by Faiz Shakir, Amanda Terkel, Matt Corley, Benjamin Armbruster, Alex Seitz-Wald, and Zaid Jilani
October 23, 2009
Reining In Wall Street's Greed
In "a sharp departure from the hands-off approach that has dominated regulations for decades," the Obama administration announced new restrictions on executive compensation for financial firms this week. On Wednesday, Special Master on Compensation Kenneth Feinberg said he will order seven companies that received government bailout funds to cut cash salaries by about 90 percent compared with last year. Separately, the Federal Reserve announced its own plan yesterday to review compensation in the banking industry as a whole, with a particular focus on the 28 largest and most complex companies. The announcements could not have come at a better time. Despite the deep financial crisis and the reliance on taxpayer dollars, compensation at financial firms is on pace to be higher than ever. The Wall Street Journal reports that Wall Street firms are "on pace to pay their employees about $140 billion this year," a record amount. Financial firms and their supporters say they need the hefty payment packages to attract the best people, but as Sen. Sherrod Brown (D-OH) noted, if they have "produced so much money for themselves and they're such geniuses, where have they led this country?" Conservatives lawmakers and the U.S. Chamber of Commerce have come to Wall Street's defense, decrying the government's intervention. "I have a visceral reaction against so much government involvement in free enterprise," said Sen. Lamar Alexander (R- TN). Wall Street's compensation methods encouraged people to take on excessive risks that put their companies -- and thus the entire economy -- in jeopardy. Moreover, as President Obama said yesterday, "it does offend our values when executives of big financial firms, firms that are struggling, pay themselves huge bonuses even as they continue to rely on taxpayer assistance to stay afloat." But while the moves were welcome announcements, Congress needs "to continue moving forward on financial reform that will help prevent the crisis we saw last fall from happening again."
COMPENSATION FAILURE: In addition to addressing the populist outrage over taxpayer-funded bonuses and benefits, curbing executive compensation is essential to the health of our economy. Wall Street compensation levels played a direct role in causing the financial crisis. As Fed Chairman Ben Bernanke explained yesterday, "Compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability." Compensation practices like guaranteed bonuses, which lock-in multi-million dollar bonuses regardless of how the company performs, encourage executives to take huge risks while removing any accountability in case their gambles fail. As Nobel Prize-winning economist Joseph Stiglitz wrote,"They did what their incentive structures were designed to do: focusing on short-term profits and encouraging excessive risk-taking." Wall Street said it would change, but just a year after the depth of the financial crisis, some firms are returning to their old habits. Some banks -- even those ostensibly owned by the federal government -- have again begun offering guaranteed bonuses, while salaries and fringe benefits, like private jet rides, are on the rise. The giant miscalculations that led to the financial crisis prove that, despite what some conservatives say, Wall Street cannot be counted on to regulate itself. Executive compensation needs to be reigned in and restructured so executives are held accountable for taking risk, especially for those companies which are alive today only because of government help.
BUZZ CUT: The cuts announced by Feinberg will affect the 25 most highly paid executives at Citigroup, Bank of America, AIG, General Motors, Chrysler, and the financing arms of the two automakers. All seven firms received billions of dollars from the Troubled Asset Relief Program (TARP), giving Treasury the authority to regulate them. The department will also "curtail many corporate perks, including the use of corporate jets for personal travel, chauffeured drivers and country club fee reimbursement." The companies were required to submit compensation requests to Feinberg, and he said he found them "almost without exception to have been not in the public interest. They were both too high and the wrong mix of stock and cash." Feinberg's plan will "change the form of the pay to align the personal interests of the executives with the longer-term financial health of the companies. For instance, the cash portion of the executives' salaries will be slashed on average by 90 percent, and the rest will be replaced by stock that cannot be sold for years." The Fed, meanwhile, will create a two-tier system of supervising pay, in an effort to better tie rewards to long term performance. The 28 largest and most complex firms, such as JPMorgan Chase, Goldman Sachs, and Morgan Stanley, will have to present their compensation plans to the Fed, which will then evaluate them to ensure they "properly balance goals of short-term growth and long-term stability." For the other hundreds of banks in the country, the Fed will conduct "regular, risk-focused" reviews of compensation structures in an effort to prevent banks from encouraging "excessive risk-taking beyond the organization's ability to effectively identify and manage risk."
REAL REFORM: The announcements are a welcome step to prevent another financial crisis, but as The New York Times noted, the Fed's principles "are less strict than plans suggested by some European leaders and some members of Congress." The plans are also devoid of specifics, and have no teeth behind them. So long as the banks make an attempt to conform with the principles above, it seems like the Fed will be willing to give them a pass, which is why Obama is pushing for major financial reform that goes beyond compensation. Sen. Chuck Schumer (D-NY) wrote a letter to Feinberg endorsing the Treasury's action yesterday, but he underscored that he also wants Feinberg to force the seven TARP companies to "significantly revamp their corporate governance across the board." Schumer has been pushing for the adoption of a Shareholder Bill of Rights, which would give shareholders more say over how executives manage corporations, allowing them to better regulate compensation and excessive risk-taking. Other proposals like "say on pay," which allows shareholders to voice opposition to compensation structures, have worked well abroad. As Treasury Secretary Tim Geithner points out, "[say on pay] has already become the norm for several of our major trading partners." In two of those countries -- Great Britain and Australia -- CEO pay "grew 2.4 percent and 25.3 percent, respectively, from 2002 through 2006, while pay in the United States soared 59.9 percent in the same period."