Monday, October 26, 2009

Curbing pay will not eliminate roots of crisis

Business Times - 27 Oct 2009


Curbing pay will not eliminate roots of crisis

By LEON HADAR
WASHINGTON CORRESPONDENT

PROPONENTS of the free market were quick to express their disdain over the sight of American bureaucrats imposing restrictions on the pay of executives on Wall Street. The 'socialists' in the Obama administration were taking the first step in having the government dictate salaries in the private sector, they contended.

You know the story. First, they came for the executives in companies that received government bailout money, and I didn't speak out - because I didn't receive government support. Then, they came for everyone else . . . Yep! It's the slippery slope on the road of turning the USA into the USSR, starting with enforcing the level of pay on top executives at 'too big to fail' firms under TARP.

Well, comrade, the Obama administration does have something called a Pay Czar - 'Czar' being a pre-Soviet term - who last week unveiled his plans to cut compensation packages at some of the firms that had received the most taxpayer money. Adam Smith forbid! There are going to be reductions of about 50 per cent for the top earners at the seven companies that got the most public money. Or to put it differently, the American people whose tax-money - amounting to trillions of US dollars - helped save these companies are demanding through their government that these executives make a few sacrifices. Imagine that.

Hence, some of the financial wizards at AIG - a firm that is 80 per cent owned by the government - will be making no more than US$200,000 a year. What a disgrace.

But enough of this nonsense. Let's not shed too many tears here. While there will be some salary slashing for the top executives at Citigroup, AIG, Bank of America, Chrysler and GM, many of these cuts to their cash salary could be made up in stock - which they could cash-out after a few years. And in any case, no one is going to prevent our suffering CEOs from taking jobs in a company that will pay them what they want. Indeed, by not being recipients of government bailout money, most of the financial companies will not be bound by the new restrictions. Indeed, some of these firms, including Goldman Sachs, JP Morgan and Morgan Stanley are making huge profits now and are expected to award record bonuses to their executives.

There is no doubt that most Americans will applaud Kenneth Feinberg's restrictions that were, in part, a political response to populist rage around the country and in Congress over reports that those reviled executives at AIG and other bailout recipients were continuing to experience La Dolce Vita while the rate of unemployment in Main Street was inching towards 10 per cent.

But much of the pressure to change the pay structure in the large financial institutions went beyond populism and reflected growing recognition that the out-of-control compensation for executives encouraged the kind of risk-taking, if not recklessness, that led to the recent financial meltdown. And it is not clear that restricting pay at the bailout firms and giving free pass to most of the other financial institutions is going to change the incentive structure on Wall Street that rewards executives and traders who make a lot of money with more money.

In fact, the toxic mix of the moral hazard represented by Washington's bailout of some of America's leading financial institutions and the persistence of the current pay structure in the financial industry makes it almost certain that more reckless behaviour will take place with the expectation that the government would come to the rescue once again.

Hence, the plan unveiled by the Federal Reserve Board under which compensation at 28 massive banks will be reviewed to 'to determine their consistency with the principles for risk-appropriate incentive compensation' set in the proposal. 'Compensation practices at some banking organisations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability,' Federal Reserve chairman Ben Bernanke said after presenting the new plan. 'The Federal Reserve is working to ensure that compensation packages appropriately tie rewards to longer-term performance and does not create undue risk for the firm or the financial system.'

According to the Fed's plan, the 28 large bank holding companies, including Goldman Sachs and Citigroup, will have to demonstrate to the Fed how their pay policies match the way they manage risk. Regulators would have the authority to veto policies.

While the Fed's proposal is the first serious plan to contain excessive risk-taking in the financial system, some critics suggest that the review should go beyond 28 financial institutions. But then again, even an effective system to restrict pay in the financial industry is not going to take care of some of the major structural problems that led to the current crisis.



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