Topic: Finance, Banking & Monetary Policy

Washington Push on Executive Pay Has Unintended Consequences

Regulators at the SEC and politicians on Capitol Hill seem to have short memories when it comes to executive compensation.  When the SEC years ago decided to make the compensation of top executives public information, it had the all too predictable result of actually increasing average compensation levels.  Once a top CEO knew what other CEOs were making, he could argue for a pay hike based upon being “underpaid”.  Of course regulators were “shocked” by the resulting “race to the top.” 

Similarly Congress was shocked when after deciding to heavily tax salaries over $1 million, that companies shifted away from direct cash pay and toward options and increased bonuses in the form of shares. 

And soon Washington will also pretend to be shocked and outraged that the current anger over Wall Street bonuses is leading firms to reduce bonuses, but increase base pay.  As illustrated in today’s Wall Street Journal, companies like Morgan Stanley have increased their base pay from $300,000 to $400,000.  Even Citibank, essentially a ward of the US government, is increasing its base pay to $300,000 for employees that were previously eligible for bonuses.

The real harm in this is not that Wall Street employees are getting paid more in cash, but that less of their compensation will be tied to their performance, and the performance of their firm.  A flat salary, regardless of how hard you work, will encourage shirking. Perhaps even worse, is that more upfront cash, and less long-term stock options, will shift Wall Street’s focus even more toward today, rather than tomorrow.  So much for Washington fixing the short term focus of Wall Street, but then one shouldn’t be too surprised given the even more short term focus of Washington.

Too Big to Fail

One of the most pernicious public policies aggravating the financial crisis is that of “too big to fail.” The doctrine states that some banks (now financial institutions generally) are so large that their failure would incur “systemic risk” for the financial system. That sounds terrible and it is intended to. Financial services regulators and Treasury secretaries use it to frighten small children and congressmen. How can an elected official vote to incur systemic risk? He must vote to approve the bank bailout of the day. In fact, people who use the term cannot even agree among themselves as to what it means, much less what causes it and, therefore, what the appropriate response would be. I suggest the reader substitute the phrase “too politically connected to fail” whenever he sees “too big to fail.” What follows will then be rendered intelligible.

The Failure of Do-Nothing Policies

A news story from today in a slightly alternate universe:

Jobless Rate at 26-Year High

Employers kept slashing jobs at a furious pace in June as the unemployment rate edged ever closer to double-digit levels, undermining signs of progress in the economy, and making clear that the job market remains in terrible shape.

The number of jobs on employers’ payrolls fell by 467,000, the Labor Department said. That is many more jobs than were shed in May and far worse than the 350,000 job losses that economists were forecasting.

Job losses peaked in January and had declined every month until June. The steep losses show that even as there are signs that total economic activity may level off or begin growing later this year, the nation’s employers are still pulling back.

White House press secretary Robert Gibbs said, “President Obama proposed a $787 billion stimulus program to get this country moving again. He tried to save the jobs at GM and Chrysler. But the do-nothing Republicans filibustered and blocked that progressive legislation, and these are the results.”

House Speaker Nancy Pelosi said at a press conference, “We begged President Bush to save Fannie Mae, Merrill Lynch, Bank of America, AIG, the rest of Wall Street, the banks, and the automobile industry. We begged him to spend $700 billion of taxpayers’ money to bail out America’s great companies. We begged him to ignore the deficit and spend more money we don’t have. But did he listen? No, he just sat there wearing his Adam Smith tie and refused to spend even a single trillion to save jobs. And now unemployment is at 9.5 percent. I hope he’s happy.”

Democrats on Capitol Hill agreed that the “do-nothing” response to the financial crisis had led to rising unemployment and a sluggish economy. If the Bush and Obama administrations had been willing to invest in American companies, run the deficit up to $1.8 trillion, and talk about all sorts of new taxes, regulations, and spending programs, then certainly the economy would be recovering by now, they said.

Congress Just Raised Our Credit Card Fees

Technically, it was the companies which raised their fees.  But they did so to anticipate new legislative restrictions on fees taking effect.  Congress wanted to cut costs for consumers, but ended up costing them instead.

Reports the Washington Post:

Credit card companies are raising interest rates and fees seven months before new rules go into effect that will limit their ability to do so, much to the irritation of Congress and consumer advocates.

Chase, for instance, will raise the minimum payment required of some of its customers from 2 percent to 5 percent of the statement balance starting in August. Chase and Discover have increased the maximum fee charged for transferring a balance to the card to 5 percent of the amount, up from 3 and 4 percent, respectively. Bank of America last month raised the transaction fee for balance transfers and cash advances from 3 to 4 percent. Card issuers including Bank of America and Citi also continue to cut limits and hike up rates, which they have been doing with more frequency since January.

“This is a common practice and will continue to be common, because issuers can do these things for really no reason until February,” said John Ulzheimer, president of consumer education for Credit.com, which tracks the industry. “It’s what I call the Credit Card Trifecta – lower limits, higher rates, higher minimum payments.”

It’s not just the top card issuers making changes. Atlanta-based InfiBank, for example, will raise the minimum annual percentage rate it charges nearly all of its customers in September “in order to more effectively manage the profitability of our credit card account portfolio in a very challenging economic environment,” said spokesman Kevin C. Langin.

The flurry of activity, which the banks say is necessary to shore up their revenue losses, has irked members of Congress, who passed a new credit card law, which was signed by President Obama in May. The law, among other things, would prevent card companies from raising rates on existing balances unless the borrower was at least 60 days late and would require the original rate to be restored if payments are received on time for six months. The law would also require banks to get customers’ permission before allowing them to go over their limits, for which they would have to pay a fee.

One hates to think of what additional “help” Congress plans on providing for us in the future.

Support for Federal Reserve Audit Increasing

Last week Cato hosted a policy forum on “Bringing Transparency to the Federal Reserve,” featuring Congressman Ron Paul. As mentioned in CQ Politics, Rep. Paul’s bill, HR 1207, has been gaining considerable momentum in the House, with currently 244 co-sponsors, ranging from John Boehner to John Conyers Jr. In fact, the Senate companion bill was introduced by Senator Bernie Sanders.

Fed Chairman Ben Bernanke discussed the very topic of Federal Reserve Transparency at Cato’s annual monetary conference in the Fall of 2007.

After praising moves toward greater transparency at the Fed, Bernanke argued that “monetary policy makers are public servants whose decisions affect the life of every citizen; consequently, in a democratic society, they have a responsibility to give the people and their elected representatives a full and compelling rationale for the decisions they make.”

Chairman Bernanke also goes on to argue that “improving the public’s understanding of the central bank’s objectives and policy strategies reduces economic and financial uncertainty and thereby allows businesses and households to make more-informed decisions.” Bernanke’s full remarks can be found in the Spring 2008 issue of the Cato Journal.

Over the last two years, we have seen an almost tripling of the Federal Reserve’s balance sheet to $2.3 trillion, resulting from the bailouts of AIG and Bear Stearns and the creation of 14 new lending programs.

Our recent forum, and Rep. Paul’s bill, bring much needed debate and focus to the issue of Fed’s inner-workings.

Gift Cards: What Congress Gives, the States Take Away

Little noticed in the recently enacted credit card bill was a provision prohibiting retailers and financial institutions from issuing gift cards that expired with a set time, except under certain circumstances.  While card issuers had been using expiration dates to estimate and manage their liabilities, many States had been “collecting” the value of these unused cards as “abandoned property”, as discussed in today’s Wall Street Journal.

Some states have even been going after cards with no expiration date, arguing that if you leave that gift card sitting around your house or in your wallet for too long, then you’ve abandoned.  What’s next, funds sitting unused in your bank account will next be considered abandoned.  The States that require unused gift cards, or unused portions, to be turned over require retailer and card processors to maintain databases tracking card amounts and usage.

There is some comfort, however, in knowing that some States do allow you to re-claim your “abandoned gift dollars,” for instance of the $9.6 million collected by New York State last year in unused gift cards, rightful owners were able to recover $2,150.

Consumer Financial Product Commission Distracts from Real Reform

Today the Obama Administration released a 152-page draft bill to create a new Consumer Financial Product Commission. While intended to protect against consumer confusion and reduce the likelihood of future financial crises, the proposed agency will at best have little impact and at worst contribute to the next financial crisis, with the added effect of decreased homeownership and increased litigation.

The president promises that “those ridiculous contracts with pages of fine print that no one can figure out – those things will be a thing of the past,” The president ignores that those “ridiculous contracts” and “fine print” are the result of previous rounds of so-called consumer protections. The disclosures one receives with a mortgage or a credit card are those mandated by some level of government. They don’t call those credit card disclosures a “Schumer Box” because they were invented by a baron of industry. In addition to the government-mandated disclosures that have failed, are the endless amount of fine print added to protect companies from frivolous litigation. The Obama approach to that problem is to increase the amount of litigation.

If the president were serious about avoiding the next housing bubble and financial crisis, he would propose eliminating some of the various federal policies that contributed to the housing bubble. For instance, how about requiring real down payments when the taxpayer is on the hook – as with Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA). Talk about bad incentives; under FHA, a borrower can put almost nothing down and if the loan goes bad, the government covers the lender for 100 percent of their losses.  No wonder we had a housing bubble. In addition, the proposed agency does nothing to address the underlying causes of any type of credit default: unemployment, unexpected health care costs or divorce.

Once again, when given the opportunity to address the real flaws in our financial system, the administration chooses to appease the special interests and provide a distraction from the underlying causes of our current financial crisis.