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Fed considers rules to regulate pay at banks

The Federal Reserve is preparing what would be the most sweeping rules yet to regulate the pay at banks across the country.
/ Source: The New York Times

The Federal Reserve is preparing what would be the most sweeping rules yet to regulate the pay at banks across the country, people close to the discussions said on Friday.

The rules would apply not just to the compensation and bonuses of top executives but also to traders, loan officers and other employees. But rather than focusing on the specific amount employees are paid, Fed officials will be scrutinizing whether the structure of compensation, like the use of bonuses based on the volume of loan origination, encourages excessive risk-taking.

The proposed rules were reported on Friday by The Wall Street Journal.

The rules are not expected to be ready for several weeks. But the central bank is expected to invoke its authority as a regulator monitoring the safety of the banking system and soundness of banks’ decisions.

The surprising move comes as both the Obama administration and the Congress, as well as governments in other industrialized countries, are pushing for restrictions on executive pay, which many experts say contributed to reckless risk-taking that led to the financial crisis of the last year.

The Treasury Department already has a team led by Kenneth Feinberg that is examining the pay packages at banks that received money under its $700 billion bailout program. Congress is pushing for broader regulations that would apply to all financial institutions.

Fed officials are expected to have a two-tiered system of supervising pay, using different approaches for about 20 of the nation’s biggest bank holding companies on the one hand, and for thousands of medium and smaller banks on the other.

The biggest money-center banks would get the closest supervision, though Fed supervisors would give individual institutions considerable flexibility in how they design their compensation plans.

The big bank holding companies, like JPMorgan Chase or Goldman Sachs (which converted itself into a bank holding company at the height of the crisis), would present their compensation plans to Fed supervisors, who would then evaluate each plan to see if the pay incentives properly balance goals of short-term sales and production against long-term risk-taking.

Bank supervisors would have the authority to demand changes in the pay packages, and they would monitor pay practices to make sure they conformed with what the banks had pledged to do.

For smaller institutions, Fed officials would issue supervisory “guidance” on the principles that banks should follow in designing their compensation programs.

The Fed program would come on top of what Mr. Feinberg at the Treasury Department is already doing to scrutinize pay at companies that have received money under the Troubled Asset Relief Program. He has the power to veto pay packages only for the most highly paid executives at the seven distressed institutions, like American International Group, Citigroup, Bank of America and General Motors, that received “exceptional” assistance.

For the thousands of other banks that have received federal government help under the TARP program, Mr. Feinberg’s role in reviewing their compensation plans is largely advisory.

By contrast, the Fed program would affect about 5,000 bank holding companies as well as state-chartered banks. It would reach down much more deeply into the operational levels of a bank, setting rules for mid-level traders, mortgage loan officers and office managers whose pay is tied to revenues generated by local branches.

People familiar with the proposed rules said they are not intended to address questions of fairness or even the balance struck between management compensation and shareholder earnings.

The Fed chairman, Ben S. Bernanke, has long maintained that his primary concern has been the structure of incentives rather than the absolute amounts of compensation. The key issue, he has said, is whether compensation plans reward excessive risk-taking by placing too much emphasis on short-term revenue production rather than the long-term soundness of the company.

Fed officials, in discussions with bank supervisors from other countries as well as with industry executives, have identified several ways in which they expect banks to reduce incentives for excessive risk-taking.

Supervisors will be looking to see if banks are adjusting rewards, such as commissions, to account for higher levels of risk in the particular activity. They will also be looking for programs that defer compensation for several years, or that defer the calculation of the exact compensation long enough to provide the time for true risks of an activity to surface.

But while the goals of the new regulations will be straightforward, their actual implementation is certain to be devilishly complex.

Fed officials have apparently decided that the differences between compensation for top executives and that for other highly paid employees — like top traders — are so great that they cannot come up with their own rules for the biggest and most complicated institutions.

Mr. Feinberg at the Treasury is grappling with that same problem as well in evaluating the pay package for the head of Citigroup’s Phibro unit, which trades commodities and has been one of the company’s biggest profit sources. The head of Phibro is supposed to receive about $100 million, a staggering amount that is tied to the profits his unit has generated.

The Federal Reserve’s move to restrict pay comes at a time of fierce political debate about the Fed’s failure to rein in reckless mortgage-lending and the proliferation of disastrously risky financial instruments at the height of the housing bubble.

In Congress, Democratic critics of the Fed, like Senator Christopher J. Dodd of Connecticut, chairman of the Senate Banking Committee, want to strip the Fed of its authority to regulate consumer lending practices and oppose President Obama’s proposals to expand the Fed’s authority as a “systemic risk” regulator.

But Republican critics on the right are attacking the central bank as well, charging that it has accumulated far too much power during the financial crisis and become too autocratic in telling banks what to do.

In addition, an unusual alliance of left-wing Democrats and right-wing Republicans has joined in sponsoring a bill to allow the Government Accountability Office, Congress’s investigative arm, to “audit” the Fed’s monetary policy decisions — a move that Fed officials fear would reduce their political independence in setting interest rates.

That bill was introduced by Representative Ron Paul, a libertarian Republican from Texas who has campaigned for years to abolish the Federal Reserve and has just published a book entitled “End the Fed.”

In recent weeks, the Federal Reserve has labored mightily to revamp its image as a hands-off, industry-friendly regulator that cared primarily about saving feckless financial institutions and little about curbing bad practices.

On Tuesday, Fed officials announced they would begin examining mortgage-lending practices at both banks and “non-bank” lenders in order to enforce its new rules against abusive and deceptive mortgage-lending practices. Consumer groups, while welcoming the new assertiveness, have nonetheless sharply criticized the Fed for doing what it had already been authorized to do since the early 1990s.

This article, “Fed Considers Sweeping Rules to Regulate Pay at Banks,” first appeared in The New York Times.