A recent Wall Street Journal survey predicted that compensation for the Street would rise 4 percent in 2010. By past standards, that might seem modest. Nonetheless, socialist-leaning U.S. Senator Bernie Sanders from Vermont called the payouts “unconscionable.” Some on Wall Street might agree, but from a different perspective: They may well regard their bonuses as too meager.
Goldman Sachs, whose third-quarter profits declined from $3.2 billion in 2009 to just $1.9 billion in 2010, said it was slashing 2010 compensation by 26 percent. Morgan Stanley, which lost $91 million in the third quarter, is cutting investment bankers’ bonuses by 8 percent.
The (strictly relative) hardship is not spread across finance. Alan Johnson, a Wall Street compensation expert, estimates that fixed-income and equities traders are looking at a reduction of 25 to 30 percent in their bonuses. By contrast, asset management, hedge fund, private equity and wealth management executives are likely to get 10 to 15 percent hikes in their incentive comp.
Although it might seem obvious that it should, pay does not automatically decline on Wall Street when profits do. Yale political scientist Jacob Hacker, co-author of Winner-Take-All Politics, a recent book purporting to show how Washington helped create a new class of rich, says recompense in finance was seemingly designed “so that it is good when times are bad and even better when times are good.”
Hacker and his coauthor, Berkeley political science professor Paul Pierson, argue that financial industry compensation must be restructured so that incentives that can “cause huge problems for the rest of the economy” are minimized and Wall Streeters engage in more-productive activities.
This can no longer be regarded as a fringe opinion. In an October speech, James Gorman, CEO of Morgan Stanley, complained that a lot of people on Wall Street are “frankly pretty average” yet undeservedly earn 10 times what their counterparts in other industries do. Gorman, who himself took home $15.1 million last year, asserted it was about time that Wall Street created “a compensation system that better aligns or balances shareholders’ interests and the broader society’s interests with the individual’s interests.”
Washington appears to be groping in that direction (or was until the midterm elections). Federal financial regulators’ “Guidance on Sound Incentive Compensation Policies” for banks stipulates that their incentive pay should balance risk and results so that employees aren’t tempted to take imprudent risks. How the government proposes to enforce this dictum was not made clear.
The Dodd-Frank Wall Street Reform and Consumer Protection Act gives shareholders a voice in determining the pay of financial executives. In October the SEC followed up with proposed “say on pay” regulations.
Such measures are partly a response to the public outcry over taxpayer-rescued Bank of America’s having paid $3.6 billion in bonuses in 2008 to executives of Merrill Lynch, which BofA had just acquired, even though the brokerage firm had lost $15 billion that year. Congress demanded that executives at banks bailed out by the Troubled Assets Relief Program receive comparatively modest cash salaries and take most of their pay in deferred compensation reflecting their firm’s performance. (To escape this constraint, bailed-out banks rushed to pay back TARP loans well ahead of schedule.)
Wall Street seems to be quietly heeding the blowback over unmerited compensation. Five years ago half of Wall Street bonuses were cash and half equity in the recipient’s firm; today closer to 75 to 80 percent is doled out in deferred stock, according to compensation expert Johnson.
The Street is also beginning to employ clawbacks to recover part or all of a bonus if, say, a trader’s investments go sour in subsequent years. Yet these pose legal issues and have been used only in isolated cases.
Are these steps enough to rein in the Wall Street bonus culture? Kevin Murphy, a compensation expert at the University of Southern California, observes that 38 percent of the senior executives covered by TARP rules quit and found other jobs rather than accept pay limits. He adds that if a firm tries to reduce bonuses across the board because of poor performance in one division, top performers in other parts of the firm might well exit.
The new rules may be too mild-mannered to reduce risky behavior. Thomas Cooley, an economics professor at NYU’s Stern School of Business and co-author of a new book, Regulating Wall Street, asserts that “shareholders and managers can be perfectly aligned [on pay], but if incentives provided by the financial system, such as the moral hazard created by too-big-to-fail guarantees and mis-priced FDIC insurance, encourage riskier behavior, then that’s not in the interest of the public.”
In the end, stricter regulations, such as Dodd-Frank’s ban on proprietary trading, may make Wall Street a less alluring place to work. Ariell Reshef, an economics professor at the University of Virginia, studied a century of Wall Street compensation. He found that after the federal government imposed heavy regulation in the 1930s, finance industry wages fell relative to pay in other industries and didn’t start rising in relative terms until deregulation began in the Reagan era. Now that regulation seems to be coming back, Reshef says, “people will be leaving the financial sector, and wages are going to go down.” If that means firms take fewer risks and have more-reliable profits, it could be as good for Main Street as it is for Wall Street.
