The Dodd-Frank Act (The Act) enacted in 2010 mandated that our regulatory Agencies, Security & Exchange Commission (SEC) , Federal Reserve Bank (FED) and Consumer Financial Protection Bureau (CFPB) force Wall Street to end the risk-taking culture that started in the 1980s and brought the financial system to its knees in 2008.
To do this, the Act emphasized the importance of changing the incentive pay structure which encouraged bank executives to take risks. The structure, which has yet to change, basically encourages bankers to take short term risks for great pay with the underlying belief that should the risk blow up, the US government will eventually bail out the bank. We witnessed the result of that behavior with the 2008 meltdown where some traders made billions of dollars for the few years leading up to 2008 and when their institutions went bankrupt due to those bets, they got to keep their bonuses and the government was forced to bail out the banks. For the past four years, the regulatory agencies have not proposed anything to address this issue. Now, we may finally see some movement.
Federal Reserve Governor Daniel Tarullo and New York Fed President William Dudley stated on October 20th, 2014 that “Banks must encourage executives to behave more responsibly…or be dramatically downsized and simplified so they can…” William Dudley then suggested that a simple method to accomplish this task would be to adopt compensation packages similar to what existed prior to the late 1980s when bank executives did act more responsibly.
Dudley proposed that compensation for executives should be mostly deferred and contingent. The annual bonuses which make up most of the executive’s pay would only be paid if the banks are healthy and meet the stress test criteria. Rather than pay annual bonuses at year end, banks could delay them for five years and then pay them out over another five years. So overall, executives would receive compensation over a 10 year period making them dependent upon the health of the overall institution. The deferred compensation pool would be used to pay for fines and/ or weaknesses in the bank should they fail the stress test at any time prior to the executive receiving his/her pay.
Now, to me this seems simple. It encourages executives at these banks to behave more cautiously, it penalizes the executives rather than the shareholders for the executive’s mistakes and it allows a large pool of money to first bail out the bank if the unforeseen happens rather than the US Taxpayer. Yet, the regulators are having difficulty imposing Dudley’s suggestions. Maybe the Government’s mistake has been to focus on banks being too big and unwieldy to control when it is the Regulatory Bodies that are too big and complex to manage their tasks effectively.
