James Saft

The revolving door between government and Wall Street is wrong, antithetical to both democracy and capitalism and ought to be stopped.

For the second time in two weeks a high-ranking recent U.S. public servant has traded a position of influence in the corridors of power for a massive paycheck working for an institution that owes its very existence to government largess.

This time it is Theo Lubke, who has transitioned smoothly from heading the New York Federal Reserve Bank’s derivative regulation effort to working for Goldman Sachs, where he can be expected to, well, help it do well out of regulation, current and future.

Last week it was Peter Orszag, who until July was the Obama administration’s Director of the Office of Management and Budget, joining Citigroup’s investment banking unit as a vice chairman. Several days before that Citi hired George W. Bush’s Commerce Secretary, Carlos Gutierrez, as vice chairman for its institutional clients group.

To be clear, none of the parties is doing anything illegal and there is no suggestion that any of them wittingly acted against the public interest while in government service.

That, however, is a very low standard and far from an argument for a system in which regulators and high-ranking political appointees oversee the financial industry while at the same time having a near guarantee of being in line to be made rich by it a short time after leaving office.

It would take an angel to stand aloof from that kind of money, especially after having rubbed shoulders for years with their better paid, better shod but not better qualified peers in banking.

Money gives people a warm fuzzy feeling, and so does the prospect of it; it is little wonder that financial regulation has been so loose and so poorly enforced.

And please, don’t tell me that the right to go and make a fortune in finance afterwards is the price a people must pay for the services of the most able policymakers. Larry Summers is a genius and Bob Rubin evidently the wonder of the world, but having them at the center of banking and regulation has hardly been a boon for either taxpayers or investors these past 15 years.

The United States would have been far better off, as it was until the 1980s, with a set of regulations so tight it could be administered by plodders and a banking industry peopled by able but unimaginative types making a decent living.

That, of course, would lower the rewards on offer in banking, both in terms of the money banks could produce and their motivation to offer it. And don’t believe that simple banking can be equated to simple medicine or technology; on the evidence growing complexity in financial services has hurt clients, shareholders and taxpayers, leaving the sole certain winner bank employees. Future bankers in public service have done rather well out of it too, you could say.

NUPTIAL LOGIC

The Orszag-Citigroup marriage is particularly striking, given that he was in the inner circle of an administration that made the controversial decision to keep the bank alive despite ample evidence that it richly deserved to fail. If that does not give you a queasy feeling, and on the evidence it did not for Orszag, consider that Citigroup is now the lucky owner of too-big-to-fail status, giving it an unfair advantage over smaller competitors who haven’t convinced those in power that they are indispensable.

Hanging on to the too-big-to-fail brass ring is arguably job 1 for Citigroup going forward and having someone with Orszag’s experience and, er, contacts is obviously useful. Gutierrez can be viewed as an insurance policy against the fickle winds of political fortune.

As for the Lubke-Goldman nuptials, the attractions and dowry are pretty much the same. While Lubke can’t claim credit for seeing Goldman through its rough patch during the crisis, he was, as head of the New York Fed’s Financial Infrastructure Department instrumental in derivative regulation reform efforts. He is reported to have pushed for on-exchange trading, a policy that is almost certainly against Goldman’s best interest, it must be said. As a former top Fed official he will be banned from any Fed-Goldman meetings or from contacting his former colleagues on matters in the area he once worked, according to Bloomberg News.

That is something, but not nearly enough.

It is all quite a contrast with Kansas City Fed President Thomas Hoenig, who asked by the New York Times about his plans after his coming retirement, said:

“I can tell you one thing. I’ll never work for a too-big-to-fail bank.”

Hoenig, cussed as he is, is a bit of an angel, and so may be Lubke, Orszag and Gutierrez, but depending on angels is a lousy policy.

(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.)

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.)