Today, the Wall Street Journal reported that the Federal Reserve is crafting a proposal to significantly step-up its regulation of Wall Street compensation practices. According to the Journal, the proposal would allow the Fed to “reject any compensation policies” it believes encourage bankers to take too much risk. The Fed “wouldn’t set the pay of individuals, but would review and, if necessary, amend each bank’s salary and bonus policies to make sure they don’t create harmful incentives.”
Though the Fed’s proposal is still weeks away from being finalized, it has already provoked quite the reaction from the right-wing. Rep. Spencer Bachus (R-AL), the ranking member on the House Financial Services Committee, was asked about the policy shift on CNBC today, and claimed that the very notion of regulating Wall Street pay means “abandoning a model that’s worked for America”:
We all know there were compensation practices that created incentives for executives to take outsized risk. Having said that, why are we abandoning a model that’s worked for America? We’ve got the largest economy in the world, it’s over three times larger than the Japanese economy and we didn’t get that by government micromanaging companies and setting compensation.
The notion that Wall Street’s reckless compensation structures, which incentivized short-term risk taking over long term financial viability, worked well is ridiculous. And even Bachus couldn’t really bring himself to defend Wall Street, spinning off into a defense of capitalism itself, as opposed to “so-called utopian society.” But James Hamilton at Econbrowser laid out exactly how Wall Street’s perverse pay structures cause systemic problems:
Suppose that in 2005, the individuals who were putting together securities derived from subprime and alt-A mortgage loans could have known, with perfect foresight, events that were going to unfold in 2008. Would they have still done the same things they did in 2005? My concern is that, for many individuals, the answer might be “yes”, insofar as they were richly rewarded personally in 2005 for making exactly the decisions they did. It was other parties (namely you and me) who later down the road were forced to absorb the downside of their gambles
As for this particular proposal from the Fed, I think it’s yet another instance of the Fed promising far too little, far too late, and expecting the last crisis to be water under the bridge so long as it vows to do better next time. As Yves Smith put it, “the ideas on the table suggest any moves will [be] directed at the most extreme practices, simply to curry the image that the Fed is Doing Something.” The Fed has already shown that many of its regulatory responsibilities get shunted down the list of priorities — or outright ignored — when times are good, so I’d prefer that something other than Fed promises be the basis for regulating Wall Street’s compensation.