This morning we ran Lucian Bebchuck’s case against the new limits on compensation at financial firms that take bailout bucks. Bebchuck makes a persuasive case that the new limits foisted on Obama’s stimulus bill will be both unfair and counter-productive: they may actually convince bankers to risk their firms by attempting to pay back the TARP despite weak balance sheets, putting the entire financial system at risk in order to increase their own upside. One of our favourite commenters, Larry Ribstein, has called the pay caps blindingly stupid.
But some of the problems addressed by Bebchuck and Ribstein have relatively easy fixes. We don’t have to allow banks with weak balance sheets to pay back the TARP. In fact, mandatory bailouts for “too big/connected to fail” banking institutions seems to be precisely what Treasury Elf Tim Geithner is contemplating when he discusses regulatory stress tests. In short, there’s no reason we have to let bankers risk their firms this way.
The broader point made against pay caps is that they will drive talent away from troubled firms. But this point seems exactly backward: we don’t want government bailouts trapping the best and brightest in failed firms. The opportunity costs of keeping good assets–smart people–in bad banks is enormous. Why not use the TARP to break the golden handcuffs that have trapped so many intelligent people inside investment banks?
In a sense, it’s the photographic negative of bad banks hanging onto bad assets because they don’t want to suffer the consequences of selling them at market prices. In the same way, banks want to use TARP money to pay bonuses because they want to avoid the market consequences of their own failure.
It’s true that firms will likely fail if their best people leave. That is true of any company, however. The goal of the TARP, and every subsequent bailout, was supposedly to prevent a disorderly dissolution of the financial system. An orderly exit of talented people could well lead to the orderly liquidation of failed firms.
Keep in mind that these people who would leave the failed banks would not simply vanish. Some would probably take up other occupations altogether, most likely to the benefit of those fields. Others, however, would simply start new firms or join successful ones. This market process would only make our financial industry healthy.
In short, Bebchuck’s criticism of the pay caps makes sense if your goal is to keep alive failed firms that are on TARP money. But if your goal is different–to preserve the financial system while allowing for failure, for example–pay caps make much more sense. The pay caps in the stimulus bill may be too blunt to accomplish the goals but that is no reason to conclude that it is unreasonable to seek ways to avoid paying bankers with taxpayer money.