An oped in the WSJ today shows that there is little evidence that compensation structures were the cause of the financial crisis.  Instead studies suggest that bankers weren’t aware of how much risk their companies (and they themselves) were assuming:



In the only scholarly study of the relationship between banker pay and the financial crisis, Mr. Stulz and his colleague Rüdiger Fahlenbrach show that banks whose CEOs held a lot of bank stock did worse than banks whose CEOs held less stock. (The study was published in July on SSRN.com.) Another study by compensation consultant Watson Wyatt Worldwide in July shows a negative correlation between firm Z scores-a measure of their risk of bankruptcy-and their use of such widely criticized practices as executive bonuses, variable pay and stock options. These studies suggest that bank executives were simply ignorant of the risks their institutions were taking-not that they were deliberately courting disaster because of their pay packages.


Ignorance of risk is also suggested in a study by Viral V. Acharya and Matthew Richardson of New York University (just published in the journal Critical Review). Their research shows that 81% of the time the mortgage-backed securities purchased by bank employees were rated AAA. AAA securities produced lower returns than the AA and lower-rated tranches that were available. Bankers greedy for high returns and oblivious to risk would have bought BBBs, not AAAs.


This is important since policymakers are justifying the push for government to regulate how banking executives are compensated with the claim that their pay structures create incentives that threaten the economy. 


But the public should ask a more fundamental question:  by what possible right does the federal government decide how these workers get paid?  Where in the Constitution is the federal government empowered to decide if one sliver of the workforce can receive bonuses for their work or not?


And the public should also be warned, the feds may be focusing on “banking executives” next, but that’s just a first step.  How many other segments of society will ultimately be considered too important to the overall economy to let the free market determine their pay?