The Federal Reserve announced Thursday that it would crack down on pay packages that encouraged bankers to take excessive risks, but officials acknowledged that the plan might not reduce the biggest paychecks on Wall Street.
While unlikely by itself to end the practice of lavish compensation, the Fed’s plan is one of the most far-reaching responses yet to last year’s financial crisis. It will subject executives, traders, deal makers and other employees of the biggest banks to regulatory scrutiny of their compensation and represent another increase in government intervention in the marketplace.
The announcement was timed to coincide with the decision by the Obama administration this week to cut the pay of many high earners at the seven companies that received the most taxpayer help. Both decisions were announced amid growing public outrage over large pay packages at many of those companies.
“Compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability,” said Ben S. Bernanke, the Fed chairman. “The Federal Reserve is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system.”
In one sense, the announcements by the Fed and the Treasury are a sharp departure from the hands-off approach to regulation that had dominated this city for decades. The abiding principle of both announcements was the same — companies that make a lot of money over a sustained period will be allowed to reward their executives handsomely, while those who put the economy, the financial system, shareholders and the taxpayer at risk may not.
The principles proposed by the Fed for the nation’s 28 largest banking companies are less strict than those from some European leaders and some members of Congress. They do not impose caps on pay or prohibit multimillion-dollar packages. One senior official predicted that they would do nothing to curtail the lucrative pay at firms like Goldman Sachs and Morgan Stanley, both regulated by the Fed since becoming bank holding companies last year during the financial crisis.
Instead of pay limits, the Fed rules are intended to discourage pay packages that may encourage risky practices. The government wants to encourage pay packages that reward executives for long-term performance.
Officials acknowledged that it could be months before they would be able to tell whether the Fed’s changes would have the intended effect. Bank examiners will have to be trained on the ties between compensation and risk management. Moreover, compensation consultants have been adept at finding ways to get around pay restrictions.
Even as the Fed was unveiling its plan, Kenneth R. Feinberg, the Treasury official in charge of overseeing pay practices at the companies that received the biggest government bailouts, was providing details about his decision to curb the compensation of the 25 top employees of each of those firms.