Pendulums often swing too far in either direction.  It has been shown that complete deregulation or total self-regulation leads to "Big Business Gone Wild."  And now the pendulum in regulation over executive pay caps is on the verge of going too far in the other direction.  The Obama administration is set to release executive pay caps at institutions which are highly dependent upon financial assistance from Uncle Sam.  President Obama called for $500,000 salary caps in a speech, but more formal details of the rescue will not be out until next week.  We agree that more "governance" and more "limitations" are needed, and more importantly are coming any way.  But if these become too stringent, then these businesses will be killed.

Even with the $500,000 limit, it looks like executives can be rewarded via restricted stock or other compensation which is tiedto long-term performance and the health of the company after payingback the government money.  There will be a ban on huge executiveseverance packages at taxpayer-assisted companies and it also lookslike shareholders will get more of a say in executive compensation.

And today we have seen word that Goldman Sachs Group (NYSE: GS) wants to pay back the TARP money.  Jamie Dimon of J.P.Morgan Chase (NYSE: JPM) has complained that his company was forced to take TARP monies.  Should he be forced to work for $500,000.00 for the rest of his days?  We think not.  And if Goldman Sachs is going to try to repay the money, then Morgan Stanley (NYSE: MS) would probably try to as well.

Citigroup (NYSE: C) and American International Group (NYSE: AIG) fall under far different categories.  They couldn’t pay Uncle Sam back right now if they wanted to.  Neither CEO at AIG nor Citi is responsible for today’s problems.  They both came in after the fact.  What about Bank of America (NYSE: BAC)?  The company can’t pay back the money right now.  Its stock is trading like an at-risk business, so its chances of paying back money are slim to none.

But here is where this gets very interesting.  The WSJ noted that thisexecutive pay cap at the companies which have already participated in that first$250 billion of TARP money might not fall under the executive pay caps.  Or it was implied that is the caseunless they go back for more assistance.  Ifthat is the case, then this might not kill the same financialinstitutions which are helped financially by Uncle Sam.  But if thegovernment wants to cap pay at all of the institutions using any government funds then this willcome at a much higher price tag.  To what extent the criteria will be for determining what "extensive assistance" is still something that has yet to be determined.

Late last week we read about Senator Claire McCaskill’s executive paycap program which proposed all institutions having ALL employees, notjust executives, getting a $400,000.00 total compensation pay cap.  Thebasis seemed to be that they should not earn more than what thePresident makes.  The difference is that the President isset for life.  A president’s annual pay package is also exponentiallylarger than the paycheck.  And please find me the last person that tookthe Presidency because of the $400,000.00 per year paycheck.  Punishingexecutives who have wronged taxpayers and shareholders is expected, butthese banks will not attract any new qualified people with any ambitionof making money to lead these companies nor to generate any profits forthe company.

The dangers from a proposition along the lines of whatSenator McCaskill would like to see are too many to list.  But the endresult in regulation as tight as what she has proposed falls shortof the country changing its official name on the U.N. charter to theU.S.S.A.  If you cap the pay like this for rain makers who bring inmillions in assets which generate millionsin management fees, then they will leave and take their booksof business with them.  The traders that make millions of dollars forthe company will leave if they get capped at $400,000 per year.  Andthose institutions will be left with the people that generate nobusiness and generate very little in the form of upside.  McCaskill’splan would ultimately kill all of the entities which come under it.

The Russian czars have very few fans in modern history.  They too were outof touch with reality and governed horribly.  But we all know what thesituation was for three generations after the Russian Revolution.  Itmay seem an unfair comparison.  But history offers great lessons andparallels. Senator McCaskill’s plan sure sounded like it was not just punishment for what has happened, but would be punishment for even those coming in to help. Ask Jamie Dimon how he feels if he is capped out at $400,000.00 or even $500,000.00.  He would leave and either start a new bank or go to another bank. 

None of the executives seeking government handouts, or bailouts, shouldexpect that they will get to keep pilfering money to the extent thatthey have been.  The days of spending millions in decoration, flyingprivate jets, taking $20 million severance packages, and other greatexcesses are over at most institutions.  Some capping out has to come.We expect it.  Executives expect it.  Wall Street expects it.  But…

If this goes too far and gets too extreme, then the government willkill the same businesses it claims to be trying to help.  If Uncle Samwants to gets too restrictive on executive compensation, then it shouldreally just consider the route of letting the free markets run with nohelp at all.  Tell the banks they have 90 days to get solvent or a newRTC-type of entity will take them over, sell off the garbage, andrelaunch the banks as healthy entities.  The end result will be thesame with many failed and insolvent institutions, but it won’t comewith an upfront price tag nearing a trillion dollars.

The details of the bailout plan and stimulus package are not going tobe fully out until next week.  Again, the excesses of yesterday shouldbe and will be curbed at companies which are responsible for this mess and which contribute to the financial mess of today and tomorrow.  But there are limits.  Taking the regulation andmandate pendulum too far in the other direction will bring about thesame sort of failure and destruction, and will likely even make it worse.

The danger here comes in what can become precedent.  Lawyers use public courts, and there is a huge portion of the population that wished they made less money.  Doctors are often thought of as the enemy because health care costs so much.  Are athletes worth $20 million per year?  Or movie stars?  Defense contractors sell almost only to the government.  The list goes on.  The obvious issue is that none of these are in the current government bailout plan.  But what about health care reform?  What about defense spending reviews?  And what about all of the companies who may do work in the coming infrastructure work?  Before this becomes a reality TV show and a CEO’s pay (or all workers’ pay) becomes capped, there are potential ramifications.

Interesting times indeed.

Jon C. Ogg
February 4, 2009

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