Cool anger over Wall Street bonuses by governing how they're handed out

Tuesday, January 19, 2010

ANOTHER Wall Street bonus season is upon us, accompanied by another round of studied outrage in Washington. White House economic adviser Christina Romer said the prospect of tens of billions of dollars in payouts "offends" her. So profound was the disgust of Andy Stern, president of the Service Employees International Union, that he could express it only in a complex metaphor: "They backed the truck up to Fort Knox in broad daylight," Mr. Stern said. "They emptied it out, we rescued them and they get $150 billion in bonuses."

How much is the right amount to pay a Wall Street trader? Perhaps no one "deserves" $5 million a year to swap bonds, especially when the financial industry has performed badly. But no one "deserves" $5 million to bat .220 for a last-place baseball team, either. There is simply no objective, scientific answer to such a question. Therefore, it is best left to market forces and the decisions of private-sector figures, such as executives and the boards of directors who are supposed to hold them accountable, on behalf of shareholders. Over time, firms have found that bonuses -- performance-linked portions of company revenue added to a base salary -- are the best way to reward and retain talent.

There are two provisos: First, government's say on pay properly grows when financial institutions are living off taxpayer support, as they have been for much of the past two years. Second, even when taxpayer support ends, the public has a legitimate interest in financial stability, including an interest in ensuring that Wall Street's pay systems -- as opposed to the amount of any particular person's pay -- are not destabilizing.

At the moment, the financial system is transitioning from massive and open government support for Wall Street to (one hopes) a more normal state of affairs. It would be counterproductive to saddle financial institutions with punitive pay controls. But it would be equally mistaken to return to business as usual. With or without a nudge from government, Wall Street must learn and apply the lessons of the crisis. One of these is that compensation systems can provide employees with incentives to maximize short-term results -- and hence short-term income -- at the risk of giant, long-term losses. Kenneth R. Feinberg, the Treasury Department special master who oversees pay policy for bailed-out companies, has forced them to pay more compensation in long-term stock rather than bonus cash.

The Federal Deposit Insurance Corp., at the urging of Chairwoman Sheila Bair, has begun formal consideration of a proposal to link banks' deposit insurance fees' to their adoption of such payment rules. There are serious questions about whether the FDIC is the appropriate agency to spearhead such an effort. But the general idea that banks should be free to pay people as much as they want, as long as the method of payment is not financially destabilizing, makes sense. Boards of directors and shareholders must take a much more active role in ensuring sound pay policies. This is not only a matter of their own interest but that of the public as well.

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