James Saft

Sometimes it’s what doesn’t happen that is most illuminating.

When Pay Czar Kenneth Feinberg first slashed executive compensation at U.S. firms that benefited most from a government bailout the cry was that this would hurt these weakened firms when they could least afford it, as the best and brightest would leave for better money elsewhere, where the free market still ruled.

Well, the door didn’t hit them on their way out, but mostly because they stayed rooted to their desk chairs.
Feinberg evaluated the compensation of 104 top executives at affected companies in 2009, reducing pay for most to levels far below financial industry norms and their own former earnings.

Yet here we are in 2010 and about 85 percent are still working for the same firms, still toiling for the kinds of wages that may well make them wish they’d gone into the law rather than finance. Remember all those articles in glossy magazines about how impossible it is to make it in New York City on $500,000 a year?

“The argument that we hear all the time; that if we don’t pay more this key official will leave, he will go to a foreign competitor,” Feinberg told CNBC television.

“I’ve always been dubious about that argument and I think the statistics bear out the fact that most officials stay at those companies.”

Feinberg announced this week that he has told AIG, General Motors Co, GMAC Inc, Chrysler Group LLC and Chrysler Financial Corp to cut cash compensation for 119 top executives by a third in 2010 and total pay by 15 percent. Bank of America and Citigroup have repaid taxpayer funds and are now subject to diminished supervision by Feinberg, whose brief is to determine if pay at bailout firms is “in the public interest.”

Feinberg also announced he will examine pay in late 2008 and early 2009 at all 419 companies which got bailout money via the Troubled Asset Relief Program.

Even if you think, as I do, that the mechanisms intended to protect the interests of shareholders in setting executive compensation are broken, the idea of a government Pay Czar is untenable, even risible.  The U.S. bailed out its banks and automakers and had to do something to address the obvious inequity of seeing some of that money line the pockets of executives at the mismanaged firms. His power is more moral than actual, and will diminish quickly as the visceral memory of the acute phase of the crisis fades.

TIME FOR BOARDS TO ACT
In showing that one of the main arguments used to back ever-expanding executive pay — a market that will snap up the under compensated — may be flawed, Feinberg has done us all a great favor.

The great thing about Feinberg’s little experiment is that it is massively scalable and doesn’t require government intervention. All Feinberg has done is test a false market. If I were on the compensation committee of a corporate board and I looked at that 85 percent figure, I might just feel compelled to give it a go at my own company. Heck, I might even feel I was obliged to.

Executive compensation at U.S. corporations has grown massively in comparison to overall wages. That’s not a problem because it denotes inequality, it is a problem because it indicates that the same market forces that determine most wages are somehow not operating in the same way when the elevator gets to the top floor. One of those markets is false, and I am betting that it is the one tightly controlled by a self-interested group of executives, board members and compensation consultants.

This is a problem, in other words, of shareholders’  rights.

Lucian Bebchuk of Harvard Law School has argued that relations between top executives and boards are not truly arm’s length. There are simply too many ways for management to reward boards for overpaying them. A given board member has much to fear by taking on a highly paid chief executive and little reason to believe he will be rewarded or defended by shareholders if he does. Institutional shareholders have ranged from ineffective to comatose.

All of this makes a case for breaking down the barriers that protect executives and boards from shareholder influence — staggered board elections and takeover defense measures to name just two.

Feinberg, in an admittedly extreme set of circumstances and as the representative of government power, has cut through those defenses with a single stroke, and in so doing, has demonstrated the lie that market forces have driven compensation.

What is needed now is not one big Feinberg working for the government, but thousands of little Feinbergs working for shareholders.

(Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

-- James Saft is a Reuters columnist. The opinions expressed are his own. --

U.S. plans for a public-private fund to buy up toxic assets are likely to amount to a fig leaf with which to hide subsidies to failing banks.

It is also, inevitably, an entirely new subsidy to outside investors, who by definition will only participate if they get better terms than now available in what we formerly thought of as the free market.

Treasury Secretary Tim Geithner last week announced the plan, which will provide between $500 billion and $1 trillion of financing to private sector funds which will use the money to lever up their own capital and make offers for complex and doubtful securities now clogging balance sheets. Further details are to follow.

But it's likely the plan won't work, if by work we mean come up with a believable price for these assets.

Banks won't sell at market prices because to do so would make many fall over bankrupt. The U.S. can surely manipulate prices by providing cheap and plentiful leverage - sound familiar? - but that will be seen for what it is; a subsidy for the funds and the banks rather than a firm base to allow confidence to return.

As it is, there's a standoff in markets as to how to price these assets. For the sake of illustration, let's pretend that banks have a security marked on their books at 90 cents on the dollar, while similar securities change hands at 60 or 65 cents when bought and sold in arms length transactions.

The first thing to recognize is why the market and bank prices are so far apart for these assets, many of which are tied to real estate or consumer loans. It partly reflects uncertainty about how the underlying loans will perform given the poor economic outlook. But it also reflects the potential that assets will get cheaper still, that banks will become forced sellers later and so why commit your capital now as prices may well fall when banks disgorge.

It finally and powerfully reflects the fact that there is very, very little secure term funding at a reasonable price available with which to buy this stuff. That means you have to be a cash buyer with a long time horizon, meaning the return has to be pretty juicy.

The banks have a partly legitimate beef with what they see as a market failure and partly are applying self-serving valuations in order to avoid going bust. The assets may throw off more income than implied by market prices, in other words those returns to cash buyers may be a bit rich, but on the other hand these high carrying prices are very convenient for the banks which would fail if market prices were applied.

BETTER THAN PAULSON BUT STILL FLAWED

The earlier Paulson held-to-maturity plan was aimed at buying up these loans at higher than market prices, the justification being that there was a market failure and the government would actually make a "profit" on the deal.

That plan failed while the new one hopes to use private investors to set prices, thus justifying the numbers. It will avoid some issues, lessening the chances that banks just fork over the worst loans or that the auction is corrupt, but it won't achieve a market price.

Imagine for a moment that you are a hedge fund manager and in your subjective view a security now held by a bank will generate a return of five percent over its lifetime at the price at which the bank is willing to sell. No deal.

But if the Treasury will lend you eight times your capital for five years at 2 percent, well then that works pretty nicely, at least from the hedge fund's point of view.

Competition between funds for access to the leverage can improve the outcome for the taxpayer, but banks have to be willing to sell and won't do it if it drives them under. The U.S. can and I fear will simply increase the amount of leverage it will give relative to capital until the returns to the funds are good enough to justify them buying the asset for a price that keeps the banks magically solvent.

Sound familiar? It should because that kind of leveraged speculation is everyone was doing until the summer of 2007. Only then they were doing it with money borrowed from banks, now they are doing it with taxpayer money. Actually, in retrospect it always was taxpayer money.

So, it's a bit better than the Paulson plan, and maybe we want to spread subsidies across funds and banks to help soothe the problem. But will it work to restore faith in banks? I am not sure it is enough money to do that without getting a multiplying effect from the rest of us believing the prices. If the result appears to be fixed, that won't happen.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns, click here. --

Alan Greenspan hasn't been chairman of the Fed for three years, but his policy mistakes keep paying dividends in the form of blame at this year's World Economic Forum in Davos.

Polish Finance Minister Jacek Rostowski yesterday:

"This was the failure of one of the key institutions in the world." During the Greenspan era he said they continually met downturns and distress with easing and "eliminated fear."

Ken Rosen of Berkeley, who was writing about the housing bubble in 2005 or so, is in the same camp:

"Alan Greenspan personally prevented some needed regulations being put in place. The free market fundamentalism we had was a mistake, to go the other way would also be a mistake.

We had excessively loose monetary policy and regulations on these aggressive loans were not put in place. There were Fed board members who wanted to do it, and Greenspan himself said the had too much belief in the market. ...it was a global problem of excess credit led by the central bank in the U.S. but ratified by the central banks around the world."

Maybe history will be kinder to his reputation as a jazz musician.

James Saft is a Reuters columnist. The opinions expressed are his own.