Is Curbing Bank Pay Socialist or Capitalist?

There are two arguments for curbing pay on Wall Street. The two sides argue bankers should not receive such huge compensation because:

1. Socialist view: No individual should be allowed to earn such a disproportionate salary.
2. Capitalist view: Government intervention allows banks to be so profitable, at cost to other members of society.

Bank apologists always attack the socialist (straw man) argument. Labeling something as “socialist” is a lot easier than addressing the real issues. “Fine, that’s just fine!”, they say. “But I hope you like communism, cause we’re gonna have to cap everyone’s salary – Bill Gates, A-Rod, Britney Spears, and Steve Jobs.”

Only the capitalists’ case holds water. America’s banks cannot be described as free-market enterprises by any rational person. I will outline various ways our government subsidizes bank profits, while eating their losses. I will explain why bank executives do not deserve their current level of pay, and why this view is not socialist or anti-free-market in nature, as many claim.

Gambling With Government Guarantees

American banks are currently allowed to gamble with other people’s money. They are given dirt-cheap funds by the Fed. They loan it out at a higher rate, pocketing the difference. If and when these loans go bad, they’re bailed out with even-lower interest rates, or outright cash-injections.

Banks are also not required to hold nearly enough reserves. Why? That would limit leverage and potential profits (and losses).

Would this happen in a truly free market? Of course not. Therefore there is no reason they should receive the outsized pay packages they do. Those who argue that limiting bank pay is socialism either do not understand the issues, or are biased in favor of the industry.

Benefits For All (Finance Firms)

Cheap government liquidity has been extended to entities it was never meant for: Investment-banks like Goldman Sachs (GS), even American Express (AXP) has access to the discount window, government-debt guarantees, and more. These programs were designed to shore up banks in desperate times.

American Express, for example, has borrowed an unknown amount from the discount window. They even highlight this benefit on their investor-relations page under sources of cash: “Access to the Federal Reserve discount window”. Clearly having US Government backing is a major asset. It allows financial firms to offer huge salaries and bonuses.

Why do investment banks and credit card companies deserve access to taxpayer funds? They don’t. I question whether traditional banks,which actually lend to consumers and small businesses, should have access to this dirt-cheap cash fountain. It has enabled their insane pay packages to continue. Paul Volcker recently spoke to Congress on this very topic, specifically citing Goldman Sachs:

“There’s nothing wrong with making money,” Volcker said. “But I don’t want them to make money by taking risks with the support of the taxpayer.”

At 82 years old, Volcker is sharper than any other member of Obama’s financial team. Unfortunately his role has been minimized, and some say he has been cast out for his “anti-Wall Street” views.

There are countless other ways banks benefit from government largesse. They can currently borrow at 0%, using the capital to buy treasuries earning 2-4%. Risk-free profits. And guess what the Fed’s exit strategy involves? Paying banks more riskless interest, encouraging them not to lend money. Starting to see a trend?

Prior to 1920, when banks wanted to borrow from the government, they were required to pay a premium to market-interest rates (which they could not get, obviously). Rightly so. If banks need cash so badly, they should pay a premium for it. Taxpayers should gain something for the risk they take. Banks need to drastically slash costs, cut bonuses, dividends, payroll, etc. This has yet to happen on the scale required. Instead we’ve offered trillions in support, asking little in return.

Video: Nassim Taleb makes the Capitalist case to Congress. Richard Bookstaber makes a more socialist argument. Taleb explains the difference:

Popout

I’ve run into the same argument numerous times. They call these arguments “socialist”, say they would “put limits on private profits”. Understand this: Banks in the US are not free-market enterprises. They own shares of the Federal Reserve. They all have access to dirt-cheap capital, and powerful ones will be bailed out unfailingly. At least while guys like Greenspan and Bernanke are in power.

Lamenting Volcker’s Absence

A chairman like Paul Volcker would have handled this much better. He recently made statements to this effect. But the era of a responsible Fed ended with him, it seems. It’s a shame that Mr. Obama’s administration has largely ignored him in favor of Summes and Geithner.

Bernanke is of a different mind. He will continue to support maximum moral-hazard, minimum reform, and total lack of transparency. Which is why we need to force change.

See also:

• Don’t Blame The Free Markets, They Never Existed
• Greenspan Was NOT Free-Market

Disclosure: No positions in companies mentioned
Disclaimer: None of this information is investment advice. Always consult a professional.

Comments

[worriedwart:]

Fire this guy immediately!! for writing the following under a "capitalists view:

..."at cost to other members of society."

A bank making trillions in a capitalist market does so fairly

If you dont like the fee structure etc well, in a free market there is always someone with a better way

The governments JOB IS TO OVERSEA THAT ANY CLAIMS MADE BY ANY COMPany i.e as we offer full protection against blah blabh has to be able to back that up

how much more would our savings be covered if REAL INSURANCE COMPANIES protected our savings FOR A FEE

Banks pay the FDIC and then pass them on to us
sO WHY NOT GET DIRECTLY charged by a company for the amount we want protected

example: its 100% a fact that we die and therefor we pay premiums to a company that will pay our heirs xx amount

Well , we pay a premium to a company to protect us if our bank closes and ITS NOT A FACT THAT your bank is going to close

As long as the government DOES THEIR job making sure that the insurance company that says it has the funds to pay off any claim ACTUALLY HAS IT, THATS CAPITALISM AT WORK

If the company lied ( their claims are false) then people actually go to jail and if the company is closed down those who have paid in our allowed to divide up the liquidation of the company

Sep 28 05:58 PM

[Tony Petroski:]

Mr. Smith. Let me make the case for not regulating the salaries and bonuses of bankers:

1) Price controls don't work.

2) Price controls require regulators, auditors and controllers thereby adding a layer of bureaucrats to an already bloated bureaucracy.

3) The G-20 likes it. If so many Citizens of the World are in favor, it can't be good for Americans. It will pave the way for international boards of regulators plaguing the planet with their make-work.

4) If we accept your premise that the banks are currently arms of the government, then your capitalist case leads very rapidly to "socialism" or socialism, whichever you are prepared to accept. Government running auto companies, banks, the entire health-care industry, health insurers, mortgage banking, railroads, green industries, 90% of "education, pension funds, whatever else Obama's Tzars can gobble up, leads to socialism or another term yet to be invented to spare the feelings of the socialists.

Why not call for less government involvement in the economy, not the omnipresent Obama crowd running and regulating everything? After all, that's what Americans do, associate with whom they want, bank where they want, and pay employees and partners what they want. It's called freedom.

Sep 28 07:51 PM

[Adam Sharp:]

Price controls suck, I agree. But if we're not going to let big-banks fail, and continue to subsidize their profits with low interest rates, then we need to cap them somehow.

It's far from perfect, but better than nothing. ALL banks benefit from being able to borrow at below-market interest rates. How could you not?


On Sep 28 07:51 PM Tony Petroski wrote:

> Mr. Smith. Let me make the case for not regulating the salaries
> and bonuses of bankers:
>
> 1) Price controls don't work.
>
> 2) Price controls require regulators, auditors and controllers thereby
> adding a layer of bureaucrats to an already bloated bureaucracy.
>
>
> 3) The G-20 likes it. If so many Citizens of the World are in favor,
> it can't be good for Americans. It will pave the way for international
> boards of regulators plaguing the planet with their make-work.<br/>
>
> 4) If we accept your premise that the banks are currently arms of
> the government, then your capitalist case leads very rapidly to "socialism"
> or socialism, whichever you are prepared to accept. Government running
> auto companies, banks, the entire health-care industry, health insurers,
> mortgage banking, railroads, green industries, 90% of "education,
> pension funds, whatever else Obama's Tzars can gobble up, leads to
> socialism or another term yet to be invented to spare the feelings
> of the socialists.
>
> Why not call for less government involvement in the economy, not
> the omnipresent Obama crowd running and regulating everything? After
> all, that's what Americans do, associate with whom they want, bank
> where they want, and pay employees and partners what they want.
> It's called freedom.

Sep 28 09:55 PM

[untrusting ...:]

Adam,
The fallacy of your arguements, socialist vs. capitalist, is the very concept that banks (or most US corporations or most US corporate executives) actually EARNED it.

Nobody objects to somebody getting rich if they EARN it. It is when they game the system and effectively STEAL it, then the masses get irate. And that is how the US pseudo-capitalist system works in many cases now.

One could cite literally tens of thousands of examples of this, but it just makes no difference as that is the pseudo-capitalist system now. But to show a few for illustration.
1) Pfizer just admitted to their 4th case of fraud and agreed to settle for about $2 billion. No Pfizer executive went to jail or lost any of their personal wealth. No wonder they will continue to be capitalists and get caught yet again for a 5th massive fraud. But the free-enterprisers/capi... claim this is capitalism. It is very simply oligarchical enrichement through fraud. In short it PAYS, big time, to be a capitalist crook. Just make sure you steal billions or trillions, cause they will send you to jail for stealing a few hundred dollars or a DUI.
2) Haliburton/Brown - Haliburton collected many millions of dollars for electrical contracts in Iraq. An independent master electrican examined the work for Congess and testified "it was the worst electrical work he had ever seen and was totally useless". No Haliburton employee ever went to jail or lost their personal assets for an obvious massive fraud.
3) Ratings agencies - hundreds of millions of dollars in fees collected for fraudlent ratings of securitized mortgages as AAA that were probably not even DDD. Not one rating agency employee or executive has gone to jail or lost any personal assets, but many got rich based on their fraud. Investors have lost trillions though.

You don't hear anybody complaining about Oprah Winfrey getting rich, now do you? But then she didn't steal her wealth, she EARNED it. Nobody objects to Steven Spielberg getting rich from making lots of popular movies. Now that's real capitalism.

In short the issue isn't capitalism, socialism, communism, or any other 'ism. It is purely greed, fraud, corruption, theft, dishonesty, manipulation and other means used by a tiny minority of politicans, lobbyists, oligarchs, public company executives, and others to enrich themselves with little consequences to their actions. That's not capitalism or socialism .... it's theft and corruption and nepotism.

Sep 29 01:19 AM

[a fat panda:]

Call me when AIG's officers are in jail.

Separately, banks don't pay the full freight on the insurance. This is why the system is heading to default. Now that it is in default, the banks don't want to pay the full freight. So get this... They want to make a loan to the FDIC instead of paying their bills.


On Sep 28 05:58 PM worriedwart wrote:

> Fire this guy immediately!! for writing the following under a "capitalists
> view:
>
> ..."at cost to other members of society."
>
> A bank making trillions in a capitalist market does so fairly
>
> If you dont like the fee structure etc well, in a free market there
> is always someone with a better way
>
> The governments JOB IS TO OVERSEA THAT ANY CLAIMS MADE BY ANY COMPany
> i.e as we offer full protection against blah blabh has to be able
> to back that up
>
> how much more would our savings be covered if REAL INSURANCE COMPANIES
> protected our savings FOR A FEE
>
> Banks pay the FDIC and then pass them on to us
> sO WHY NOT GET DIRECTLY charged by a company for the amount we want
> protected
>
> example: its 100% a fact that we die and therefor we pay premiums
> to a company that will pay our heirs xx amount
>
> Well , we pay a premium to a company to protect us if our bank closes
> and ITS NOT A FACT THAT your bank is going to close
>
> As long as the government DOES THEIR job making sure that the insurance
> company that says it has the funds to pay off any claim ACTUALLY
> HAS IT, THATS CAPITALISM AT WORK
>
> If the company lied ( their claims are false) then people actually
> go to jail and if the company is closed down those who have paid
> in our allowed to divide up the liquidation of the company

Sep 29 03:25 AM

[casey00001:]

Well we used to have a capitalist society before Obama. Now without question we have a Socialist society under his reign.

Sep 29 09:28 AM

[Angry Banker:]

The implication that banks are getting out of jail free is ludicrous:

"American banks are currently allowed to gamble with other people’s money. They are given dirt-cheap funds by the Fed. They loan it out at a higher rate, pocketing the difference. If and when these loans go bad, they’re bailed out with even-lower interest rates, or outright cash-injections."

The above is not correct - the TARP funds charge a punitive interest rate of about 8% far higher than the banks were previously getting on the open market. As for cash injections, these were in the form of preferred or common stock purchases. Should the stock prices go up (which in most cases they have dramatically), the government (taxpayer) can and will reap huge returns.

Additionally you say:

"Taxpayers should gain something for the risk they take. Banks need to drastically slash costs, cut bonuses, dividends, payroll, etc."

Fact is that banks receiving "extraordinary assistance" under the TARP program are by law now required to address all these points. They can no longer pay dividends until TARP is repaid, bonuses of the top 100 execs are under strict scrutiny by the so-called "pay czar" and expenses are the major companies are way down, almost 25% in some firms.

It is true however that banks benefit from government support. But in return for their FDIC guarantees (which they also pay for through FDIC insurance), regulations require massive amounts of lending in areas that would not be considered prudent if the banks were using their own money. So when banks fail because of compliance with government mandates on lending under the Community Reinvestment Act, HMDA, HOEPA and other so-called "consumer protection" laws and regulations, then it is not necessarily unreasonable for the government to come to the banks' aid.

Lastly, one more point on executive compensation -- in many of the firms (not all I grant you), much of the upper tier was swept out after the financial crisis began and the new management should not be held accountable for the failures of the previous execs. If this new management performs well and returns the banks to sustained profitability, they should be well compensated for their good work.

Sep 29 11:26 AM

[a fat panda:]

Angry,

You are simply misinformed, and your anger is misplaced. I trade bank debt, and in Oct and Nov I was getting 5% to hold Citi debt for a month. Morgan Stanley debt due in 7 days traded down at a 70% discount to par. If GS paid Buffett 10% plus warrents and puts, you ought to be thanking every taxpayer you meet on the street for 8%, and that is higher than what was originally offered.

The welfare isn't just the money lent to the people who caused this mess. The Fed has singlehandedly created a market for the CMOs that bankers rushed to buy. It extends to being able to issue debt backed by the FDIC - if that isn't welfare why is every business in the country forming a bank holding company. There is the TAF, TARP, and capital injections via AIG.

You want to blame the CRA? If that were the problem, why is the housing bust in condos in Vegas and Miami Beach? Sub-prime loans were largely originated by lenders not covered by the CRA. The CRA is a whipping horse of bankers who want to blame someone other than themselves.

Sep 29 06:39 PM

[Scott Croly:]

Mr. Sharp makes extremely valid points. En banque (most particularly, NY dievestment [sic] en banque staff hyperbole) is subsidized and insured not simply by paper based upon nominal advance transfer (as in, front letter of credit, repay via retail), but, at times like these, a real "MES": Market, Economy, Society, leave the last 'S' off for savings. Obviously, and currently, we are on the 'S', as we have largely been over the past supply side cycle, at least with equity/entitlement, two sides of the same coin, on the back of real investment/production/... and work in the West, most particularly in the large macro-jurisdictions: the dynamic and stable world work/earnings line (not staff) citizenry, particularly within the USA, Isles, Commonwealth, and Russia, have much to be proud and dignified about; it has been, and still is, a tough period. This past cycle evidences the equivalent of a reprise of the two generations prior to it (simple analogue sine wave quant with general discrete application -- it extends way back, the equivalent of Euclidean proof is undeniable, and presents periodic sinusoids with 3 legs, 3 gen each, 7 -7 -7 there between, of fascinating application, as in, 9 inning ball game style USA -- with 3 breaks -- 2000, 2008 the last; yeah, I got those: C.gov). The true model in the West, and certainly the US, is corporatio consortium, though obviously with reprise (as just indicated), over many generations, as per above. The past generation has evinced the equivalent of LLP and en banque trust (Carnegie, Rockefeller) from the late 19th century, finally "busted" by President Teddy Roosevelt, himself a veteran of the Spanish American War, in Cuba; also a theatre in the Phillipines. This period and model stasis may be somewhat compelled in light of the equivalent of an historical economy reboot, as well as compelled world trade (6 billion heads, hearts, and guts are always better than 300 million, and real time cost of production (dy) discount enables diminished time variable (dx) product build and transfer toward increased velocity derivative (dv), through obvious profit static caste capital build within a consumption model, reapplied, but not quite in the way you might think. (Actually through animate first, with reapplication therefrom toward inanimate progress, and cycle). Progress is obviously existentially and otherwise compelled; there is no contemporaneous mass-time paradise -- it is not currently 19:00 EDT, Tu, 09/28/2009 in paradise. Without question, this is an incredibly challenging cycle change underway these days, particularly within purview of massive labor/earnings/production downtime and desperately needed real, not nominal innovation input, in subtext market contraction, volatility, initial real rise toward challenged progression, within context change. Nevertheless, it is quite exciting, as evidenced currently, and more than apparently a priori, by the compelled move from nominal supply side market final retail cap (past 9 years within total 28 year period, first part of which was de jure, obviously de facto the night of Monday, 10/19/2009, market reboot (TNX/DJIA) via gp event -- an evident a priori trade). Severe, and even hyper-equity/earnings divergence, with equity price level unsustainability worldwide has occurred, initiating some vulnerability from regressive, though economically injured, elements. USA DoD, the pinnacle of world citizenry, has engaged the most dystopian of these small, fringe elements overseas, who can be characterized as luddite, at least in social terms. This is de minimus sad, as so many wonderful, inventive devices and logic systems have been invented and created in that jurisdiction, among which is the wheel, no more than approximately 12,000 years old; it has significant and obvious application. The world B10 counting system application, as well as amazing light oil and otherwise fired work product (ex: reciprocating app.) devices emanate from that area. The US former administration's attempt to democratize that area was obviously not entirely displaced; quantitative (en banque admin compatible) foray/trade into and with the world with potential synergistic, positive return, eventually for all, is infinitely better than the alternative: potential all-out war. We must thank USA DoD, Isles, Commonwealth, NATO DoD personnel for their tremendous service, honor the individuals who have made the ultimate sacrifice, and the families, life love loss. It takes time; the way to progress is never a smooth road. Rome was not built in a day. Fringe elements use our IP manifestation and invention toward miserable ends. The tactical challenge presented by this group is difficult, at best. It is for this reason, primarily, that we are now on 'S', macro-system wide. Those who are micro-socialist, and demand over-extended, currently hyper-inefficient and obsolete supply side extension, through nominal paper transfer via intra, inter-national, market B & A one-price model arbitage with leverage, et al, extension, are ultimately subversive to national and international stability, safety, and security. The spread was bread; now the spread is dead. Fiat UCD (unit currency devaluation) is already occurring, and will continue. Supply side entry evidenced macro-earnings induced demand inflation; exit indicates micro-currency devaluation (shrinking rectangular dimension paper fiat currency bills cover less area on a loaf of bread), from nominal market over-leverage, and somewhat over-expensed government though this would and could be mitigated through more expeditious and reasonable use and application of 4 component price model template dynamic, rather than stasis -- as in, reasonable compensation, reflection of merit from both sides, profit reinvested toward "real," with synergistic return, motivating real production acceleration and velocity increase. Of course we are Keynesian coming out of the cycle: differentiate in, integral out -- calculus theorem 101; buy time, and time does heal some wounds. The injury caused by UCD money print, borrowing, TARP up/down (bank run panic sucks), further Fed support, with some help to industry/manufacturing enterprise (keep it real), especially at this cycle point where public/private sector capital partnership is compelled (keep it real) is mitigated by more real efficiency, expedition, macro-technology (from discreet applications learned from B2 former micro-application toward entropy, 2nd law thrmdynmcs 101 mitigation in energy production, n. gas, alt, boutique robtc mfg, res p.plants), very hard work (expedite jobs in "real," quickly), learning, backend sales of evolving application success, defense, within Newtonian space and mass-time: (a = F/m; v = d/t). Those, who evidently are of the micro-socialist and micro-communist element regarding redistribution via extraction of independent, dynamic, real production, work, and earnings to dependent, wasting, hyper-consolidation and concentration nominal "wealth" stasis, and even, in evident final frustration, have applied the rather awkward tag of "producerist," on duty, honor, country, with worse than insulting and destructive insinuation, particularly to those who have real heritage, as in, among other arenas, that which is mentioned above, need to realize that at this point, this obsolete, indeed subversive and anti-American, nominal supply side stasis, if over-extended, inevitably leads to historical collapse with sudden dy limit down, over dx limit in, with consequent reciprocal macro-dysopian result. Capital, as is real Wall Street with reasonable trade platform, is great, especially the dynamic variety; so are real investment/production/... work/learning/creativity/intelligence/innovation/invention; it isn't the "what," it's the "how." It is time to get real; in the end, who ya gonna call?

Sep 29 07:04 PM

[GerryB43:]

Before the 1999 dissolution of the barriers set up by the Glass Steagall act, banks were not allowed to take the kind of risk that brought down so many "too big to fail" institutions last year. Prior to that banks failed only when "disintermediation" was triggered by Fed action that produced an inverted yield curve. For the most part anyway. The "systemic" risks caused by the collapse of the derivatives market have been growing for nearly ten years and were completely predictable in magnitude if not in exact timing.

Sep 29 10:03 PM

[Michael Clark:]

During many periods of history, banks were not allowed to charge interest. It was considered immoral. SHOULD the populace live to make bankers rich; or SHOULD bankers exist to support the populace (and the development of a rational form of capitalism)?

Banks have been sucking the blood of human societies for much of human history (but not all) -- perhaps we need banks that serve the society instead of themselves.

Oct 01 11:17 AM

[Michael Clark:]

Maybe we should re-institute the system wherein bankers are personally liable for loses their banks accrue. Perhaps this would make them behave more responsibly with the money they loan and invest. Instead, we provide them with a safety net of taxpayer money. Where is the incentive for them to avoid risky investments if the government funnels them billions when their investments flop?


On Sep 29 11:26 AM Angry Banker wrote:

> The implication that banks are getting out of jail free is ludicrous:
>
>
> "American banks are currently allowed to gamble with other people’s
> money. They are given dirt-cheap funds by the Fed. They loan it out
> at a higher rate, pocketing the difference. If and when these loans
> go bad, they’re bailed out with even-lower interest rates, or outright
> cash-injections."
>
> The above is not correct - the TARP funds charge a punitive interest
> rate of about 8% far higher than the banks were previously getting
> on the open market. As for cash injections, these were in the form
> of preferred or common stock purchases. Should the stock prices go
> up (which in most cases they have dramatically), the government (taxpayer)
> can and will reap huge returns.
>
> Additionally you say:
>
> "Taxpayers should gain something for the risk they take. Banks need
> to drastically slash costs, cut bonuses, dividends, payroll, etc."
>
>
> Fact is that banks receiving "extraordinary assistance" under the
> TARP program are by law now required to address all these points.
> They can no longer pay dividends until TARP is repaid, bonuses of
> the top 100 execs are under strict scrutiny by the so-called "pay
> czar" and expenses are the major companies are way down, almost 25%
> in some firms.
>
> It is true however that banks benefit from government support. But
> in return for their FDIC guarantees (which they also pay for through
> FDIC insurance), regulations require massive amounts of lending in
> areas that would not be considered prudent if the banks were using
> their own money. So when banks fail because of compliance with government
> mandates on lending under the Community Reinvestment Act, HMDA, HOEPA
> and other so-called "consumer protection" laws and regulations, then
> it is not necessarily unreasonable for the government to come to
> the banks' aid.
>
> Lastly, one more point on executive compensation -- in many of the
> firms (not all I grant you), much of the upper tier was swept out
> after the financial crisis began and the new management should not
> be held accountable for the failures of the previous execs. If this
> new management performs well and returns the banks to sustained profitability,
> they should be well compensated for their good work.

Oct 01 11:24 AM

[Michael Clark:]

I for one would love to see the salaries of ALL sports stars, movies stars, business stars, and music stars (I use the word 'stars' loosely) come down significantly. These salaries are ridiculous. These salaries reflect the INFLATIONARY cycle we have barely survived and with which we are now seeking to DEFLATE so that prices generally can return to a level that is reasonable for all members of our society. I don't believe that super-salaries are or should be a sacred cow in any society. Is it really a sign that our society 'works' that AROD gets paid $200 million to play baseball when the average salaries of American workers have been declining since the mid-70's. Or is this a sign that our society is NOT working very well.

Oct 01 11:44 AM