Update 693 — “Stupid” Bad, but Systemic Worse
Bank Bust Risks and Rewards for CEOs… and Us
Reckless and risky financial behavior is on full display in Washington this week, with financial system stability, if not the macroeconomy in the balance. Exhibit A is the ongoing debt limit negotiation, where serious demands that energy project permitting is a “red line” on a par with honoring the nation’s full faith and credit. The markets dropped 300 points right after another fruitless leadership meeting yesterday.
Also yesterday, and again today, the failed chief executives of SVB, Signature, and First Republic banks appeared on the Hill, offering damning testimony about mismanagement, short-terms thinking, self-dealing, even bonuses while their banks burned. As Sen. Vance joked, “I… would be willing to screw something up for much less than $1.5 million.” And all this as the runs on these banks threatened more principled ones and the sector broadly. What can be done? See below.
Silicon Valley Bank, Signature Bank, and First Republic Bank — the three banks collapsed within the past few months, but that’s not all they had in common. In 2018, SVB, Signature and First Republic were the three highest-paying public banks in the United States. The money went to the executives who were paid millions under incentive compensation agreements that pegged their bonuses to the profitability of their banks.
This week, some of those same executives testified before Congress. None of them agreed to return the money they made. At least one of them — former CEO of SVB Greg Becker — said that he deserved the pay, despite the fact that his failed leadership almost took down the stability of the financial system alongside his bank.
Executive Comp: Risky Plans and Incentives
For executives at SVB, bonuses were tied to the bank’s return on equity (RoE), a key measure of profitability. From 2017 to 2021, the bank’s RoE went up, and so did executives’ compensation. According to a Financial Times analysis of SVB’s securities filings, the bank’s former CEO, Greg Becker, and former chief financial officer, Daniel Beck, together received $8 million in compensation in 2017, when SVB’s RoE was about 12 percent. By 2021, the bank’s RoE was over 17 percent. That year, Becker received a cash bonus of $3 million, bringing his overall compensation to roughly $9.9 million, while Beck received a $1.4 million bonus, bringing his total payment to $3.8 million.
Compensation for SVB Executives and Return on Equity (2017-2022)
Source: Financial Times
RoE went up, and so did executives’ paychecks, but over those four years, the bank’s investment portfolio changed. The duration of SVB’s securities portfolio went from an average of 2.5 to 3.8 years, making its value more sensitive to fluctuations in the interest rate. The poor risk management that led to SVB’s failure made its executives millions.
At Signature, executives’ incentive compensation plans were pegged to return on assets to “reflect additional focus on profitability.” Former CEO of Signature Bank Joseph DePaolo — who could not testify due to his health — received $8.7 million in total compensation in 2022. The Signature executives who did appear — former chairman and co-founder Scott Shay and former president Eric Howell — also made millions in the years leading to the bank’s collapse.
First Republic also structured its executive compensation plans to tie bonuses to profits. Under former chairman Jim Herbert’s 2021 employment agreement, he was entitled to an annual cash bonus equal to 0.5% of First Republic’s pre-tax profit each fiscal year. In 2021, he was paid over $21 million in direct compensation, up 35 percent from the year prior.
Accountability Through Clawbacks
The resolution of the recent spate of bank failures cannot come without accountability. Executives kept making money ahead of the banks’ failures. Eleven days before SVB went into receivership, Becker sold over $3.5 million in the bank’s stock and Beck sold just over $575,000 worth of shares, about a third of his total holdings. The sales were executed under 10b5-1 plans filed 30 days earlier, allowing insiders to book share sales in advance to avoid liability for trading on nonpublic information. DePaolo — the former Signature CEO — sold stock in Signature in the years leading up to its failure. Jim Herbert — the former Chairman of First Republic — sold $4.5 million worth of shares since the beginning of 2023, while the bank’s former chief credit officer, president of private wealth management, and chief executive together sold $7 million in stock.
The Dodd-Frank Act’s special resolution authority provides the FDIC with claw back authority, but this only applies to the very largest financial institutions. After the failures of SVB and Signature, President Biden called on Congress to expand the FDIC’s authority to claw back excessive compensation – including gains from stock sales – to cover a broader set of banks.
Congress’s antagonism toward the executives played out at Tuesday’s hearing in the Senate Banking Committee and today’s Financial Services Subcommittees on Financial Institutions and Monetary Policy and Oversight and Investigations joint hearing. Legislators on both sides of the aisle took aim at executives of the failed banks — Becker, Shay, Howell, and former CEO and president of First Republic Bank Michael Roeffler. Senate Banking chair Brown (D-OH) called out the executive compensation structures at the banks and blamed mismanagement on executives seeking to get richer.
“Recklessness and greed,” was to blame, per Congressman Brad Sherman (D-CA). To pointed questioning by Senator Van Hollen (D-MD), Becker said of his $1.5 million bonus in 2022, “the board thought it was fair and I believe they were accurate.”
The leading reform proposals:
- Senators Elizabeth Warren (D-MA) and Catherine Cortez Masto (D-NV) — both members of the Senate Banking, Housing, and Urban Affairs Committee — along with Senators Josh Hawley (R-MO) and Mike Braun (R-IN) have introduced the Failed Bank Executives Clawback Act
- The companion bill was introduced in the House by Representatives Katie Porter (D-CA), Victoria Spartz (R-IN), Ruben Gallego (D-AZ), Ken Buck (R-CO), and Marie Gluesenkamp Perez (D-WA)
- Senators Reed (D-RI) and Grassley (R-IA) introduced the Bank Management Accountability Act. The bill would make it easier for banking regulators to claw back compensation from negligent bank directors and senior executives at failed systemically important banks.
The legislation would require that, in the event of a bank failure, federal regulators claw back all or part of the compensation received by bank executives in the five-year period preceding the failure.
Section 956: Delink Executive Comp from Risk-Taking
To prevent the next collapse, we need more than accountability for recent failures. Policy needs to prevent inappropriate risk-taking in the first place. Congress recognized the need to do this following the financial crisis in 2008. Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act required a rule to ban incentive-based executive compensation that encourages “inappropriate” risk-taking. The May 2011 deadline set by Congress passed roughly 12 years ago, and still, a final rule has yet to be finalized.
20/20 Vision has joined with a coalition of organizations to call on the Federal Reserve, Federal Housing Finance Agency, Federal Deposit Insurance Corporation, Securities & Exchange Commission, Office of the Comptroller of the Currency, and National Credit Union Administration to finalize a rule this year. Specifically, we request a rule including the following policies:
- Defer a significant percentage of executive compensation for 10 years, and if the financial institution fails, make it subject to forfeiture to reduce the costs of insuring depositors; or if it engages in misconduct, use it to pay any fines
- Ban stock options as part of executives agreements
- Ban executives from hedging bonus pay
Anat Admati, a professor at the Stanford Graduate School of Business, has gone as far as to say that linking bonuses to return on equity is an “inducement to take risk.” Recent bank failures further prove that executive compensation plans that incentivize risk-taking by banks is a systemic issue that makes the financial system more vulnerable. This was clear in the case of SVB’s failure following contagion could have spread to the broader banking sector. When executives prioritize short-term profits over everything else, they put at risk not just the long-term health of their own banks, but can risk stability of the financial system.