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Federal Reserve Guidelines On Executive Pay Could Have Teeth, If Used

Here’s an FAQ from the Federal Reserve on executive compensation guidelines to all the banking organizations they supervise. This is in ADDITION to the Administration’s efforts to slash pay at firms that received massive federal aid.

The “guidance” explains from the Fed to banking firms what they would like to see enacted with respect to executive compensation. This is not a pay cap, but it is fairly interesting:

The Board will accept comments on the guidance for 30 days. Nevertheless, the Board expects banking organizations to immediately review their incentive compensation arrangements to ensure that they do not encourage excessive risk-taking and to implement corrective programs where needed.

To help spur action, the Federal Reserve also will move forward with the two supervisory initiatives outlined in the guidance. For example, as part of a horizontal review, large, complex banking organizations (LCBOs) will provide the Federal Reserve with information and documentation that clearly describes their plans, including relevant timetables, for improving the risk-sensitivity of incentive compensation arrangements and related risk management, controls, and corporate governance practices. We will work closely with the LCBOs on these plans and will monitor their adherence to the plans and associated timetables.

The Fed specifically mentions its role providing a “federal safety net” to the banks as a reason for them speaking on this matter. And they cite the “safety and soundness” section of the Federal Deposit Insurance Act to give themselves the authority to “take action against a banking organization if the organization is engaged, or is about to engage in, any unsafe or unsound practice.” While not a cap, this does give the Federal Reserve leeway, if they choose to use it, to crack down on any compensation they deem “excessive.” They don’t choose to define it, however.

Robert Reich today called Wall Street reform “stuck in reverse”. This kind of guideline could easily shift gears if those empowered to act actually did so. That was the problem throughout the financial crisis, however; just enforcing the laws on the books would have prevented some of the worst effects.

One way to get the Federal Reserve to act is to reorganize it, as Sen. Richard Shelby (R-AL) suggested today. Currently, the directors of the regional Federal Reserve banks are chosen by the banks they oversee, making a mockery of the word “oversight.” Changing that selection process would go a long way toward having an actual independent body.

The President had a bit to say about executive compensation in remarks today, and I’ll add them on the flip.

THE PRESIDENT:  Thank you.  Please, everybody have a seat.  Good afternoon.  Before we begin, I’d actually like to say a few words about something that is of interest to the broader public.  Obviously how we treat our veterans is hugely important, but I just want to make a quick comment about the decision made public today by Ken Feinberg on executive compensation.
I’ve always believed that our system of free enterprise works best when it rewards hard work.  This is America.  We don’t disparage wealth; we don’t begrudge anybody for doing well.  We believe in success.  But it does offend our values when executives of big financial firms — firms that are struggling — pay themselves huge bonuses, even as they continue to rely on taxpayer assistance to stay afloat.
And that’s why last summer, we gave Ken Feinberg and his team the task of making an independent judgment on the executive pay packages for firms that received extraordinary assistance from the federal government.  He was faced with the difficult task of striking the proper balance between standing up for taxpayers and returning a measure of stability to our financial system.  Under these competing interests, I believe he’s taken an important step forward today in curbing the influence of executive compensation on Wall Street while still allowing these companies to succeed and prosper.
But more work needs to be done, which is why I urge the Senate to pass legislation that will give company shareholders a voice on the pay packages awarded to their executives.  And I also urge Congress to continue moving forward on financial reform that will help prevent the crisis we saw last fall from happening again.

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David Dayen

David Dayen