Will the Government Enact Compensation Limits on Non-TARP Banks?

By Megan McArdle

Apparently, the government is getting ready to enact a new round of restrictions on financial services pay:

The Obama administration plans to require banks and corporations that have received two rounds of federal bailouts to submit any major executive pay changes for approval by a new federal official who will monitor compensation, according to two government officials.

The proposal is part of a broad set of regulations on executive compensation expected to be announced by the administration as early as this week. Some of the rules are required by legislation enacted in the wake of the worst financial crisis since the Great Depression, and they would apply only to companies that received taxpayer money.

Others, which are being described as broad principles, would set standards that the government would like the entire financial industry to observe as banks and other companies compensate their highest-paid executives, though it is not clear how stringent regulators will make them

It's not clear what the restrictions on non-TARP firms will be.  But depending on what these restrictions are, we could finally be seeing the administration give full-throated voice to the moral outrage of its voters--an understandable, but dangerous, precedent.

There is a decent argument for regulating how broad compensation at banks is structured.  More than one smart analyst thinks that the yearly bonus regime encouraged both traders and their managers to take excess risk.  I'm not sure, as an empircal matter, that I buy this argument.  Most of those bankers who were allegedly gambling for free with (implicit) taxpayer money in fact lost half or more of their own fortunes in the ensuing crash.  From this I infer that they did not, in fact, realize that they were gambling.

There's also the problem that wise men have spent years and fortunes seeking compensation structures that more perfectly align the interests of employees with those of shareholders and, in this case, us.  To sum up their findings:  simple schemes like bonuses and stock options leave wide gaps between employee and shareholder interests.  Complex schemes are easier to game, usually lead to higher turnover, and tend to blow up in some entirely unexpected way.

Maybe Uncle Sam will discover the perfect scheme that has so far eluded everyone else.  But we'd probably get a better return on their mental effort if we had them figure out how to turn lead into gold.

But enforcing, say, a multi-year bonus scheme wouldn't be terribly destructive, and it might help.  On the other hand, if the government starts meddling with the level of compensation, this will be disturbing both because it will not do good things for the American financial services industry, and because, well, who the hell is the government to start telling private firms that are not receiving any taxpayer money how much to pay their employees?

But this feels more like a trial balloon than a fleshed out plan, so for now, I'll hold off on the capitalist panic.

This article available online at:

http://www.theatlantic.com/business/archive/2009/06/will-the-government-enact-compensation-limits-on-non-tarp-banks/18915/