Pity the pay czar. When Ken Feinberg announced last month that he would slash pay at seven firms that received federal bailout funds and convert large chunks of compensation to stock units that can’t be sold for years, he was met with almost universal opprobrium. Critics of Wall Street protested that simply paying out salaries in stock rather than cash would have little effect on executives at the bailed-out firms, to say nothing of the banking culture at large. “This is a ploy to appease a public enraged by Wall Street bonuses, particularly Goldman’s which is notably unaffected by the move,” finance blogger Yves Smith wrote in The New York Times. Meanwhile, bankers complained that the scheme would hamper the ability of those firms to compete for the best talent in the business. “It looks like meatball surgery with a sledgehammer,” one independent compensation expert told the paper. “There are going to be some people who just pick up their sticks and go.” Even the administration seemed lukewarm about Feinberg’s compromise. The Wall Street Journal reported that the White House deliberately made him unaccountable to Treasury so that it wouldn’t have to deal with the predictable fallout.
Fortunately, we get to start replaying the whole tortured drama in a few short weeks. Because Feinberg’s agreements only apply to 2009 salaries, he still has to negotiate next year’s compensation packages for all seven major bank-bailout recipients--AIG, Bank of America, Citigroup, GM, GMAC, Chrysler, and Chrysler Financial--set to take effect in January. Which is why, as we approach the next round--sure to launch its own separate uproar--it’s worth keeping in mind that the pay czar is largely beside the point.
That’s not to say bankers are underpaid. Far from it. Financial-industry bonuses are expected to rise 40 percent this year. Goldman Sachs, just months after paying back taxpayer dollars, is expected to give out bonuses that exceed what the company paid out in 2007, at the height of the bubble. Even after Feinberg’s pay cuts, 66 executives at the seven companies under his jurisdiction will receive at least $1 million in long-term compensation.
The point, rather, is that there’s very little that a czar--even one as apparently well-intentioned and tough-minded as Feinberg--can accomplish in this realm. Compensation reflects a number of factors: a firm’s profitability, size, business model, competitors, etc. When a firm is making billions in profits and has all sorts of unregulated competitors (like hedge funds or foreign banks) who are equally profitable and can afford to pay multimillion-dollar salaries, it’s very difficult to force its executives to take an 80 or 90 percent pay cut. More likely, such a decree will be counterproductive, causing the targeted executives to leave for unregulated competitors, and therefore undermining the government’s efforts to recoup its investments in these firms.
Really changing executive pay at big commercial banks would require reforming the structure of the banking industry. That would start with the kind of proposal former Fed Chairman Paul Volcker has put forth, which would separate traditional commercial banking (and some investment-banking functions) from proprietary trading--in other words, separating the banking parts of the business from the hedge-fund parts of the business. The current problem is that the hedge-fund parts of the business create huge profits, in turn driving huge salaries, while the banking parts of the business give the firm access to cheap borrowing from the Fed in a crisis, federal deposit insurance, and fdic backing for its debt issuance. The fact that the two parts are combined also makes the government more likely to bail out a large institution if it verges on collapse.
Let’s not kid ourselves. Hedge funds and outlandish financial-sector salaries are probably here to stay. But there’s no reason that they should benefit from government support. Spinning off the hedge-fund activities of a company like Citigroup from the more traditional bank activities would drive down salaries in the parts of the business that benefit from enormous government largesse. And if the government did have to step in and save a bank, at least taxpayers wouldn’t have to pay salaries that were quite as titanic.
Unfortunately, that’s not something a pay czar can accomplish with limited powers over a few bailed-out firms. It would require tough legislation, which means a massive fight in Congress and an investment of presidential capital. The administration opposes Volcker-esque proposals for breaking up the banks, suggesting that truly reforming executive compensation is not a top priority. That’s disappointing but understandable--there’s a lot on Wall Street that needs reforming. But, as long as that’s the case, don’t blame Ken Feinberg for failing to lower executive pay. There isn’t much he can do.
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COMMENTS (3)
The size of the banks is almost as much of a red-herring as executive pay. If the banks are all taking more or less the same imprudent risks (and bankers run in herds because their greatest fear is taking a loss that no one else has or missing a gain that everyone else has), it doesn't matter how big or small they are any more than it matters whether the gains from the imprudent risks go into the pockets of shareholders or executives. It matters a little, as a second-order phenomenon, but not much. Trying to limit bank risk by fussing with pay or bank size is inane. The thing to do to limit bank risk is ........ limit bank risk, openly, and directly, and the risks assumed by anything els ... view full comment
The size of the banks is almost as much of a red-herring as executive pay. If the banks are all taking more or less the same imprudent risks (and bankers run in herds because their greatest fear is taking a loss that no one else has or missing a gain that everyone else has), it doesn't matter how big or small they are any more than it matters whether the gains from the imprudent risks go into the pockets of shareholders or executives. It matters a little, as a second-order phenomenon, but not much. Trying to limit bank risk by fussing with pay or bank size is inane. The thing to do to limit bank risk is ........ limit bank risk, openly, and directly, and the risks assumed by anything else that could be consider a financial institution.
Primarily this means restricting leverage, both for individual institutions and the system as a whole. The starting place is to understand that without regulatory restraint, financial institutions will ALWAYS lever themselves excessively. They always have and they always will because no matter what the structure or size or compensation, the upside will always be greater for them than the downside, much, much greater. The first step is to put all assets and liabilities, including those implied by derivatives, on their balance sheets. No more fraudulent accounting sanctioned by the government. Then, their leverage, including all of the synthetic liabilities, must be limited to something not more than 10:1 in contrast to the 100:1 they were running and probably still are. Then, we must eliminate "bank equivalents," such as securitized debt, that have more leverage (infinite in that they have no equity) than what we permit to financial institutions. It is MORONIC (my favorite appellation for Alan Greenspan) to have leverage restrictions, even the fatally weakened ones we still had in the last decade, and permit them to be avoided merely be having banks and financial institutions spin off chunks of their assets and liabilities.
Although the monetarist nuts who have been in charge of our asylum have zero historical memory and think that economics began with them, the leverage restrictions imposed in the 1930s had two distinct objectives -- protection of the soundness of individual institutions AND governing the pace of credit creation and the leverage in the system as a whole. We progressively abandoned those restraints beginning in the 1980s and got the inevitable outcome in 2008, an epic bust
With sufficient leverage, there will inevitably be crashes, no matter how the risks are managed, no matter how large or small the individual over-leveraged players. Long-Term Capital. Long-Term Capital. Repeat, repeat, repeat. We had the core principle of financial regulation right 60 years ago -- restrict leverage. Even after the epic bust, we, including the TNR editors, seem unable to focus on what matters.
I should add two points: restricting leverage means in all its forms, including intra-day trading risks that never appear anywhere. I mean total liabilities, the ones that would surface if an institution declared bankruptcy at a moment in time, including undelivered securities, counter-party risk, the works.
Second, although leverage is overwhelmingly both the most important parameter to control and the very one that makes outlandish income for financial institutions possible (their income would drop by a huge factor if leverage were tightly controlled), the other major thing to regulate is asset concentration. Yes, there are "systemic" risks, but those are kept in check by limiting indivi ... view full comment
I should add two points: restricting leverage means in all its forms, including intra-day trading risks that never appear anywhere. I mean total liabilities, the ones that would surface if an institution declared bankruptcy at a moment in time, including undelivered securities, counter-party risk, the works.
Second, although leverage is overwhelmingly both the most important parameter to control and the very one that makes outlandish income for financial institutions possible (their income would drop by a huge factor if leverage were tightly controlled), the other major thing to regulate is asset concentration. Yes, there are "systemic" risks, but those are kept in check by limiting individual and hence systemic leverage. The individual institutions then have to be kept sufficiently diversified that only a systemic crash is going to shake them.
One new twist we might consider is defining a financial (and hence regulated) institution to be anything levered more than 4:1 and having assets of more than $100 million. That would sweep up a lot of private funds that contribute to the systemic problem.
I am put in mind of this by the line in the Editors' piece that says outlandish financial instruments and compensation are here to stay. Why are you all unable to think about just how it is that the outlandish income is generated in the first place? That is the key issue. The rest of it is, as I said, a red-herring.
Oh, had lunch last week with a world-bank economist who shares the view that Geithner and Summers are totally co-opted by the implicit promise of future riches on Wall Street and a thorough stewing in the culture and society of Wall Street.
Gotta go. Many pages of Karl Marx (a "minor post-Ricardian" as Paul Samuelson aptly said) still to read. Ugh. And the kids need shoes.
Let me be clear. I am not a critic of early screening. As someone who lost both parents and a sister to cancer (cervical cancer for my sister), I am huge proponent of screening. The point I was attempting to make (apparently not very well) is that statistics show that if physicians based their diagnostic testing and treatment on statistical analysis rather than their personal judments as applied to each patient, outcomes, when viewed solely over the entire group of patients with similar symtoms, conditions, etc., are statistically better. As applied to screening specifically, false positives, along with both anxiety for the patient and bad outcomes from uneccessry (in many cases aggressi ... view full comment
Let me be clear. I am not a critic of early screening. As someone who lost both parents and a sister to cancer (cervical cancer for my sister), I am huge proponent of screening. The point I was attempting to make (apparently not very well) is that statistics show that if physicians based their diagnostic testing and treatment on statistical analysis rather than their personal judments as applied to each patient, outcomes, when viewed solely over the entire group of patients with similar symtoms, conditions, etc., are statistically better. As applied to screening specifically, false positives, along with both anxiety for the patient and bad outcomes from uneccessry (in many cases aggressive) treatment, would be reduced if physicians followed the statistical analysis. That's not to say some patients wouldn't be better off if his or her physician relied on the physician's judgment rather than statistical analysis, rather overall outomes would be better. Go with statistics that improve the likelihood of a better outcome, or follow the physician's judgment that may prove best in a particular case. Most folks aren't very good at statistics. Nobody would buy a lottery ticket if they were. But the person who wins the lottery would disagree.