To Rein In Pay, Rein In Wall St.

(The profit numbers the government uses, by the way, are a version of operating profits. They don’t count big write-offs, which would seem quite unreasonable if it did not turn out that bankers did not need to count them either. Bailed out, they could return to collecting big paychecks.)

If those are the reasons for the profits, then perhaps regulatory attention should focus on the causes, not the effect. Rather than have a pay czar try to determine fair compensation for bailed-out banks while others can do as they please, Congress could look at changing the environment that produced this mess.

One way to do that is to encourage more competition. The impulse last year to have bigger banks take over failing big banks now looks exactly wrong, even before remembering that the regulators thought Citigroup

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[C  Loading...      ()   ] and Bank of America

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[BAC  Loading...      ()   ] were good acquirers with solid balance sheets.

The new regulatory system also needs to force banks to hold a lot more capital, and it needs to keep them from using tricks to take the same risks while appearing to need less capital. If the regulators can do that, it would reduce bank profits by tying up capital. One Wall Street executive I know suggests that would, in turn, bring down compensation by stimulating shareholders to demand more of the profits for themselves.

Mr. Kaufman argues that to prevent further socialization of the financial system, there simply have to be fewer banks that are too big to fail. He thinks such institutions should face more stringent regulation, and be barred from certain activities. If they want to do those things, they can find ways to split up or shrink.

Customers can also be empowered. Forcing most derivatives onto exchanges would increase the number of people who would be in a position to trade them, and probably bring better pricing for customers. One reason there are so many custom derivatives is that banks have persuaded customers they are cheaper, which is absurd. They can argue that because the banks do not force companies to put up cash when the value of a position declines. That should change. The banks could still lend the needed margin, or course, but by separating the credit and pricing functions customers would know more, and possibly get better deals.

Some such ideas were in the Obama proposals, but they are being watered down by intense bank lobbying. Some legislators who loudly denounce bank pay seem unwilling to do anything about the actual causes.

If policy makers want to bring down bank pay, they should do something to make the industry more competitive, and to assure that no one expects the taxpayer to again pay all the costs if the industry blows up again.

Floyd Norris comments on finance and economics in his blog at nytimes.com/norris.