The big news on the regulatory front last week was the Wall Street Journal’s revelation that the Federal Reserve will give its regulators the ability to reject any pay package for any bank employee that encourages excessive risk-taking. The Fed is apparently claiming this authority on the grounds that as a safety-and-soundness regulator, it has the right to prohibit any bank practices that threaten the safety and soundness of the bank. Sounds good to me.
Now, there are certainly reasons to be skeptical, which Yves Smith abundantly outlines. This could be a ploy to gain some populist credentials and head off more Congressional oversight of the Fed. The Fed has been willing to trust banks to tell it what their risks are, so it is not equipped to identify compensation packages that create excessive risk. TheFed will be looking (according to the WSJ) for outliers among the group of the top 25 banks – so as long as all 25 banks are engaged in the same silly compensation practice, the Fed will let it go.
Still, though, I am a little bit encouraged that this is on the table. Only a few months back, Treasury was trying to convince us that the best it could do on banker compensation was (1) say-on-pay legislation (non-binding shareholder up-or-down votes on executive pay packages) and (2) increased independence of compensation committees. As I wrote at the time, these proposals both suffer from the near-fatal flaw of relying on shareholder governance, which (a) is weak and (b) suffers from the same skewed incentives that managers do.
The idea of Fed civil servants vetoing traders’ pay packages just shows how tepid the Treasury proposal was. While I share much of Smith’s skepticism, I at least hope that this will move the ball in the right direction.
By James Kwak