Thursday, July 23, 2009

Capping Bankers Compensation Is Bad Policy

This just in.

Wall Street banks which have paid back federal bailout funds are stockpiling billions of dollars to pay employee bonuses that at the present rate would exceed compensation levels before risky trading plunged the industry into a meltdown last year.

It's business as usual, President Barack Obama said mockingly at his Wednesday night press conference. "With respect to compensation, I'd like to think that people would feel a little remorse and feel embarrassed and would not get million-dollar or multimillion-dollar bonuses," he said.

My question. What else would one expect?

"It strengthens our commitment to getting legislation passed," Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, said in a Washington Post interview Wednesday, adding that a committee vote on a bill to increase oversight of Wall Street pay has been scheduled for Tuesday. "The amounts are troubling," Frank said.

Bailout funds administered by The Treasury under the Toxic Asset Recovery Plan (TARP) limits compensation but are removed once the money is repaid.

It has always been my contention that it is dangerous precedent for the federal government to cap salary and bonus compensation in the private sector. It is worse policy when the major banking institutions, freed from TARP regulations, offer greater compensation and rewards when other banks still struggling to pay off the loans are handcuffed and competing with a different set of rules. It is only natural that the best and brightest -- and, yes, even the greedy -- seek the best paying jobs in the market place.

That's the culture the financial institutions work. No matter what the rules are, those sneaky corporate lawyers will find a way around restrictions Congress may impose. Always have. Always will.

Having said that, I also believe Congress can lay down safeguards protecting stock holders and investors from unscrupulous practices which ran crazy leading up to the 2008 financial market collapse. That is part of the legislation and rules drawn by Treasury Secretary Tim Geithner that are under consideration. Some banks already have enacted self-imposed rules that reduce or eliminate compensation for brokers whose activity results in losses for the company. One proposal is requiring transparency to inform stock holders exactly what the compensation rewards entail and allowing them to squelch what is known as rainbow umbrella retirement or severance packages.

What Barney Frank means as "troubling" is the $74 billion six Wall Street banks have set aside for employees so far this year, up from $60 billion at this time last year.

On the one hand is Goldman Sachs, which reported $3.4 billion second quarter profits, earmarking $11.4 billion so far this year at a pace that its employees will earn an average of $773,000 which is double from last year but still more than the $700,000 paid in 2007.

But, as the Post story pointed out, rival Morgan Stanley, which reported a $1.26 billion second quarter loss, has set aside $3.9 billion in compensation expenses that represent 72% of its entire second quarter revenue. Says the Post:

Traditionally, Wall Street banks have set aside about 50 percent of revenue to pay their workers, though that ratio is lower at firms with larger commercial banking operations, like Citigroup and Bank of America, which have a sizable number of lower-paid employees handling consumer business.

Morgan Stanley's compensation figures raised eyebrows among some analysts, who peppered Chief Financial Officer Colm Kelleher with questions about employee pay during a conference call.

"Clearly, we have to pay competitively," Kelleher said during the call. "We are a preeminent investment banking franchise. Obviously, we really would like to have far more revenue to make the compensation issue easy."

... In an interview, analyst Brad Hintz with Sanford C. Bernstein challenged that explanation, saying Morgan Stanley's compensation ratio has remained high throughout the financial crisis. "Unfortunately, this means that Q2 was a pretty good quarter for the employees, but not so for the shareholders," Hintz said.

Congress is barking up the wrong tree by capping compensation. Rather, the high-rollers should be more closely monitored to avoid high risks and institutions should be required to keep reserves at a minimum level and pay into a fund for default insurance such as the banks are required through the Federal Deposit Insurance Corp. A similar system has been installed by the oil commodities market that quickly detects unlawful oil speculation among its brokers.

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