James Pethokoukis

Politics and policy from inside Washington

More reasons to mock the Fed’s plan to regulate Wall Street pay

Sep 18, 2009 17:29 UTC

My Reuters amigo Christopher “Black” Swann goes after the Fed plan to curb Wall Street pay — with a vengeance. Here is a bit, but read the whole thing. Your brain will thank you:

1. The Fed is certain to be outmatched. In one corner you have a central bank that has been notoriously spineless on regulatory matters. The institution is crammed with officials who have traditionally seen themselves as defenders of the banking system and advocates of laissez faire. … In the opposing corner you have heavy-weight Wall Street institutions with armies of lawyers dedicated to gaming the regulatory system.

2. There is a deeper objection to the Fed’s effort. The real problem is not the structure of bank pay but its scale. The received wisdom remains that longer-term incentives will curb risk taking. Lock up bonuses in stock and you will tame bankers. The experience of the 2008 financial crisis screams otherwise. In the case of Lehman Brothers and Bear Stearns, leading bankers were major shareholders. Richard Fuld was heavily invested in Lehman stock and saw the bulk of his fortune evaporate when the firm collapsed. Ownership does not seem to lower risk.

3. The key, then, is to curb the overall amount of risk that banks can take on. The main tool for doing this is by insisting on much larger capital reserves. This kills two birds with one stone. Tighter capital rules will increase the stability of the financial system and limit the exposure of taxpayers in the event of failure. In addition, tighter capital rules are the most reliable way of bringing down overall bank pay.


Let’s all say this together – “socialism”. Very good boys and girls, now practice it every day until you get it down pat.

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A terrible week for financial regulatory reform

Sep 18, 2009 16:32 UTC

After a big speech by the POTUS and the leak of a Fed proposal to monitor and curb Wall Street pay (really, pay at thousands of banks), what has changed about Too Big Too Fail, erratic Fed monetary policy and U.S. housing policy? They’re the true villains of the financial crisis. You want to limit leverage and raise capital requirement? Fine.  But the WH is taking its eye off the ball, I think …

The Fed’s dangerous plan to regulate Wall Street pay

Sep 18, 2009 16:22 UTC

The Obama administration wants the Federal Reserve to be the maximum regulator of the American financial system. As Treasury Secretary Timothy Geithner told the Senate Banking Committee, “The Federal Reserve is best positioned to play that role. It already supervises and regulates bank holding companies, including all major U.S. commercial and investment banks.”

The problem, of course, is that most informed observers have concluded that the Fed failed to adequately supervise and regulate banks during the lead-up to the financial crisis. Count Senator Chris Dodd, chairman of the Senate Banking Committee, in that camp. “There’s not a lot of confidence in the Fed at this point,” Dodd said right after the White House released its financial reform proposal.

This is where Daniel Tarullo makes his appearance. The newest member of the Federal Reserve has apparently authored a plan to have the central bank approve compensation policies potentially But previous to joining the Fed, Tarullo was an influential economic adviser in the Obama presidential campaign.

So now what we have, I think, is Obama’s man at the Fed pushing a politically savvy plan that could bolster the Fed’s standing as a tough regulator in the eyes of Congress and deflect some of the criticism of the central banks past failings. Score one for the White House in its push to make the Fed super-regulator.

Surely, the timing couldn’t be better. Not only has the administration been refocusing attention on passing financial reform – witness the president’s tough Wall Street speech – but next week’s G-20 meeting will include extensive discussion about banker pay issues.

But this is a case where good short-term politics makes for bad long-term bad policy. The greater the Fed involvement in the regulatory process, the greater attention it will receive from Congress – and the greater the threat to its cherished independence.

As it is, the Fed’s historic efforts to rescue the financial system have raised concerns on Capitol Hill that it has too much power with too little oversight. That’s why Rep. Ron Paul’s bill to audit the Fed, according to Financial Services Committee Chairman Barney Frank, will pass the House this year. (Indeed, what Paul really wants to do is end, not mend the Fed.)

Really, could anyone possibly believe that having the Fed become the pay czar at 5,000 banks would lessen congressional interest in its activities, including monetary policy? Not to mention that a better solution to excessive financial risk taking is the restoration of market discipline on Wall Street.

Better that Wall Street understand the consequences of poorly incentivized pay structures. “Too big too fail” remains the biggest threat to America’s fragile financial system.



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Should the Fed determine pay at 5,000 banks?

Sep 18, 2009 13:23 UTC

Talk about a phenomenally bad idea. According to the WSJ:

Policies that set the pay for tens of thousands of bank employees nationwide would require approval from the Federal Reserve as part of a far-reaching proposal to rein in risk-taking at financial institutions. … Under the proposal, the Fed could reject any compensation policies it believes encourage bank employees — from chief executives, to traders, to loan officers — to take too much risk. Bureaucrats wouldn’t set the pay of individuals, but would review and, if necessary, amend each bank’s salary and bonus policies to make sure they don’t create harmful incentives.

Me: Team Obama wants the Fed to be the super-regulator of the financial system. Sen. Chris “I have no confidence in the Fed” Dodd, chairman of the Senate Banking Committee, would prefer a new, separate entity. A now here we have a plan that would see the Fed doing the kind of thing a super-regulator might do. It is like the Fed is saying, “Hey, we know we dropped the ball before. We get it.  Now we are getting tough. Trust us.”  And don’t ignore the fact that the guy pushing this is Daniel Tarullo, a Fed governor and Obama economic adviser. This is like a joint Fed-WH operation. Also don’t forget that this is coming right before the G-20 meeting where there are expected to be calls to get tough on banker pay. So one could view this as a PR ploy by a WH that is less enthused about pay restrictions than Europe.

Of course, this is a lousy idea. Banker pay didn’t cause the financial crisis. The government should not be micromanaging private-sector compensation. Also, the more the Fed is involved in the regulatory process, the more it is open to political scrutiny.  Yves Smith seems to think this will tamp down support for Ron Paul’s Fed audit bill. Actually, I think this increases support for the bill since the more powerful the Fed seems, the greater the attractiveness of increased oversight and congressional meddling.


Ritesh -
I assume by a 90% tax on bonuses over $1 million, you meant a 90% tax only on the portion over $1 million (ie, the 90% rate would apply to $200,000 of a 1.2 million bonus). Other wise you’re effectively capping pay at $999,999.99. Making a dollar over that would decrease your income by 90%.

They myth of Lehman, part two

Sep 15, 2009 10:07 UTC

John Taylor has maintained that it was the government’s reaction to Lehman that freaked out financial markets. Now Luigi Zingales and John Cochrane make a similar pitch in the WSJ:

On Sept. 22, bank credit-default swap (CDS) spreads were at the same level as on Sept. 12. (CDS spreads are the cost of buying insurance against default.) On Sept. 19, the S&P 500 closed above its Sept. 12 level. The Libor-OIS spread—which captures the perceived riskiness of short-term interbank lending—rose only 18 points the day of Lehman’s collapse, while it shot up more than 60 points from Sept. 23 to Sept. 25, after the TARP testimony. (Libor—the London Interbank Offer Rate—is the rate at which banks can borrow unsecured for three months.)

Why? In effect, these speeches amounted to “The financial system is about to collapse. We can’t tell you why. We need $700 billion. We can’t tell you what we’re going to do with it.” That’s a pretty good way to start a financial crisis.


Dear friend,
Let allow me boasting of myself in regard to articles.
Major of your articles on pure economics are very interesting,grasping and reaches to high school of thoughts.
Here,you have narrated Lehman part two,
Everywhere, after shock of Lehman brothers, financial organisations closure and its impact.
Instead of forgetting these worst financial disaster,you-means journalists and famous world news channels,websites and newspapers had almost conducting ritual ceremony to this closure.
To conclude here,we need 700 million dollars for recovery and for running financial system.
This financial journey is very hard,roads are in bad conditions and lot of confusions, daily more statements on this subject by world leaders,economists, blogs are common on now a days.
I am typing one semi real solace sentences for more interests and for correct solution finding exercises from famous schools of economic theories.
Economic roads are very rough ,but we will overcome from known hurdles with future years.

The president’s speech on Wall Street

Sep 14, 2009 18:59 UTC

First, the great Stan Collender:

But the real purpose of the speech was to refocus the financial services reform debate in Washington.  The president may have been speaking to Wall Street executives, but the real audience was members of Congress, especially Democrats, some of who in the next few weeks will be marking up various pieces of financial services regulation legislation.  He had to show that the general issue hasn’t gotten lost in the health care debate and to say that the effort is still needed even if things seem to be better (“Normalcy cannot lead to complacency”).

Me: I also found it interesting that he focused first and foremost on the consumer financial products reform aspect of all of this. I think that is a way of keeping the public engaged on the issue, though I am not sure the administration necessarily feels it is a crucial aspect of reform in and off itself. Kind of like fighting the last war.

More on Free Market Day

Sep 14, 2009 18:22 UTC

Barry Ritholtz responds to my previous post:

While I love the idea of Free Market Day, I have to disagree with the typical post-mortem assessment of Lehman. This was not a binary choice; The Lehman decision was not an either/or situation, limited to a gladiatorial thumbs up/thumbs down.

In the real world,  there are shades of grey.

I have said — and I am still saying — that the best option would have been a more Bear Stearns approach (w/o the Fed’s $29B) — essentially, a prepackaged, orderly bankruptcy sale/liquidation. The problem with Lehman wsn’t that it was allow to suffer for its own sins –t he problem was they were allowed to do a header onto the sidewalk and splatter everyone else around. They should have been gently euthanized, their body parts sold off.

The Rescue them” or “Let them die” choice is really a false dichotomy.  When reviewing how the Fed and Treasury behaved, discussing what was done, and analyzing the possible impact of the alternatives, we need not be limited to simple Yes or No choices.

Me:  Yeah, but that is the real-world dichotomy that Paulson and Bernanke created for themselves by wasting the five months or so between Bear and Lehman.


“Let`s be rich not poor”

Culture, religion are mean to practice “peace” in society rather than to provoke
“individual interest”. Need of respect of culture is prime concerns , that lacks in today’s`
context. Culture are always rich than the mean mentality that people exhibit , on
behalf of their benefits, ignoring prime objective. Making bargains or agreements on ground of people sentiments ,following certain ideology is a practice of lodaciens.

Nobody has rights to play on rich culture & try to sabotage each other, whether it is “Christian, Hindu, Islam, Buddism or Jain”. Let`s not play dirty game.

In context of India, Indian culture always enriched with “Tamil, Kannada, Malyalam & Telgu” are the property of nation & has to respected by all because they are rich & have evolved through generation & their growth is never involved.

Concern over the article published on “The Hindu” on September 14 2009 Title “Engaging Nepal:Soon difficult questions “elaborates different meaning & differences & has deviated from cultural richness of “Tharu,Madesis & Limububan & other ethnics group ” who represents small in number but are rich in culture in comparison to persisting one & always respectful to live in “HARMONY” with unity.

National interest, without hurting neighbor who exhibit their potential rather than effect of “Gravity Model” in globalized market will be followed .

Global environment, which is always guided by UNITY ,is what will be on next article ,based on population statics’, prime concern & it`s effects on development of individual nation.

Happy wishes for Ramadan & Deepawalai ,wishing everybody to enjoy festive mood & always be merry ,having gala time.

Ananta Paudel
Student-Madras University, Chennai.

Permanent Dweller of Nepal.
15 September,2009

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Get ready to celebrate Free Market Day

Sep 14, 2009 15:21 UTC

At a House Financial Services Committee hearing just after Lehman Brothers filed for bankruptcy protection a year ago, the committee chairman, Barney Frank, suggested that September 15, 2008 be commemorated as Free Market Day, since Lehman was allowed to fail and free markets allowed to work. Frank then added that because AIG was bailed out the next day, “the national commitment to the free market lasted one day.”

Funny guy, the chairman — but probably not to Ben Bernanke, Hank Paulson, or Timothy Geithner. They’re the folks, obviously, who get the blame for not ginning up some way — any way — to bail out the investment bank and avoid a dangerous escalation of the financial crisis.

At last check, both Bernanke and Paulson steadfastly maintain that legally their hands were tied, thus the need for expanded authority to take over and wind down failing financial firms. If such authority had existed, Bernanke said a month after Lehman’s implosion, “we could have saved it. We would have saved it.”

Of course, that explanation seems to have evolved a bit over time. There are plenty of hints that a way would have been found to save Lehman, had Bernanke and Paulson anticipated the breaking of the buck by the Reserve Primary Fund and the flabbergasted reaction by international investors who had expected a repeat of the Bear Stearns bailout.

Yet in the year since the Lehman collapse, the consensus that it was an unmitigated disaster may be starting to shift. Free Market Day may be worth celebrating after all.

There are a couple of main arguments here. Call one of them the No Real Harm Theory. This has two aspects. First, economist and former Treasury official John Taylor argues that credit spreads didn’t really blow out until the market got a look at the government’s reaction to Lehman’s demise — the hasty construction and apocalyptic selling of the TARP.

At the same time, others argue that given the fragile state of the market, saving Lehman would merely have shifted the spotlight to some other endangered firm.

Then there’s what we’ll call the Worse the Better Theory. It holds that the severe market reaction to Lehman is what persuaded Congress and the Fed that it was time to do whatever it took to stabilize the financial system through bailing out AIG and passing the TARP.

Without Lehman, a continuation of piecemeal fixes would have allowed the financial system to erode further, heightening the chance of depression. What’s more, Lehman exposed the dangerous fragility of our interconnected financial system, serving as a catalyst for reform.

So is the case for letting Lehman die a clear-cut one? No. But it is a reasonable one, and even more so if the government had spent the time between March’s Bear Stearn rescue and Lehman’s chaotic bankruptcy creating a predictable and transparent resolution protocol.

So celebrate Free Market Day? You bet, but make it a quiet dinner rather than a wild party.


Good point on celebrating with a quiet dinner. However, I feel that unfortunately the govt has done very little to try to change and improve the structural problems in the economy. The govt has tried to prevent the normal business cycle from running its course, in which the recession would clear out the excesses and clear the way for a more sustainable recovery.

They have instead tried to fix a debt problem with more debt, which I believe is very reckless. Unfortunately though, the ones in power are the same people who mismanaged things and helped create the financial crisis.

So in my opinion, one of the few ways for the average person to protect themselves is to invest in gold related assets, because gold should continue to benefit from the Fed’s Keynesian efforts to avoid deflation at all costs. I have been reading some interesting articles on these topics at http://www.goldalert.com that I think are useful for investors to check out. They discuss in depth the inflationary consequences of the money printing, in addition to the potential impact on the dollar, the gold price, and prospects for the international and global economy.

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First financial reform, then healthcare

Sep 9, 2009 17:05 UTC

I think this is a pretty smart piece of political analysis from my friend Barry Ritholtz:

I believe the brain trust behind the Obama White House has made a huge tactical error.

As Rahm Emmanuel likes to say, one should “never waste a crisis” — and the White House has done just that.

There was a narrow window to effect a full regulatory reform of Wall Street, the Banking Industry and other causes of the collapse. Instead, the White House tacked in a different direction, pursuing health care reform.

There was widespread popular support for a full reform of finance. What the White House should have pursued was: 1) Reinstatement of Glass Steagall; 2) Repeal the Commodity Futures Modernization Act; 3) Overturning SEC Bear Stearn exemption allowing 5 biggest firms to leverage up far beyond 12 to one; 4) Regulating the non bank sub-prime lenders; 5) Continuing high risk trades to be compensated regardless of profitibility; 6)  Mandating (and enforcing) lending standards, etc.

All of this could have been accomplished in the first 6 months of the Obama administration. The consumer protection stuff could have been tossed in as well, though it was not the cause of the collapse.

What we got instead, was the usual lobbying efforts by the finance industry. They own Congress, lock stock and barrel, and they throttled Financial Reform. It did not help that the Obama economic team is filled with defenders of the Status Quo — primarily Summers, but it appears Geithner also — the dynamic duo that fiddled while the economy burned.

Such dithering can be fatal to an administration.

This was a colossal blunder.  Passing reform legislation successfully would have fulfilled the campaign promise of “Change;” it would have created legislative momentum. It could have provided a healthy outlet for the Tea Party anger and the raucous Town Hall meetings. It might have even led to a “throw the Bums out” attitude in the mid-term elections, forcing the most radical de-regulators from office.


You forgot:

7) Repeal the Riegle–Neal Interstate Banking and Branching Efficiency Act of 1994 (signed by CLINTON), until then at least enforce the 10% deposits rule in it.

8) Repeal Depository Institution Deregulation and Monetary Control Act of 1980. (signed by CARTER)

9) Never vote Democratic or Republican

And this is only the start…

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Another banking crisis would not be good

Sep 4, 2009 17:52 UTC

Curious Capitalist Justin Fox notices that time is running out on financial reform:

Earlier this year, when this regulatory crackdown was still in the hypothetical future, it was easy to sound tough about it. But now the big banks are making money again. The global economy seems to be recovering. The time to start cracking down is coming soon. Because if big financial regulatory reform doesn’t happen in the next year or so, it may never happen.

Me: I do know this: We can’t afford another banking crisis anytime soon. American debt-to GDP is already going from 33 percent to at least 80 percent by 2019. Another one and we just might have to follow Andrew Mellon’s advice and liquidate, liquidate, liquidate.


Dear James,
After reading your short article on banks in America,i started smiling.
I have not seen anywhere,except in developed countries like America,Germany,England and some western countries banks are in serious troubles,and their crisis are multiplying day by day.
Because of no proper banking regulations and loopholes of functioning and maintaining their day today operations.
Who are all suffering?Only deposit holders,saving bank pass holders and retired people.
This is not a good sign at all.
Hereafter,there should be very strict regulations,transparent banking transactions,and a very good audit mechanism for creating,consolidating confidences from public and for correct,balanced growth for smooth transition to real good results.