It’s a problem from Hell. Taxpayer funds have been promised to support banks around the world in hopes that the banks will make loans that will ameliorate the global economic depression. But taxpayers are understandably outraged when bank executives receive huge bonuses and salaries that, in the last analysis, are financed by tax dollars. So what to do?
In the US, one hard and fast rule was put in place in connection with the bailout bill—disallowing corporate tax write-offs compensation above $500,000. This penalizes companies—and shareholders—that pay huge amounts but doesn’t seem to have created a serious obstacle to big payouts. Mainly, we seem to have settled on a kind of pseudo-regulatory rule: lawmakers and regulators—think Andrew Cuomo—threatening investigations if compensation seems excessive.
It’s still unclear whether this is working—last year Goldman paid out $11 billion in bonuses after taking $10 billion in TARP money. It mystically says that TARP funds weren’t used to pay bonuses, as if money weren’t fungible or the TARP had been paid in market bills. It also, somehow or another, reduced its tax rate despite being subject to that $500,000 tax penalty.
In Germany, lawmakers tried to pay a bit harder with the bonus question by telling bankers that if they accepted government money their salaries would be capped at 500,000 euros. According to finance professor Hans-Werner Sinn, bankers simply chose to go it alone, refuse government money, get paid lots of money personally, and shore up their balance sheets by slowing down lending.
To stabilise their balance sheets, German banks have the choice of issuing new equity or reducing their business volume in proportion to their write-offs. In light of the low value of bank stocks, it is difficult to raise equity. The lowering of business volume via a fall in the amount of credit that is taken on and lent out will be inevitable. For an economy dependent on banks to finance investment, this means the danger of a domestic credit crunch and a transfer of the banking crisis to the real economy.
According to a recent Ifo survey, 39 per cent of all companies already complain about credit constraints. Concerns about access to capital are rising sharply, in particular in large corporations whose credit demands cannot be satisfied by Germany’s savings banks, which are protected by the state.
The German rescue plan is intended to prevent a credit crunch by making available to the banks government equity of up to €80bn, which represents about a fifth of the equity the banks held in the summer. The state has intervened as a stockholder in the banks to prevent them from collapsing and to enable them to maintain their levels of lending. In addition, the state has offered itself as guarantor of debt to make it easier for banks to borrow. The government is also prepared to purchase their toxic securities, with more than €400bn made available for this end.
Berlin has tied its aid to a number of conditions, which are now being defined in statutory orders. One of the conditions that is causing problems for the banks is the decision to limit the salaries of top management to €500,000 a year. This condition will not undermine insolvency protections, since before a bank goes bankrupt it will take advantage of the government funds. However, it will prevent banks that are weak but not threatened with bankruptcy from taking on government equity. Faced with the choice of reducing business or seeking to return to previous volumes by accepting government equity, bank executives will opt for the first alternative in order to avoid cutting their own salaries.
You can see why this is a problem from Hell: we’re trying to manage an economy, achieve higher levels of lending and lower banking compensation through government rules. It’s price fixing on a grand scale and there’s little evidence that there is an appropriate government fix here. We chose—or, rather, our lawmakers and regulators chose—to abandon market processes for these things. Now we’re stuck with choices that all seem unworkable, mired in politics and fraught with nasty unintended consequences.
Oh, hey. Happy New Year!
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