May 31, 2011
I’m writing because my family, friends, and I were and still are being affected by the economic collapse of 2008, and we don’t want it to happen again.
Wall Street greed and outrageous pay practices were a major cause of the collapse. One way to change the incentives so that they don’t collapse our economy again would be for regulators to use a *safety index* for incentive compensation, instead of a profit index.
Under the current profit index system, most bankers receive stock options as compensation. This creates a conflict of interest in that when the bankers can generate more profits, the stock price goes up, and their options become more valuable.
Instead of a profit index compensation system, what if regulators used the bank’s bond price, which measures the overall ability of the bank to repay its own debt? Another measure of bank stability is the spread on credit default swaps (the insurance-like policies that are essentially bets, where one gambler bets with another that a particular firm will fail). The closer a bank comes to failing (such as in failing to pay of its bond debt), the bigger the spread on credit default swaps becomes.
This would reduce the incentive to drive up stock prices at the expense of all else.
A second way to change the incentives so that they don’t collapse our economy again would be to delay the bonuses for three, five, or more years. That way, we’ll know if the loans they made in year one remain good. In the bad days, bankers paid themselves on the volume of loans (mortgages) they generated, not on their quality.
Regulators should also set up a way for shareholders to grab back ill-gotten gains. If it turns out that the profits in a given year were built on shoddy practices that become clear in the out-years, those bonus payments should be forfeited.
Thank you for considering my comment,
Christopher Lish
Olema, CA