Compensation in the Financial Sector: Returning to the Halcyon Days of Yore

There have been many developments over the last several weeks in the corporate governance area, some in Delaware (mostly predictable bad news) and some at the federal level, including an Inspector General's report on supervision by the Fed (out of New York) and Treasury over AIG's compensation practices.  The report is a tutorial on why the federal government (as opposed to a properly regulated board of directors) cannot be the supervisor of compensation.

But without govenment supervision, one thing is for certain.  There have been no systematic permanent reforms since the financial crisis began and, as the WSJ speculates, Wall Street may be on the verge of yet another record year in compensation and bonuses.  In other words, compensation practices, at least in terms of amount, are going right back to the way they were before the crisis. 

As the WSJ reported earlier this week, 23 financial firms surveyed (a mix of hedge funds, brokers, banks, asset managers, and exchanges) look to be set to pay out a total of $140 billion in compensation (based upon projected revenues and the projected percentage that would be used for compensation).  The table that breaks the data down by firm is here. 

There are several observations to be made about the data. 

First, if you are not government regulated, you pay more in compensation, at least in terms of percentage.  Thus, Goldman (49%) and Morgan Stanley (70%) pay larger compensation, by estimated percentage, than Citigroup (23.4%) and BofA (24%).  JP Morgan Chase also paid back its TARP money and paid a less eye-popping 28.6% in estimated bonuses.  In other words, as long as you are under government oversight, the amounts paid are relatively modest.  Outside of government oversight, they go up.  This puts paid to those who argue that social pressure is now enough to keep compensation in line.

Second, while no one supposes that the compensation is coming from practices that involve the same amount of risk that occurred before the financial crisis, isn't it only a matter of time?  Sooner or later, with amounts so high, financial institutions somewhere will start taking excessive risk in order to increase revenues and, concomitantly, increase the bonus amount.  In other words, what happened in 2008 will happen again.

In truth, nothing has been done to make sure that the dynamics in place prior to the financial crisis have changed at all.  Nothing looks to emerge from Congress anytime soon, perhaps ever.  The only proposals likely to surface in the short term with respect to compensation are rules that are anticipated by the Federal Reserve Board.  But as the Inspector General's report shows with respect to supervision of AIG's compensation, there is not much room for confidence in this area either.