Pay curbs are not the answer

October 22, 2009

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.

Comments

In order to fix a problem, one must first view it in the proper light.

Since the removal of Glass Steagall banking lobby has been successful in the creation of a system within a system that is no longer bounded internally by our laws, this is why it failed.

As Dennis Ratigan is now railing, the banks went into default in a natural market mechanism of price discovery of their behaviors. The unnatural bailout, allowed for continuance of the behaviors while all banks that received US Federal Funds should have been in a Federal Receivership.

The failure of enforcment of receivership allowed an immediate repeat of excessive risk, though because the US Government ate the loss on the Systemic Failure, allowing certain institutions to exponentially profit making enormous risk bets with public funds at the bottom, then proposing to distribute the rewards of the bets made with public funds to a group of private bankers. GS.

This is an unequitable transaction with the Public and special legislation should be immediately passed to close the Loop hole of 2009 and recover a large portion of that 20 billion++ dollar gain for the US treasury that supported indirectly – the inappropriate of a newly regulated commercial bank that took unique risks that are incongruous with their change in bank status.

I believe if we review our existing laws about deposits, that we will find GS probably broke some laws in 2009.

 

If I were an investigator looking at a particular investment bank that became a commercial bank in the middle of the chaos, I would look at their handling of deposits as related to their enormous bets in proprietary trading and if the allocations of gains to depositors is being properly accounted for, specifically regarding laws in the handling of public funds as a depository bank as opposed to an investment bank.

 

I do think that the companies who, via poor management, should cut expenses and pay back the shareholders and the federal treasury. Excessive salaries only reflect the greed in these companies. An example of poor management is that General Motors purchased a new Ferrari for approx 200 K dollars while claiming it was loosing money. They sold the car at a loss at a collector car auction. I think that when American companies get back to down to earth management earning down to earth profits, and providing excellent products we might even agree that they should be well paid.

Posted by f belz | Report as abusive
 

Excuse me.

These companies you’re so concerned for had free reign, prior to the crisis, to spend as much as they wanted on this allegedly-indispensible “talent.” How well did these dearly-purchased “geniuses” perform? Remind me?

“People want to work here, but they want to be paid fairly,” said Scott Silvestri, Bank of America’s spokesman. To which I would like to reply “so do we all, Scott. Now please explain to me how being a parasite on society is ‘fairly’ worth $600,000/year.”

Posted by Matt Kuhns | Report as abusive
 

In the “golden” days of the American economy, the ratio of CEO pay to average pay was around 40-1.

Employees, including CEOs, are not entrpreneurs. They can and do walk away from sinking ships with golden parachutes. They operate in a “heads I win, tails I break even” world.

Salaries can be reigned in by limiting the deductibility of pay to the first $1,000,000. I can’t believe that $1,000,000 is not enough to motivate anyone to do their best job. The average combined salary of the 3 highest paid executives at the S&P500 companies is more than 10% of profits. That is a crazy transfer of wealth from the shareholders to the top employees. Arguments of “vote with your feet and sell the stock” are bogus, since it is the same throughout American business. All these top executives sit on each other’s boards, and pad each other’s wallets.

If $1,000,000 is not enough, let them start their own company and make their money through an equity stake rather than salary and bonus.

 

Transactional banking should be disintermediated altogether. It will lead to job losses, but there won’t be the existing ‘interest turn’ on Libor and Federal Reserve Bank lending rates. All it requires is good software programming and a single brand for ATM’s. Debit orders and EFT’s still have to clear somehow, but this can happen via the Federals and SWIFT. Card business under the current brands would have to continue somehow, and reduced as the capital investment should have been paid off long ago, which only leaves maintenance of systems, but should really be disintermediated as above. That would automatically separate investment banking out, which could remain branded. The portfolio owners should decide on remuneration, so rather pay market related salaries and cut out bonuses, except if the client believes it is warranted. That leaves structured finance and project finance. Here too, we are dealing with fees which drive salaries, so it is up to the transacting parties what they can afford or want to afford. All of the above would effectively cut out bank and super corporate treasuries and the obvious risks associated and they would become hubs, instead of gluts. I hope I covered everything.

Posted by Casper | Report as abusive
 

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