The Wall Street Journal is outraged at the temerity of the Obama Administration’s “pay czar”, Kenneth Feinberg’s, demands that bankers who have driven the institutions for which they had responsibility over the edge of insolvency not be rewarded for doing so:
In the annals of what used to be known as American capitalism, yesterday will go down as a sorry day: The Treasury and Federal Reserve announced wage controls on private American companies. So once again our politicians are blaming bankers, rather than addressing the incentives the politicians themselves created for bankers to take excessive risks.
President Obama cheered the pay reductions as “an important step forward” and urged Congress to “continue moving forward on financial reform to help prevent the crisis we saw last fall from happening again.” The pay curbs are intended to feed the official political narrative that the bankers caused the entire crisis, and that cutting their future pay will prevent the next one. Only a politician could really believe this, or at least pretend to.
The editors go on to mourn the fate of the institutions being placed under pay controls:
Mr. Feinberg thus has the impossible job of navigating between Congress’s desire for revenge and the incentives needed to motivate business success at companies that still need to repay taxpayers. His strategy seems to be to slash cash compensation to $500,000 or less for most of the affected workers, while the bulk of their compensation will come in the form of stock tied to future corporate performance. This seems reasonable enough in principle. But the danger is that these pay limits will drive the most talented people at these firms to other companies without such onerous pay limits.
I remain skeptical about the legality of these machinations. Congress may well have the power to regulate bankers’ pay. Its power is nearly unlimited, at least as it’s presently construed. However, the one area in which I do believe its power is limited is in its ability to delegate that power to the executive branch.
I can only wonder what the WSJ’s operational model for banks might be? Do they envision conditions under which the bankers are rewarded when their banks prosper and rewarded when they fail? To me at least that sounds less like “nature red in tooth and claw” and a lot more like crony capitalism, aristocracy under another name.
I guess it’s only fair if I suggest an operational model of my own. My preference would be that no institution should be allowed to become too big to fail. The first line of defense in the case of banks would be a ban on branch banking and regulations of the ratio of deposits to reserves and loans to deposits. Those things would have implications which would require other adjustments. For example, we’d need to place restrictions on foreign banks operating in the United States and allow consortiums of U. S. banks to operate overseas.
I also think that we should be protecting depositors and the banking system rather than banks and bankers. Deposit insurance rather clearly has introduced moral hazard and we need to come up with other mechanisms including rakebacks.
If necessary to keep them small enough to avoid the collapse of single bank presenting systemic threat, banks should be divided once they’d reached some threshold size.
I genuinely fail to understand the operational model for banks under which the Obama Administration is operating. Perhaps someone could explain it to me. If there’s one thing of which we can be confident, it should be that be that bank regulators aren’t capable of regulating banks. It’s not that there weren’t enough regulations or that the regulators didn’t have the powers necessary to do their jobs. They were either disinclined to do their jobs or they screwed up, plain and simple.
Nonetheless, to my eye it appears that the Obama Administration is proceeding as though more regulations will prevent the problems we’ve seen from recurring. If they’re very lucky the Administration will be out of office before their approach fails and produces another collapse.
Here’s the thing I find puzzling. Under an unregulated system the problem institutions would have collapsed and their assets divided among the government, creditors, stockholders, depositors, and other stakeholders. I think what we’re seeing, including the pay controls, are a form of controlled, slow motion collapse. That’s worse than a quick collapse only because we’ve poured a big chunk of cash into the errant institutions and because the institutions continue to consume resources that could be used by other, more successful organizations longer than they otherwise would. Why does the WSJ complain about the injury to the banks? They would have collapsed anyway.
From what I read in the AP coverage, the pay restrictions aren’t as problematic as announced earlier from my point of view. I’ll wait to see policy, instead of second-hand reporting.
I’ve also been thinking about whether the government is simply overseeing the winding down of AIG and a few other financial institutions. The problem as Yves Smith put it earlier this week, wasn’t that these institutions were simply too big to fail, their role was too important to the economy. The collapse of Lehman, which was relatively small, evidenced this. I believe the appointment of RTC – type receiverships would not have been cheap or quick either, and would have presented its own stresses on the Constitutional order as the receivers came to people’s homes and businesses to liquefy financial assets. We may be in the least bad of alternatives, just making them worse by ad hoc political judgments replacing business judgments.
It seems to me the way to control executive pay is to provide regulation that empowers shareholders and increases pay package transparency.
Oh come on. Its business as usual. You really think that the Obama Administration is going to offer up meaningful reform? Like with health care?
There are ways to reformulate the banking industry to reduce the issue of bank failures and too big to fail. For example, Kotlikoff and Leamer have suggested limited purpose banking. But that isn’t going to go anywhere because the Obama Administration is not interested in meaningful reform. Where will they all go work if they reform the banking industry too much? Where will Summers find a 1 day a week gig that pays millions? And I’m sure Emmanuel, Obama, Geithner and all the rest have at least given some thought to what to do anywhere from 4 to 6 or so years from now. They are all young, as Presiendents and their administrations go, so its not like they are going to just retire to an academia job, not when there are million dollar salaries via Wall Street in the offing.
Yes, and there is also a question of how large any single bank would be allowed to get. Would we see a system like we see today? Highly doubtful as what we see today is at least in part a product of legislation, laws, rules and regulations. Change the rules of the game and the game is played differently and you may very well get different outcomes.
I think what we are seeing is something like what happened in Japan, keeping the zombies shambling along via government bailouts and support. This was a key part of what lead to Japan’s lost decade. Even if you favor a technocartic approach that Obama is so enamored with, identifying the banks that can be saved and those that can’t and killing the one’s that can’t be saved and moving resources to those that can be saved or are in good shape would make sense. But we aren’t doing that either. It is basically full steam ahead on the course that was initially laid by Bush and his Administration, when you get right down to it.
These problems could be solved if, rather than adopt a byzantine maze of regulations, we simply started phasing out the institution of the publicly-held corporation, which is just a creature of the state to begin with and whose presence is a consistent distorter of markets as a result.
I think there are two fundamental points to be made about govt controlled pay:
The first is obvious. This is a slippery slope. If the govt can claim that TARP money is the predicate for dictating salaries, why not national defense issues, anyone receiving non-standard tax treatment, “emergency” situations, favored industries (“green” company executives should get 2x normal pay) etc etc.
Second, you don’t pour billions of capital into companies and then chase away the managers. That’s irresponsible and irrational. If you judge the managers incompetant, you don’t pour the money in. If you want to fire the old managers because they are boobs, fine, but you don’t make it unattractive for new ones to come in. This is just silly.
This is nothing but a populist sop to the malcontents. Go over to OTB for the post on this same subject and read the comments. You’ll see what I mean. Bizarre arguments of all manner with one common theme: “I wanna stick it to these rich bastards.” Sigh.
And the advocates for the future prospects of the taxpayer bailout money? (crickets chirping……)
No argument here, Alex. I’m not sure how that would have solved the problem at hand, though. Privately held banks of this size would have posed as much systemic risk. It wasn’t whether they were public or private it was their sheer size.
Are you suggesting that privately held companies can’t reach such a size? That’s an interesting point. None of the Fortune 50 are privately held.
“These problems could be solved if, ………….. we simply started phasing out the institution of the publicly-held corporation………and whose presence is a consistent distorter of markets as a result.”
Sometimes you laugh. And sometimes you belly laugh.
Dave,
I don’t think that privately held banks would have taken the same risks. The incentives are aligned properly.
And yeah, I don’t think privately held companies could reach the same size, either. But again, even if they could, the incentives are properly aligned.
Drew,
Not an Adam Smith fan, I take it? The Wealth of Nations illustrates the many reasons why they’re economically a bad idea.
Not a student of history, either. You do know that the reason why chartered corporations were created in the first place was to stamp out local markets, which were threatening feudal sources of revenue, right?
Drew, it’s not an imaginary slipper slope. Today, the treasury is capping compensation at the beg seven TARP recipients. In 30 days, the Fed is going to have guidance on compensation at all federally regulated banking institutions, even the small guys who aren’t too big to fail. Over the next several months and years, Congress will debate and possibly pass executive compensation laws for all U.S. companies.
The slipper slope being the most deadly of all . . .
That’s right Alex, a pure market mechanism for everything. Transactions costs and so forth be damned. Where do I sign up? Do you have a newsletter?
I am a supporter of eliminating too big to fail, but TBH, how and more importantly, when would we implement this? What would happen to the economy if it was announced tomorrow that we would start breaking up the big banks? What would this do to international banking?
As to the specific topic of exec pay, the WSj has just become a mouthpiece for the very wealthy. These execs really should have gone broke, that is what happens when your companies destroy an economy and you should have lost billions of dollars. The only reason most of them, even Goldman I believe, survived is because we bailed them out. There is no personal risk for these execs. A pretty good reason to question the LLC model in finance. However, all that said, if they have contracts those should be honored. I cannot see breaking the law to make up for prior bad decisions. I do this it legit to ask that parties consider renegotiating the contracts. It would also be legit, IMHO, to raise fed fund rates for those banks that are unwilling to renegotiate.
You need to remember that this is a fairly small group of people at the top of these banks. For all practical purposes they ARE the bank when it comes to decision making. These bankers have shown that they were willing to make decisions that could adversely affect their companies, and the whole economy, if it could reward them personally. Let us see if they are willing to maintain their salaries to the detriment of their corporations. They were willing to play hardball with us. Let us see how they act if we play hardball with them. No hard feelings, just business. BTW, if those execs leave, where are they going that will pay them that much money to make such bad decisions?
Steve
Alex –
Shed yer wooden teeth. Sell your horse and buy a car. Inside or outside plumbing?? Its 2009, Alex.
If you have a coherent argument to make, make it. Else admit to a temporary brain cramp and move on. Your position is ridiculous.
That doesn’t make any sense. Corporations have been around for centuries.
In a nutshell, the publically traded corporation produces business entities whose very incentives are aligned against the free-market and against sustainable economic growth. By their nature as creations of the state, they tend to have special privileges that privately held companies do not. The end result are industries dominated by one or two companies, their sheer size and lobbying ability preventing real competition.
You can have free markets, or you can have publically traded corporations. You can’t have both.
steve, part of the problem is that some of the executives like AIG’s executive came out of retirement a few months ago, essentially for the purpose of selling off portions of the company. He wasn’t there when this happened, so why should his pay be anything other than what is needed to get somebody with the background in the financial sector and in IPOs who can sell off the subsidiaries to pay back Uncle Sugar?
Alex,
Cease fire, cease fire. Adjust targeting.
You have the wrong target in your last couple of posts man. Or more accurately, you have the right target in your posts, you just aren’t shooting at it.
PD-Good point. I would hope they make exceptions for those people if they decide to go ahead with this. TBH, I think this is kabuki. They will say they want to cut their salaries but it is illegal and back off. Still, I think going forward, it would be reasonable to work on eliminating the entitlement sentiment in the financial industry. I would prefer to reinject personal risk for the execs in these finance related companies as my preferred method. The kind of risk where they will end up on welfare or working at WalMart, not the kind of risk where they lose $199 million but still have $50 million left.
Steve
I think there already is a size limit on how much of the banking sector a single bank can control (10%, or something like that). Perhaps you could shrink it downwards, but that would probably require some aggressive action by the Treasury Department, and they’re not going to be rushing to do that when they’re in bed with Goldman Sachs.