Making the Bank Bailout Fun
In a desperate effort to keep the collapsing housing bubble from sinking the economy, or at least the country’s leading financial institutions, Federal Reserve Board chairman Ben Bernanke has broadened access to the Fed’s discount window beyond the commercial banks who it directly regulates. Bernanke has decided to allow 20 major securities dealers to also take advantage of this special low-rate government loan program.
It remains to be seen how much good this will do for the economy, but with the Fed desperately trying to make up for its failure to contain the housing bubble, anything is probably worth a try. Even if this new lending route turns out not to help the economy much, it is certainly a good deal for these financial firms. They can now borrow tens of billions of dollars from the government at just a 2.5 percent interest rate.
Why shouldn’t the taxpayers get something in return?
While we could think of all sorts of elaborate concessions we can ask from the Wall Street crew in exchange for these special discount loans, we can keep it simple. Suppose we put a cap on the compensation for their most highly paid executives of just $1 million a year. That’s a cap on total compensation of $1 million, not just salary. (We don’t have to be stupid all the time, previous efforts to limit categories of compensation proved to be completely worthless.) Anything that is paid to the execs that has value – health care and pension benefits, bonuses, stock options, private use of jets and vacation homes, bizarre deferred retirement schemes – gets included in this $1 million figure.
This suggestion will no doubt provoke outrage on Wall Street. For the big boys, $1 million is what you earn in a few days or a week, not a year’s salary. But the shareholders of these investment banks may see things differently. After all, the highly paid hot shots at Bears Stearns managed to lose almost every last cent of the shareholders’ equity with their bad investments. Very highly paid honchos at other Wall Street firms are not doing much better.
Shareholders might consider it a win-win to both get access to low-cost loans and much lower paid executives at the same time. If the bunglers who are currently running these companies don’t think they can get by on $1 million a year, they could just step aside and let more competent people take over.
This condition could turn the Fed policy from a quasi bailout into a real winner for the economy and society. In addition to helping sustain the financial system, we will also be taking a huge step toward reducing inequality. And, it will all be totally voluntary. There are no taxes; we’re simply setting conditions on handouts from the government. If we didn’t have a conservative nanny state, the Fed would have already imposed some condition like this on the Wall Street welfare crew. But, it’s not too late to force the Fed’s hand.
Comments (29)
An excellent idea, what does Feingold think?
March 21, 2008 11:55 PM | Reply | Permalink
Restraining compensation is certainly the way to go - in the future. Watch Charlie Rose's interview this week with Paul Volcker:
http://www.charlierose.com/shows/2008/03/18/1/a-discussion-about-the-economy-with-paul-volcker
I don't think the Fed has much choice in this matter. These firms have no other source of very short term liquidity and intervention is simply a must.
What I would like to know is what strings the Fed has attached to these borrowings? Banks have capital Tier requirements they must meet to borrow at the window. If the Fed enforces similar requirements, they can by default enforce restrictions on the investment banks' activities and possibly re-stabilize those firms - like a cease and desist lending order.
Given that Lehman and Goldman were just downgraded after the markets closed today indicates how bad the problem is - now they too are nearly out of short term options.
Those executives have taken too much short term risk and were paid way too much; the taxpayers will foot the bill. But the price we'd pay if the Fed does nothing is orders of magnitude worse.
Restricting compensation is a start, but we also need to encourage an element of caution and long-term stability by perhaps delaying compensation for 5-10+ years, so they don't risk bringing the whole thing down just for this quarter's EPS.
March 22, 2008 1:25 AM | Reply | Permalink
A beautiful dream.
March 22, 2008 1:53 AM | Reply | Permalink
I don't see how capping compensation gives anything to taxpayers. In fact, it would do just the opposite, since a guy making $1 million pays a maximum of about $300K in taxes (and only if he's got horrendously poor accountants), while a guy making $10 million pays many times that, even if he has the best damn accountants in the world.
A better approach would be to loan at low rates, but receive some equity in the firm so the taxpayers share some of the gain if the investment banks earn a lot of money on the cheap money we just lent them.
March 22, 2008 9:23 AM | Reply | Permalink
If being severely overpaid for failing to do your job can be excused because the overpayee will - if likely to be caught not filing - possibly pay higher income taxes, they could just pay me the higher pay, I'll promise not to do anything at all (thus not screwing up the economy) and I'll pay my taxes by the book.
That has to be as poor an excuse for overpayment of executives as I have ever seen. The next most irrational excuse is the idiotic complaint I have to get at least as much as the average executive! That's reminiscent of Garrison Keillor's "all the kids are above average." gag, and of course pushes the average up uncontrollably.
Who was it - Circuit City executives who were paid a million dollar bonus each last Fall so they wouldn't jump ship as the company was collapsing from decisions like firing all teh experienced sales reps well before Christmas because their pay and benefits were too expensive, hiring traininees to cover Christmas season at half the wage and no benefits, and when that caused the customers to stay away in droves, those same executives offered the old, experienced sales reps their jobs back - at the same entry-level pay and no benefits as the trainees?
Sadly, that is normal for the culture of American executives. They are so busy gouging their companies for more pay and benefits that they have no time or training in actually doing competent jobs. The few executives who might be competent are shamed or otherwise socialized into treating workers badly and joining the culture of failure that has become the American management system. And, of course they expect to be overpaid for this. They all sit around and tell each other so - or hire expensive executive management pay consultants to tell them this. They paid a lot for that advice. Who are they to disbelieve it?
I'm sure there are exceptions, but they are younger executives and unlikely to get promoted since they don't go along with the common wisdom. It's not a meritocracy. It's a social system that you are allowed to join as long as you support the social system and everyone who is already there likes you. Sort of like Washington D.C. political pundits.
March 22, 2008 12:40 PM | Reply | Permalink
Richardxx, I agree with your basic sentiment, that executives are way overpaid and are often handsomely rewarded even when business performance is abysmal.
That said, I'm not sure that capping salaries is the right answer. The real answer is a better system of corporate governance that gives both shareholders and employees a stronger say in the way money is spent on executive salaries. We also may need to make certain that high-paid officers are held personally responsible for business failures. Maybe some portion of their earnings should be held in trust for some period of time. If the business collapses, then the trust can be used to reimburse shareholders and employees. If the business does well, then the executive at some point can get his or her earnings out of the trust. What bothers me most is not so much the high salaries that executives earn, but the fact that they can walk away from a failing business with great wealth while ordinary shareholders and employees lose everything.
March 22, 2008 1:43 PM | Reply | Permalink
Limits on compensation is always a dead-end street. Comp is set by Boards, etc and this is still a Horatio Alger philosophy fantasy- based country. Work hard and thou shall get a corporate jet.
The rate of tax on compensation, however, is another story. Legislation has been proposed by Sen Grassley (R-IA) among others to tax hedge fund managers at a normal tax rate akin to salary - just like you, me Drs, journos, soldiers, nurses etc instead of a favored rate of 15% as they get now. A hedge-fund manager today, may earn $50 million per year and pay 15%. This has broad approval of many Republicans because of the intellectual purity of the reason. But Sen. Schumer (D-NY) who represents Wall St and hedge funds and of course lists them amongst his largest contributors has steadfastly opposed this and according to reports I have read promised to block it at every turn. In a battle of principle vs. principal, the latter always prevails.
A solution: Executive and everyone's compensation should always be taxed (6.2% + employer contribution) for Social Security purposes without an upper limit and expand the Medicare tax without upper limit, and all people earning up to $100 k should be exempt. This will solve the Social Security and Medicare funding problems and make for an equitable distribution of wealth.
Full disclosure: I would pay more so this is not self-serving.
March 22, 2008 9:30 AM | Reply | Permalink
Applying FICA taxes to all income is a good idea, though I'm not sure I like the $100K deduction, because I suspect that would reduce tax receipts too much and therefore weaken funding for Social Security and Medicare.
I think ending all or most deductions and taxing capital gains at the same rate as income (maybe with an inflation adjustment) would be a useful way to ensure the wealthy pay a fair share of taxes.
March 22, 2008 9:39 AM | Reply | Permalink
The cap on wages subject to the Medicare tax of 2.9% was removed some time ago. Any employee now pays it on total wages received as has for a number of years.
(That's 1.45% paid by the employee and then matched by the employer.)
March 22, 2008 12:46 PM | Reply | Permalink
I guess I need a little education to understand a few of the comments above--exactly how, by what mechanism, would it be harmful to stockholders like me and loanholders like me to allow executives to have extravagant salaries up to a million dollars a year, rather than the spiraling greedfest that produces $300 million salaries and bank failures which result in the printing of hundreds of billions of new discount dollars to prevent collapse of the whole system?
I could quite well be missing something here, but the economic news of 2008 would seem to me to indicate that Mr. Baker's plan is prudent and worth serious consideration.
March 22, 2008 10:24 AM | Reply | Permalink
Re: Purple State's comments, raising capital gains tax rates to those of ordinary income is an old, tired argument. There is plenty of reason involving economic growth, venture investment and especially tradition to maintain the favored cap gain rate. In addition, it doesn't affect the wealthy - most middle income people have some mutual funds and receive cap gain distributions in up markets. A better idea would be to have a small tax on realized gains earned by pension plans, endowments and non-profits. Do that and you could then drop FICA taxes.
March 22, 2008 10:25 AM | Reply | Permalink
Seems like the old, tired argument might actually be the one that is based "especially" on "tradition." Tradition is indeed the strongest argument for keeping capital gains tax rates lower than income tax rates because the alleged economic benefits of lower capital gains rates have not been demonstrated empirically. In recent history, our economy actually grew fastest when capital gains rates were highest (during the 1990s). The reduction in capital gains taxes in the 2000s has resulted in lower taxes paid by the wealthy, but hasn't led to solid economic growth (unless you count the housing bubble as solid economic growth).
March 22, 2008 10:59 AM | Reply | Permalink
Actually, prmco, I see from your web site that you may have an even better reason for keeping capital gains tax rates low:
Peter R. Mack & Co., Inc., established in 1991, is an SEC-registered broker/dealer specializing in equities, fixed income, options, and exchange-traded and mutual funds for individual investors. The Firm conducts all of its business activities using National Financial LLC (NFSC), the brokerage subsidiary of Fidelity Investments, as its clearing agent. All customer assets are held by NFSC and each account is protected for $500,000 by SIPC (Securities Investor Protection Corporation) and an additional $99.5 Million by private insurers.
Peter R. Mack, the General Securities Principal of the Firm, has been active in the investment business for 40 years. He also serves as President of PRMCO Advisors, a related asset management company currently in formation.
That explains everything. Tired, old argument indeed.
March 22, 2008 11:14 AM | Reply | Permalink
The shortage of capital is not a current restriction on economic growth and venture investment. That's what most companies are sitting on too much cash today. They have no likely investments to invest that cash in. There is not enough demand.
Investing opportunities with better returns are available outside the U.S. which, since capital was globalized years ago, is where any additional capital created by your proposed policies goes already.
Your argument doesn't hold water today, if it ever did.
March 22, 2008 12:53 PM | Reply | Permalink
It's also true that there was no shortage of venture capital during the 1990s when capital gains taxes were quite high by current standards. In fact, the venture capital industry went through something of a boom as capital gains taxes increased. Based on the experience of the 1990s, one could even hypothesize that contrary to conventional wisdom, high capital gains taxes encourage investors to seek higher-risk, higher-reward investments (possibly to compensate for the tax cost). I'm not arguing that this hypothesis is true--but the experience of the 1990s certainly suggests that higher capital gains taxes may place less of a drag on investment in new businesses than is usually assumed.
March 22, 2008 2:03 PM | Reply | Permalink
Re: UpDoc, it may be a great idea but it has no future in the United States. Wouldn't pass any legislative body.
The US is a funny place. In the 2004 election, one of the biggest Republican issues was the Estate Tax - promoted by them as the Death Tax. The Repubs were against repeal, and favored elimination of all Estate taxes. Out in the West, and in what I would say were the traditional Red States, the issue was a big one, especially among people who were just about broke. Even though the then-exemption was $2 million, now $4 or 5, and these Repub voters had no more than a passing curiosity about it, they were vehemently opposed to taxes on estates. Totally unrealistic, unexplainable, but a fact nevertheless. Americans aspire to wealth, through lotteries gambling, hard work or day trading and don't want to limit their own potential earnings when they hit pay dirt.
March 22, 2008 10:46 AM | Reply | Permalink
Re: . Totally unrealistic, unexplainable, but a fact nevertheless.
Explainable, I think, by simple ignorance: too many people think the estate tax applies to all estates and are unaware that there's a huge exemption under which very few people ever have to worry about paying it.
March 22, 2008 11:51 AM | Reply | Permalink
I was enjoying the economic dialogue until I saw that I was the subject of a cynical, ad hominem kind of assault on my arguments by Purple State who associates my defense of the capital gains tax with my profession. Certainly, my profession supports a capitalistic view which would seek to eliminate all taxation in general and especially reduce the cap gain tax rate from 15% to 0%, and do it retroactively. Maybe Purple State - whatever that means - is somebody's disgruntled client. It was not nice.
Aha, Purple State says, I've caught this bastard in his own lie and conflict of interest.
To quote Joan Rivers, "Talk among yourselves."
March 22, 2008 1:44 PM | Reply | Permalink
Just trying to better understand why you dismissed my argument as "tired" and "old."
I think I found the answer . . .
And if you think my approach was an unfair ad hominem, remember that you defended one of your suggestions for a change in tax law with this statement:
Full disclosure: I would pay more so this is not self-serving.
If you're going to try to build credibility for your arguments by claiming that they aren't self-serving, then it seems perfectly legitimate for me to test the claim.
March 22, 2008 2:30 PM | Reply | Permalink
The current housing bubble and subprime fiasco now unfolding is a result of easy monetary policies by the Fed in 2001-2004 to deal with the bursting of the dot com bubble. The Fed is dealing with the bursting of the current bubble again by easy money and bailing out the usual suspects. Why will easy monetary policy solve the problem this time, if in fact it was the cause of the problem in the first place?
March 22, 2008 4:10 PM | Reply | Permalink
Hmm let's see...apparently bailouts are okay now, but only if the rich "Wall Street boys" are punished as well? And not just the ones involved in Bear Stearns or other failed banks, but ALL executives. This is nothing more than envy, naked envy, motivated by quasi-Marxist ideas that the rich only get rich by exploiting people. This idea might have had some rational basis if you all had proposed confiscating income over $1 million, because then you could at least claim that the money was going for some "worthwhile endeavor" (i.e., government boondoggle) as opposed to the money being used by rich guys to exploit more workers (i.e., create jobs). But no, you don't even want the money, you just want to FORBID them from even earning it in the first place. That, is hateful. It is a hatred of the rich which motivates these types of schemes.
March 22, 2008 7:30 PM | Reply | Permalink
Chemjeff - please see my earlier post and please do watch Volcker, who is in a unique position as former Fed chairman to comment as he has the direct experience of managing a prior crisis through that preceded a very successful expansion.
I don't have a practical problem if successful executives are rewarded with substantial sums (philosophy is a separate issue). I also don't think the senior management of these firms intended to get rich by exploiting people in this case.
I do think that they gradually and profitably (for a time) followed the market, increased their exposure to these risky investments, simultaneously increased their leverage, and decreased their reserves. On a massive scale along with the five largest peers they have. But we're all human and cannot see sum of all firm's market choices over time - there must be limits, especially when the integral sum has the potential to collapse the entire system. The only tools (albeit crude) available to address this are Fed interference, regulation, and compensation changes.
I think we'd agree there was no way to know what was in those CDO portfolios, and that those risks change with time and economic conditions as well. Due diligence / risk rating is the first place to regulate, as well as capital reserve requirements for those that hold them. Reserve requirements can vary with risk; the risk ratings could be independent; and there is another system that has, since the runs on banks in the depression, successfully managed risk - the traditional regulated banking system.
With the notable exception of the S&L crisis. Again, precipitated by lending long and borrowing short... and then the rate environment changed, causing prepayments and liquidity issues. hmmm...
I'd prefer that the investment banks develop their own independent system rather than the government as it would probably be faster, more efficient, transparent, and based on facts and data rather than rhetoric such as "marxist" or "greedy bankers". No such luck so far, so it starts with the Fed, then finger pointing, attorneys...
March 23, 2008 1:54 AM | Reply | Permalink
BRILLIANT! What else can I really say?
March 22, 2008 9:37 PM | Reply | Permalink
How about - - -
"Hi Guys. It's Saturday night and I am sooo WASTED!!!! Criminee, I can hardly make out the letters on the screen. I asked my principal other to read it for me, and she said we're all going to get $1 million. I think that's BRILLIANT! I could use a million bucks; I'll bet you could, too."
March 23, 2008 6:34 AM | Reply | Permalink
Capping stupid compensation is similar to REMOVING a huge tax on the economy.
Every business that pays $100 million to an executive is essentially being taxed $100 million. If that money is allowed back into the company, the company can pay it's employees, it can pay taxes, it can pay shareholders.
If a company has 20 executives taxing the company for $10-100 million each, just think of the boost twe could provide by letting that moeny loose into the wider economy. I could let some air out of the Manhattan Penthouse market bubble, but I'm not sure I care.
March 23, 2008 8:13 AM | Reply | Permalink
The reality is that CEOs largely control the boards that set their pay. We could deal with this by changing the rules of corporate governance. (Yes, there are rules -- the government already does not let corporations set up any rules they want.) For example, we could require that the compensation packages for the top 5 paid executives get sent out at regular intervals (e.g. 3 years) for shareholder approval.
Furthermore, the rules could require that the vote be based on those actually voting. We don't let the management count unreturned proxies as supporting their position (the current standard). This is like letting incumbent members of Congress count all the non-voters as having voted for their re-election.
Of course what I have described here is far more modest. It's completely voluntary -- if you want the taxpayers' money you've got to follow our rules. If you don't want to follow our rules, then don't take out money. It's as simple as can be.
Of course the Wall Street crew is used to making up its own rules and getting its own way, so they will yell and scream over this, but hey -- life's tough.
March 23, 2008 9:07 AM | Reply | Permalink
Dean, I'm much more concerned with ensuring the taxpayers share in any gain achieved with the help of taxpayer money. If we are going to bail out these banks with low-interest loans, we need to share in any upside. It seems like we give them cheap money and accept the risk of them defaulting on their government loans, but don't have any upside. That's just stupid. We should insist that if the company turns around it shares some significant portion of its gains with the taxpayers. We're essentially giving these investment banks high-risk loans at low interest rates. No sane investor would do this. Sane investors might accept the risk, but they'd want some chance of a high gain to compensate them for it--either in the form of high interest rates or in some kind of equity stake. We should insist on a variable interest rate (that increases with company performance) or some kind of share in profits or equity.
March 23, 2008 10:07 AM | Reply | Permalink
I have never said that capping executive salaries and compensation is THE answer. It's a part of the answer. A small part, in fact, but it is one of the easier things to do.
I spent several years in grad school studying CEO's, top management executives and the Boards of Directors of large companies, and if you want to get an idea how feudal government worked, look at CEOs and their personal hangers on. That complex mess is the last major vestige of autocratic organizational hierarchy in modern life.
The usual justification is that it allows a leader to make rapid decisions in times of emergency, or it allows a single leader to impress his vision on his organization. But when you consider that any organization with over about 200 people or that is found in multiple locations is as bureaucratic as any government (of necessity - bureaucracy is all that holds large organizations together, but when it works as it does most of the time it is invisible) the lack of effective and honest feedback from either labor or the customers is what drives most businesses (like Circuit City, my current hobby horse of management incompetence) out of business.
The problem is that you have large business organizations that have a culture of autocracy and a form of executives-as-aristocracy trying to run massive bureaucracies out of their hip pockets based largely on their own experiences at lower levels two or more decades earlier.
What amazes me is the degree to which so many large businesses operate using ad hoc information-gathering systems that frequently change as management changes. Those systems are (with notable exceptions) also primarily focused on markets and not on the labor force or technological change and especially not on the stock holders.
More standardized and systematic forms of Intelligence-gathering are desperately needed, and stock-holder democracy is one of those areas of needed change.
But a lot of it starts by exposing the failures of the existing aristocratic social system surrounding highly insulated and overpaid CEO's and their subordinates, Boards of Directors, and hangers-on. The idiocy that we call CEO remuneration these days is part and parcel of the entire failed package and quite symbolic of it.
March 23, 2008 1:10 PM | Reply | Permalink
I like the post, but I prefer higher taxes on excessive remuneration generally (see http://40yrs.blogspot.com/2008/03/re-regulating-financial-markets.html)
I'll post to the cafe too.
March 25, 2008 10:42 AM | Reply | Permalink