Regulating Compensation: Where Does It Stop?

I haven’t sermonized about the AIG (AIG) bonuses, not because I don’t have an opinion but primarily because reasonable discourse has been overwhelmed by emotion and demagoguery. I am going to stick a toe just a bit into the swamp in order to tackle a larger issue.

One could argue the rationale for paying bonuses to AIGFP all day long and not reach any agreement. The most definitive statements I believe you can make about the entire episode are that AIG management was politically insane to have made them and the Obama administration and Congress have been duplicitous in their response to them.

The first statement needs little elaboration. Any fool should have seen that the payment of monies in significant sums to the parties that were primarily responsible for the disaster would provoke public outrage particularly in the midst of a severe recession. There may be merit in the argument that these employees had to be retained to mitigate the losses but some other means should have been crafted to do so.

As for the second statement, both the legislative and executive branches of the government aided and abetted the payment of these bonuses. The legislative branch knew of the obligation of AIG to make these payments and specifically authorized the payment in enabling legislation. The executive branches of two administrations also were aware of the bonuses, worked with the legislators to legitimize their payment and withheld information about the payment of the bonuses from the public.

When cornered, both the administration and the Congress have acted in a craven fashion. Rather than owning up to their complicity they have attempted to deflect attention from them towards the company and its employees. A firestorm of dangerous rage has been stoked by the political class and they are in the process of using the tax code to directly attack a small group of people in order to seize personal property that was legitimately acquired.

That being said, one would have hoped that this would go down as a sad but small footnote to the financial crisis. Apparently, the Obama administration wants to use it as an opening to a sweeping initiative to control compensation across a swath of the economy.

The New York Times is reporting that the administration is planning to call for oversight of pay at all banks, Wall Street firms and other companies. Details of how to implement such control are still under discussion but they envisage some requirement that compensation is tied to performance and achievement of financial goals. The article implies that the program could be expanded to include publicly traded companies that are subject to the oversight of the Securities and Exchange Commission.

Admittedly, the administration may just be floating a trial balloon and a part of the discussion may be simply to indicate to the Europeans ahead of the G-20 meeting that they are serious about regulation, but they are playing a dangerous game. Congress has tasted a pretty heady elixir with the AIG fiasco and may be in the mood for much more. Giving them any opening at this time is a dangerous move.

The country has, in the past, strayed from its constitutional roots and persecuted groups, often under the guise of national security. Today we speak of systemic risk and too big to fail as our excuse for tampering with property rights. Certainly society has a right to protect itself from enterprises that grow too large and thus threaten the common weal. There is a defined set of procedures for dealing with that situation, our antitrust statutes.

The fact that we neglected to protect ourselves by not using this tool is not an excuse for confiscating property by any means. The proper procedure is to reverse the error and in doing so ensure that citizens can go about commerce certain of a minimum of interference from government at any level.

Nothing good can come from the sort of government activism that we are witnessing. Entrepreneurial spirits are going to be quelled and the groundwork laid for state economic control. We know the end result of that course. AIG may indeed be a footnote but not a small one. It might well be the point at which the American economy turned its back on success and opted for a dead end.

Comments

[Annualgain:]

Obama hinted, correctly, that the 90% tax legislation that went so quickly through the house may be unconstitutional while on 60 Minutes. At last we have one politician who is not pandering to the anger of the public. Witch hunts are the antithesis to justice; I want to see some heads role, I just don't want to stop being America in the process.

Mar 23 01:31 PM

[dw57:]

i suspect that its more about noise than any thing actually being done. as usual. the best they could do is to really constrain the tax deduct ability of salaries in excess of a million and any bonuses greater than base pay. they say its there today, but its really not. too many loop holes are there. we seem to be in the mode of its ok for executives to get great pay, but its not ok for any one else. little wonder there isn't much support for them. and then we wonder why the economy tanks when the consumers (mostly workers) quit buying since that easy credit nonsense is gone. business needs consumer (aka workers) who want to buy their products and services and can afford to. but business has shown very little support for workers pay

Mar 23 02:42 PM

[cabanker:]

The "AIG Tax" bill which passed the House is a "very" slippery slope. Where does it end? The auto manufacturers took TARP funds are their employees included? How about the banks that took under $5 billion, why not tax their executives as well? What about "any and all" employees of GE subsidiaries (NBC, CNBC, GE Capital...etc)? Shouldn't we also look at employees of all companies with government contracts? Boeing, McDonald Douglas...etc.?
Trying to manage this through the tax code does not seem very strategic with the cure worse than the disease.

Mar 23 02:55 PM

[RSAAKS:]

Regardless of the outcome of AIG bonus fiasco, one thing that must change for the sake of "shareholders"--that is massive compensations in $30-100 million per year for the wall street exceutives has to stop. Such massive compensations, regardless of how well the GS-MS-JPM do, is unjustified and is legalized robbery of shareholder money. I don't know what is the right compensation, but anything exceeding $10 million is neither deserved nor justified. And hedge fund manager compensations should not be cap-gains, it is compensation to be taxed at usual rates.

Mar 23 03:42 PM

[CowboySledge:]

Your right! We did trample their "property rights". We bailed them out. They threatened to destroy our entire country unless we gave them large and we agreed to do it. Shame on us for doing that. Of course giving people large sums of money certainly shouldn't mean that we have even the slightest say in their business. None. Nada. Zilch. Anything else is truly un-American! Say, we should check to see if anyone on their payroll received only a government-mandated minimum wage. More outrage on the pay front! All of these businesses should be wound down in the most expedient fashion so that "too big to fail" becomes "no longer exists".

Mar 23 07:14 PM

[mac.barron:]

It stops when we get all these d- nozzles on chain gangs where they belong.

Mar 23 09:57 PM

[User 371080:]

It stops when the highest paid employee at these banks is paid no more than 20x what the janitor makes. Still a very long way to go. 90% tax is a good start though!

Mar 23 10:00 PM

[William Cowie:]

Tom, I hear what you're saying. However, there is a groundswell of resentment regarding executive compensation. It has become ridiculous. Nobody is "worth" $10 million. Obama, with his finger to the wind, is picking up on this.

The economic history of the U.S. is replete with government regulation following egregious abuse of market freedoms by business. I'm a libertarian at heart, but even I have to admit, most of those regulations (antitrust, etc.) have worked. The message from history is simple: if CEO's abuse their freedoms, government regulation will ensue. Whether it is right or wrong becomes not the point, it just becomes inevitable. It happened with business spending on sports stadium suites, and that got addressed by making those expenses not deductible. It didn't put a total end to it, but it did create a brake.

Personally, I believe the government would do much better by simply breaking up recent mergers. Why did Exxon and Mobil have to merge? Conoco and Phillips? Banks? Every time the government broke up big companies (standard Oil, AT&T) only good things happened. Why not do it again? It's harder to pay big bonuses from smaller companies. They employ more people, make more money, and when someone does something stupid, the damage is much easier to contain.

Mar 23 10:46 PM

[Tom Lindmark:]

There is a groundswell and that concerns me. Bad decisions are often made in the heat of the moment.

That having been said, I agree with the general tone of your comment. Size has become the enemy particularly in banking. I've written several articles advocating a return to Glass-Steagall or some variant of it. We have to make sure too big to fail does not occur again.


On Mar 23 10:46 PM William Cowie wrote:

> Tom, I hear what you're saying. However, there is a groundswell of
> resentment regarding executive compensation. It has become ridiculous.
> Nobody is "worth" $10 million. Obama, with his finger to the wind,
> is picking up on this.
>
> The economic history of the U.S. is replete with government regulation
> following egregious abuse of market freedoms by business. I'm a libertarian
> at heart, but even I have to admit, most of those regulations (antitrust,
> etc.) have worked. The message from history is simple: if CEO's abuse
> their freedoms, government regulation will ensue. Whether it is right
> or wrong becomes not the point, it just becomes inevitable. It happened
> with business spending on sports stadium suites, and that got addressed
> by making those expenses not deductible. It didn't put a total end
> to it, but it did create a brake.
>
> Personally, I believe the government would do much better by simply
> breaking up recent mergers. Why did Exxon and Mobil have to merge?
> Conoco and Phillips? Banks? Every time the government broke up big
> companies (standard Oil, AT&T) only good things happened. Why
> not do it again? It's harder to pay big bonuses from smaller companies.
> They employ more people, make more money, and when someone does something
> stupid, the damage is much easier to contain.
>

Mar 24 12:09 AM

[jksisco:]

The Obama AIG bonus outrage, Congress fielding another bad Executive dog and pony show, Obama condemns bonus tax plan; this is all part of a large, well-crafted smoke and mirrors campaign to distract the folks from seeing the big picture. When you wake up one morning to realize "we are all Socialists now", you'll understand what it was all about.

Mar 24 02:05 PM

[mediapro:]

If I combine the range of comments from many sides of this compensation bubble, let's see if we can agree on a set of principles that might govern the excesses of the few with the money of the many.

I would invite comment from anyone on why the following is or is not a good idea.

1. Reinstate Glass-Steagall. None of these shops (Citigroup, B of A, etc.) should have ever been allowed to dally in businesses about which they knew nothing. AIG has (had) 111,000 employees. It's an insurance company. How can it effectively manage its core business while allowing thse AIG FP geniouses to manipulate the financial markets with CDO's and CDS's?

2. Eliminate bonus structures altogether. Why are salaried employees and small businesses hit time and time again, while big business always seems to 'bend' the rules and still come out on top? Think of it this way, if I’m an average corporation and I pay a qualified employee 100k as their salary, I am required to withhold taxes, insurance and a host of other items – in addition to setting aside money for federal programs. However, if I pay that individual 60k, and a bonus 40k, the situation looks much better. The employee has to handle withholding taxes on the 401k and I am only required to deal with the payroll effects of 60k. If we want to stimulate productivity, then structure compensation the old fashioned way. Provide a salary/commission structure, but don't play games that allow some to escape taxation by fiddling with the code.

3. If we are stuck with an income tax, level the field and fix the code by eliminating subsidies. Free market preachers always talk about existing in a world without artificial props. Eliminate oil and gas subsidies. While we're at it, eliminate import tariffs that stifle free trade.

For people who don't count the payroll, FICA, SUI, etc. automatic worker payroll contributions while conveniently ignoring the "bonus structure", offshore accounts, shell businesses, and other manipulative uses of the tax code by those who can afford tax attorneys, let's treat everyone as the workers they are. Those who actually contribute a day's labor for a fair wage vs. the incredible sums paid to those who move money through the system is an obscenity that is finally being recognized through this crisis. Look where that system of rewards has put us.

4. Finally, would someone please explain to me why there is a ~$106 K cap on wage contributions to Social Security? Then, at the tail end of the SS contribution cycle, these same wealthier individuals garner an elevated SS income based on their historic salaries. If we are to cap SS contributions, then why not put a means test on the back end when those same SS scoflaws come to the trough for their share?

Mar 24 06:34 PM