In the span of the last few days both the International Monetary Fund and the White House have come down on Wall Street compensation, saying that it was a factor in causing the financial crisis.
The IMF dedicated much of its recent Global Financial Stability Report to discussing how different compensation structures impact the amount of risk bankers take. This isn’t a new idea — for years regulators and politicians have been arguing that when bankers are working toward big annual bonuses, they don’t think as much about the long term effects of their actions.
From the report:
Traditionally, compensation structures for bank executives have been based on operating profitability and stock price performance metrics such as return on equity and book value per share. These metrics are short term and do not account for operational, credit, and liquidity risks. More appropriate performance measures account- ing for longer-term risk could include the sensitivity of a bank’s stock to the wider stock market (beta), the credit default swap spread of a bank’s debt, or risk-adjusted economic capital (measured by market capitalisation plus total debt minus risk-weighted assets).
The IMF recommended that Wall Street tie pay to longer term performance by forcing institutions to take more ownership of themselves (through stock), and by instituting clawbacks.
So if you’re a banker, and something you did years before blew up in the bank’s face, the bank can take back some of your pay.
On Monday President Obama met with financial regulators and urged them to continue working on capital standards and compensation regulation as a way to curb risk taking at banks.
From the White House:
The President acknowledged the collaborative work of the regulators, specifically recognising their work in finalising the Volcker Rule, and also urged participants to consider additional ways to prevent excessive risk-taking across the financial system, including as they continue to work on compensation rules and capital standards.
The Wall Street Journal reports that no specific new measures were discussed, but it sounds like the President wants regulators to start working on them.
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