Saturday, January 31, 2009

Bonuses and Regulation

Barack Obama used his weekly radio address to reinforce yesterday's sharp discontent with unrealistic (should we say "bloodsucking?") bonuses in the financial sector. Deutsche Press-Agentur (courtesy of Monsters and Critics) reported today's remarks as follows:

Obama also reiterated his criticism of bonuses paid to company chiefs in the past year despite the precarious economic situation. 'We'll ensure that CEOs are not draining funds that should be advancing our recovery.'

The obvious question is whether or not such abuse can be controlled through regulation. The latest New York Review has a piece written by Jeff Madrick on January 14 ("How We Were Ruined & What We Can Do"), which devotes a paragraph to this question:

Any regulation should also take account of the incentives for manages to take company risk for personal benefit. The ability to take immediate profits from fees on risky loans infected the financial industry and eventually the entire economy, and made possible disproportionately large annual bonuses. These incentives were among the main causes of the irresponsibility on Wall Street. The best way to prevent that from occurring is to base the bonuses and compensation of financial executives on the long-term profitability of the investment firms for which they work.

This kind of thinking is sure to raise howls from the high priests of free markets, but it is hard for them to make a case for the market punishing foolish decisions made in the name of nothing other than personal greed in this particular situation. Nevertheless, we have to wonder just how powerful the "greed lobby" will be. It is easy enough to assume that both Executive and Legislative branches will be made aware of Madrick's position statement; but it is just as easy to assume that those who cashed in on those bonuses will be applying some of their ill-gotten gains to maintaining this small corner of status quo. Invoking the rhetorical wrath of the President of the United States is a small price to pay if the rest of that money remains in your pocket. (This might be called "bribery logic.")

The overall message of Madrick's article informs us that recovery will be complicated but can still be feasible in spite of this complexity. Neither Obama nor members of the Congress will be able to "sell" recovery measures to the electorate on the basis of such complexity. It will be necessary to drive some stakes in the ground, even if they are largely symbolic, to demonstrate that progress has being made in ways that Main Street will appreciate. In choosing to go after those bonuses, Obama has probably chosen a good stake; since those bonuses are likely to aggravate just about everyone except their beneficiaries. If this means that our government decides to make "a Federal case" (as it were) out of reforming compensation practices in the financial sector, then I am all for a regulatory framework that can stand up free-market complainers in favor of everyone else looking for signs of repair.

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