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Why executive compensation should be on the table

Political blogger Ezra Klein says that making limiting executive compensation a part of the bailout plan is scam.

I disagree.

Most critics argue that penalizing the companies involved serves no good outside of providing catharsis for the taxpayers required to fit the bill. Fed chairman Benjamin Bernanke and Secretary of the Treasury Henry Paulson argue that penalizing executives will make it more likely that companies will opt out of the plan.

The point of penalizing the companies by limiting executive compensation or through other measures is to keep them out of the plan if they don’t really need to be in it. The basic idea of the bailout plan is that the federal government will purchase debt from banks at some price above the market clearing price. These companies are failing because they hold assets (in the form of securities and derivatives) that nobody knows how to value right now. The government is expected to buy them at roughly the price that the failing banks paid.

If there are no penalties for participating in the bailout program, then every single bank will sell all of its questionable assets to the federal government. Why wouldn’t they? I imagine if the government announced that they were buying up all of the used cars in the country for the original sticker price, there would be no shortage of participants.

Even a very strong bank with a little bad debt should sell off that debt just to cheaply lower its risk. So for this thing to work at all, it has to suck (badly) for a bank to participate in the bailout program.

The bailout is corporate welfare. Welfare is supposed to be for people who have no other option. I don’t know whether limiting executive compensation is the right penalty for participating companies, but some penalties are essential or this is just a handout.

3 Comments

  1. Rafe, excellent post. I agree that any solution needs to suck for the banks that choose to participate. It needs to suck enough that companies aren’t at a competitive disadvantage if they don’t participate. Why did all the airlines dump their pension plans on the government? It’s simple. Once one was allowed to without penalty, it became a competitive disadvantage to keep your pension plan. The same mistake needs not be repeated.

  2. Yeah — I’ve heard “keep it broad” as a way to keep from penalizing the companies that didn’t make stupid and risky loans, but if you put some penalty into the bailout, then you accomplish the same thing — you save the stupid companies, but they suffer some kind of consequences too.

  3. Couldn’t agree more with Rafe here.

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