Inside Financial Services

Feds’ Proposed Pay Rules Aren’t Needed

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From this morning’s New York Times:

Regulators released long-awaited rules on Thursday morning that aim to restrict how big financial institutions can pay their top executives.

The new limits on banker bonuses would make the highest-paid employees at the biggest banks wait at least four years to receive parts of their annual pay. If the proposals are completed in the coming months, banks would also have to reclaim bonuses from bankers who take risks that lead to big financial losses. [Emph. added.]

Another example of needless and intrusive government meddling. You’ll get no argument here that big-dollar compensation at the large banks ought to match the life cycles of the financial products that big banks sell. Prior to the housing blowup (which is what these rules are a response to), too many bank executives made too much money writing too many bad loans that later almost brought the system down. But the banks don’t need regulators to tell them that. As it happens, most large banks have already changed their compensation policies to reflect what the government seems to have in mind. Banks know what’s in their long-term best interest a lot better than government bureaucrats do. So, sure enough, they’re generally holding back some employee compensation in case the loans/deals/whatever the comp is based on blow up unexpectedly. And they’re availing themselves of clawbacks. As one expert tells the Times, the regulators’ proposal “largely codifies the practices that have evolved over the last eight years.” If that’s so, why even have it?

But more to the point, regulators are in large part fighting the last war. The fact is that bankers just don’t make as much money as they used to. They can’t. Dodd-Frank and other post-panic rules have rendered the banking industry fundamentally less profitable than it once was. ROEs are permanently lower. Goldman Sachs, for instance, reports that its compensation pool is down by 40% from last year. So the government’s new rules to control Wall Street compensation will apply to compensation that’s already being well-controlled, thanks very much.

If regulators were serious about reining in Wall Street excess, the first thing they ought to do, it seems to me, is to stop encouraging banks to write loans that are nearly doomed to fail. Which is to say, stop encouraging banks to lend to unqualified—that would be subprime—borrowers. Ease up on CRA requirements. Tell the GSEs to raise their lending standards. Define QRMs in a way that takes actually take FICO scores into account. The irony is that despite all the carnage of the housing implosion and credit panic, the government’s policy is still to encourage (and by that I mean force) banks to make home loans to iffy borrowers. We see what that led to once. The government can write all the banker-pay rules it wants. But as long as banks are still writing loans that in strict economic terms they shouldn’t be, the risk to the system remains.

What do you think? Let me know!

2 Responses to “Feds’ Proposed Pay Rules Aren’t Needed”

  1. Avatar gary alngabum

    While you are quite right that the government rules on pay are fighting the last war, that is always the way government works. So, why should it be any different with financial institutions? But, to say it isn’t needed is to assume that banks will not revert to their old ways and that the most senior of management would also be subject to the internal measures and I am skeptical on both of these. Having watched managements in financial institutions, and other industries, reward themselves for doing nothing or worse, making short term decisions which had long term negative implications, I find myself thinking that government imposed regulations are both needed and warranted. The key to me is that the rules are fair and implemented across the board.

  2. Avatar jsc173

    What’s the over/under that banks will agree to pay their top execs a total comp that’s actually more than they’re paid now. If the government is going to require a multi-year payout, you can be assured the discounted present value of those payouts will exceed current plans.

    And the idea there would be some sort of claw-back if the future didn’t pan out as it was forecast? So, if the Fed does something stupid (again) and the economy tanks, executive bonuses will have to be returned?

    Perfect.

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