How to Fix Bank Compensation
Timothy Geithner (Treasury Photo)
Joe Nocera is not impressed with the Obama administration’s new program for changing compensation schemes at major financial institutions. And I think he’s right. What Timothy Geithner announced were some good ideas for improving corporate governance—arguably ideas that should be implemented across the board—but not ideas that speak to the unusual circumstances of financial institutions that are operating with implicit government guarantees and posing unique kinds of risks to the economy.
I thought back in March that Brad DeLong had spelled out the right idea:
The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed–in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. And the engineers of Silicon Valley have every incentive to use all their brains and all their hours to make their firm viable and successful: they get their cash only at the end of the process. They don’t get big retention bonuses if they stick around until the end of a calendar year. They don’t get big payouts if they report huge profits on a mark-to-market basis.
One of the goals of regulatory reform should be to push Wall Street out of its current compensation equilibrium and more toward what they do in Silicon Valley.
15 Responses to “How to Fix Bank Compensation”
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June 13th, 2009 at 4:07 pm
The problem with the silicon valley comparison is that the engineers do something useful, while the financiers don’t.
Commercial banks are supposed to be conservative, stable pillars of the community and they should be paid like they used to – well but not extravagantly.
Private equity, hedge funds, etc should have to play with their own money, not the publics – then they can do whatever they please.
June 13th, 2009 at 4:22 pm
They don’t get big payouts if they report huge profits on a mark-to-market basis.
Rilllllllllly? So every single dot com company that IPO’d and made millionaires out of its founders, is still trading? Are you absolutely sure about that?
June 13th, 2009 at 4:33 pm
The Wall Street firms banks must be held to honest accounting standards and all public monies withdrawn. Then most will collapse and the compensation issue will be settled. Anything else is just trying to square a circle and cannot be done. Except perhaps through threats of violence. I’m sure crowds of thousands outside JPM with a guillotine and effigies of Dimon and the board burning, would quickly lead to announcements of drastically lowered compensation. That isn’t going to happen of course. The blood of thousands would run down Wall Street into the sewers first.
June 13th, 2009 at 4:36 pm
Seems to me that better than any “compensation [controlling] scheme is (as Matt has I believe said before) to institute a frankly confiscatory income tax, or a steeply graduated variant thereof, above maybe $1 million (NET!) per year. Those whose talents grow capitalism also enjoy the benefits of an entire business culture and legal order that enables them to shine. Whether or not they feel any noblesse oblige, they need to throw back a whole buncha tuna. Yearly. And the estate tax needs to be revisited with rational framing. Why the grandchildren of genius businessmen should be able to sit around and shoot heroin all day and talk to their brokers on the phone is beyond me.
June 13th, 2009 at 4:43 pm
P.S. I recall seeing top income tax rates of around 90% in JFK’s time, 70% in Reagan’s time….
June 13th, 2009 at 5:11 pm
Actually, financiers are how Silicon Valley guys get the money to fund their projects. While the point is valid, dissing capital isn’t.
That said, this is just another example of why people without experience actually making things, should not be allowed to direct policy regarding people that do.
BigY and Delong would be better off advocating transparency rather than mucking around places they don’t understand.
June 13th, 2009 at 5:40 pm
Except that the Silicon valley model was largely destroyed by Sarbanes-Oxley. Note the drastically reduced number of IPOs in the wake of that legislation, even with all of the startups that were created during the biggest portion of the “Web 2.0″ bubble. Most new startups have either
– committed to staying private
– gone with the “sell to Google or Microsoft” theory
If you want that model to work, you need to do a serious rethink on SarbOx.
June 13th, 2009 at 6:01 pm
“The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. ”
I had a lot of friends who went both directions. The traders work longer hours than those at startups, but the people who worked at startups worked harder in school. I wouldn’t call either group smarter, except to the extent that joining a bank at the height of a bubble was a pretty dumb move.
June 13th, 2009 at 6:33 pm
I don’t know much about the SarbOx effects on IPOs but I do know that thinking about going public has to be a very scary prospect for Silicon entrepreneurs. The short sellers are always lurking, laying in wait for an opportune moment to wreck these newbies.
Short sellers have picked off and destroyed dozens of Silicon start-ups in the last decade. Many lifetimes of work and personal financial investment have gone up in smoke in a few hours of frenzied trading several thousand miles away.
Wall Street performs what many consider a vital Capitalistic function, it culls the weak, but it also, like any efficient wolf pack, harvests the young.
The American economy should not operate on some Caribou/Wolf paradigm garnered from the tundra. We need our young to survive. Entrepreneurship is repeatedly squelched by the very forces that proclaim it to be Capitalism’s greatest virtue.
June 13th, 2009 at 6:38 pm
Umm, a non-public startup can’t be impacted by short sellers. They can be impacted by onerous terms on additional funding rounds from VCs, but you can’t be affected by stock manipulation if you aren’t publicly traded.
June 13th, 2009 at 6:46 pm
Governance is as governance does. Obama wants TARP recipients and public companies to change executive incentive compensation.
Guess who doesn’t have to comply? Private equity firms buying banks with major FDIC funding. The Carlyle Group’s $4.9 billion in subsidy for BankUnited is non-TARP. As a private firm, BU isn’t subject to any new SEC regs on executive pay.
http://www.ft.com/cms/s/2c49e972-5792-11de-8c47-00144feabdc0,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F2c49e972-5792-11de-8c47-00144feabdc0.html&_i_referer=http%3A%2F%2Fwww.economicpolicyjournal.com%2F
Obama loves the PEU boys and crafts plan after plan for them to benefit from Uncle Sam’s dinero.
New rules, the old ones don’t apply. The same greed and leverage boys (who caused the crisis) benefit:
http://zerohedge.blogspot.com/2009/06/just-how-many-regulations-is-goldman.html
June 13th, 2009 at 7:15 pm
It’s not that banksters are any more or less useful than engineers, it’s that in computer programming and software development there is “alpha,” but in commercial and investment banking, there just isn’t. MAYBE there’s alpha in hedge funds, but those guys are paid based on ROI anyway.
DeLong’s proposal is also similar to the “bonus” model that got us into trouble, only the bonii would be paid in equity rather than cash. I’d prefer a model where bankers got relatively high base salaries, smaller bonuses, and acted in a manner similar to other educated professionals like orthodontists. This is sort of like Krugman’s call to make finance boring again.
June 13th, 2009 at 10:08 pm
Compensation doesn’t make any difference. If they had made ten times as much, but the financial system was sound, would we give a big rat’s ass?
This is a Geithner and MY circle jerk.
June 14th, 2009 at 7:47 am
One of the reasons we have had so many talented people going into finance is that engineering and science have become less attractive in recent decades. Most American engineer/scientists do not want their children to pursue the same course. Our corporations do less and less stimulating fundamental work, thanks to the Jack Welch/GE model, and if you want to do research you have to spend all your time grubbing for money.
So, if you are going to have to grub for money anyway, why not do it big-time on Wall St.?
June 16th, 2009 at 11:22 am
Brad Delong may or may not be a smart economist, and he may or may not work harder than the average Wall Street trader (I am not qualified to judge), but he sure as **** doesn’t know anything about how financiers are compensated.
You do yourself no service, Matt, by linking to people who talk through their hats. If you would like an unbiased (no, really) insider’s perspective on how things really work, and are willing to put up with reading a detailed and nuanced analysis of compensation on Wall Street rather than a rabble-rousing cartoon, feel free to mosey on over to my ever expanding collection:
http://epicureandealmaker.blogspot.com/search/label/filthy%20lucre