Is it Time to Police Pay at Wall Street Banks?
Sept. 20, 2009
As a longtime free-market advocate, I never thought I would be writing this – but the time has come to regulate the Wall Street compensation of senior banking executives. So, I’m endorsing the proposal from the Federal Reserve – with two provisos.
The Fed ostensibly wants to discourage excessive risk-taking by many banks, including their permissive lending by regulating bank executives’ pay. Nearly 6,000 banks would be covered.
Such practices helped lead to the deepest financial crisis in decades. The behavior has been so bad, it also helped exacerbate problems with the agency that insures consumer accounts to $250,000. Federal Deposit Insurance Corp. may have to borrow money from the U.S. Treasury. FDIC’s bank insurance fund will be paying out $70 billion through 2013 after 123banks collapsed by Thanksgiving in 2009.
Businesses have suffered because their accounts are not insured.
“Wall Street greed and irresponsibility have nearly destroyed the U.S. economy,” said Dr. Peter Morici, a professor at the University of Maryland School of Business and former chief economist at the US International Trade Commission. “Big bonuses for bankers encourage reckless risk taking and were a principal cause of the credit crisis and Great Recession.”
Here are some examples:
“Banks wrote mortgages and sold those to Wall Street financial institutions, who bundled loans into bonds and sold those to investors, such as insurance companies and foreign governments,” said Dr. Morici. “From loan officers to the Wall Street bond salesmen, opportunities to exaggerate the quality of loans emerged. If local banks or Wall Street financial houses could pawn off high-risk, high-fee loans as reasonably safe, they enjoyed big paydays.”
He bluntly criticized the behavior on SWAPS, a financial instrument called a derivative. Simply put, it pays face value to the buyer if a company does not meet its debt obligations.
“Wall Street bankers wrote bogus insurance policies called SWAPS that were supposed to limit losses for investors when mortgages defaulted,” added Dr. Morici. “AIG wrote many SWAPS without capital to back them up, and banks even wrote SWAPS on each other’s mortgages – like two homeowners on a North Carolina beach promising to pay one another in the event of a hurricane.”
SWAPs and bad bonds victimized investors and the bankers garnered mega paychecks. But when the homeowners failed to pay mortgages, banks faltered and the huge losses rippled throughout the economy. But only the banks were bailed out by the government (taxpayers).
To add insult to injury, banks have been allowed to borrow at extremely low interest rates. But they failed to make funds available to consumers and business, and once again enjoy enormous profits. And they have been paying huge paychecks to management.
“Consequently, widows relying on Certificates of Deposit for income, now receive much reduced interest rates” said Dr. Morici. “That’s right – Ben Bernanke is taxing grandma to bail out Goldman Sachs.”
Receiving comparatively little attention has been the continuing predatory behavior on credit card customers – banks and credit card companies are still geting away with bogus reasons for jacking up credit card rates and fees.
But a year after the collapse of Lehman Brothers, another SWAPS practitioner, SWAPS have lost their stigma, according to published reports.
Dr. Morici agrees:
“Flush with profits, the banks are up to their old tricks – again creating highly engineered financial products, selling swaps, setting aside massive profits for bonuses, and manufacturing conditions for another crisis,” said the business professor. “If Wall Street banks are too big fail, then they are too big to let go on with this irresponsible behavior.”
But he points out the Fed would be over-matched in its proposal to regulate bankers’ pay.
“The latter is too complex to be realistic – the banks would run circles around such rules, much like lawyers creating tax shelters,” he said. “Better to limit bonuses and salaries of bankers to a fixed percentage of net income that aligns financial sector salaries with those of other industries.”
Agreed. In addition, I would add two caveats:
- Strictly reduce the amount of risk that banks undertake.
- Require high reserves – much higher.
And on a related topic while we are cleaning up Wall Street practices, let us correct the predatory behavior of banks and credit card companies that dramatically increase rates and fees for bogus reasons. The companies are domiciled in a handful of states that permit such behavior.
In other words, here is what is really needed: Police the behavior of these people.
But are the Obama Administration, Congress, certain state lawmakers, and regulators conscientious and determined enough to do the right thing and stop the madness?