The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Late Friday, Congress finished its conferencing and passed the “American Recovery and Reinvestment Act” – and law firms went to work drafting their memos analyzing this stimulus package (we’ll be posting all these memos in our “Rolling Back Compensation” Practice Area). The final text of the legislation is posted on the White House’s site in five parts, along with the ability for anybody to post comments!

The most relevant part of the legislation for our members is the tax provisions in Division B, which includes the controversial executive compensation restrictions among others (eg. see this Hodak Value commentary) – even President Obama is not happy (as noted in this article) with what Senator Dodd inserted as the final exec comp language. Oddly, the stimulus legislation went from no new executive compensation restrictions on Friday morning to more restrictive than previously contemplated by the end of the day. More coverage to come…

Populism Over Bankers’ Pay

I thought this piece from the Financial Times’ Blog by Martin Wolf made good reading:

Populism is breaking out, not surprisingly, over bankers’ pay. When an industry has played a huge role in creating what may well be the first depression since the 1930s, that is hardly surprising. Even Lloyd Blankfein, chairman of Goldman Sachs, has admitted the industry screwed up comprehensively. That is pretty obvious now.

The response to the pay curbs is that the high pay is needed to obtain and reward talent. I think that’s nonsense. Do we really want to reward the “talent” that has just brought down the world economy?

So what makes sense here? I suggest there are four questions.

First, does the government have an interest in how bankers are paid?

Answer: yes, of course. Since the government is, on behalf of the taxpayer, the ultimate risk-bearer in banking, it has a profound interest in the structure of pay or, as Lex puts it more precisely, incentives. We have seen the impact of incentives to destroy the bank. Do we really want to go there again?

There are obvious collective action problems in all corporate payment systems. But in the case of banking the consequences are very severe. In any case, if governments are shareholders, they must have a role in setting pay, as owners.

Second, Is banking an exceptionally difficult job or one that demands exceptional talent not required by brain surgery, fighting in Afghanistan etc?

Answer: of course not. It is a gross misallocation of resources to pull the most talented people into a business whose true value added is modest and many of whose activities are zero sum. For the UK it has surely been a catastrophe.

The more energetic and “talented” bankers are, the bigger the risks they will take. I no more want bankers to have such characteristics than I want those who run the electricity grid to have these characteristics.

The reason even junior bankers make so much money is that they sit on the money flow, which is the result of the licence given by the state to create money. We should not give any support to the ridiculous idea that bankers really do deserve their pay in some objective sense. Even Hayek would not have supported that idea.

Special talent really isn’t needed in commercial banking. What is needed is trustworthiness, caution, scrupulousness and organisational ability. Everybody knew this until a couple of decades ago. They were right. Investment banking may be different (I doubt it), but then they can’t rely on government money.

Third: what sort of pay structures should the government seek?

Answer: I agree that a simple pay cap is distorting. It is well-known that this leads to all sorts of ways of disguising incomes, as happened when we had pay policies. So the intervention has to be more subtle. It needs to focus on the structure of incentives and particularly whether there is any tendency to increase risk-taking.

Finally, are current circumstances exceptional?

Answer: yes. If taxpayers are putting trillions of dollars into these ghastly institutions, do they really have no right to decide how their employees are paid? Do we not accept that they have a right to decide how the doctors they employ are paid?

Until banks are free of the need for massive government subventions, they have to accept such interventions. This is the price of failure. I would certainly agree that 500,000 dollars is too low, though it is at least double what Ben Bernanke is paid and he is at least as intelligent as – and doing a far more important job than – any banker I have ever met.