Friday, March 26, 2010

Banking regulation and wages

It looks like the furore over outsize pay in banking is dying down. Kenneth Feinberg's final report on the pay practices identified $1.6 billion of "ill-advised" pay among banks that took TARP funds. Yet it named no names, and insisted that the pay was all legal.

The transatlantic gap on pay looks set to widen. While the European commission is requiring that 40-60% of bonuses be deferred for three to five years and half the upfront bonus be paid in shares, pretty much all that the Dodd- Frank bill does is require that share-holders have a non-binding vote on executive pay. The logic behind Dodd-Frank's "say-on-pay" provision is unclear; after all equity holders generally stand to gain as much as executives when the risks pay-off, and it's society that ends up paying when the risks don't.

Interestingly, a study by Thomas Philippon and Ariell Reshef shows that there is a strong correlation between regulation of finance and the wages of financiers. The wave of regulation enacted in the Great Depression not only prevented a systemic crisis for over 70 years, it also had the secondary effect of reducing the wages of bankers to roughly the same level as other non-farm workers. As the chart below illustrates, the deregulation over the last 30 years that arguably contributed to the present financial crisis, also led to a dramatic increase in banker's wages.

So will the Dodd-Frank bill lead to the same sort of precipitous drop in banker's wages as the Glass-Steagall bill in 1933? Too early to tell, but as I noted in my post on BankSimple, it doesn't looks promising.