What to Make of the TARP Pay Cuts?

Last week, we touched on the symbolic win the administration's compensation watchdog, Kenneth Feinberg, scored against Bank of America CEO Kenneth Lewis. Now the administration is rolling out a plan for executives at seven TARP companies to cut their pay by about 50 percent. Many populists are saying that this is another empty gesture, that it is taking place on too small a scale, since many more than seven companies are benefiting, directly or indirectly, from federal largess.

It's certainly a good idea to bring the executives directly benefiting from TARP under the stricter rules (it should have been part and parcel to the original program) even if doesn't go far enough. I'm less stressed about most of the other Treasury/Fed programs, since many of those were designed to support markets and not institutions. But while cutting banker pay is satisfying, what is far more important is realigning the payment incentives for Wall Street bankers. Feinberg is following along with the Fed's new rules, which are also going to be expanded in the regulatory reform legislation currently moving through Congress:

The portion of salary given in stock would vest immediately, although executives will have to wait two years before redeeming the shares. Even then, they will be able to cash in on only a third of that stock. The executives will be able to cash in another third after three years and the rest after four years. Because it is considered salary, executives get to keep the stock even if they leave their employers.

The final component of an employee's compensation under Feinberg's plan would come in the form of long-term stock. The awards would be based on performance and could be redeemed after three years, or sooner if the company repays its government aid, the source said.

Tying up the value of compensation with the success of the firm over three to four years is a good start toward aligning long-term incentives of bankers toward sustainable growth rather than risky cash-outs. Other measures that make banks slower and safer -- higher capital requirements and limits on leverage -- will also make banks less profitable going forward and also lower salaries. Ultimately, what Feinberg does this year is less important than ensuring the reforms are done right.

-- Tim Fernholz