Cut Their Pay and Send Them Home

Today “compensation czar” Kenneth Feinberg announced the Obama administration’s plan to punish executives of companies that received TARP money by cutting their compensation by an average of 90 percent:

Under the plan, which will be announced in the next few days by the Treasury Department, the seven companies that received the most assistance will have to cut the cash payouts to their 25 best-paid executives by an average of about 90 percent from last year. For many of the executives, the cash they would have received will be replaced by stock that they will be restricted from selling immediately. …
The pay restrictions illustrate the humbling downfall of the once-proud giants, now wards of the state whose leaders’ compensation is being set by a Washington paymaster.

We are living through dark times. The administration’s demagoguery will have far-reaching consequences. Presumably most of the executives affected by the cuts will leave their companies, while adequate replacements can hardly be hired at the rates the federal government is offering. And it isn’t clear what ripple effects the government’s high-handed decree will have. At Citibank or Bank of America, for example, will there be hundreds of employees paid more than the former top 25? Or will the pay cuts work their way down the chain? Any way you look at it, this decree will make it harder for the affected companies to regain profitability, the ostensible point of the TARP program.
Beyond that, though, this focus on a handful of top executives obscures–probably intentionally–more basic points about the TARP program. Coincidentally, today the Special Inspector General for the TARP program issued his quarterly report. The SIG, Neil Barofsky, was harshly critical of some aspects of TARP. This is from the executive summary of his report:

On the cost side of the ledger, although it will take many years to assess all of the costs associated with TARP, financial and otherwise, this report begins to categorize them. It is useful to analyze any Governmental intervention in the market like TARP against three distinct types of cost: the financial cost to the taxpayers; the “moral hazard” damage to market incentives created by Government intervention; and a cost that has received scant attention thus far — the impact on Government credibility due to the failure to explain what is being done with billions of taxpayer dollars transparently and forthrightly. The past year has demonstrated that TARP’s costs, in each category, could prove to be substantial.
Financial Cost: Although several TARP recipients have repaid funds for what has widely been reported as a 17% profit, it is extremely unlikely that the taxpayers will see a full return on their TARP investments. Certain TARP programs, such as the mortgage modification component of the Making Home Affordable (“MHA”) program, which is scheduled to use $50 billion of TARP funds, will yield no direct return; for others, including the extraordinary assistance to American International Group, Inc. (“AIG”) and the auto companies, full recovery is far from certain. Some of these potential costs are discussed in Section 2 of this report, including a discussion of financial cost that is rarely considered — the cost associated with borrowing the money used to fund TARP.

Good point–there is a certain irony in the fact that the government borrowed the money that it loaned to the TARP recipients. There are two differences between the federal government and the financial institutions that got TARP money: 1) the feds have run infinitely farther into the red, but 2) they can print money. If AIG could print money, it would be lending it to the federal government and dictating President Obama’s pay.

Moral Hazard: Market behavior is bound to be impacted by the massive infusions of Government capital into the very institutions that caused the crisis; by the modifications of mortgages for homeowners who may have borrowed irresponsibly; and by the provision of cheap, non-recourse loans to incentivize the purchase of the same volatile and over-valued asset-backed securities (“ABS”) that were a major cause of the current crisis. The firms that were “too big to fail” last October are in many cases bigger still, many as a result of Government- supported and -sponsored mergers and acquisitions; the inherently conflicted rating agencies that failed to warn of the risks leading up to the financial crisis are still just as conflicted; and the recent rebound in big bank stock prices risks removing the urgency of dealing with the system’s fundamental problems. Absent meaningful regulatory reform, TARP runs the risk of merely reanimating markets that had collapsed under the weight of reckless behavior. …

Many observers argue that a series of bailouts in the 1990s contributed to the excessive risk-taking that played a role in the financial crisis.

Government Credibility: The Government’s capacity to address financial crises depends in no small measure on its credibility, both with market participants whose confidence is essential to stabilize the financial system and with the American public whose confidence is essential to underpin the political support required to take the difficult (and often expensive) steps that are needed. Unfortunately, several decisions by Treasury — including Treasury’s refusal to require TARP recipients to report on their use of TARP funds, its less-than-accurate statements concerning TARP’s first investments in nine large financial institutions, and its initial defense of those inaccurate statements — have served only to damage the Government’s credibility and thus the long-term effectiveness of TARP. Notwithstanding TARP’s role in bringing the financial system back from the brink of collapse, it has been widely reported that the American people view TARP with anger, cynicism, and distrust. These views are fueled
by the lack of transparency in the program. The beliefs of some, for example, that TARP funds went into a “black hole”; that TARP was created in secrecy to transfer wealth from taxpayers to Wall Street insiders (exacerbated by the announcement of billions of dollars of profits and record-setting bonus pools at TARP recipients while unemployment and foreclosures continue to rise); or that Treasury is just too closely aligned with the interests of Wall Street are only reinforced by Treasury’s failures of transparency.

One of the basic problems with the ever-increasing intrusion of the federal government into our economy is that questions that should be economic become political. What becomes most important is not providing the best product or service at the best price, but having the most pull in D.C. The Obama administration is feverishly engaged in rewarding its friends and punishing its opponents. That’s a natural instinct for politicians, but having almost unlimited sway over the economy opens hitherto-unknown scope for political control and influence. Here, as in many other respects, we are sailing in uncharted waters.