Bair offers her own solution on bank compensation

Bair offers her own solution on bank compensation
http://www.nakedcapitalism.com/2010/01/bair-offers-her-own-solution-on-bank-compensation.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

Posted: 12 Jan 2010 04:16 PM PST

By Edward Harrison of Credit Writedowns. Following up on Yves’ earlier piece on the Obama Administration’s banker windfall compensation tax scheme, I want to talk about a competing plan by Sheila Bair. While the first plan seems designed for political purposes in an election year, this plan is geared more toward the longer-term and systemic issues.

FDIC Chairperson Sheila Bair has released her own proposal to compete with a recently floated proposal for a tax on bank compensation. Her proposal calls for linking compensation with FDIC insurance levies as a means of aligning incentives in the banking industry going forward. In contrast, the competing initiative calls for a one-off ‘windfall’ tax as a means of recouping bonus money due to be paid out by large financial institutions.

In announcing her competing plan, Bair said:

A broad consensus of academic studies agrees that poorly designed compensation structures can misalign incentives and induce risk taking. I share those concerns. The recent crisis has shown that compensation practices that encourage excessive risk can create significant losses in the financial system and the deposit insurance fund.

What I like about Bair’s proposal is that it is designed both as a longer-term solution and meant to align compensation with the larger systemic risks, which Bair explicitly mentions in the quote above. On the other hand, I see the windfall tax proposal as a gimmick designed to harness the public’s outrage on a serious issue and misdirect it toward a one-off political ploy. Windfall taxes are not going to change systemic issues on risk, compensation and moral hazard, whereas the insurance levy does move in that direction.

The public is right to be angry about excessive compensation in financial services. The real issue in compensation has to do with individuals being compensated in the present for riskier bets which appear to accrue higher payoffs in the near-term but have disastrous consequences longer-term. Imposing a one-off tax does nothing to eliminate this problem. Tying compensation and risk together does.

What angers me personally is that this banker windfall tax appears to be a naked ploy to quell voter anger. The tax offers superficially satisfying populist solutions which fail to address any of the more systemic issues that led to the financial crisis. After the one-off tax, it’s back to business as usual on Wall Street. This seems to be a solution designed to win votes and nothing more. Let’s hope Bair wins the day in the Obama Administration’s internal politics.

Source

FDIC Board Seeks Comment on Incorporating Employee Compensation Structures Into the Risk Assessment System – FDIC: Press Releases – PR-5-2010 1/12/2010
http://www.fdic.gov/news/news/press/2010/pr10005.html

Also see FDIC’s Bair Blasts Other Regulators for Reluctance on Banker Pay Plan from the Wall Street Journal.
http://blogs.wsj.com/economics/2010/01/12/fdics-bair-blasts-other-regulators-for-reluctance-on-banker-pay-plan/