Wall Street Pay Regulation – How to Create a Win-Win Situation
Much has been written and debated over whether the government should regulate Wall Street bankers and traders' compensation. The proponents and the detractors each have valid arguments to support their thesis. It is all but certain that some form of government regulation will be in place sooner rather than later.
At the end of the day, the biggest question remains will the regulations work? The government can mandate certain rules to be met but as we all know, rules can be broken or circumvented. So here are my thoughts on how the Fed can help create a WIN-WIN situation:
Wall Street Pay Regulation
1) CREATE A PARTNERSHIP – If the crux of the financial crisis was the outsized risk-taking engendered by what the critics called as the ability to gamble with other people’s money, then the only solution is to turn the traders and bankers (for that matter anyone in a revenue generating function) into partners with the firms they work for, and plow back the bulk of their compensations into the “partnership”.
Once someone is gambling with one’s own money, I think one will weight the risk reward a bit more carefully. And certainly if you and I where in a partnership together, presumably we will create a natural check and balance on each other to make sure we don’t squander each other’s capital away.
2) ALL RULES NEED TO BE UNIFORM – Imposing rules on some and not others will create dissent and give rise to greater problems down the road. I will venture to surmise that some very enterprising individuals will be extremely skilled at circumventing whatever rules you will impose upon them by going to other firms (or spinning off separate legal entities) that aren’t subject to the same regulatory constraints. For example, bailing out others but not Lehman was tantamount to tacitly stating that one firm is more important than another, and the ensuing consequence was a heartrending one.
Reality is that it will also stave off any criticism if there is standardization across the entire industry, not just those with x$ in capital. Pay regulations in its fairest manner ought to be applied uniformly to all financial institutions, if it is to be applied at all.
3) DEFINITION OF RISKY / RISKLESS PROFITS & RETURN ON CAPITAL – Does the Fed hold the view that a trader or a banker who generates $10 of profits with $10 of capital should be paid the same as one who utilized $100 of capital?
Also, what if the $10 profits are deemed risk less vs. risky (however the Fed defines it)? The definition of risk must also then be uniformly configured. The deployment in the size of the capital and hence the Return on Capital should be configured into the policy.
4) HOLDING BOTH BUY SIDE & SELL SIDE EQUALLY CULPABLE – Should there be similar regulations for the buy side firms? What if fund managers buy into risky assets simply because they thought they were hot and think they can flip for a quick profit?
What if these fund managers do not even understand the product, let alone understand the risks, and yet, they are deemed as professionals charging a pretty hefty management fees and profit sharing fees for managing money? To simply blame or regulate just the sell side is not the most optimal solution, for it takes two to tango.
5) CLAWBACKS / GAME OF MUSICAL CHAIRS – Whether claw backs work or not will be a function of whether 1) an individual is held personally liable, and 2) a competitor is willing to buy talents with a blank check and reimburse the claw backs?
At the top of the bull market it is impossible to entice “talents” from a competitor to move unless one is prepared to dole out multi-year blank check guarantees.
Most managers on the Street were simply too willing to use stocks as an acquisition currency, they just match someone’s deferred compensation with their own companies’ stocks. Managers were too willing to write blank checks because it is NOT their money.
So going back full circle, if all bankers, traders and revenue producers are now “partners” of a firm, and every time they hire someone, they are paying out of their own pockets, it will change the mentality on the Street. Unless there are regulations in discouraging the self-perpetuating cycle of buying out talents with other people’s money, this will be ineffective.
Wall Street Pay Regulation Has Happened
Creating a partnership will foster greater trust in building a franchise, and force every participant to rethink how they will run their own businesses with their own money. Partnership culture is the solution and will replace the existing mercenary and short term culture on Wall Street.
Some think that Wall Streeters haven't suffered during the downturn. Tell that to the loyal 20 year Lehman employee who had several million in Lehman stock that went to zero. Because part of my bonus is in the form of company stock, I do feel much more accountable and passionate about the firm. I pick up the random pieces of trash in the hallway. I make sure unfamiliar clients get the right answers instead of just hanging up on them or saying I don't know, and I always look out for the reputation of the firm.
Readers, please feel free to share your thoughts on ways to make compensation right and whether you agree with Elaine's proposal or not. Feel free to ask her about her life on Wall St. as well as her decision to retire early.
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