Government Control of Salary: Good or Bad?

There is a significant amount of coverage of the proposed control of salaries and overall compensation in the financial service industry by the Government. The reports from the Wall Street Journal to the New York Times stress the intent to match compensation and responsibility.

The Journal states:

"Administration and regulatory officials are looking at various options, including using the Federal Reserve's supervisory powers, the power of the Securities and Exchange Commission and moral suasion. Officials are also looking at what could be done legislatively.

Among ideas being discussed are Fed rules that would curb banks' ability to pay employees in a way that would threaten the "safety and soundness" of the bank -- such as paying loan officers for the volume of business they do, not the quality. The administration is also discussing issuing "best practices" to guide firms in structuring pay."

The Times remarks:

"Among the ideas under consideration are incorporating compensation as a “safety and soundness” concern on official bank examinations as well as expanding the existing regulatory powers of the Securities and Exchange Commission and Federal Reserve to obtain more information regarding compensation. The policymakers are also expected to publish formal guidelines regarding Wall Street pay."

Let me take a brief look at how compensation works in other industries.

Insurance Sales: The classic plan is that for the old insurance salesperson. They go out and sign up some person for a life insurance plan, say whole life. This is a very lucrative policy for the company but the salesperson gets paid over time if and only if the person who purchased the policy still keeps it and pays their premium. If the customer drops the policy then the salesperson gets nothing.

Telecommunications Services: This is an area in which I have considerable experience having run these businesses for years. The sales person gets a percent of the gross revenue per year for say five years. The customer must stay with the company and there is a motivation for the salesperson to both get a good customer and to keep the customer. The sales person may get 2% per year of the gross revenue for five years. If the customer goes away then the revenue goes away.

Now let us look at investment banking. Let us look at say an IPO. The bank prepares the S1 filing and gets a payment at closing of the public offering but takes no responsibility as to whether the company and the offering make an economic sense. They may very well be selling junk. The perpetrators of this sale upon the public get their money and move on. If compensation in the financial world matched that of the rest of the world then the bankers would be compensated over a period of time if and only if the company were successful.

Now move to mortgage brokers. Why is their compensation not like an insurance sales person? Because the mortgage is fungible, it can be sliced and diced. The sales person gets their money and runs. Making compensation run contemporaneously with the product sold would improve the situation especially since that is what works in most of the rest of the world.

The issue is what role does the Government play in this process. It appears that the current Administration wants to use its heavy hand and added to that is the Congress especially under Congressman Frank, want to use legislation to "punish" Wall Street. Beware the un-intended consequences.

There are many fine examples, models, precedents for a balanced commission and remuneration. They should be followed and fiscal policy should be used, not the heavy hand.