Pay curbs are not the answer
If an austerity program had been imposed on the court of Versailles in those turbulent months of early 1789, the Paris mobs might have cheered but they would no doubt have gone right ahead and sacked the Bastille.
Similarly, the pay cuts imposed on seven firms by the Obama administration convey the right sentiment, but they are merely a gesture that should not distract us from the real changes that are needed in the financial system.
The administration’s pay czar, Kenneth Feinberg, will cut the compensation of the 25 top earners at the seven companies that are essentially wards of the state by roughly half.
The obvious problem is that it is only seven firms. The more than 700 banks and other companies that have directly benefited from the government’s largesse are not affected — even those who are minting profits from credit markets propped up by trillions of dollars of the taxpayers’ money.
Instead, the pay curbs will only add to the burdens of the weakest. The zombie institutions — Citigroup, Bank of America and AIG — are depending on talented executives to bring them back to life. What hiring and retention incentives will these firms now be able offer?
Some will argue that Feinberg’s ruling is a start. After all, huge bonuses and outsized compensation plans have been symptomatic of excessive risk taking and destructive corporate behavior. Yet they are only symptoms. It is the business that has to change so that government intervention will never again be necessary.
Past efforts to rein in corporate behavior or instill accountability by changing the way compensation is taxed, or by insisting that pay be linked to performance, have rarely worked.
Companies find new ways to enrich their top executives or they rig the game so that performance targets are easily met. Lehman Brothers, for one, had a compensation plan that was tied to the long-term health of the firm.
Government intervention and government-sanctioned guidelines on pay don’t change the business of trading and taking on risk. For Wall Street to work as a maker of markets, the animal forces must have free reign. Successful risk-taking should be well rewarded.
There’s a place for that. But those risks should not be shouldered by taxpayers. By making executives at seven companies wear hair-shirts, some of the populist anger over bonuses and Wall Street may be assuaged — anger that should rightly be channeled into calls to prevent banks from engaging in risky activities.
There’s no reason that banks that are back-stopped by the government should be in the securities business. Taxpayers — voters — should ignore the media fascination with pay and urge that Congress heavily regulate and tax such risky activities.
In the wake of a watered-down derivatives bill, it’s clear that even Representative Barney Frank needs to hear more from angry Main Street than from revisionist Wall Street.
A complex financial regulatory overhaul is difficult to condense into a political slogan, but populist outrage can rally around the calls from Paul Volcker and others for a new version of Glass-Steagall. Banks that take deposits and lend serve a public function, and must be prohibited from engaging in investment banking.
Now that would be a revolution.