Obama and Financial Pay

From Wall Street Journal article:

"The Obama administration has begun serious talks about how it can change compensation practices across the financial-services industry, including at companies that did not receive federal bailout money, according to people familiar with the matter. The initiative, which is in its early stages, is part of an ambitious and likely controversial effort to broadly address the way financial companies pay employees and executives, including an attempt to more closely align pay with long-term performance. Administration and regulatory officials are looking at various options, including using the Federal Reserve's supervisory powers, the power of the Securities and Exchange Commission and moral suasion. Officials are also looking at what could be done legislatively."

Is this right? Is it legal? It is clear that executive pay has gotten out of hand, but is the correct way to remedy the problem to have government use laws or "moral suasion" to dictate pay? This seems to be the first steps down a slippery slope. These are private companies owned by shareholders who dictate executive pay.

Capitalism vs Socialism

A recent editorial in the Wall Street Journal observed:

"What caused this recession? We still don't have a simple explanation. Such is the uncertainty sapping the country's confidence that in a recent Rasmussen Reports poll only 53% of Americans said they prefer capitalism to socialism; 27% were unsure and 20% preferred socialism."

A number of political pundits agree that the current economic crisis is causing the country to shift from a mindset of free market enterprise since Reagan in the 80's to a new period favoring socialism. We will continue to discuss the merits of the debate, but would like to include a quote from Warren Buffett for the time being:

"Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges. Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead."

Before proclaiming death to capitalism, it is important that people review the broader historical spectrum and compare the last century in the US with other systems throughout time and domicile.

Empowerment and Helplessness

With the combination of economic downturn, financial bailouts, and rampant bankruptcies one begins to wonder, "What can individual communities do to regain control of their own destiny?"

As more and more cities, towns, and neighborhoods struggle with a sense of helplessness, are their any innovative tactics worth pursuing that may allow these places better control of their own futures? What can be done locally to ensure prosperity (or even survival) for these respective areas? More importantly, what actions can be made to empower citizens to be involved? Or are we simply stranded on a broken escalator... waiting for someone to come fix it? Share your ideas.

Hussman Update

Economist John Hussman recently published a great piece on the financial crisis. It is well worth your time:

http://www.hussmanfunds.com/wmc/wmc090330.htm

Of note: notice the graphs at the bottom of the essay, illustrating the coming resets of Alt-A and Option ARM mortgages; we are not out of this yet.

Bernanke Quote

I have been in agreement with John Hussman (http://www.hussmanfunds.com/) that the federal government's biggest mistake is not finding a place to operate large firms that pose systemic risk to the economy somewhere between solvency and bankruptcy. Federal Reserve Chairman Ben Bernanke recently recognized this:

"If a federal agency had had such tools on Sept. 16, they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders, and impose haircuts on creditors and counterparties as appropriate."

Congress and Your Money

The House bill aimed to tax 90% of bonuses at certain firms receiving taxpayer money has slowed, but sentiment remains. House Majority Leader Steny Hoyer (D, Md.) stated that no one receiving taxpayer money "ought to miss the anger that was reflected in the passage of that bill, or the possibility of policies being adopted in reaction to the continued insensitivity to the concerns of taxpayers." We are witnessing a serious strain between the government and private sectors. Congressional leaders assumed that if you give people public money, they will automatically behave in the best interests of the general public welfare, as opposed to their own private self-interest. Instead of responsibly ensuring that taxpayers had a series of protections in place before distributing their money, Congressional leaders just assumed, or hoped, or perhaps wished that businesses would behave like governmental bodies as soon as public money touched their balance sheets. Now people are outraged because of these companies "selfishness." I am of a different mind - this selfishness is in part what drives capitalism and causes economic agents to ensure efficiency. Many say this selfishness is what caused the crisis - I disagree. Selfishness was a part of it, but only selfishness embedded in a system with assymetric payoffs, or selfishness with the wrong incentives. Perhaps if Congress had exhibited some responsible self-interest, we wouldn't be watching taxpayer money get thrown away.

The Government and Your Money

The public is infuriated over the bonuses paid to employees of AIG, and rightfully so. It is incomprehensible that taxpayer money is being used to reward employees of the same unit responsible for the misguided bets that eventually spelled doom for the insurance giant. Unfortunately, the public has only seemed to focus their anger on AIG and its employees, without placing due blame on our elected officials in Washington. Meanwhile, elected representatives have been publicly spewing their “outrage” over the bonuses and proceeding with a plan to tax 90% of certain incentive payments over $250,000. The federal government needs to accept their due blame and move quickly to correct their errors.

The truth is that taxpayer money ended up in the hands of AIG employees only because elected officials voted to provide bailout funds without necessary taxpayer protection; they hoped that simply throwing money at the problem would fix it. I agree that it was completely necessary, in order to avoid a financial Armageddon, to ensure that AIG did not suffer a meltdown; the failure of Lehman Brothers nearly spelled ruin for our economy. But that does not mean that the government is justified in simply allowing the company to accept taxpayer money and operate as a going concern. Federal Reserve officials have complained that they do not have the necessary tools needed to implement an orderly liquidation of a large financial services company such as AIG; the options to a company are either solvency or bankruptcy, with little room in the middle. Funding the bailout in a manner that allowed AIG to continue operating as a going concern forced the company to honor contracts, including employee retention bonuses. The government knew this; in fact, Senator Christopher Dodd added language to the federal stimulus bill explicitly requiring that companies receiving bailout money continue to honor their previously existing employee contracts (including bonuses). After taking majority ownership of the company in September, and knowing that they structured the bailout so that the company would be forced to honor all contracts on going forward, how can elected officials now claim title to victim alongside the US taxpayer?

I am afraid that we are flirting with Japan’s mistakes at the onset of their “lost decade.” Ian Stewart of Deloitte notes that Japanese “government support was not conditional on better risk management and the behaviors that led to excessive risk-taking persisted.” Nearly twenty years later the US government is providing capital to failing financial institutions without necessary readjustment, including the reorganization of misguided employee payment policies. AIG has failed as an institution, and needs to be operated as such while simultaneously minimizing the overall harm to the economy; this means that all stakeholders, including AIG employees, need to accept pain as the company is wound down. It is the responsibility of government to ensure that the necessary laws, regulations and requirements are in place to ensure this happens.

How did AIG get into so much trouble in the first place? They issued promises to pay contracts in the future that they subsequently did not have enough money to honor and they operated a weak risk management system to monitor these contracts. Does that sound familiar? The Government Accountability Office, a non-partisan government body, estimates that in the second half of this century, under current federal programs, federal government debt held by the public will represent over 600% of GDP, our annual domestic output. Meanwhile, our elected officials are spending taxpayer money without necessary taxpayer protection in place. We do need to spend federal money to recover from the current crisis, but not on policies that reward and protect the same misguided behavior that got us into this mess.