How Wall Street got its greed back

The Obama administration's anaemic proposals to regulate executive pay won't end Wall Street's bonus culture

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Andrew Clark
guardian.co.uk, Tuesday 16 June 2009 20.00 BST

The credit crunch's wrecking ball has done its worst, but much of Wall Street, however pockmarked, is still standing. Among battered banks, there is cautious optimism that the worst of the financial crisis is over. So the nation's financiers can revert to their number one priority: self-enrichment through the accumulation of telephone-number-sized paycheques.

The past year's financial apocalypse has provided a golden opportunity to end the greedy, vulgar culture of stratospheric bonuses in the financial industry. But the Obama administration, initially keen to take up the challenge, has blinked.

In an anaemic monologue last week, the Treasury secretary, Timothy Geithner, blandly acknowledged that executive compensation was a "contributing factor" to the financial crisis, as vast rewards for short-term gains encouraged an appetite for irresponsible risk. He waffled on for 19 paragraphs about aligning pay with performance. But what does he propose actually doing about it?

Geithner offered only two modest measures. He wants to allow shareholders in US companies to hold a British-style "say on pay" advisory vote on executive pay. And he will tighten up the rules surrounding the independence of directors on pay-setting committees. He reassured Wall Street: "I want to be clear on what we are not doing. We are not capping pay. We are not setting forth precise prescriptions for how companies should set compensation, which can often be counterproductive."

His tone was a far cry from Barack Obama's robust attitude in January, when the newly elected president summoned television cameras into the Oval Office to blast banks for the "height of irresponsibility" in paying out $18.4bn in bonuses last year, a sum equivalent to $112,000 per employee. Although a drop of 44% on 2008, the payouts were the fifth largest on record during a year in which the industry begged for taxpayers' support to avert institutional collapse. Obama called it "shameful", and within days he proposed a now-abandoned cap of $500,000 on salaries at banks receiving taxpayer aid.

Big bonuses on Wall Street never used to bother the American public too much. In comparison to the annual outrage over boardroom remuneration in Britain, Americans took a relatively laid back view, seeing high earnings as an outcome of the American dream. That view has changed markedly, partly due to several causes celebres.

There was genuine popular outrage at the spectre of a group of AIG executives getting $165m in "retention" payments when their own department had crippled the insurer's balance sheet. And the former Merrill Lynch boss John Thain displayed a staggering disconnection with the rest of society when he suggested to his board that he deserved a $10m bonus for guiding the struggling brokerage into the arms of a cut-price takeover by Bank of America (shortly after spending $1.2m on an antique-heavy refurbishment of his corner office).

The public memory is short, and the bonus furore has already drifted to the back of many minds. But Geithner's softly-softly approach simply will not do. The centrepiece of his solution, a non-binding annual shareholder vote at each company on executive pay, is a modest improvement in accountability. But it isn't enough. Shareholders are imperfect referees of the pay game because most votes are wielded by hedge funds managers and investment managers who are bonus-driven Wall Street insiders themselves.

So what else can be done? Remuneration experts argue, with some plausibility, that an outright cap on pay won't work because the financial industry will simply invent ingenious new ways to get round the measure. Many of the ruses we know only too well – share options, restricted stock, long-term incentive plans, deferred compensation – were developed to get round previous efforts to restrict pay. And there is a genuine risk that a cap would cause a brain drain as top staff simply leave for higher paid jobs in Asia and Europe.

But it is possible to use the tax code to punish excess. And the chairman of the House financial service committee, Barney Frank, has a decent idea. He suggests that incentives should be balanced by penalties. If executives are to get financial rewards for decisions that bring in money, they should equally have money deducted from their core compensation for decisions that go wrong. That, argues Frank, would encourage them to think harder before taking reckless risks. At the moment, as he puts it, the deal is "heads they win, tails they break even", so the logical course of action is to keep flipping the coin.

This issue needs to be settled soon. Since January, 18 different proposals have been discussed in Congress to regulate executive pay, and the White House has failed to offer coherent leadership on the subject. The administration has shown a tendency towards grandstanding – last week's appointment of a much-vaunted "pay tsar" looked, at first glance, like a big move. But the small print reveals that the appointee, Washington lawyer Kenneth Feinberg, will only oversee pay for a few dozen top individuals at institutions in receipt of taxpayer handouts. Since the Treasury is allowing a dozen of Wall Street's biggest banks to pay back their emergency government funding, institutions such as Goldman Sachs, Morgan Stanley and JP Morgan will be outside his reach.

An influential banking analyst, Richard Bove, today predicted that banks, recapitalised and refreshed, will shortly enter "a new golden age" of moneymaking. If that proves true, then Goldman's chief executive Lloyd Blankfein, who is the highest paid bank boss on Wall Street, can soon look forward to bettering his record 2007 pay packet of $68.5m. And it is hard to see investors voting him down if profits are on the up.

It is time for a decision. Do we really want Wall Street to go back to playing the same old casino games? Or shall we change the rules to make sure that irresponsible bonus-chasing doesn't cripple the economy again?

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