Executive Compensation (Part I): Systemic Risk

In the wake of the financial crisis, according to the Huffington Post, “a number of the nation's largest banks were excused from the government's rescue program before they had returned to a position of complete financial security -- in part because they wanted to avoid restrictions on how much their executives would get paid, according to a new report from the program's government overseer. Citigroup, Wells Fargo, PNC and Bank of America successfully lobbied to leave the federal bailout program early in 2009, even though the Federal Reserve Board and the Federal Deposit Insurance Corporation had recommended they take additional steps to shore up their assets, according to a new report from the Special Inspector General for the Troubled Relief Asset Program, a government watchdog office. Regulators, including the Treasury and the Federal Reserve Board, eventually ‘relaxed’ their criteria for letting the banks out of the program, the report says, leaving questions about whether the banks had strengthened their holdings enough to be able to withstand another systemic crisis.”[1]

The Huffington Post reports that according to SIGTARP, in 2009, the “four banks repeatedly tried to leave the bailout program, also known as TARP, ahead of schedule, claiming that the stigma attached to the bailout would damage investor confidence in their stability. Bank of America was especially persistent, submitting 11 separate exit proposals to the Federal Reserve Board in less than a month. The banks, particularly Citigroup and Bank of America, also expressed concern that if they stayed in TARP, they would be subject to the program's restrictions on executive compensation.

"Ultimately, the federal banking regulators ended up bowing to pressure" to let the banks leave early, said Christy Romero, Acting Special Inspector General for TARP and the author of the report. Romero added that in the event of another shock, many banks could be left with too little capital to endure, raising the possibility that "it could potentially trigger an avalanche of severe consequences to the broader economy." As a result of the regulators’ lenience, Romero told The Huffington Post, the financial system is still carrying considerable systemic risk from huge, interconnected banks, well after the meltdown of 2008. "The institutions that were 'too big to fail' ... are bigger than they were before," said Romero. "It's very critical that regulators remain vigilant to banks' demands to relax capital requirements."[2]

In short, the U.S. Government and its central bank, the Federal Reserve, acquiesced on bank executive’s desire for more (i.e., greed) at the expense of reducing systemic risk. That the bankers presumed themselves as being in a position to lobby—especially to obviate compensation restrictions —given the roles played by the banks in the mortgage securities crisis, is astounding, as is the obsequious reaction of the regulators. The dynamic itself evinces the U.S. as a plutocracy rather than as representative democracies. Furthermore, the motive of the bankers demonstrates a continued fixation on gain at the expense not only of the system (i.e., systemic risk), but also of stockholders. 

See Essays on the Financial Crisis.

1. Alexander Eichler, “BofA, Wells Fargo, Citigroup Left TARP Early to Avoid Restrictions on Executive Pay,” The Huffington Post, September 30, 2011.

2, Ibid.

On the Unfairness of the Bonus System on Wall Street

Craig A. Dubow, Gannett’s former chief executive, had a short six-year tenure that was, by most accounts according to The New York Times, “a disaster.” David Carr reports: “Gannett’s stock price declined to about $10 a share from a high of $75 the day after [Dubow] took over; the number of employees at Gannett plummeted to 32,000 from about 52,000, resulting in a remarkable diminution in journalistic boots on the ground at the 82 newspapers the company owns. . . .  the company strip-mined its newspapers in search of earnings, leaving many communities with far less original, serious reporting. . . . Not only did Mr. Dubow retire under his own power because of health reasons, he got a mash note from Marjorie Magner, a member of Gannett’s board, who said without irony that ‘Craig championed our consumers and their ever-changing needs for news and information.’ But the board gave him far more than undeserved plaudits. Mr. Dubow walked out the door with just under $37.1 million in retirement, health and disability benefits. That comes on top of a combined $16 million in salary and bonuses in the last two years.”

Besides the inherent unfairness in an incompetent manager getting millions of dollars in compensation (for championing incompetence?), it is morally problematic when, as Carr puts it, “the consequences of bad decisions land on everyone except those who made them.” As already pointed out above, in the midst of Dubow’s “championing” (this word is so broad it has scarce any real meaning), “the number of employees at Gannett plummeted to 32,000 from about 52,000.” One could just as easily point to Bank of America’s downsizing of its labor force in the wake of Ken Lewis’ shopping spree at Countrywide and Merrill Lynch. Lewis really did exemplify the “walmart” mentality applied to banking: an almost-complete indifference to quality in a desire to be everything to everyone. The “exporting” of bad consequences while exuberant rewards are retained indicates that the corporate executive compensation system in the United States is fundamentally broken. The fixation on aligning an executive’s incentives with the financial enrichment of the stockholders has not functioned as anticipated.

For one thing, the vesting of stock, which is meant to orient an executive to the longer term financial interest of the stockholders, is typically bypassed as an executive gets the equivalent in cash (or stock) from his or her new employer. An executive can thus discount having to look out for the eventual downside in his or her decisions.

Moreover, the sheer amount of the compensation cannot be justified on the basis of a competitive upper echelons labor market (which functions more like an oligarchy). Indeed, the degree of fixation on the bonus system alone has resulted in larger payouts (as executives make decisions primarily from the standpoint of the impact on their bonus). David Carr points to the excess as mentioned in a USA Today editorial: “The bonus system has gone beyond a means of rewarding talent and is now Wall Street’s primary business. Institutions take huge gambles because the short-term returns are a rationale for their rich payouts. But even when the consequences of their risky behavior come back to haunt them, they still pay huge bonuses.” Carr’s overall point is that this hypertrophy allies to corporate America—not just Wall Street, though certainly it is salient there too.

When John Thain of Merrill Lynch gave lip-service to serving the stockholders, even his own subordinates knew he was more concerned with having to play second fiddle to Ken Lewis at Bank of America than with keeping Merrill’s stockholders from losing everything (as Lehman Brothers’ stockholders did). Even as Fleming got $29 per share as a buyout price from Lewis, Thain preferred a line of credit of billions from Goldman Sachs in exchange for a 10% ownership that would keep Thain on top. That was Thain’s driving motivation: to remain CEO. Meanwhile, the general public assumed that CEOs, including Thain, were motivated to act in their stockholder interests—that boards of directors insisted on this agency. However, where a CEO is focused on his or her bonus (Thain insisted on $40 million cash bonus even as Merrill was losing billions) and position (and thus future bonuses) and the CEO controls “his or her” board, the stockholders are in actuality left unknowingly fluttering in the wind—relying on a system of executive compensation that supposedly aligns the executives’ motivation with the financial interests of the stockholders. Much too much is being assumed here, yet assumptions, like habits, are difficult to break.

Source:

 David Carr, “Why Not Occupy Newsrooms?” The New York Times, October 24, 2011. http://www.nytimes.com/2011/10/24/business/media/why-not-occupy-newsrooms.html

Fraudulent Foreclosures

Looking at foreclosures from 2008 to 2010 of federally-backed mortgages serviced by five major banks, federal investigators at the Department of Housing and Urban Development (HUD) found that bank managers “ignored widespread errors in the foreclosure process, in some cases instructing employees to adopt make-believe titles and speed documents through the system despite internal objections.” Generally, the banks engaged “in a pattern of unfair and deceptive practices.”[1] This finding contradicts the self-serving statements by managers at the banks that blamed low-level employees. The investigation found that the managers had actually been the active agents. That is, the shortcuts were in many cases formulated and directed by managers. The inspector general at HUD pointed to “simple greed” to explain how so many people could have participated in the misconduct.[2] Considering that millions of Americans were tossed out of their homes as a result, I would sociopathic indifference or even callousness to the mix. Additionally, the rush to sign documents may have undercut the banks’ own positions with respect to both the foreclosure process and the homeowners—adding incompetence to the mix.

                  Four million foreclosures in the US during the 2007-2011 period.      Spencer Platt/Getty

The full essay is in Cases of Unethical Business, available in print and as an ebook at Amazon.com.  

1. Nelson Schwartz and J.B. Silver-Greenberg, “Bank Officials Cited in Churn of Foreclosures,” The New York Times, March 13, 2012.

2. Ibid.