James Pethokoukis

Politics and policy from inside Washington

The risk of a supertax on banker bonuses

Dec 11, 2009 14:31 UTC

U.S.-based bankers shouldn’t worry too much about their bonuses. Even though Wall Street remains wildly unpopular and Washington needs more revenue, it’s unlikely U.S. authorities will follow their UK counterparts with a giant windfall tax on banker payouts.

That upcoming election cycle will certainly give American politicians all the impetus they need. A combination of fat payouts of 2009 bonuses in the first quarter and high unemployment will tempt incumbent lawmakers to play the populist card ahead of the 2010 vote.

But past efforts at such radical moves have failed. Congress is again struggling to raise taxes on carried interest, the profit generated by private equity firms and hedge funds. Some Democrats want such performance-based compensation to be considered regular income taxed at a 35 percent rate rather than the current capital-gains treatment it gets with the accompanying 15 percent rate.

The policy logic is plausible. Plus, as Warren Buffett has famously argued, fund managers shouldn’t pay lower tax rates than their office assistants.

But legislation to change carried interest taxation probably isn’t going anywhere. Sure, the House just voted in favor of it. But the bill is DOA in the Senate, which has shown scant interest in direct higher taxes on the wealthy or on capital. For example, it declined to copy one of the House’s preferred methods of paying for healthcare reform — a surtax on the wages and capital gains of top earners.

Moreover, New York Democrat Charles Schumer, a key player on the Senate Finance Committee, is an avowed opponent of higher taxes on alternative asset managers.

What’s more, the United States has already trod this path unsuccessfully. The House voted overwhelmingly to tax 90 percent of AIG bonuses, but the effort went nowhere in the Senate. The Obama administration didn’t push the issue, and polls showed only a bare majority in favor once the issue was fully explained. There were also substantial questions about the constitutionality of a tax targeting a specific group.

U.S. bankers have another six weeks or so to stew before seeing an actual bonus check. But in reality, they should be able to enjoy the holidays.

The UK banker bonus supertax

Dec 10, 2009 20:50 UTC

I don’t see this happening in the US.  I mean, the effort to raise taxes on private equity carried interest, while passing the House, is going nowhere in the Senate. And that is far less controversial and a less stupid idea. And remember how the 90 percent tax on AIG bonuses fell flat back in March.  The one caveat, as Dan Clifton notes in an earlier post,  here is that 2010 is an election year and the combo of big bonuses  and high unemployment could cause endangered Ds to play the populist card and try something

Why bankers should worry in 2010

Dec 10, 2009 16:38 UTC

Already, the crazy ideas are returning, such as mortgage cramdowns. But more could be on the way in 2010, says the great Dan Clifton of Strategas (bank bonus tax, American version?):

We are entering a period where bank profits are increasing but lending is declining. Bonus season is on the horizon while job growth remains negative. And bank lobbying on financial regulation is increasing while politician’s approval ratings are declining. Adding even more fuel is that with government spending up and tax revenues lagging, sovereign fiscal issues are rising to the top of policy matrix.

Wall Street pay continues to be the Great Distraction

Oct 27, 2009 17:05 UTC

Again, all this focus on Wall Street pay distracts from more important issues.  Gary Becker summarizes:

I have not seen convincing evidence that either the level or structure of the pay of top financial executives were important causes of this worldwide financial crash. These executives bought large quantities of mortgage-backed securities and other securitized assets because they expected this to increase the average return on their assets without taking on much additional risk through the better risk management offered by derivatives, credit default swaps, and other newer types of securities. They turned out to be badly wrong, but so too were the many financial economists who had no sizable financial stake in these assets, but supported this approach to risk management.

The experience of other financial crashes also does not indicate that either the level or form of compensation of top financial executives were major factors in precipitating these crashes. Thousands of banks failed during the Great Depression, as did hundreds of American savings and loans institutions during the 1980s, without heads of these institutions in either case getting particularly high pay, or pay that was mainly in the form of bonuses and stock options. My impression is that this same conclusion applies to the Mexican bank crisis of the mid 1990s, and the Asian financial crisis at the end of the 1990s.

The generous bonuses and stock options received by financial executives may often have been unwarranted, but they are being used as a scapegoat for other more crucial factors. Financial institutions underrated the systemic risks of the more exotic assets, and apparently so too did the Fed and other regulators of financial institutions. In addition, large financial institutions may have recognized that they were “too big to fail”, and that they would be rescued by taxpayer monies if they were on the verge of bankruptcy because they took on excessively risky assets.

COMMENT

I think you’re both missing the point. This whole business of Wall Street pay levels and bonuses &c. has been a convenient shield for Mr. Obama and his radical advisors to move into territory previously off-limits. See David Rosenberg’s analysis of the current situation in the subsequent article. Mr. Obama has moved into corporate management (GM, Chrysler, AIG); has demonized insurance companies preparatory to taking over (read: socializing) the healthcare industry; and attempted to delegitimize FOX news and anyone else who would dare differ with his agenda. (Think Jimmy Carter and his criticism = racism remarks) Keeping the ignorant masses occupied watching some hapless Wall Street executives get crucified might have seemed a winning strategy for Mr. Obama’s radical advisors. American voters may be getting wise to this game.

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Wall Street pay is the Great Distraction of the Great Recession

Oct 22, 2009 11:49 UTC

If I made of list of factors contributing to the recession and financial crisis, Wall Street pay would come in around 6th, after 1) easy monetary policy; 2) TBTF; 3) US housing policy; 4) global savings glut/China labor shock; 5) Wall Street group think.  Yet pay is where so much energy is being directed at this issue thanks to its populist appeal. America hates TARP so Washington needs to make amends by hammering execs at TARP recipients.

Now two other takes. First, Marginal Revolution:

There is no way this will work as advertised.  If the administration actually follows through, most of these executives will quit and get higher paying jobs elsewhere.  Executives not directly affected by the pay cuts will also quit when they see their prospects for future salary gains have been cut.  Chaos will be created at these firms as top people leave in droves.  Will the administration then order people back to work?

Here is Naked Capitalism:

The point is that the collection of these scalps will do nothing to comp levels ex these firms. The companies that also enjoy implicit government guarantees are free to do the “heads I win, tails you lose” game of privatized gains and socialized losses. And Ken Lewis is the poster child of why these measures are completely meaningless. He sacrificed his 2009 pay, but will still collect $125 million when he departs Bank of America.

If the government is going to backstop the industry (and this isn’t an “if” anymore), it needs to limit those firm’s activities to what is socially valuable and regulate them heavily to contain risk taking. As we have said, reining in executive pay (and note there is no will to do that anyhow) is not an effective approach. Those employees who don’t like that are free to decamp and raise money in ways that do not involve the regulated firms in any way, shape, or form, save perhaps counterparty exposures on very safe, highly liquid instruments.

COMMENT

I agree with much, but take issue with the Naked Capitalism blurb. The solution is not to’limit those firm’s activities to what is socially valuable and regulate them heavily to contain risk taking.’ The solution is to eliminate the government policy of too big to fail.

Once that message is sent loud and clear, then the behavior of market participants will adjust accordingly and ‘excessive’ or ‘irresponsible’ risk taking will decline by virtue of the natural dynamics of capitalist discipline. Because the prospect of real failure is powerful incentive for any institution to be more judicious in the risks that it takes — as opposed to today’s environment where ‘failure’ means the government will likely step in to make you whole.

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The Fed’s dangerous plan to regulate Wall Street pay

Sep 18, 2009 16:22 UTC

The Obama administration wants the Federal Reserve to be the maximum regulator of the American financial system. As Treasury Secretary Timothy Geithner told the Senate Banking Committee, “The Federal Reserve is best positioned to play that role. It already supervises and regulates bank holding companies, including all major U.S. commercial and investment banks.”

The problem, of course, is that most informed observers have concluded that the Fed failed to adequately supervise and regulate banks during the lead-up to the financial crisis. Count Senator Chris Dodd, chairman of the Senate Banking Committee, in that camp. “There’s not a lot of confidence in the Fed at this point,” Dodd said right after the White House released its financial reform proposal.

This is where Daniel Tarullo makes his appearance. The newest member of the Federal Reserve has apparently authored a plan to have the central bank approve compensation policies potentially But previous to joining the Fed, Tarullo was an influential economic adviser in the Obama presidential campaign.

So now what we have, I think, is Obama’s man at the Fed pushing a politically savvy plan that could bolster the Fed’s standing as a tough regulator in the eyes of Congress and deflect some of the criticism of the central banks past failings. Score one for the White House in its push to make the Fed super-regulator.

Surely, the timing couldn’t be better. Not only has the administration been refocusing attention on passing financial reform – witness the president’s tough Wall Street speech – but next week’s G-20 meeting will include extensive discussion about banker pay issues.

But this is a case where good short-term politics makes for bad long-term bad policy. The greater the Fed involvement in the regulatory process, the greater attention it will receive from Congress – and the greater the threat to its cherished independence.

As it is, the Fed’s historic efforts to rescue the financial system have raised concerns on Capitol Hill that it has too much power with too little oversight. That’s why Rep. Ron Paul’s bill to audit the Fed, according to Financial Services Committee Chairman Barney Frank, will pass the House this year. (Indeed, what Paul really wants to do is end, not mend the Fed.)

Really, could anyone possibly believe that having the Fed become the pay czar at 5,000 banks would lessen congressional interest in its activities, including monetary policy? Not to mention that a better solution to excessive financial risk taking is the restoration of market discipline on Wall Street.

Better that Wall Street understand the consequences of poorly incentivized pay structures. “Too big too fail” remains the biggest threat to America’s fragile financial system.

COMMENT

IN MY OPINION THE BANKS,THE FED, AND THE GREED OF THE MANAGEMENT AT THE TOP ARE ALL AT FAULT FOR THIS MESS WE ARE IN . THESE GUYS WOULD RATHER SPEND OUR INVESTMENT CASH ON A PLUSH OFFICE AND TRIPS FOR THE UPPER ECHELON THAN TO RETURN IT TO ME IN INTREST EARNED IN MY ACCOUNT. THEY ARE A BUNCH OF EGOTESTICLE IDIOTS AND THE ONLY WAY TO CONTROL THEIR THEIVING WAYS IS TO REGULATE THEIR COMPENSATION. BUSINESS AS USUAL THE RICH ARE STILL SCREWING EVERYONE THEY CAN AND FEEDING THEIR WALLETS WITH OUR CASH. ITS LIKE THE REGAN TRICKLE DOWN THEORY THAT DIDNT WORK EITHER. REGULATE THESE GUYS NOW OR WE WON’T HAVE A SYSTEM LEFT TO REGULATE. CHARLES BOWEN

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Citigroup’s big pay hikes

Jun 24, 2009 15:26 UTC

Instead of big bonsuses, Citigroup is moving toward bigger salaries. Here is what the company should be doing:

What sort of compensation might work better to align executive compensation with long-term shareholder interests? A group of academics — Alex Edmans of Wharton, Xavier Gabaix and Tomasz Sadzik of New York University and Yuliy Sannikov of Princeton — have devised an approach based on what they call “dynamic incentive accounts.”

Unlike bonus clawbacks, this system doesn’t try to recoup money already sent out the door.

Here is how it works, according to their new study: Executive pay is escrowed into an account, a fraction of which is invested in the firm’s stock and the remainder in cash. The account would be rebalanced each month according to company guidelines — rules would certainly also vary by industry — and by how close the executive is to retirement.

The gradual vesting of the account — cash from a sold stock cannot quickly withdrawn — even after retirement, “allows the CEO to consume while simultaneously deterring myopic actions.”

In other words, the goal is to promote long-term thinking over short-term manipulation.

For instance: If company’s stock soared, the executive could sell, though the proceeds would say in the account. If the stock then dropped, that money would have to be used to buy more stock. He couldn’t just take the money and run.

Is this the best system out there?. Maybe, maybe not. Or maybe for some firms or sectors and not for others. But that is why you don’t want a one-size-fits-all plan devised in Washington, particularly one with political rather than economic goals. That is a pothole that Barack Obama and Timothy Geithner have so far avoided.

Sentence of the day

Jun 8, 2009 13:48 UTC

From the NYTimes articles on a White House effort to control executive compensation in the financial industry:

“In the past, banks had free rein to determine the base salary and bonuses they awarded their employees.”

Me: Or put it this way: “”In the past, companies could pay their workers at a level that made business sense.”

COMMENT

What a private sector company chooses to do with their dollars is entirely up to them — http://en.wikipedia.org/wiki/Capitalism — Probably the strongest argument against bailouts.

On the contrary, public funds raised through taxes most certainly are not subject to the same indiscretion. Setting pay restrictions in the private sector sounds like an idea taken straight out of the Communist Manifesto. This notion of disincentivizing people to produce and generate more products and wealth will inevitably guarantee a future of mediocraty in a country founded on innovation and private business.

“The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.”
~Winston Churchill

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