The Obama Administration thinks loan officer pay should be tied to the quality of their loans. From the Wall Street Journal:
The Obama administration has begun serious talks about how it can change compensation practices across the financial-services industry, including at companies that did not receive federal bailout money, according to people familiar with the matter…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.
This idea reflects a fundamental misunderstanding of how loan origination works. Loan officers do not approve their own loans; there is always some kind of credit approval structure with people other than the originator signing off. I’m not saying that system doesn’t break down (for example, see my post, “Why Did WAMU Abandon Underwriting Standards?”). However, if a lender does a lot of bad loans, it means senior management made bad decisions and/or looked the other way.
VoxEU addresses the issue in their article, “Bonus Incensed”:
Until the 1970s, the predominant institutional form for risk taking in financial institutions specialising in speculative trading was partnerships, with partners’ unlimited liability a central element.
Employees were entitled to bonuses, but entirely at the discretion of the partnership. Employee traders producing significant profits were very well paid; those generating losses did not get bonuses, were often dismissed, and even blacklisted. The partners had a highly developed sense of risk and their asymmetric exposure to it, in no small part because failure could also mean personal bankruptcy.
Partnerships have disappeared over time, and the predominant institutional structure in the financial industry is now the limited liability corporation. This transformation is a key reason for the emergence of the bonus culture, because it substantially reduces the incentive of senior management to monitor risk taking. Any financial institution engaged in speculated trading faces the inherent danger of individual traders taking so much risk that it threatens the firm. It is the role of the senior management to prevent that.
Their solution:
Financial institutions should adapt elements of partnership structures to the limited liability financial institutions of today. Senior management (the partners of old) need to have a substantial part of their compensation deferred over a long period of time, with the amount of compensation directly related to the long run fortunes of the firm. Any senior manager in an institution receiving public assistance should lose all of their deferred compensation. By contrast, the supervisors should not mandate deferral of trader bonuses or regulate junior employee compensation. This provides management with an incentive to check for gaming.
When I’ve been in a credit position, I’ve always been impressed with how effectively experienced loan officers triage their loan applicants. Spending time on a loan application which is not going to be approved is a waste of time, and good loan officers can’t afford to waste time. In my experience, applications for bad loans are almost invariably taken by inexperienced loan officers who don’t know a good loan from a bad one and/or who are desperate to establish a client base. Changing their compensation structure is not going to solve that problem – you need good credit people willing to say no to bad deals and senior management willing to back them up.
To the extent bad loans are originated, the problem lies with the lender’s credit people and senior management, not the loan officer.
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