Asia Times Online :: Asian news and current affairs

Oct 7, 2009

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Payback time
By Julian Delasantellis

The late American bank robber Willie Sutton, when asked why he robbed banks, used to say because that's where they kept the money. In the same way, if in 2006 you asked someone why he was using a questionable $250,000 subprime mortgage to turn it into $10,000,000 of even more dicey collateralized debt obligations, the answer might have been just about the same - for the money.

The Harvard and Wharton MBAs who dreamt the waking nightmares of greed and reason that ravaged the world in the early years of this decade must have thought themselves quite superior to the state college graduates always two or three paces behind them, right up until they saw those said same mental deficients

manning the tollbooths preventing them from leaving the house with all their bags stuffed with lucre.

It's all about the money. In a capitalist society, it's always about the money. You may not know American professional basketball from a game of "Twister" played by those with overactive pituitaries, but if you knew Cleveland's LeBron James, at $16 million a year, was the National Basketball Association's highest paid player, it should not be that hard to go back, watch his tapes, find out why he's getting paid so much and ultimately understand the game. Similarly, you may not be able to tell the difference between a RMBS (residential mortgage backed security) and a 1960 Nash Rambler, but if one banker is finishing the day with a lot bigger bankroll than another, you can pretty well assume that's the guy whose activities pose the greatest challenge to the previously existent standards and strictures of the banking system.

These days, the public protestations regarding total financial remuneration usually go to the issue of bonuses; Wall Street is mostly continuing its tradition of paying its superstars small salaries (maybe only 5%-10% of total yearly pay), along with huge year-end performance-based bonuses. This was particularly true with the banks and automobile companies that received funding under the government's Troubled Assets Relief Program (TARP). Also, if the rationale of bonuses was to reward superior corporate performance, why did bonus payments barely stumble when the companies' performance turned so bad? Examples of this were Citigroup, with losses of $27.7 billion in 2008, $45 billion in TARP taken from the government, and $5.3 billion in bonuses payments for the year. Wells Fargo reported $43 billion in losses, took $25 billion in TARP, but still paid out $977 million in bonuses.

This grated with the public more than any other aspect of the financial crisis. Mr Lunchbucket may not know a subprime security from a submarine sandwich, but if Mr CEO makes more just getting a coffee on his first morning of the year at work (with part of that coming from government money paid by taxpayers), than the Working Class Hero makes in 12 months, that fact is going to get noticed.

The tremendous political power and advantage of attacking the banking and finance industry through its pay packets rather than just its practices was demonstrated with last winter's controversies over the bonuses paid out to executives at the government-rescued AIG investment partnership, wherein executives arrived on Capital Hill feeling themselves pure as the driven Gstaad snow only to find they were being led down Pennsylvania Avenue in tumbrels for appointments with Federal Deposit Insurance Corporation chairwoman Sheila Barr attired as Madame de la Guillotine.

In early June, came the Obama administration's next baiting of the unwashed with the appointment of a "pay czar", former September 11, 2001 attack victims fund special master Kenneth Feinberg, to oversee salary and stock bonus and option arrangements at previously bailed out companies such as AIG and Chrysler.

Yeah, but down there on the ground in "flyover America", folk weren't fooled by such artifice. Pointing their shotguns and semi-automatic assault rifles skyward, in the direction of the private jets carting the media elite from one coast to another, they knew full well that, since both words had their historical antecedence in Russia, "czar" and "bolshevik" had to have interchangeable meanings.

In mid-summer, the US House of Representatives rolled the ball a bit further down the hill, taking HR 3269, the "Corporate and Financial Institution Compensation Fairness Act of 2009" out of chairman Barney Frank's House Financial Services Committee, and, by a mostly party line vote of 237-185, sending it to the Senate.

Answering the charge that stockholders are never given a chance to vote on exorbitant executive pay packets, this bill stated that it "shall provide for a separate shareholder vote to approve the compensation of executives as disclosed pursuant to the Commission's compensation disclosure rules for named executive officers (which disclosure shall include the compensation committee report, the compensation discussion and analysis, the compensation tables, and any related materials, to the extent required by such rules)".

However: "the shareholder vote shall not be binding on the issuer or the board of directors and shall not be construed as overruling a decision by such board, nor to create or imply any additional fiduciary duty by such board, nor shall such vote be construed to restrict or limit the ability of shareholders to make proposals for inclusion in such proxy materials related to executive compensation".

It is fairly easy to assume that Frank would have preferred something more forceful than a non-binding vote, but even this would have been impossible back in the days of a Republican Congress backstopped by a Republican president's veto pen. Also Frank is most likely just daring the corporations to ignore shareholder will even after a clearly stated shareholder vote. Backdoor financial regulation through salary restrictions continued apace.

At the recent Group of 20 meeting of economic powers in Pittsburgh, a revolutionary agreement was reached on international standards to limit pay and bonuses in the world financial sector. The final communique of the conference noted that:

Excessive compensation in the financial sector has both reflected and encouraged excessive risk taking. Reforming compensation policies and practices is an essential part of our effort to increase financial stability. We fully endorse the implementation standards of the FSB [Financial Stability Board] aimed at aligning compensation with long-term value creation, not excessive risk-taking, including by (i) avoiding multi-year guaranteed bonuses; (ii) requiring a significant portion of variable compensation to be deferred, tied to performance and subject to appropriate clawback and to be vested in the form of stock or stock-like instruments, as long as these create incentives aligned with long-term value creation and the time horizon of risk; (iii) ensuring that compensation for senior executives and other employees having a material impact on the firm's risk exposure align with performance and risk; (iv) making firms' compensation policies and structures transparent through disclosure requirements; (v) limiting variable compensation as a percentage of total net revenues when it is inconsistent with the maintenance of a sound capital base; and (vi) ensuring that compensation committees overseeing compensation policies are able to act independently. Supervisors should have the responsibility to review firms' compensation policies and structures with institutional and systemic risk in mind and, if necessary to offset additional risks, apply corrective measures, such as higher capital requirements, to those firms that fail to implement sound compensation policies and practices.

Not only do the new rules provide for big bonuses to be paid out over a period of years, to make sure that the trader's or CEO's performance was not just a flash in the pan, or maybe just an aggressive play on the trend; they also provide for "clawback", having the company take some of the bonus back if future events have the success then followed by big losses. Also, it will now be expected that the company's overall fiscal position will be a factor in individual bonuses. No longer will successful traders in one division be able to drain the company dry with bonuses as the other parts of the company wither on the vine and die. It'll be all for one and one for all in the banking system; for many of Wall Street's most pampered princes and princesses, a very bizarre and difficult to understand sentiment indeed.

Taken together, one should not underestimate the revolution in economic thinking these changes represent.

A while back, I was giving a lecture on the Sixteenth Amendment to the US Constitution, the one that legalized progressive interest rates on the taxation of income in 1913. Before this amendment, all income had to be taxed at the same interest rate; ever since, the more you made, the higher percentage rate you paid.

I told the students that, when they graduated and took their first jobs, most of them would probably be paying taxes at the 15% tax rate, but if they earned more than $373,000, they'd be paying at the current maximum marginal rate of 35%.

"Wow!", one student exclaimed.

What would have been her reaction to learn that, at the end of the Second World War, the highest marginal tax rate was 94%, and even during the most of the 1950s and early 1960s, the rate was 91% or 92%?

These were the days of high Keynesianism through maximum government fiscal influence over the economy. Government spending was believed to have been responsible for ending the Great Depression and winning the war. By the early 1960s, John F Kennedy's "new look" defense posture put the Pentagon budget at almost 75% of total discretionary federal spending.

It was then that the new philosophy, with its emphasis on the health of the private sector, took hold. Kennedy lowered the top marginal tax rate from 91% to 77%; it stayed in the 70s until Ronald Reagan lowered it in stages to 28% by 1988.

The new emphasis on tax rates associated them not with what the government could collect if they were high, but what the private sector would produce when they were low. The thinking here was that a businessman, say a cobbler, would not fix that many more shoes if each shoe repair purchase was taxed at 91%, but at 28% he probably would. Thus, an economy taxed at a maximum rate of 28% would see more shoes, or more cars, or maybe more computers and software applications, and everybody would be happy.

Unless, it now seems, if the extra something being produced was the recent product of the banking and finance industry. Here, the sentiment, as illustrated by the move to take bonuses, incentives, away from the banking system, is for "no more" - no more financial innovations; no more credit default swaps; no more collateralized debt obligations; nothing. Whatever the society paid the banking system in the early years of this decade, it now wants to stop, for society no longer wants to pay bonuses, in effect, to underwrite activities that subvert and undermine the bedrock institutions that support society as a whole.

In that light, perhaps it is time to re-assess those supposedly deadly dull and staid 1950s. Conventional wisdom has always had it that it was the boring, Middle American white-bread values of the country's president, Dwight David Eisenhower, that led to a decade of a supposed national snooze; but, in reality, maybe it was something else - the tax system.

No families were threatened by gangsta rock or movies and TV shows that celebrated and encouraged prepubescent sexuality; there was just not all that much money in it, at a 90% highest marginal tax rate, for the producers of these legal social desiccants to take their blowtorches to the community's culture. With high marginal tax rates, there would not have been such incentive for consumer goods producers to manufacture the illusory horn of plenty that drove the national savings rate below zero earlier in this decade. Americans might not have bought all that dross, and in doing so spend down the fortune it took their forefathers and antecedents 200-plus years to earn and accumulate.

And in Millburn, New Jersey, wealthy girls will have to find methods other than fancy clothes and serial plastic surgery to gain entree to the slut club. For the ones whose parents actually do work for Goldman Sachs, they shouldn't have that far to look.

Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.

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