cooks and waiters.  If the survival of the entire U.S. economy depended upon the survival of your restaurant, and if certain compensation plans made it more likely that your restaurant would survive, would you nevertheless consider it a sane requirement that you sit down with pay bureaucrats?  Would you think that its a good use of your time, energy, and money (for paying an adviser) to fill out their forms and prepare for the meeting, and explain the particular circumstances and talent needs that led you to the practices you adopted for your business, and how those practices conformed to 90 percent of the generic one-size-fits-all regulations that the bureaucrats are compelled to enforce, but how the other 10 percent don’t make sense for your particular business at this particular time?  Would you bother going through the brain damage of demonstrating the benefits of those exceptions under the bureaucratic appeal process that the government generously provided you, before concluding on advice of your paid adviser that it might just be less costly to conform your practices to that last, silly ten percent, and take the risk that your talent will end up a little more demoralized or absent?  Or, would it occur to you that this added cost and risk necessitated by this regulatory process does the opposite of helping ensure that your business thrives.

That is what these regulations look like to those of us working with them.  They’re mostly reasonable on their face, but crazy nuts in their application.   Unfortunately, most readers and voters don’t run businesses, but all of them did have to bail out banks whose employees are paid far better than they.  And when politicians had a choice between accepting any blame whatsoever for the calamity that led to those bailouts, or blaming it on highly paid bankers and how they got paid, the politicians did what came naturally, and started writing new laws.

Fortunately, this is still America, and our government has shown more restraint than our European counterparts:

Michel Barnier, the European Union’s financial-services commissioner, said at an industry conference in New York in October that “more could be done” in the fix pay practices. “If we do nothing, it means that we have not drawn the right lessons from the crisis.”

Of course, the U.S. is not “doing nothing.”  Its hard to imagine what this Eurocrat means by “more,” but it includes caps on pay.  American politicians could be persuaded by the bank lobby to forgo that level of regulation because the American people wouldn’t press for such caps.  Most of us are not yet so blinded by socialist envy that we would trust the Federal government to decide who should make what, and expect anything good to come from it.

  • Bernard S. Sharfman said,

    There are alternatives to putting caps on executive compensation. One approach is to use tax policy to encourage the deferral of bonus payments. See “Using the Law to Reduce Systemic Risk,”

    Happy Holidays!

  • Dividing fiduciary attention » Hodak Value said,

    […] as “the trader’s option” here and here, as has the problematic side of proposed regulatory remedies. Much of Dodd-Frank was meant to moderate the risk appetite of banks via direct regulatory […]

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