The ERM Current™

Reports about new regulations on compensation practices at U.S. financial institutions emerged today in the Wall Street Journal.  Evidently, the Federal Reserve is working on new rules designed to reduce excessive risk taking such as incentives for mortgage loan production that fueled the current economic crisis.  Here is what was reported.  

Among ideas being discussed are Fed rules that would curb banks’ ability to pay employees in a way that would threaten the “safety and soundness” of the bank — such as paying loan officers for the volume of business they do, not the quality. The administration is also discussing issuing “best practices” to guide firms in structuring pay.

Government officials said their effort, which is just beginning, isn’t aimed at setting pay or establishing detailed rules. “This is not going to be about capping compensation or micro-management,” said an administration official. “It will be about understanding what is the best way to align compensation with sound risk management and long-term value creation.”

Solid corporate governance practices and effective risk management programs should be enough to limit excessive risk taking through well designed compensation plans.  However, it seems the U.S. Government is not convinced that companies will navigate the proper course.  

An article in yesterday’s New York Times details the contribution made by Fannie Mae’s former chief executive officer, Daniel Mudd, toward the financial meltdown we are experiencing in the US mortgage securities market.  Mr. Mudd, like many other CEOs of his time, joined the group of lemmings chasing profits, placating investors and taking excessive risks.  The article points out that Mr. Mudd told employees to “get aggressive on risk-taking, or get out of the company.”  When Mr. Mudd’s chief risk officer warned him about the housing bubble and the potential negative impact to the company, Mr. Mudd argued that the market, shareholders and Congress all thought the companies should be taking more risks, not fewer.

While his name is literally Mudd, Fannie’s CEO also serves as a metaphor for the dozens of CEOs and many more executives who failed to heed the warnings of risk professionals in the face of external pressure and personal greed.   Do you agree?  Please join the conversation below.