Pay Cut Backfire

By putting compensation caps on some bailed-out firms, pay czar Kenneth Feinberg sent a message, writes Nomi Prins. But he also strengthened the hands of the rest, including Goldman Sachs.

Kenneth Feinberg, the so-called pay czar who President Obama has charged with making the take-home pay among our bailed-out behemoths logical again, took a deep breath yesterday, stepped up to the plate, wound up a couple of times and… bunted. His intent was admirable, if politically timed to coincide with the renewed bonus wrath following the bank’s quarterly earnings results. But the details will ultimately exacerbate the systemic risk that propels high compensation and nearly destroyed the financial world, not to mention the rest of the general economy. In short, Feinberg made the situation worse.

Feinberg’s plan would cap compensation at the seven companies that received "exceptional assistance” (AIG, Bank of America, Citigroup, General Motors, GMAC, Chrysler, and Chrysler Financial). It would cut the total compensation of the top 25 executives at these firms by 50 percent and their annual salaries to 90 percent of 2008 levels.

Shouldn’t those 175 executives who have to now ask permission from Feinberg for perks greater than $25,000 take it upon themselves to fly coach once they hit $24,999?

To be sure, these companies owe their very existence to the federal government. Bank of America still owes the government $63.1 billion, AIG sits on top of a $181.8 billion pile of federal help, and Citigroup has a $368.7 billion public cushion, The auto industry? $89.4 billion.

The problem is, by simply tying compensation caps to the TARP program (a year late), Feinberg and the Obama administration are completely ignoring the rest of the $14.6 trillion federal bailout and subsidization of the banking industry, which has helped propel many key banks to 2007 levels of compensation, unfettered. If this is the best he can do, all the other Wall Street bankers can breathe a huge sigh of relief.

Charlie Gasparino: Behind Ken Lewis’ PanicThere are those who think that if the government has any say in any pay, it’s only a matter of time before it will be rationing air intake. They should back off—unless they also believe that the government shouldn’t have taken such a generous approach to subsidizing the banking system, in which case they should be happy that Feinberg wants to do something to ensure our money is spent fortifying the firms we’re subsidizing (so that it’s returned) rather than on luxury items.

The bigger question for those fearing this is some outrageous government intervention: Why aren’t the firms receiving public money making these cuts themselves? Shouldn’t those 175 executives who have to now ask permission from Feinberg for perks greater than $25,000 take it upon themselves to fly coach well before they've hit $24,999?

Feinberg engineered Citgroup's sale of Phibro to Occidental Petroleum, which the firm did to get out of its $100 million bonus contract with star trader, Andrew Hall. Bank of America’s Ken Lewis’ chat with Feinberg resulted in him agreeing to take no salary or other pay for 2009—of course, he’ll survive with a nearly $50 million retirement package and the $165 million he made since 2001. Feinberg will also cut the total compensation of AIG’s top 25 executives to $200,000. No doubt, these people are already negotiating employment deals at Goldman Sachs, where $12.9 billion of AIG's public assistance went anyway. But Feinberg sent the right message there.

The Feinberg principles fall short, however, by only focusing on a subset of the subsidized industry. The same firms that turned a profit and repaid TARP (on the back of federal aid) are leading the industry in renewed trading risk, the kind that crashed the system last year—only this time, it's with our money on the table. In essence, he’s green-lighting an increase in the kind of aggressiveness that leads to higher bonuses at the other firms. And that’s downright dangerous.

Like it or not, every company that has outstanding government support has a debt to pay. The problem with targeting a few companies with compensation caps is that it provides an unfair advantage to the very firms that are paying the highest bonuses. Goldman Sachs is on track to pay out $22.7 billion in total compensation compared to $11.8 billion in 2008 and $20.1 billion in 2007. JPMorgan Chase is on track to pay $29 billion, nearly what it would have paid out in compensation in the year before the crisis, had it owned Bear Stearns and Washington Mutual then. Yet, Goldman Sachs still enjoys $54 billion of federal support and JPMorgan Chase $73 billion—even after repaying their TARP obligations.

Attaching compensation strings to federal subsidies requires taking a cold, hard look at the sheer immensity of the full federal support beneath the financial industry and to treat all of its recipients equally. If Feinberg’s goal is to reduce the systemic risk that underlies big bonuses (which should really be the point), this doesn’t cut it. If the goal is to cap bonuses for the banks that got federal assistance, this doesn’t cut it.

What his plan does is perform a little piece of what’s needed—putting excessive-pay restrictions on federal support recipients, but by only capping a small portion of companies under the federal tent, he will ultimately create a bigger chasm between the most and least powerful banks. That will, in turn, lead to greater risk disparity throughout the system—and though it may feel satisfying to cap some bankers' bonuses, it leaves that wider goal unaccomplished.

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Nomi Prins is author of It Takes a Pillage: Behind the Bonuses, Bailouts, and Backroom Deals from Washington to Wall Street (Wiley, September, 2009). Before becoming a journalist, she worked on Wall Street as a managing director at Goldman Sachs, and running the international analytics group at Bear Stearns in London.