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Executive Compensation – Weekly Round Up

Due to the financial meltdown in Wall Street, the Obama administration has decided to bail-out troubled banks using taxpayer money. As can be expected, the public was outraged by this development. The common consensus during the time the TARP program was being developed was, “why should we pay for the banks’ mistakes?” Well, the bailout actually came with a long list of strings attached. One of the most notable ones was the limit imposed on executive compensation.

Over the course of these past few months, we’ve seen the fast recovery of some of the nation’s biggest banks. And how each of these banks has struggled to raise capital in an effort to pay back the TARP money they received. Behind all this is a very strong motive: bank executives want to be in control of their compensation and company strategy. This week’s round-up is composed of blogs that had talked about banking executives’ compensation, its importance, and what it will mean for the average person.

Mark @ CS Monitor talked about how the government plans to restructure how bank executives are paid. His post titled “Obama Looks of Overhaul Executive Pay” talked about the proposed “say on pay” legislation. It will essentially give shareholders a bigger voice in how much the board and other top management officials will be paid. The initiative is designed to minimize risky behavior by tying executive compensation to behavior.

Gary @ Uncommon Common Sense wrote an in-depth post titled “America’s Big Business: When you Commit a Crime” on his blog. The article essentially discussed how bank executives “knew better” than to take the risks they were taking prior to the financial crisis. But they were operating in an industry that encourages high risk to increase they pay.

Andrew @ Harvard Law School Blog provides a comprehensive look as to why bank executives behaved the way they do in the industry. Titled “Compensation Structure and Systematic Analysis” dealt with pay arrangement that encouraged extreme risk taking to product pay incentives. In addition, the article discussed how short term focus distorted long term planning on the part of the banks.

Banks Bracing to Fight against Strict Government Regulations

Since October last year, the nation’s largest banks were holding marathon telephone sessions every day amid the darkest economic crisis. As the momentum for the
financial regulatory overhaul gathered in Washington, Wall Street was gearing up for the fight. Bank executives knew that their once profitable credit-default swap and other types of derivatives will be reined in by the government. Originally designed to minimize risk, it pushed the economy on the brink of collapse.

The nine largest institutions involved in the derivatives market – Bank of America, Citigroup, JPMorgan Chase, and Goldman Sachs – formed the CDS Dealers Consortium after they came into an agreement on November 13. The lobbying organization was created merely a month after five of its members got the government bailout fund.

The consortium even hired an influential Washington power broker to oversee their agenda. Edward J. Rosen, from the Cleary Gottlieb Steen & Hamilton Law Firm, previously helped stopped the regulation in the derivatives market more a decade ago. Now, the confrontation between legislators and Wall Street promises to be a repeat of what happened in the past.

But the fight today is no longer about whether regulation is required or not. It is easily apparent that the public will demand nothing less than stricter regulation in the financial industry. At the core of the argument will be how much regulation is really necessarily. From every front, this is a very difficult question to answer. Every party has their own agenda they want to push.

Those who want more regulation will state that early warning signals are necessary to prevent catastrophe in the financial market. For example, industry giant American International Group, had received over $170 billion in taxpayer money because of its gaping derivatives losses. Meanwhile, the banks are concerned that if the regulations become too tight, economic growth and innovation will be stifled.

In the end though, the argument will come down to two things: disclosure and transparency in the markets. Legislators want an open exchange – akin to the stock market. On the other hand, banking institutions unsurprisingly want some of its financial products to be privately traded in clearinghouses where less disclosure is required. Only time will tell which party will get its way.

Bank of America Now Closing in on the $33.9 Billion Gap

Previously, the government stress test had revealed that Bank of America (BofA) has a deficiency of $33.9 billion in common equity. Now, it seems that the company is fast plugging this loophole. The bank announced its plans to add an extra $26 billion, or as much as 76%, of the $33.9 billion that they were told to raise.

The Charlotte-based bank was able to raise $5.9 billion by exchanging its 436 million common shares into preferred stock. The bank further noted that it might issue an additional 564 common shares in the same scheme. Another source of capital was the sale of its stake in the China Construction Bank Corp. which is worth $13.47 billion. It is highly likely that the BofA will also sell its Columbia Management Group and First Republic Bank units to close the remaining gap.

The BofA statement included stipulations that requires future capital raise to fulfill the regulator’s mandate. In the earlier part of this month, it was revealed that 10 of the nation’s biggest banks need to infuse capital into their system.

Government regulators have asked these institutions to raise common equity levels as the safety net against possible adverse economic situations in the future. In addition, this will provide a sense of security for the banks’ depositors. After the expected announcement, the shares of the company went up 1.5 percent to $11.5.

Other Banks Are Doing the Same

BofA, as the largest US-based bank, does not stand alone in these drastic measures. Several major financing firms such as Citigroup Inc increased its common equity by requesting preferred shareholders to swap their stakes into common shares.

Meanwhile, PNC, the seventh-largest bank today, was asked to raise $600 million by the government. This bank is plugging their shortfall by selling 15 million common shares in a market offering. PNC has also said that it planned to repay the $7.6 billion it took from the TARP program as soon as it was “appropriate”.

Although the TARP has greatly helped the banking sector at the time of crisis, it is seen as a weakness by most. Furthermore, most of the banks it helped does not like the excessive restrictions imposed including its executive pay regulations.

Larger Banks to Pay Bigger Share in FDIC Levy

The Federal Deposit Insurance Corp. has approved a new policy that requires big US banks to pay a larger share of the insurance bill. Recent bank failures have been draining the funds from FDIC forcing the institution to ask for larger contributions from the banks even at the time when a significant number of them can barely keep afloat.

The FDIC board, composed of five members, will collect an extra $5.6 billion for these banks to a total of $17.6 billion. The new assessment can decrease the amount of loans available to customers and businesses. Bigger banks will feel the brunt of this change. Those with at least $100 billion in assets will foot an estimated $500 million more than was previously forecasted.

Forcing larger banks to shoulder a larger share of the levy is a good move because the bailout funds have been disproportionately given to the largest banks in the country. This leaves smaller community institutions at a big disadvantage. Sheila C. Bair, the FDIC Chairman, is particularly aware of these problems. According to her, collecting more money from major banks will contribute to equity. In addition, it was the big banks that played a major role in the financial crisis.

There are some dissents over this structure though. For example, the Controller of Currency has mentioned that asking larger amounts from big banks was unsuitable because majority of the insurance funds are being used by smaller banks. However, Bair doesn’t agree with this because she said that because of government intervention in not letting larger banks fail, smaller banks are hurting as the government guarantee takes away business from community institutions.

Traditionally, the FDIC has collected its percentage from each institution based on its deposits and adjusted for its overall health. Under Bair’s leadership, the assessment now includes the likelihood of failure based on the bank’s business structure. The shift to asking bigger banks to pay its appropriate share is a big step away from the previous deposit model.

Now, the FDIC will collect 0.05 percent of bank asset, the amount invested, loaned, or committed to clients in any way. Smaller banks have the tendency to lend out the same amount they receive from deposits. Meanwhile, larger banks tend to lend from different sources. Thus, the larger assessments asked from them.

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