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Weigh in on FDIC Proposal on Executive Pay

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The FDIC is seeking public comment on a proposal to link bank deposit insurance premiums to the degree of risk-taking encouraged by the bank's executive compensation program. Note that this measure does not require Congressional approval. However, the FDIC board is split, which makes the public's input a much more important input than on issues where the board is united. This summary of the state of play via CBS News:

A divided board of the Federal Deposit Insurance Corp. voted to make public a preliminary proposal for using executive compensation as a factor in assessing the fees that banks must pay for the deposit insurance fund. The plan could involve both rewards and penalties for banks.

"This is something we cannot ignore," FDIC Chairman Sheila Bair said. But two heads of Treasury Department agencies, who also sit on the five-member board, voted against floating the proposal.

John Dugan, director of the Office of the Comptroller of the Currency, and John Bowman, acting director of the Office of Thrift Supervision, said it would be premature because Congress and the Federal Reserve were addressing the bank compensation issue.

The FDIC is seeking public comment on the plan for 30 days. If there is a final rule, it isn't expected to be adopted until late in the year...

"We're really just asking questions at this point," Bair said. She stressed that the regulators weren't seeking to dictate compensation levels for banks but were exploring whether certain pay practices encourage banks to take excessive risk.

The FDIC proposal seeks input on a possible model for banks' compensation policies that would include payment in restricted company stock for a large portion of pay for employees whose work is deemed potentially risky. In addition, significant awards of company stock only would become vested over a multi-year period.

The plan could involve both rewards and penalties for banks. A possible reward: Banks that are able to "claw back" compensation from executives under pay contracts could get reductions in their insurance premiums. Penalties, on the other hand, would call for increased fees for banks with pay deals that involve more risk.

If the plan were adopted, banks' compensation structures would be added to the other risk factors now taken into account by the FDIC in assessing fees, including diminished reserves against risk and reliance on higher-risk so-called brokered deposits. The idea is for institutions deemed to be higher-risk to pay bigger insurance fees.

You can read the text of this Advanced Notice of Proposed Rulemaking here.

I am in favor of this idea, and will send a message in support of it. I would like to attach reader comments (both on your views of the general merits of the idea, and any particular suggestions you have on the particular issues raised in the ANPR).

To be clear on the ground rules: any bona fide comments on the proposal will be sent to the FDIC. Comments that are not about the proposal will not be included (not that you should restrict yourselves to the proposal, philosophical discussions are always welcome, but I just want to be clear about what will and won't be sent to the FDIC). Anything disrespectful will not be included either. I will clean up typos and minor errors, but will not change substance. Please indicate where you live (city and state).

Some Congressmen have stepped forward to voice support:

Sheila Bair
Chairman
Federal Deposit Insurance Corporation
550 Seventeenth Street, NW, Room 6076
Washington, DC 20429

Dear Chairman Bair,

We write to applaud you for taking an important step towards holding bank executives accountable for risky, destructive behavior. If your proposal to tie deposit insurance premiums to executive compensation structures is enacted, banks will be charged more for deposit insurance if their executives gamble with the firm's money. Our constituents feel that executives on Wall Street have looted their banks, and then have billed taxpayers "for services rendered." They have lost confidence in other regulators. Thanks to you, finally it seems as though there's a cop on the beat on Wall Street.

A bank executive who seeks to maximize short-term gain at the expense of solvency is not just putting his bank's shareholders and creditors at risk, but also the US taxpayer and the FDIC deposit insurance fund. By seeking to foreclose that possibility, the FDIC continues to earn the kind of public trust that is so lacking throughout the regulatory community.

On the specific question of whether pay packages contribute to risk, it should by now be quite obvious that a financial institution that pays its executives with a 'heads I win, tails you lose' pay package is likely to destroy itself. We saw this during the Savings and Loan crisis, during the bailout of Long Term Capital Management, and during the most recent financial crisis. Paul Volcker, Bill Black, Simon Johnson, and other economists and observers have made this point.

It's also clear, as well, what happens when executives have well-designed pay packages. When "bulge bracket" investment houses were private partnerships, executives were leery of putting their own capital on the line in risky schemes. This created a natural barrier against reckless and risky behavior. When Wall Street firms began going public, and offloading risk onto shareholders, executive behavior suffered. Now that these firms can gamble with money from the Federal Reserve and from taxpayers, executive behavior is even worse.

While it would be nice to presume that large banks are chastened by their recent need to beg the public for capital, it is clear that financial services executives "just don't get it". Lloyd Blankfein of Goldman Sachs recently claimed that his firm is 'doing the lord's work'. Harvard Business School Professor and Goldman Board member Bill George just compared bankers who lose gargantuan amounts of money to professional athletes and movie stars. The large bank lobby has worked furiously to water down reform; the Securities Industry and Financial Markets Association is resisting a mild fee on large banks, and aggressively sought loopholes in derivatives legislation.

Unlike those at community banks, executives at large Wall Street banks have consistently displayed cavalier attitudes towards risk. Despite large bonuses on Wall Street and the gnashing of teeth among regulators, very little seems to have changed as of yet. We applaud Chairwoman Bair and the FDIC for breaking this damaging cycle of passivity, and taking the first real steps to rein in dangerous executive compensation structures. According to Section 7 of the Federal Deposit Insurance Act, the FDIC clearly has the authority to use any factor it "determines relevant" when assessing the probability that the Deposit fund will incur a loss with respect to any specific institution. Compensation structures are certainly relevant in terms of understanding the risks that these banks are incurring.

We disagree with Comptroller John Dugan's dissenting statement on this. Comptroller Dugan's argument is that higher insurance deposit costs are unnecessary merely because Congress is debating granting authority to rein in executive pay, and that the Federal Reserve is working on the problem. He also argues that there is no evidence that executive compensation structures contribute to losses in the Deposit Insurance Fund. These arguments seem meritless. In light of recent history, trusting the Fed to rein in banker pay is like asking an arsonist to guard the armory. His argument that there is "no evidence" compensation structures contribute to institutional risk might have credibility if his own agency had shown any interest at all in stemming the 'epidemic of mortgage fraud' that the FBI noted as early as 2004. As is, his arguments simply justify the continued looting of large banks by their executives.

Our constituents are demanding action, not idle chatter. In Congress, we are debating what steps to take. In the meantime, we appreciate outstanding judgment that Chairwoman Bair, Vice Chairman Martin Gruenberg, and Thomas Curry have shown in carrying out their duty to the public.

Regards,

Alan Grayson
Michael Capuano
John Conyers
Lloyd Doggett
Keith Ellison
Bob Filner
Luis Gutierrez
Marcy Kaptur
William Lacy Clay
Eric Massa
Brad Sherman
Jackie Speier
Pete Stark

Yves here. I hope you will take a few minutes (or more than a few, if this topic is of particular interest to you) to add your views. Thanks for your efforts and input.