With good reason, a political storm is gathering over the prospect that financial firms now being rescued by taxpayers at immense expense will pay out billions in bonuses to employees this year.
New York State Attorney General Andrew Cuomo is
pressuring some firms, as The New York Times reports. So is Congress. Friday's Wall Street Journal reports that the executives running several firms may
show some leadership and take pay cuts.
But this isn't a one-year issue. The practice of giving outsize rewards to big-time risk-takers based mainly on their results in a given year is one of the main reasons we have a financial sector that's too big and too self-serving. As financial firms become more and more focused on maximizing compensation for employees, they get more and more distracted from their basic reason for existing: managing society's wealth and directing it to productive purposes. On these points, check out
the thinking of Paul Woolley of the London School of Economics.
Regulating financial sector compensation practices is sure to be a big topic at the
G-20 financial summit in Washington on Nov. 15 and at subsequent meetings. The challenge is doing it in a way that preserves rewards for people making real contributions and also doesn't just drive talent to unregulated areas en masse. It's not something you can accomplish by fiat.
What to do? Morris Goldstein of the Peterson Institute for International Economics has an interesting proposal, part of a comprehensive,
10-plank plan for financial reform. It's based on several of the planks he identifies (most of which are under discussion in some form by various bodies) and would work this way:
1. Any institution big enough to pose systemic risk -- banks for sure, but also hedge funds, etc. -- gets regulated and is subject to minimum capital requirements, which by the way need to be raised from current levels.
2. Financial firms develop best practices in tying comp to long-term results. Some of these are already in the works, apparently.
3. Financial firms that embrace those practices get a break on capital requirements, enabling them to employ somewhat higher leverage and enjoy higher profits.
That assumes a lot of change, but then we need a lot of change. Perhaps it would even work. Are there other, more draconian fixes out there? We'll find out, probably soon. -
Kenneth Klee
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