As always, there’s far less here than meets the eye. And as always, there will be unintended consequences.
According to the reporting on the issue, Obama isn’t going to make this retroactive. So it doesn’t apply to companies that have already been bailed out, like AIG and Citigroup (which have each received over $100 billion in taxpayer support) or Fannie Mae and Freddie Mac. Or even GM and Chrysler LLC, the original poster children for taking the corporate jet to ask for handouts.
But this is less than it seems, because companies are still free to issue any amount of restricted stock to their executives. It will just be subordinated to any claim that the taxpayers may have on the assets of the affected companies.
And given that the whole ad hoc bailout policy has called for taking as small a claim as possible on the assets of the affected companies, the whole thing seems like a lot of PR to me.
After all, it’s already impossible to give an executive more than $1 million in cash in any given year without paying a large income tax penalty. Companies usually just “gross up” their millionaire executives, meaning they give them additional cash to pay their penalty tax rates. It all comes out in the wash.
But let’s suppose that the restrictions on cash comp and corporate jets will actually have some marginal effect. In a way this is a very good thing, because it may make it tough for anyone new to come asking for handouts.
The financial industry is already pretty much in bailout heaven. But the smaller and medium banks that are in trouble would have the alternative of merging up with the large, already-assisted banks. So their executive pay and perks would be grandfathered in. No problem there.
What about industries like steel, homebuilding, and others that might, just might, need bailing out? They would have a problem, and they might use the pay restrictions as an excuse to look for a better way to solve their problems. That’d be healthy.
And what about the top-flight Wall Streeters? These are the guys people are talking about when they say that you need to pay people lavishly if you want to keep them.
The best of them will just start up new firms. There’s a lot of capital out there, hundreds of billions of dollars of it, just sitting on the sidelines. It’s not going to go into traditional, economy-building investments any time soon. Not as long as there is so much uncertainty about the extent to which government will control the economy in the future.
But it’s got to go somewhere. For now, a lot of it is going into corporate bonds, which are yielding gargantuan spreads over risk-free rates (although those spreads are compressing as people join the party).
But proprietary trading, the basically-parasitic activity that seeks to profit from capital-market volatility (and actually creates much of the volatility to begin with), is alive and well. The strategies have to be adjusted to deal with exceptionally high risk premia in derivatives pricing, but that’s not hard for the rocket scientists.
When there’s so much to be gained from gaming the system, the smartest people will always find a way to do it. At the end of the day, the only thing Obama is accomplishing is to apply a little morphine to the raw nerve which is the public’s disgust over high pay for failed strategies.
But let me be a little more serious about this. This isn’t just a PR problem. There are real economic inefficiencies that come from the fact that finance and other professionals receive outlandish compensation without delivering commensurate value. Anyone who is a shareholder in public companies in the banking and financial industries needs to be concerned about this.
The basic problem is to align risk with reward, in both directions. The people who trade in and manage today’s investment firms participate lavishly in the upside, but not the downside. In all candor, the only really effective way to solve that problem is for the investment-firm principals to have their own money on the line in every trade. It’s not good enough for them to make 2% of assets under management every year, and 20% of the upside. They need to take capital losses pari passu with their limited partners. For public companies, that includes their shareholders. For assisted or nationalized companies, that includes the taxpayers.
Will that happen? Umm, good luck. Depends on whether Obama sees this as something more than a PR problem.
This post also appears at MarketsAndPolicy.com.