Gordon Brown on Bankers' Comp: Not Totally Idiotic

In the UK, Gordon Brown means to get tough with banks’ pay practices:

Gordon Brown has pledged tough action to clamp down on excessive remuneration for bankers as part of an international effort to rectify the systemic weakness that led to the global financial crisis.

The prime minister said in an interview with the Financial Times that pay and bonuses should be based on long-term success not short-term speculative gains; banks should “claw back” bankers’ rewards if their performance suffered in subsequent years; and regulators should be able to impose higher capital requirements on financial institutions.

The crypto-Socialist! . . . . Wait a minute. . . . “Clawback” is supposed to be a dirty word among Wall Street comp types, but I don’t see why.

Fact: the true profitability of a financial services product—a mortgage, say, or an auto lease—won’t be known until years after that product is originated. So paying people just to originate (which is the way the world has worked for as long as anybody can remember) can be a reliable way to burn down the house, as many, many people have lately realized to their undying regret. If a mortgage has an expected life of, say, seven years, pay the guy who wrote it over seven years, too.

And by all means, if the loan blows up in the meantime, go back and take back some of his up-front money. He’ll get with the program in a heartbeat. Managements would love that system: it would align employees’ interests with the firm’s, and could serve as a worthwhile retention tool.

There’s just one problem. If you really want Wall Street to move to a compensation system built around delayed payouts and clawbacks, I’m pretty sure you’d have to do some serious tinkering to the tax code. If Acme Mortgage Co. commits to pay Mr. Originator $70,000 in annual $10,000 installments over seven years, with the right to take it all back under certain circumstances, who’s on the hook for the taxes on that seventy grand in income in Year 1? Acme? The only way it gets the money is if the borrowers default, in which case there’s no income to tax. Mr O? But he doesn’t control the $70,000 free and clear yet, and won’t for years. Both? Double taxation a bad idea. Neither?

Um, no. . . . This is hardly an insurmountable problem, but its solution would probably involve delaying or refunding of tax receipts, which the feds aren’t going to be so crazy about. As a way to help prevent future Wall Street blowups, though, delayed comp and clawbacks are not the worst ideas in the world. . .

Comments

[john s. gordon:]

pay for performance.
long term performance not just originations. let's get crackin with the tinkering of the taxcode. it's not a moment too soon.
> jack

Sep 02 09:35 AM

[Ferdinand E...:]

Who cares what Gordon Brown does or thinks. He was a disaster for the Labour Party, and the sooner he is voted out the better.

Sep 02 09:37 AM

[Tony Petroski:]

The best solution is not for Gordon Brown to sit in on all the performance reviews. It's to allow shareholders to police their management, set reasonable pay scales and bonuses, and allow enterprises that pay their managers too much to lose out to enterprises that pay their managers the right amount. Above all, bankruptcy or takeover should loom for organizations out of control.

Yeah, I realize that in modern corporations shareholders don't do much (and in fact are only shareholders for a very short time, in the case of Goldman Sachs, for only a split second) and the upper management co-opts the board of directors. Still, control by owners is the worst possible system, except for all the rest (to coin a phrase normally attributed to one of Mr. Brown's countrymen).

Sep 02 02:08 PM