The Wall Street Journal today is reporting that the Federal Reserve is finalizing a proposal to control banker pay. Wall Street compensation has been an extremely hot topic since the beginning of the financial crisis. Some have complained that the bonus culture widely accepted at banks provides incentives for short-term profits, despite the risk that actions might pose in the long-run. Some bankers and traders getting lofty bonus payments even as their firms were incurring huge losses exacerbated the disdain many Americans felt towards investment banks' compensation practices. Will the Fed change all that?
First, here's some detail, via the Journal:
Under the proposal, the Fed could reject any compensation policies it believes encourage bank employees -- from chief executives, to traders, to loan officers -- to take too much risk. Bureaucrats wouldn't set the pay of individuals, but would review and, if necessary, amend each bank's salary and bonus policies to make sure they don't create harmful incentives.
A final proposal is still a few weeks from completion and could be revised along the way, according to people familiar with the matter. It requires a vote by the central bank's board, but no congressional approval.
At this point, financial reform that would include compensation restraints will have a very difficult time getting through Congress. That's why the Fed setting rules would be a much easier road for such regulation.
The real question, however, is whether or not the Fed would actually affect compensation practices, or just create a regulatory framework as a sort of purely cosmetic move -- without ever really enforcing any changes.
Another thing to note is that the Fed's compensation oversight might not reduce compensation levels by one penny -- it could just change the mechanics for how banks pay their employees. In analyzing a speech Goldman Sachs CEO Lloyd Blankfein gave a few weeks ago, I noted that he called for Wall Street compensation changes without actually saying that bankers should be paid less. The Fed's regulatory framework could very well have the same philosophy.
But if the Fed's proposal does include compensation curbs and is accepted, what does that mean for banking? It's hard to say. You might expect to see some talent shift from member banks to smaller nonmember banks that are not required to adhere to Fed guidelines.
The logistics for that, however, could be challenging. All national banks are automatically required to be members, so they would have to be smaller, state banks. If nonmember banks, they would also be subject to the consequences of their actions -- unlike member banks who the Fed has generally worked to bail out when times got tough. So I would not expect to see member banks or its bankers suddenly all attempt to leave the Federal Reserve System: being a member has its benefits.
Could talent just flee to non-U.S. banks? Maybe, but many foreign nations are also considering curbing bank pay. In fact, compensation is set to be a topic of discussion at the upcoming G-20 meeting in Pittsburgh. France, Germany and Great Britain have all come out in support of changes in bank compensation practices.
I'll be very interested to see what this final proposal looks like when unveiled in the weeks to come. It could be very vague, simply requiring Fed approval for bank pay structures. Alternatively, it could provide insight to the types of pay structures it will accept and the types it won't. Clearly, the latter would be far more revealing in understanding the effect the new regulation would have on the financial industry.