Sorry Regulators, You'll Never (Thankfully) Curb 'Banker Pay'

U.S. regulators recently proposed new rules for compensation inside large banks and investment banks. The rules say bonuses must be "subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance." To achieve this, bonus payouts would occur over longer timeframes, they would be weighted more toward stock than cash, plus bonuses would be subject to "clawback" provisions if these allegedly errant bankers "misbehave." It's hard to know whether to laugh or cry.

Implicit in these proposals is that if a company taken public goes bad, a merger doesn't work out, or a mortgage that investors deem safe ultimately goes south, the bankers involved in each will have portions of their bonuses that reflect this work taken back. Yet missed by regulators is that if investment types could see into the future as the proposed rules presume, they would clearly cherry-pick what deals to do, and what not to do. Precisely because they're focused on bonus pay, they're generally not going to pursue deals that could put them at odds with clients who, if they're pleased, could be paying them fees and commissions well into the future. "Long-term greedy" as applied to financiers accrues to the client. Individuals in finance want to please their customers. Bad deals generally anger them.

Furthermore, if financial types could divine the bad deals of the future in the present, they wouldn't be working for banks or investment banks in the first place. People possessing the kind of otherworldly talent that enables them to see years ahead are earning many billions as private investors. But as even the best, and richest investors in the world freely acknowledge, they're wrong nearly as often as they're right. The future is uncertain. Always.

Applying the proposed new rules to mortgage securities that ultimately fell in value in 2008, and that regulators aggressively encouraged banks to issue, what's missed in this obnoxiously bad proposal is that those securities were viewed as the opposite of risky at the time they were packaged. That's why there was so much demand for them. The most sophisticated investors in the world were lining up to buy what appeared safe. Banks were simply fulfilling market demand, and as evidenced by their heavy exposure to mortgages in '08, they were plainly eating their own cooking.

Thinking about companies that Wall Street firms have taken public, Amazon and Priceline floated their shares in splashy fashion back in the 1990s, but by 2001 the shares of both could be had for next to nothing. Based on the illogic driving regulators right now, the investment bankers that oversaw each IPO would have had bonuses paid in the 1990s clawed back as punishment for duping unwitting investors. Ok, but after each company flirted with penny-stock status in '01, the shares began a long climb back. Amazon's now trading at $700/share, while a share of Priceline will set an investor back nearly $1,300. Word has it that a good portion of the mortgage securities that corrected in '08 are once again performing....Can clawbacks be un-clawed?

In subjecting the bonuses of today to potential losses in the future, regulators are asking the impossible of banks and investment banks. Once again, if they could pick and choose in the present what will shine in the future, they wouldn't toil for the relatively small bonuses paid out on Wall Street. This also reminds us that regulators almost never know what will prove dodgy in the future. If they had a clue about what's going to go bad, they decidedly would not be working as regulators.

Regulators presume that if more bonus pay comes in stock or restricted stock, that this too will drive better behavior in finance. The irony there is that financial institutions already agree. We know this because employees of Lehman Brothers and Bear Stearns respectively owned a quarter of and one third of each; the previous stats inconvenient for regulators, politicians and pundits eager to promote the wildly incorrect narrative of allegedly careless bankers risking the money of others. And then if the future were once again crystal clear for some of the world's most talented financial minds, they would be sure to avoid the mistakes that can so imperil their wealth, and that only bother regulators after the fact.

Regulators have once again taken aim at the pay inside large financial institutions. As was previously mentioned, the proposed curbs include bonuses paid out over several years, bonuses weighted more toward stock than cash (this was seen as unfortunate when Enron employees lost their life's work....), and clawback provisions if the future doesn't necessarily resemble the past in the marketplace. In their infinite unwisdom regulators are basically demanding stasis in return for reduced pay.

That's all well and good, but regulators would be naïve to think their proposals will succeed. Financial institutions are merely collections of talent. Their assets are the people who show up each day, and what must be stressed is that their skills won't desert them when they exit regulations that limit their ability to exchange their gifts for handsome compensation. Assuming pay restrictions foisted on large financial institutions, the truly talented will remain in finance, they'll earn enormous sums, but they'll do so for boutique investment groups, investment banks, and hedge funds not being strangled by regulators.

What of those same financial institutions forced to operate under the pay curbs? They won't be large for long thanks to the departure of their top players. Formerly blue-chip financial institutions will be staffed and run by the lesser lights willing to work for lower pay decreed by regulators. These institutions will arguably be in much riskier shape as compensation rules run off their best assets.

What requires stressing is that pay in finance won't decline. As evidenced by how high it is now, those who toil in finance are fulfilling crucial market needs. They still will, and for very high pay. Just not at the institutions that regulators see fit to "fix" via strangulation.