Capping Compensation Is Bad Policy
Jul 23rd, 2009 | 13 responses
This just in.
Wall Street banks which have paid back federal bailout funds are stockpiling billions of dollars to pay employee bonuses that at the present rate would exceed compensation levels before risky trading plunged the industry into a meltdown last year.
It’s business as usual, President Barack Obama said mockingly at his Wednesday night press conference. “With respect to compensation, I’d like to think that people would feel a little remorse and feel embarrassed and would not get million-dollar or multimillion-dollar bonuses,” he said.
My question. What else would one expect?
“It strengthens our commitment to getting legislation passed,” Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, said in a Washington Post interview Wednesday, adding that a committee vote on a bill to increase oversight of Wall Street pay has been scheduled for Tuesday. “The amounts are troubling,” Frank said.
Bailout funds administered by The Treasury under the Toxic Asset Recovery Plan (TARP) limits compensation but are removed once the money is repaid.
It has always been my contention that it is dangerous precedent for the federal government to cap salary and bonus compensation in the private sector. It is worse policy when the major banking institutions, freed from TARP regulations, offer greater compensation and rewards when other banks still struggling to pay off the loans are handcuffed and competing with a different set of rules. It is only natural that the best and brightest — and, yes, even the greedy — seek the best paying jobs in the market place.
That’s the culture the financial institutions work. No matter what the rules are, those sneaky corporate lawyers will find a way around restrictions Congress may impose. Always have. Always will.
Having said that, I also believe Congress can lay down safeguards protecting stock holders and investors from unscrupulous practices which ran crazy leading up to the 2008 financial market collapse. That is part of the legislation and rules drawn by Treasury Secretary Tim Geithner that are under consideration. Some banks already have enacted self-imposed rules that reduce or eliminate compensation for brokers whose activity results in losses for the company. One proposal is requiring transparency to inform stock holders exactly what the compensation rewards entail and allowing them to squelch what is known as umbrella retirement or severance packages.
What Barney Frank means as “troubling” is the $74 billion six Wall Street banks have set aside for employees so far this year, up from $60 billion at this time last year.
On the one hand is Goldman Sachs, which reported $3.4 billion second quarter profits, earmarking $11.4 billion so far this year at a pace that its employees will earn an average of $773,000 which is double from last year but still more than the $700,000 paid in 2007.
But, as the Post story pointed out, rival Morgan Stanley, which reported a $1.26 billion second quarter loss, has set aside $3.9 billion in compensation expenses that represent 72% of its entire second quarter revenue. Says the Post:
Traditionally, Wall Street banks have set aside about 50 percent of revenue to pay their workers, though that ratio is lower at firms with larger commercial banking operations, like Citigroup and Bank of America, which have a sizable number of lower-paid employees handling consumer business.
Morgan Stanley’s compensation figures raised eyebrows among some analysts, who peppered Chief Financial Officer Colm Kelleher with questions about employee pay during a conference call.
“Clearly, we have to pay competitively,” Kelleher said during the call. “We are a preeminent investment banking franchise. Obviously, we really would like to have far more revenue to make the compensation issue easy.”
… In an interview, analyst Brad Hintz with Sanford C. Bernstein challenged that explanation, saying Morgan Stanley’s compensation ratio has remained high throughout the financial crisis. “Unfortunately, this means that Q2 was a pretty good quarter for the employees, but not so for the shareholders,” Hintz said.
Congress is barking up the wrong tree by capping compensation. Rather, the high-rollers should be more closely monitored to avoid high risks and institutions should be required to keep reserves at a minimum level and pay into a fund for default insurance such as the banks are required through the Federal Deposit Insurance Corp. A similar system has been installed by the oil commodities market that quickly detects unlawful oil speculation among its brokers.
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13 Responses to “Capping Compensation Is Bad Policy”
I'd have a high trouble investing with a firm that pays such high bonuses. It suggests that they are vastly over-charging their customers.
Can't we just label them all witches, throw them in the river with rocks around their necks and move on?
The dollars that drive the pay averages up come from the deal side of the house, not the retail brokers or retail investment advisors, and not the investment managers who decided to invest the house money in CMO's and/or CDS.
The big money is made by the guys on the M&A side taking somewhere between 6 and 9% of the deal proceeds. If you are a current shareholder in the business going out and raising the capital………..go ahead and complain away. You are the only one they are taking their money from.
However, as to TARP putting in pay limits, as long as it is only for the duration they have not yet paid it back, it really is no different than any old-fashioned loan with covenants.
Not letting them pay it back when they want, however, is totally ludicrous govt policy.
I agree that it's a bad idea to dictate to private companies how much and in what manner their employees receive compensation. Our nation lost wealth in the trillions of dollars when the financial systems collapsed, and something tells me a few million dollar bonuses weren't the primary cause. What does need to be done is to somehow regulate the extremely high-risk behavior. For example, perhaps a pay-to-play system, where a firm wanting play in the high-stakes high-profit game of esoteric financial products might pay a small percentage into a fund to be used in the case of a meltdown, so that taxpayer dollars don't have to finance personal risk. The other important thing is to have some way to make sure that single entities aren't “too big to fail”. I have no idea what kind of rubric one might use to assess such a thing. But if your company is going to make poor decisions and take huge risks, you need to reap the consequences when things go wrong.
This is not to say that I was against the bailouts. The companies were too big to fail, and as the CEOs run off to Burmuda with their millions, the rest of us would have been sitting on our hands with no jobs. But let's keep this from happening again.
For example, perhaps a pay-to-play system, where a firm wanting play in the high-stakes high-profit game of esoteric financial products might pay a small percentage into a fund to be used in the case of a meltdown, so that taxpayer dollars don't have to finance personal risk.
It's actually simpler than that- we just need to restore the framework by which the risk of loans remains on the books of the investment firm that makes the loan. Way too much risk was being kicked down the road, so that there was little to no incentive to avoid making bad loans. Just write the loan, take the immediate fee and profit, and then toss the hot potato to the next guy.
CStanley — Agreed! For transactions that are bundled and repackaged pieces of loans, that would work very well indeed. I have no doubt, however, that financial institutions can come up with some other, non-loan-related way to take huge risks with other people's money.
CO, “However, as to TARP putting in pay limits, as long as it is only for the duration they have not yet paid it back, it really is no different than any old-fashioned loan with covenants.”
Agreed, it's just a stipulation there and even loans have pre-payment penalties so I'm also not too much against them unless they remove them for ALL loans. I dislike pre-payment penalties, but if the banks who use them against us consumers are complaining about them, then they shouldn't be able to use them on their customers either.
CS, “we just need to restore the framework by which the risk of loans remains on the books of the investment firm that makes the loan.”
100% agree with you there CStanley.
The “war” on our financial crisis justifies at least a temporary cap on rampant luxury. We're all in this together. When our financial systems are stabilized we can return to the original uncapped system.
All Obama has to do is follow the Cheney lead and use “war on [fill in the blank] to tweak the system to acheive the desired goal. At least in Obama's case it is the well-being of everyone instead of a small group of ultra-greedy soulless oilmen.
“Just write the loan, take the immediate fee and profit, and then toss the hot potato to the next guy.”
I have to imagine people receiving potatoes are going to be taking their temperature much more carefully in any case, and that regulations along these lines will be redundant as well as, obviously, too late.
I have a couple suggestions, as someone who has a degree in economics. First, let's put reasonable regulations on the market. This means banning credit-default swaps, which is what caused the market to collapse when it did, and the way it did. The second is banning futures markets. Futures markets, banned in many states for quite a long time, are just a legalized form of a craps game. You can do really well, but you can also lose your last penny. Second, let go of this populist rhetoric that people are earning too much, if they are off TARP funds. Just because you do not like the compensation some person gets, that does not mean that it is not earned. It's time to lay off the populism, and start realizing that sometimes, populism can be bad, as this will be. It will drive the markets out of our country more surely than Giuliani's prosecution of Milliken.
Let them have their ginormous bonuses and crazy pay raises. Meanwhile, we should add in some new tax brackets and 500k, 1mil, 5mil and beyond. “We the people” were financially bent over because of Wall Street's mess, and instead of sharing in the pain, Wall Street is doing better than before because of the government guarantees. The least we can do is get some of that money back to pay things like universal health care.
Here here!
“All Obama has to do is follow the Cheney lead and use 'war on..' [fill in the blank] to tweak the system to acheive the desired goal. “
Liberals have been irritated at that ever since the War on Poverty in the 1960s and criticism of the results.