Wednesday, February 4, 2009

Federal Limits on Executive Compensation Are Good for Capitalism

Today, President Obama announced that annual compensation for executives of banks and other companies receiving federal aid will be limited $500,000 (except for restricted stock). Equity compensation, such as restricted stock, would have to be held by the company until the government has been repaid. These limitations smack of government price controls. But they are in fact very good for the future of capitalism,

This limitation is aimed first and foremost at the banking industry. Banking, especially, investment banking, is a field you go into only for the money. The hours are long, the work can be difficult and the bosses can be very demanding. Forget about personal time; and warn your family (if you even have one) that they might see you on Thanksgiving and Christmas, but not otherwise. If you can't make a gazillion dollars, there's no reason to do this for a living.

The federal limits on executive compensation hit bank executives where it hurts the most, and prevents them from pulling a capital markets arbitrage. Under the Bush/Paulson regime, banks got taxpayer subsidies while bankers got rich. If banks had received no federal assistance and had to turn to private sector resources, the few investors that would have been willing to help them would have demanded strict accountability for results and carefully measured executive compensation. Executives that didn't write down bad assets, clean up their balance sheets, eliminate unduly risky lending and other undesirable activity, and turn their banks around would have been shown the door. Under the Bush/Paulson bailout, the same executives could have received bounteous bonuses with every prospect for more in the future, for all the government limitations that were placed on them. Only a public shaming process forced the boards of major banks to compensate senior executives in line with their nonperformance.

The new Obama administration limits will lead healthy banks to pay back federal assistance asap. Unhealthy banks will undertake to clean up their balance sheets, moderate risk and operate in profitable manner, so that they, too, can pay back federal assistance asap. They may even make some hard decisions about writing down and selling their toxic assets, all the while raising private capital to replace taxpayer money. That would lessen the need for a federal "bad" bank to buy those assets. In all cases, taxpayer subsidies will be lessened and banks will return to the freedom--and discipline--of the markets. We should be glad for these federal limits on executive compensation. They will push banks off the public dole and back toward a constructive role in the free enterprise system.

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