Commentary: Risk-taking still gets rewarded
Given a shot at tamping down risk-taking on Wall Street, did Washington miss out on using a silver bullet?
In a blanket approach, the Dodd-Frank Act attempted to safeguard almost every aspect of financial services: consumer protection, limits on hedge-fund and private-equity participation, proprietary trading, a process to deal with too-big-to-fail firms and so on. There are new rules and more rules, more desk jockeys and bureaucrats.
But there is a glaring omission: pay.
For all of the reformist talk of how Dodd-Frank will squeeze Wall Street's ability to take big risks, the plan ignores the impetus behind that risk-taking.
Wall Street's paycheck machine is undaunted in the face of reform. Bonus pay is expected to rise 5% this year, according to the latest survey from Johnson Associates Inc. Overall compensation is edging up, expected be $144 billion this year, and guaranteed pay packages are back in vogue for so-called rain-makers and heavy hitters.
Average bonus: $130,000
Although bonus levels probably won't top the records seen in the bubble years, they are outpacing revenue growth — up just 3% — as well as profits — which are flat to lower — at big firms. Blackstone Group Inc. (NYSE: FHN - News) is setting aside an average of $3.46 million per employee even though Blackstone lost $223 million in the first half of the year. It made a $339 profit in the third quarter. See list of top compensation at Wall Street firms on FINS.
And Wall Street CEOs have dropped their modesty. Bonuses for the C-level suite are expected to rise 50%.
Time will tell if the rise in pay translates into taking bigger risks. Historically, big paydays usually precede big declines. The tech bubble's fallout shredded Wall Street payrolls, and the end of the housing bubble left the economy in tatters.
Even now, there's concern that pay and risk have become intertwined. The Securities and Exchange Commission reportedly is watching with interest as retail brokers are wooed to rival firms with the promise of 300% bonuses above annual commissions and fees. See report on broker incentives.
The fear is that such compensation schemes encourage brokers to promise clients too much, and get them into risky or inappropriate investments — all in the hopes of hitting targets that trigger big payouts.
If that sounds familiar, it's because it is. Yes, pay was reined in temporarily at big financial firms including American International Group Inc. (NYSE: AIG - News) Bank of America Corp. (NYSE: BAC - News) and Citigroup Inc. (NYSE: C - News). But the restrictions were light and will be lifted once the banks pay off their government aid.
Efforts to curtail pay on Wall Street failed in Congress as the financial industry successfully lobbied lawmakers with claims that lower pay would drive top talent and business off our shores. Overseas, especially in France and Britain, limits on pay have been tougher. But firms there have argued that if U.S. regulators aren't squeezing, why should they?
It didn't have to be this way, of course. With the fire of the financial crisis still burning, lawmakers considered multiple rules tied to pay. And even some in the industry, including Morgan Stanley's (NYSE: MS - News) John Mack, seemed resigned to changes.
A couple of years ago, Mack predicted that pay would become the biggest issue facing the industry. It didn't, and he exited as the firm's chief executive.
In 2009, the Federal Reserve announced a plan to review compensation and risk practices among member banks. But that plan either hasn't been implemented, or it's having a limited effect. The Fed didn't respond to requests for comment.
As late as this summer, 40 members of Congress called on 17 banks including Citigroup, AIG and Regions Financial Corp. (NYSE: RF - News), to claw back $1.58 billion in bonuses paid out while their institutions had received bailout funds. That request was ignored.
At this stage, it's doubtful that any kind of pay reform would be enacted. Republicans already have promised to roll back many of the provisions of Dodd-Frank. Democrats, including Rep. Barney Frank (D-Mass). and Sen. Chris Dodd (D-Conn.), appeared to be sympathetic to banking interests when the issue was raised.
That's a lost opportunity for the safety of our financial system. Pay restrictions aren't about punishing Wall Street; they're about aligning compensation with risk. Clawbacks and deferred pay would make bankers and brokers more accountable for their short-term positions if those positions turn out to hurt the firms, and the economy, in the long term.
Compensation reform is the coldly efficient silver bullet that remains in the holster.
Congress may be hard-pressed to control Wall Street bankers. Yet when they had a chance to control the one thing that bankers care about — their wallets — lawmakers blinked.
David Weidner covers Wall Street for MarketWatch.