A quarterly magazine of urban affairs, published by the Manhattan Institute, edited by Brian C. Anderson.
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Cap and Bail
The governments new limit on executive pay is a symptom, not a problem.
5 February 2009
President Obama said Wednesday that top executives at banks and other companies receiving extraordinary new federal bailout cash would have to cap their own cash compensation at $500,000 annually. If this government limit on salaries and bonuses convinces more people that the feds need to get out of the financial industry fast, then it will prove beneficial.
Obamas new pay limit for bailed-out firms is actually good for the future of (relatively) free markets. It draws a clearer line between the public sector and the private sector. In government, salaries for top jobs are comparatively modest. The president himself earns $400,000 a year. The CIA director makes $172,000. Private-sector companies, by contrast, can pay their employees and executives whatever they wishas long as theyre not expecting a federal bailout when their strategy of rewarding reckless risk with high bonuses results in insolvency. Unlike Congressman Barney Frank, who has floated the idea of a permanent pay cap for companies not receiving federal funds, the president drew a distinction between private and public: This is America, Obama said Wednesday. We dont disparage wealth. . . . But what gets people upsetand rightfully soare executives being rewarded for failure, especially when those rewards are subsidized by U.S. taxpayers.
Today, like it or not, Citigroup, AIG, and a few of their brethren are wards of the government. They simply wouldnt be in business any longer if not for the hundreds of billions of dollars worth of cash and guarantees that Uncle Sam has provided. Now that theyve put their hands out for extraordinary assistance, its only fair that they lose some latitude over how they use their resources. Over the past year, though, as the government has bailed out financial firm after financial firm, its made a pretense of insisting that private managers remain in charge. Its easy to see why: Americans dont like to admit that weve nationalized our financial sector, when the financial sectors joballocating capitalis the foundation of a market economy.
But its dangerous to keep pretending that we havent nationalized the financial industry. Today, a company like Citibank likely has no idea whom its supposed to please: its few remaining shareholders and private creditors, its customers, or the government that keeps it in business. For instance, the government wants Citi and other banks to increase mortgage- and credit-card lending. But private creditors and shareholders, worried about how high the unemployment rateand more loan defaultscould go, might think thats a bad idea. To whom should Citi defer? Letting companies like Citi and AIG flail along indefinitely, serving everyone and no one, is a recipe for a difficult economic recovery and for lower growth after weve recovered. Government support of bad financial firms crowds out the good banks that will have a tough time competing against Uncle Sam, both now and in the future.
The government should strive to end its direct role in the financial industry as quickly as possible, so that it can go back to being a regulator and not a guarantor. That way the government, and the public, wont have to worry about how much pay is acceptable for the CEO of a government-guaranteed bankan absurd question. To that end, the government should make it clear that the new goal of companies like Citi and AIG is selling off their good assets as efficiently as possible over the next few years, just as the FDIC already does with the small, failed banks it ends up owning. Sales, even at low prices, are the only way to get good assets into the hands of companies and people who didnt screw up banks in the first placeand a necessary step toward a private-sector recovery of the industry. The companies who got us into this mess certainly arent going to be the ones to get us out.
Meantime, doesnt the government have to allow these banks to keep paying their top executives high salaries to ensure that they manage the sale of these assets competently? Not necessarily. Its not as though high pay led to such great executive performance over the last few years. Further, being a short-term conservator of a functionally bankrupt firmlets be honest; thats what were talking about herediffers from being a long-term CEO of a growing company. And Obamas executive-pay cap covers only the top people at each company. (In fact, much, if not most, of the $18 billion in bonuses that caused all of the recent consternation about Wall Street pay went to traders and bankers, not executives.) Finally, people take jobs for many reasons, not all of them narrowly monetary. An up-and-coming executive may realize that if he successfully winds down a failed company and unlocks the value of its good assets, hell be a hot commodity in the private sector a few years down the road. Or a retired banker may just want to serve his country.
If government-guaranteed banks really cant find a few competent people to wind them down for half a million per year, then that will be a good reason to have a discussion of whether the government pays its key people enougha legitimate question that shouldnt be confined to finance. For example, bank regulators earn far less than the bankers they regulate in the private sector. Since they often jump ship for bank jobs after their regulatory stints are up, its fair to wonder if lower government pay encourages them to think more about their future jobs than about the taxpayers whom they serve. And the revolving door between the lower-paid public sector and the higher-paid echelons of the private sectorwhether its used by retired generals working for military contractors or by retired senators working for health-care companiespresents all kinds of temptations.
But for the sake of future support of free markets, its probably not a good idea to start this experiment with higher government salaries in our new public-private financial industry.
Nicole Gelinas, a City Journal contributing editor and the Searle Freedom Trust Fellow at the Manhattan Institute, is a Chartered Financial Analyst.