The Fed’s Wall Street pay fix

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I was a little nonplussed this morning when I read the not-very-shocking WSJ article that came with the shocking headline, “Bankers Face Sweeping Curbs on Pay.” In the pre-Murdoch era that would have been a 600-word story on page A24, headlined “Fed Mulls Pay Guidelines.”

What’s happening is that the Federal Reserve is contemplating a rule that would allow bank examiners to veto compensation policies that they think encourage undue risk-taking. The rule hasn’t been formally proposed yet, but as described by the WSJ it would call for the Fed to weigh in not on individual paychecks but on bank-wide plans. As a practical matter this will mean nudging banks toward linking bonuses to long-term performance rather than one-year performance, and spreading payouts over several years. The banks are already headed in that direction now, and the real test will probably be some years down the road when Ponzi finance is back in fashion. But it is something that hasn’t been tried before, and off the top of my head I can come up with three different things it might mean.

1) People in Washington listen to Lucian Bebchuk. For a while now, the Harvard Law prof has been pushing the argument that if bank regulators have a say over lending practices they ought to have a say over pay, too. Now he appears to be getting his way.

2) The Fed is jumping in to keep Congress from passing less flexible, more draconian pay rules. That’s how Evan Newmark saw it this morning at

3) This is a backdoor way of getting at the “too big to fail” problem. The pay rules are aimed mainly at big New York banks with big investment banking operations. They might have the effect of accelerating the movement of top investment bankers and traders from big banks to boutique firms and hedge funds that won’t be subjected to so much scrutiny. Those small fry will then grab market share from the biggies, and the too-big-to-fail will get smaller. Maybe.