Banks, News

NY Fed Researchers Want To Make You Mark Your Potential Bonus Clawback To Market

The Fed has three basic functions: central banking, bank regulation, and calling down police brutality on Occupy Wall Street protesters. While the first function is getting all the attention today, the New York Fed’s blog is spending some time on the second. Specifically, they’re trying to figure out how bankers should get paid.

Optimal design of banker compensation is a thing that people like to think about, and that regulators like to regulate. We’ve talked about it before, and I’ve suggested that the right way to reward bankers is not to give them mostly equity or extra-levered equity, which encourages asymmetric risk-taking, but rather to give them exposure to their firm that roughly matches that of their main stakeholders. Which, for a bank, means basically various flavors of creditors. So a bank CEO whose net worth consists 20% of equity of his firm and 80% of unsecured debt of his firm, like Brian Moynihan, in theory has better incentives to do the right thing by bondholders, depositors and the financial system than someone who’s 100% in out-of-the-money stock options. And a banker who is paid in structured credit products that can’t be foisted on to clients has incentives … well, he’s an interesting case study at least.

I like the NY Fed researcher-bloggers because they’re pretty sober people who want to optimize banking regulation but don’t spend their time freaking out about stupid popular things like how CDS will kill us all, banning short selling, or just generally hating on bankers. So I’m pleased to see NY Fed researcher Hamid Mehran is with me on this whole comp thing:

Because stock- and options-based compensation is unlikely to curb the risk appetites of bank executives, Bolton, Mehran, and Shapiro in a 2010 New York Fed working paper proposed tying remuneration to a bank’s credit default swap spread. An institution’s CDS spread provides a market measure of the risk of a bank. Under our scheme, a high or increasing CDS spread would translate into a lower cash bonus, and vice versa. …

How would this scheme look in practice? CEOs could be required to write a given amount of CDS (or to buy swaps written by other insurers) for the duration of their employment contract. However, a more efficient policy might use money set aside by the bank at the start of the period. Deferred bonuses would then be reduced or increased under a pre-specified formula as the bank’s CDS spread deviated from the average bank spread: bonuses would be increased if the spread was below average and decreased if it was above average.

The paper itself is worth reading. Among other things, it suggests that their CDS-based comp scheme is better than just giving executives unsecured exposure to their banks by paying them in deferred cash comp, for reasons that I don’t really understand. (They seem to assume that banks have to set aside deferred cash in a pot at the time of grant, which, I mean, the whole point is that it’s unsecured, just promise to pay it later and if you don’t have the money tant pis.)

This bothered me a bit, because I am committed to the view that, in efficient markets, debtholders should view widening credit spreads and increasing probability of non-payment-at-maturity as equivalents. Thus the deep magic of DVA, where banks transmute a bad thing (widening own-credit spreads) into a creepy good thing (less chance we’ll have to pay off all these derivatives we wrote!). So, funding aside, a normal creditor of a big bank should be indifferent between writing CDS on that bank and owning that bank’s bonds. But I’m coming around to the Fed’s view, because of course the CEO is not a normal creditor: he got to be the CEO in part by being super optimistic about his bank’s chances. Making him mark his enthusiasm to market is probably a better idea than letting him discount the probability of nonpayment on his own.

Anyway, there seems to be broad agreement among, well, me and some Fed economists and not William Cohan, that giving bank executives a direct stake in the creditworthiness of their levered systemic firms makes more sense than just aligning them with shareholders, because bank shareholders are unsavory risk-loving characters just like bankers are. CDS is a natural proxy for that creditworthiness, and it’s a reasonably objective and liquid market-based proxy.

But there’s also this. Your model of a bank’s stakeholders could be 20% equity / 80% unsecured debt, in which case you could be a big fan of the Fed idea. Or your model could be 2% equity / 8% unsecured / 90% witchcraft and magic. The NY Fed, again, are sober types who are not believers in witchcraft and magic, and most of the time that’s probably a good way to look at the world. But the reason that lots of people like to freak out about bank compensation is that, every once in a great while, the fulcrum stakeholder is not a shareholder or a guy who holds an unsecured thing deliverable into CDS, it’s the financial system as a whole. When 90% of the money at risk in Morgan Stanley was the Fed’s,* Morgan Stanley wasn’t really working for either its shareholders or its bondholders – and its bonds, like its shares, looked like more or less at-the-money options to buy the firm from the vast mass of secured credit (Fed, repo, FDIC-insured, whatever you’ve got at your particular bank) that really owned the place.

CDS obviously reflects this sort of thing – Morgan Stanley CDS didn’t look so hot in September ’08 – but so do stock prices. Both are imperfect, conditional, convexity-laden reflections of the shifting risk profile of banks. Both probably under-reflect the risk to all stakeholders because in a really deep crunch the equity and unsecured are not where the bulk of the capital is at risk. If you wanted to really align bank CEO’s risk-taking incentives, you’d let the Fed empty their personal bank accounts to fund emergency loans to their banks.

Which I’m pretty sure would be a dumb idea. The lesson may just be that you can’t fully optimize comp to make bankers internalize risks. But you can improve from the current baseline. And this CDS-based comp thing seems like a decent attempt.

Designing Executive Compensation to Curb Bank Risk Taking [NY Fed]

* Quoted without approval. I think his math and understanding of how the claims work are iffy but, y’know, the gist is not wrong and he’s not the only one thinking it.

(hidden for your protection)
Show all comments

102 Responses to “NY Fed Researchers Want To Make You Mark Your Potential Bonus Clawback To Market”

  1. ZingdotZap says:

    Too early, can't Matt.

  2. Guy with A.D.D. says:


  3. I'm a Dude says:

    Matt, aren't you supposed to be studying for some big exam?
    go back to your room.

  4. InfiniteGuest says:

    Old Mumbles you could probably pay mostly in ball taps. Sure, the proper discounting is tricky, but at a certain level it's not really about the money.

  5. lex luthor says:

    I'm sure my employees/shareholders will vote this bullshit down pronto.


  6. Whoops says:

    This article finally gives us a reason to drink coffee!

    -UBS IBD

  7. Anthony Bologna says:

    While CDS spreads are a useful tool in accessing risk – they typically over-quantify events, with large news driven expansions and contractions. Lots of reversion.

    Plus – just given the new era of mass market volatility, which in part one could argue is driven by the rise of institutional investors like hedge funds (no knock on you) – CDS at times has a tendency to ignore fundamentals.

    A rumor might affect the standing of your I-bank when being chosen to underwrite a deal (and miiiight affect the top line, although we still see BAML and MS as major players), but sure as hell will blow the shit out of your CDS. I don't want my comp tied to that.

  8. CVA DVA SFA says:

    B. Moyns looks like he's trying to squeeze an addition to the bonus pool.

  9. DingALing says:

    I hope I get paid in Trident Layers!

    -UBS MD

  10. guest says:

    11:16 you feeling ok Matt?

  11. Guest says:

    Excellent tags, Matt!

  12. Super Impressed says:


    That was a damn good 30-sec elevator pitch on how improve executive comp incentives! Very succint and to the point. We'd like to hire you as a pitchman.

    -VC fund

  13. Guest says:

    So you stayed up all night typing this instead of studying…you're hired!
    -Jeffries HR

  14. NowOnePerson says:

    Matt: I read your posts in their entirety almost every day, partly because I'm waiting for the day when you go off the rails and we discover you're totally full of shit. Hasn't happened yet… but I'll be watching.

    -Backhanded compliment guy.

  15. guest says:


    Although as typical this is quite the tome, it was actually a decent read on a good topic, and I do sort of wish for once that the responses weren't all jokes. Luck on the test.

    I'll preemptively give myself a thumbs down for the comment, I know, I know.

    -Not OWS and not a fan of their work, but in favor of finding a way to keep the pitchfork holding masses out of my yard.

  16. newbie says:

    What does Conan O'Brien have to do with this?

  17. sebastian says:

    Such is the schizophrenic nature of the world economic system that US Bank credit ratings are falling while the Dow is on a holiday tear. The system looks good on the outside, but it's hiding a cancer:

  18. Mark Coble says:

    Bank of America is a criminal enterprise. How many lawsuits are they in RIGHT NOW? Defrauding investors? Big time! There is a solid reason bank stocks are down. Balance sheets that are contrived nonsense that no one with a lick of sense would believe, massive exposure to UNsecured mortgage securities, and those pesky lawsuits from major investors who now see that those "securitized " mortgages where not secure at all! When BofA admits in their own 10K that they may not have possession of the underlying mortgage notes you know there is massive fraud going on. Please read the 10k s for yourself and see how bad the banks really are. They admit it if you want to read.

  19. Yzqo03 Fantastic blog post.Really thank you! Really Great.

  20. Major thankies for the article post. Cool.

  21. Major thanks for the post.Much thanks again. Awesome.

  22. Really informative blog.Much thanks again. Awesome.

  23. Thanks-a-mundo for the article.Really thank you! Fantastic.

  24. Im grateful for the article. Awesome.

  25. Fantastic blog post.Really thank you! Cool.

  26. Thanks-a-mundo for the blog.Much thanks again.

  27. Great, thanks for sharing this blog article. Great.

  28. Awesome blog article.Really looking forward to read more. Will read on…

  29. Really enjoyed this article post.Really looking forward to read more. Cool.

  30. Hey, thanks for the blog article.Really thank you!

  31. Great post.Really thank you! Keep writing.

  32. kerem azer says:

    This is a great resource. Ill visit again.

  33. Im thankful for the blog article.Really thank you! Awesome.

  34. Thanks a lot for the article post.Much thanks again. Great.

  35. I really liked your blog post.Much thanks again. Keep writing.

  36. SEO New York says:

    wow, awesome post.Much thanks again. Awesome.

  37. I appreciate you sharing this blog article.Really thank you!

  38. Very good post.Really thank you! Will read on…

  39. I really enjoy the article. Much obliged.

  40. Really appreciate you sharing this post.

  41. ci11 irons says:

    Thank you for your blog post. Much obliged.

  42. I really liked your blog.Thanks Again. Want more.

  43. I am really impressed with your writing skills as well as with the layout on your blog. Is this a paid theme or did you customize it yourself? Either way keep up the excellent quality writing, it is rare to see a great blog like this one these days..

  44. politics says:

    Im obliged for the article post.Thanks Again. Fantastic.

  45. Fantastic post.Really looking forward to read more. Want more.

  46. best hgh says:

    Im obliged for the blog article. Keep writing.

  47. Joel Smitley says:

    If you are using Chrome as your browser, then it has problems with iTunes links, check out the Chrome Extension in my latest put up to fix this extremely annoying dilemma
    Karen recently posted..Are You Having Trouble Opening iTunes Links In Chrome

  48. Great, thanks for sharing this post.Much thanks again. Really Cool.

  49. sexy heels says:

    Really informative blog.Thanks Again. Want more.

  50. Thank you ever so for you article post.Much thanks again. Cool.

  51. Schweiz says:

    I cannot thank you enough for the blog post.Much thanks again. Much obliged.

  52. wow, awesome blog post.Really thank you! Want more.

  53. Wall Sconces says:

    A big thank you for your article post.Really thank you! Much obliged.

  54. GPT says:

    Hey, thanks for the article.Thanks Again.

  55. Cake Toppers says:

    Im grateful for the article post.Thanks Again. Fantastic.

  56. wow, awesome post.Thanks Again. Awesome.

  57. I really enjoy the blog post.Much thanks again. Fantastic.

  58. A big thank you for your blog post.Really thank you! Awesome.

  59. information says:

    I truly appreciate this article post. Really Great.

  60. Awesome article post.Really thank you! Much obliged.

  61. sale says:

    Hey, thanks for the article.Thanks Again. Great.

  62. Thanks for the article post.Really looking forward to read more. Will read on…

  63. Generally I do not learn post on blogs, however I wish to say that this write-up very compelled me to check out and do it! Your writing style has been surprised me. Thank you, very nice post.

  64. wetrorrow says:

    owgbfsor [url=]louis vuitton soldesx[/url] nyhjnpto sac louis vuitton pas cherd vqddzgbx

  65. I take pleasure in, cause I found just what I used to be having a look for. You have ended my 4 day long hunt! God Bless you man. Have a great day. Bye

  66. Teniinizell says:

    vtjoguod [url=]abercrombie pas cher[/url] dwsywctrto abercrombie france azooul aacfsrxau [url=]louboutin[/url] vfqlesvonv christian louboutin pas cher bofoaao

  67. I am delighted that I observed this weblog, just the right info that I was searching for!

  68. attaivapaxy says:

    Free Proxy Servers are used for anonymous searching. Most common usage of totally free proxy server is to bypass the higher education/place of work or any other place’s security constraints and accessibility unrestricted internet sites. But [url= ]click [/url] servers must be employed with caution. If utilized without basic safety steps, it can end result in huge decline as in contrast to advantage of browsing the web anonymously. There are two techniques through which you can conceal your identification (your IP handle) when surfing the world wide web. Initial and the most low-cost way is to use free of charge proxy server. There are many windows and linux proxy sites obtainable on the net which lets you use their companies totally free of cost. The other alternative for hiding your id is to use compensated software program. The IP hiding computer software, alterations your IP address continually to allow you browse web anonymously.

    There are couple of critical issues you want to maintain in brain when using cost-free proxy servers.

    one.) Watch out for your security

    Do not give out any sensitive info this sort of as your login specifics or credit card details when employing distinct proxy servers since when you use free proxy server, all the details you offer on any site is initial sent to totally free proxy server and then to the internet site server. So all the info go by means of the free of charge proxy server and most of the time it is unencrypted, exposing your sensitive information for prospective misuse.

    Compensated application are much much better in terms and conditions of safety. There methods are developed to conceal your IP and then discard all your information with out any human involvement.

    2.) Stability and Availability

    There are a lot of totally free proxy server internet sites but most of them are not stable and are not offered every time you pay a visit to them. This dilemma is not really considerable with paid software program.

    3.) Velocity of Browsing

    When you use any proxy server for hiding your IP, you can sense the sluggish pace of browsing instantaneously. Though there are very good websites obtainable for anonymous searching but they are really tough to discover. Also, velocity is not steady it is dependent largely on load on their servers. At times you do get good browsing speed but it’s not constant. Yet again, compensated software for hiding IP are a lot greater at browsing speed. As they cost for their providers, they make sure that the consumer expertise is far better and you do not get gradual pace while searching the net through their software.

    They are also wonderful when you discover a good quality 1 that masks your nation of origin. When looking for a On the web Proxy make certain it has Java mounted so you can observe motion pictures. As you can often have your country of origin cloaked but if java does not perform it is not much use.

  69. kjandmrs [url=]green bay packers jersey sale[/url] xmodwgn Clay Matthews Jersey aihknitd [url=]packers jersey sale[/url] ybouyit Clay Matthews Jersey asqmzivf

  70. jnmyfxlt [url=]air jordan[/url] ypxtipz air jordan lqihbziy

  71. Hietryelery says:

    awirodna [url=]gucci outlet uk[/url] pygjcobzfe gucci bags uk zwzagen enppfpun [url=]barbour sale[/url] yxzncoumxj barbour jackets weotlqm
    hbuzfgyu [url=[0..9]20]mulberry sale[/url] mjwntgyowg]94 kpvegrgi [url=[0..9]71]louis vuitton outlet uk[/url] ynxkewffqj

  72. live says:

    I wanted to compose you this tiny note just to thank you as before considering the magnificent thoughts you’ve discussed in this case. This is simply remarkably generous of people like you giving unhampered just what numerous people would’ve made available as an e-book to earn some money for themselves, most importantly since you could possibly have tried it if you desired. These good ideas additionally acted to become good way to know that other people online have a similar zeal much like my own to know the truth way more with reference to this problem. I believe there are many more pleasant occasions in the future for those who view your website.

  73. Spenueseime says:

    Asked recently to put in writing about [url= ]Ultra [/url] , I’ve to confess that I had in no way noticed of this kind of a thing. Some internet analysis later and i discovered that e cigs are very considerably a speedily increasing problem. A Google search discovered there is certainly no smoke without the need of hearth as just about 6 million final results only for the phrase “electronic cigarette” ended up returned.

    Exactly what is an ecigarette?

    The e-cigarette has become in existence for nearly 3 many years and is particularly a intelligent machine geared toward offering smokers with a more healthy possibility. Evidently also helpful in helping to lessen and certainly stop smoking cigarettes altogether.

    Now within a fourth generation, e-cigarettes have become considerably a lot more user helpful than earlier variations which perhaps were somewhat also big to stimulate a mass market appeal. The “mini” is among the most practical e cigarette up to now with its duration of 100mm remaining similar to a conventional cigarette.

    An electronic cigarette includes a style of tobacco but none of the hazardous substances discovered in typical cigarettes permitting people who smoke cravings being pleased without inhaling the countless perilous toxins. Is it all smoke and mirrors? Or can this item really be the saviour it desires to be?

    A battery, an atomiser and a renewable nicotine chamber enables the smoker to hold and smoke the ecigarette equally as they would some other cigarette, even developing a “smoke” like vapour and glow in the finish as they draw. The nicotine chamber proves quite beneficial as cartridges can be obtained in several strengths, allowing the person to lessen the amount of nicotine they intake right up until whenever they want, can give up thoroughly.

    A nicotine cartridge typically lasts the same time as fifteen to 20 cigarettes, as a result making a substantial conserving to normal fees. Conventional, medium, lower and no nicotine in the slightest degree are classified as the many cartridge strengths.

    A much healthier alternative entirely it seems, however the advantages you should not end there. A result of the electric cigarette not emitting any dangerous substances, toxic compounds or genuine smoke for that matter, they can be properly legal to smoke in community. In winter season particularly, standard cigarette smokers should brave the freezing cold as well as rain only for a fast cigarette smoking break but this alternate will permit them to remain inside their workplaces, dining establishments and pubs.

    None smokers also will profit, as their worries about passive cigarette smoking are rendered null and void by the e-cigarette. A much more sociable natural environment then!

    Upon reflection the ecigarette is actually a more healthy, less costly and environmentally friendly different to smoking cigarettes and because the consciousness as well as market grows they may have terrific possible to productively switch the dangerous cigarettes we’ve all appear to find out and lots of of us have occur to dread and anxiety.

  74. AAA AUGER Austin Plumber, it’s our objective to deliver a clean, respectful, licensed and competent plumber to your house while in the

  75. I do accept as true with all the ideas you have introduced on your post. They are really convincing and can certainly work. Nonetheless, the posts are very short for novices. May just you please extend them a bit from next time? Thank you for the post.

  76. Kenny Gusa says:

    I had the exact same practical experience several a long time in the past when selling a car on the net. This time the offer was to ship the car to Germany and offered greater than I had been asking, which to me was nuts, so I just deleted the /I then put the car that has a regional broker, and a few weeks later received a connect with from the guy in South Carolina, who claimed he just had my car delivered and required to ask some queries about /I called the broker and he explained the examine was while in the mail. It took two weeks and quite a few threats to obtain my money.

  77. There is perceptibly a bunch to realize about this. I suppose you made various nice points in features also.

  78. kbvxyhjk [url=]polo ralph lauren[/url] jkdmdbbh polo ralph lauren rskkqvvr

  79. q8WQXe Im thankful for the article.Much thanks again. Cool.

  80. Really informative article.Really looking forward to read more. Much obliged.

  81. best says:

    Very neat blog article.Much thanks again. Great.

  82. A big thank you for your article.Really thank you! Keep writing.

  83. i see, would like to know more

  84. Im grateful for the article.Much thanks again. Awesome.

  85. I cannot thank you enough for the article.Really looking forward to read more. Want more.

  86. I together with my pals were found to be viewing the excellent suggestions located on your web page then suddenly I got an awful suspicion I never thanked the web site owner for those strategies. Those young men were so very interested to read all of them and have extremely been having fun with them. Appreciate your actually being considerably helpful and for having these kinds of ideal subject areas most people are really desperate to be informed on. My personal sincere regret for not expressing gratitude to you sooner.

  87. gw2 gold says:

    I truly appreciate this post. I have been looking all over for this! Thank goodness I found it on Bing. You’ve made my day! Thanks again

  88. I really like and appreciate your blog post.Really thank you! Much obliged.

  89. I loved your blog.Really looking forward to read more. Fantastic.

  90. great video says:

    I loved your article post.Thanks Again. Really Cool.

  91. Enjoyed every bit of your article post. Really Great.

  92. You actually make it seem so easy with your presentation but I find this matter to be actually something that I think I would never understand. It seems too complicated and very broad for me. I’m looking forward for your next post, I抣l try to get the hang of it!

  93. Looking forward to reading more. Great article.Much thanks again.