Treasury Secretary Tim Geithner will try to cut down on risky behavior by financial institutions by asking them to tie bonuses to the long-term health of the company rather than short-term gains, according to people briefed on his plans.
As part of a broad financial-regulatory plan to be unveiled this week, the administration wants to put in place reforms to get financial incentives for employees closer in line with the actual results of the company. Basically, it's what bonuses used to be before Wall Street went wild in recent years.
Long before the recent focus on AIG bonuses, the administration was looking at how risky behavior in the financial system was driven in part by incentives for executives to take risky bets for a quick return.
But President Barack Obama has no plan to try to cap bonuses, according to the people who were briefed. The administration said it simply plans to update regulations, not control what people are paid.
The mechanisms could include increased disclosure, increased oversight or a bigger role for risk managers in the company.
Geithner’s new proposals for mechanisms that would push companies to restructure their own executive compensation packages go well beyond limits already in place in the initial Wall Street bailout program, known as TARP, because they will apply even to companies that have not taken government money.
The new rules will focus on “systemically important financial firms,” said a government official with knowledge of the proposal. “The principals of reform are aimed at getting the financial incentives of employees closer aligned with the interests of their overall institutions.”
Many financial experts have argued that Wall Street pay practices were partly at fault for the stock market meltdown of 2008. That’s because many firms created a "preverse incentive" for traders by paying annual bonuses well before the results of traders' market moves were known – in effect paying them for taking on risk instead of for producing positive returns.
The executive-compensation recommendations are part of the hotly anticipated financial-regulatory package that Geithner will present Thursday before House Financial Services Committee Chairman Barney Frank (D-Mass.) as part of a hearing called “Addressing the Need for Comprehensive Regulatory Reform.”
The biggest part of the secretary’s plan, and also a priority for Frank, is greater control over “systemic risk”: updating regulations to reflect the current reality that it’s not just banks that dominate the financial system, but also insurance companies and hedge funds. It’s a way for the government to oversee financial markets as a whole, rather than the individual components.
The government’s inability to monitor systemic risk has been widely blamed as a partial cause of the global market crash of 2008. For instance, the government had no authority to wind down collapsing insurance giant AIG because it’s not a bank.
As part of the package, the administration is looking at risk-taking, since recklessness—much of it involving hedge funds and derivatives—got the country into the current economic mess.
A government official says Geithner will discuss “redesigning the financial regulatory system,” but will not go as far as proposing the elimination of the Securities and Exchange Commission or a merger of that agency with other financial regulators in the government, as some experts had predicted.
“The question is how do we apply standards consistently and remove the cracks in the system that some institutions have fallen through,” said the government official.
Geithner’s moves on bonuses come as the Treasury Department also is expected to announce a three-step process to fix the nation’s credit markets, which includes an effort to convince private buyers to purchase so-clled “toxic assets,” by arranging for new federal insurance and other incentives to make the bad loans more appealing.
The toxic asset proposal could be announced by Treasury as early as Monday, but it is not clear whether Geithner will announce the details in person and on camera. Geithner been at the center of the storm of AIG’s $165 million in bonuses, though Obama has backed up his Treasury Secretary repeatedly – even telling “60 Minutes” that he wouldn’t accept Geithner’s resignation even if he tried to quit.
On Wall Street, reaction to Geithner’s plans was mixed. Many financial executives are wary of Washington after the House passed a bill to tax employee bonuses at bailed out institutions at 90%, a measure that is seen on Wall Street as pure class warfare. The vote by the House was deeply unsettling on Wall Street, where it was seen as renegotiating the bailout deal after the fact. Many bankers will be reluctant to work with a new government plan.
And the Obama Administration may find that efforts to rein in CEO compensation had a long history of failure. In the early 1990s the Clinton Administration tried something similar, in an effort to push down what they saw as excessive CEO compensation even then. The result was a change to tax law that said companies could not deduct executive compensation of more than $1 million. But the effort had unintended consequences – companies found exotic legal maneuvers around the measure, which is enshrined in the tax code as section 162(m).
Companies pushed compensation of more than $1million into stock options, and they found ways to create “deferred compensation,” in which pay would be held in escrow until the executive retired. Both of the measures were end runs around the Clinton Administration effort, and the surge of stock option pay in the 1990s was the result. That led directly, in turn, to the stock option backdating scandal of the early part of this decade, in which companies were found to be fraudulently backdating stock options to make them less risky – more like the cash they wanted to pay, but could not, due to section 162(m).
Administration officials said The Wall Street Journal accurately reported the plans, which were provided to the newspaper by Treasury: “An enhanced role for the Federal Reserve to monitor and address broad economic risks … Changes to the way banks are overseen to prevent lenders from shopping among regulators for the easiest supervision. … More transparency and stricter rules for the way money flows between banks. … Tougher capital requirements for big banks … Consolidation of consumer-protection enforcement.”
However, officials disputed the emphasis and tone of a New York Times story, posted on the newspaper’s Web site Saturday afternoon, which reported: “The Obama administration will call for increased oversight of executive pay at all banks, Wall Street firms and possibly other companies as part of a sweeping plan to overhaul financial regulation, government officials said.”