In the years leading up to worst financial crisis since the Depression, as gambling fever seized Wall Street, one of the primary forces encouraging greater risk was the way that executives at major banks were compensated: Aggressive moves that made stock prices soar in the short-term triggered hefty bonuses, and even when those same moves led to longer-term disasters, the chieftains got to keep the money, leaving taxpayers on the hook for the losses.
A new regulatory framework and much talk of lessons learned was supposed to have changed all that, putting the fortunes of the bank chiefs on the line, and tying their pay to the longer-term health of their companies.
But that has not happened, according to a provocative report released Tuesday by the Council of Institutional Investors, an association of public and private pension funds. Despite tougher rhetoric among regulators in Washington and a virtual consensus that poorly designed pay structures were a leading cause of the financial crisis, the same perverse incentives that encouraged bank executives to speculate dangerously remain in place, the report concludes.
Within the terse, jargon-laden words of a largely academic report, a disturbing warning can be found between the lines: Americans, still struggling to dig out from near-double digit unemployment and the loss of trillions of dollars in wealth, are no less vulnerable to a financial crisis today than they were before the taxpayer financed bailouts of Wall Street.
In the wake of the crisis, a series of regulatory initiatives have aimed to pressure big financial firms to more closely align their pay practices with the interests of shareholders. Despite this, chief executives are still effectively rewarded for boosting short term stock performance even when the result is long-term trouble, according to the report.
During the real estate boom, out-sized bonuses emerged as a crucial incentive driving excessive speculation. Chiefs of major mortgage companies cashed hundreds of millions of dollars worth of bonuses by driving up their stock prices through indiscriminate lending. As their institutions wrote loans to seemingly anyone who could sign their name -- and even some people who couldn't -- their loan volumes exploded, and Wall Street cheered. By the time the markets figured out that many of these new homeowners were unable to make their payments, sticking the banks with sometimes-fatal losses, the chiefs had already sold their stock.
Indeed, as real estate exploded and bank revenues multiplied, Wall Street bonuses dwarfed those at other Fortune 50 companies, according to data compiled by Council of Institutional Investors. Before the financial crisis, the average Wall Street chief executive netted a cash bonus of $8 million, compared to $3.4 million at other large companies. As many experts have argued, this situation created an incentive for bank chief to focus on large short-term returns above all else, knowing they would handsomely rewarded for immediate success.
The new rules on executive pay -- which landed as part of the stimulus spending package delivered by the Obama administration last year -- have limited bonuses, in what many experts see as a well-intentioned attempt to curb dangerous risk-taking. But in response, many large firms have merely handed executives larger base salaries, including hefty helpings of stock that they are able to cash regardless of how their companies fare.
"While compensation levels fell overall, the declines were modest and the new rules resulted in a less performance-related compensation structure," the report asserts.
Ultimately, the damaging incentives governing Wall Street will not be repaired until bank chiefs have so much of their wealth tied up in their companies that they fear the consequences of reckless speculation, argues the study's lead author, Paul Hodgson, a researcher at the Corporate Library, a research institution focused on corporate governance.
"The concept of losing their stock holdings, or their stock holdings being significantly damaged in value, was not as scary as it would be if that's where all their personal wealth were being held," he said. "If there's a prospect of them not getting any type of compensation at all, if the risks they're taking lead to the collapse of the firm, then that really focuses attention."
Experts have long argued that paying bank chiefs smaller bonuses and larger allotments of stock would encourage them to safeguard their companies' long-term interests. As early as 1990, an influential report argued that equity compensation encourages executives to maximize their company's value, rather than just their own. As lawmakers tightened Wall Street regulations after the financial crisis, and as then-pay czar Kenneth Feinberg examined Wall Street bonuses, a common refrain among regulators was that equity pay made things safer.
But the council report concludes that simply focusing on boosting stock as a percentage of overall compensation inadequately protects against excessive risk-taking by banking executives.
"The levels of vested and realized compensation were so high that they allowed executives to treat unvested equity with more recklessness than might be expected," the report reads.
The report even asserts that Wall Street banks have exploited the view that larger awards of stock in executive pay packages amounts to responsible corporate governance, taking the opportunity to distribute extra shares that have boosted overall pay.
"In the tradition of unintended consequences for compensation regulations, while incentives were capped, salaries, which were not capped, ballooned," the study says. "Wells Fargo, Citigroup and Bank of America exploited a loophole" in the curbs on executive pay "to increase salaries by several hundred percent."
Those increases are no aberration. Overall, Wall Street is on track to pay employees $144 billion this year, which would break a record for the second year in a row.