Federal Pay Regulation Finally Gets Teeth

The White House "pay czar," the Fed, and the Supreme Court are all getting involved in the finance world's compensation battles

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Three big news stories have heated up the Wall Street compensation debate. First, following up on his "suggestion" that outgoing Bank of America CEO Ken Lewis sacrifice his salary, White House "pay czar" Kenneth Feinberg has announced pay cuts at seven bailed-out companies. Then the Federal Reserve Board unveiled a new plan to review compensation at 28 massive banks. Finally, the Supreme Court is set to deliberate on the compensation of financial advisers.

As long-speculated regulations begin to take effect, financial pundits are wondering how much federal regulation of Wall Street compensation can really accomplish. Here are the best takes:

  • Fed Scheme Brilliant  Simon Johnson, former chief economist at the IMF, thinks the Fed's proposal to review compensation fantastic: "For the first time, the appropriate regulators have recognized that excessive risk-taking generates a large negative externality, i.e., a spillover that has pernicious effects on the rest of the economy, and that this can be dealt with in a reasonable manner." There are problems with the proposal, he acknowledges, such as "the quaint notion that there are only 28 financial institutions that can damage the system through excessive risk-taking," or the fact that "attacking compensation" probably isn't the best way to deal with the "externality" in question. But he offered the following translation of the announcement: "Now it gets interesting."
  • Nice Idea, 'But Don't Get Carried Away,' writes Steven Pearlstein at the Washington Post. He has no problem with banks complaining that they'll lose talent if kept from rewarding risky traders. ("If it turns out that these pay rules wind up steering the riskiest activity to smaller, more focused institutions whose failure won't require them to be bailed out by the taxpayer, that might be a good thing.") But "by themselves, these measures won't prevent future crises, nor will they likely do much to lower the prevailing pay levels on Wall Street or in corporate America." Here's why:

Much of the damage during the recent bubble was done by traders and executives who had plenty of skin in the game and lost their jobs, their reputations and virtually all of their considerable fortunes when it all crashing down. It's hard to argue they lacked sufficient incentives to be more careful with the risks they were taking.

At the same time, there is also an irreducible asymmetry ...When markets are hot and things are going well, the sky's the limit in terms of how big a bonus you can earn. But when profits suddenly turn to dramatic losses, the lowest a bonus can reach is zero.
  • Pay Caps Irrelevant--How About We Regulate Derivatives  Pearlstein's colleague Eugene Robinson compares Feinberg's pay cap proposal to "arresting jaywalkers while ignoring the bank robbery." First of all, he says, "Feinberg's writ of imperial decree doesn't extend beyond those seven companies, and the rest of Wall Street gives no indication of remotely understanding what the big deal is about compensation." But the bigger point, he writes, is that the government is "propos[ing] reforms that would ameliorate, not eliminate, this ridiculous cycle" of risky transactions.
What the administration won't do is outlaw some kinds of derivative products or transactions; officials say that if they went down that road, they would always be one step behind Wall Street's inventiveness and greed. I think it would be worth a try.
  • Questions of Legality  On the surface, the Supreme Court hearing of Jones v. Harris Associates, a case in which investors sued a firm's financial advisor for taking too outrageous a sum in compensation, seems tangential to this larger discussion. But the case "will provide insight," argues Roger Parloff at Fortune, "into how the current roster of justices view the economic question of our day: When should market forces be reined in by government?" Incidentally, Parloff is betting "the court will reject [an appeals court's] view--that virtually any fee, so long as it's disclosed, is okay."
This article is from the archive of our partner The Wire.