Discussions and proposals on reining in the excesses of the financial system remain active. The last few weeks saw an announcement by the Federal Reserve targeting executive compensation as a component of its plans for financial reform, along with discussions about reducing the financial system's exposure to firms that are "too big to fail."
While there is some logic underlying the various proposals, most of them skirt important fundamental issues. For example, the stated logic underlying proposed pay limits is that compensation agreements based on profitability created incentives for firms to take "excessive" risks. However, firms have been paying (and overpaying) their executives on this basis for decades. (I distinctly remember a Wall Street Journal article from the early 1990s that approvingly compared the pay of Bear Stearns' executive committee to the salaries of the NBA Champion Chicago Bulls' starting five.) What changed over the years was the steady deterioration of financial firms' management practices and their managers' inability to institute and maintain effective controls. At the time the Journal article was written, Bear's management had a reputation for meticulous risk management. This clearly began to break down well before the 2007 collapse of its hedge funds initiated the firm's collapse.
