Marketplace Scratch Pad

Banker pay: the wrong problem?

Scott Jagow Sep 23, 2009

One of the big topics at this week’s G-20 summit will be banker compensation. World leaders seem in unison on this topic — outrageous bonuses led to excessive risk-taking, which led to the economy’s collapse. But what if that’s just not true?

The Wall Street Journal presents a different viewpoint in an editorial today. The Journal says governments shoulder much more of the blame:

Far more important than bonuses were the incentives to issue and take on debt, especially housing-related debt, created by . . . the politicians who now want to blame banker pay. There’s the systemic risk that the Federal Reserve created with the ultralow interest rates that subsidized credit for so much of this decade; the privileged status bestowed upon the ratings agencies by the SEC and others; and regulatory capital rules that favored securitized mortgages over the same loans when held in portfolio by the banks. True reform would grapple with these issues, rather than the calculated distraction of bank pay.

Going forward, the biggest systemic risk is the emerging reality that the politicians consider our biggest financial institutions too big to fail. This is a much greater incentive to excessive risk-taking than any bonus pool because it means the bankers get the profits while taxpayers absorb the risk of failure.

Besides, the Journal says, there’s little evidence to support the bonus argument in the first place. Banks that failed paid big bonuses. So did banks that fared okay. The latter had better risk management in place and/or they were bailed out. Plus:

… as Jeff Friedman of Critical Review notes, banks on the whole bought AAA- and AA-rated securities almost exclusively for their own portfolios. Thus they sacrificed the higher yields of the lower-rated tranches for the perceived safety of a AAA seal of approval–hardly the behavior of people seeking short-term gain, whatever the long-term consequences.

Wall Street bonuses may still be out of control. The two things aren’t mutually exclusive.
But the Journal implies a compelling question: No matter how much bankers are paid to do what they do, what difference does it make if failure isn’t even a possibility?

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