One year after SVB's collapse, it's time to reform banker pay

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Sunday will mark the one-year anniversary of the failure of Silicon Valley Bank, an event that sent tremors through the banking system as a precipitous run on deposits led to shudders through other regional banks and beyond. Common conversations among ordinary bank customers about whether to withdraw funds dented an industry largely built on faith. 

Foundational policy questions emerged: Should deposit insurance be refashioned? With the government declaring that all depositors of SVB would be guaranteed, regional banks joined mega-banks with effectively unlimited coverage, stranding customers of smaller banks.

Should Congress repeal President Trump's bank deregulation bill, which encouraged SVB and other medium-size banks to grow to new asset levels that lacked enhanced oversight? And are the regional Federal Reserve banks, where bank executives (including the SVB CEO) serve on the board, inherently unable to rein in reckless behavior? 

A year later, the post-mortems leave many of these questions subject to partisan wrangling. 

On one repair, though, there's bipartisan agreement: compensation reform.

A Public Citizen analysis, affirmed by a subsequent examination by the Federal Reserve, demonstrated that SVB's compensation structure encouraged both reckless growth and interest rate mismanagement.

SVB held long-term Treasuries at a time of rising interest rates. To guard against devaluation of these assets, SVB bought a hedge. But with other problems threatening net income — the prime driver of the executive bonuses — SVB sold the hedge. That generated a reportable gain that papered over a loss, but left the bank exposed to the rational response of any sentient investor or depositor able to distinguish between SVB's real problems and its artificial accounting games.

Rational, uninsured depositors (with more than $250,000 at the bank) began to leave steadily, and ultimately fled in droves. Hours before the government seized SVB, the bank's board paid out bonuses to senior executives, punctuating a craven declaration that compensation trumps any other consideration in banking conduct.

Politics and policy

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February 28

Congressional banking committees held numerous hearings, and many members of Congress proffered compensation reform measures. The Senate Banking Committee approved one of these, known as the RECOUP Act. This bill empowers federal officials to claw back compensation in the case of failures due to mismanagement. It won the support of nearly the entire committee in a 21-2 vote. 

But election year politics may determine the fate of the RECOUP Act. 

Still, even if the RECOUP Act doesn't move through Congress at the necessary pace, regulators have a remedy. They can deploy a long-neglected statute from the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 956 of that law provides that regulators can bar compensation plans that lead to "inappropriate" risk taking.

Bonus-fueled fraud led to the 2008 financial crash. It also played a key role in a great deal of banker misconduct since then: JP Morgan's London Whale loss, Goldman Sachs' Malaysia bribery crime and Wells Fargo's fake accounts scandal, to name a few.

Finalizing this statute should be a priority. In fact, Congress emphasized the importance of this rule by setting an implementation deadline in May 2011.

Public Citizen has published a number of studies showing the relation between banking misconduct and compensation, a connection that holds in other industries as well. Regulators struggle to deter bad behavior with guardrails and speed limits. There is no more effective way to promote good behavior than by putting an executive's paycheck on the line for the conduct of the entire management.

President Biden acknowledged this connection as well. He released a post-SVB paper of recommendations, which included a call for the administration's agencies to finish the Section 956 rulemaking.

Regulators must complete the job of banker pay reform. Congress must hold them to account for steady progress. The anniversary of regional bank failures must be marked by policy progress.