Congress creates strong incentives for bankers

Posted by Marc Hodak on February 15, 2009 under Executive compensation, Politics, Stupid laws | 5 Comments to Read

…to leave the TARP program as soon as possible.

And Obama is not a happy camper.  The bill that finally passed Congress yesterday included a couple of items that his advisors neither asked for nor wanted.  They would have been OK with the restrictions on “unnecessary and excessive risks.”  They were fine with the clawbacks and the elimination of golden parachutes.  They were happy about the limits on corporate jets and office redecoration, and the imposition of “Say on Pay.”  But the bonus limits caught them by surprise.

Basically, no officer can get a bonus that exceeds half of his or her salary, and that bonus can only be in the form of stock that doesn’t vest as long as the firm remains on TARP.  So, Vik Pandit, who has sworn to only take $1 in salary now has a bonus opportunity of 50 cents.  That will lend a whole new meaning to “fighting for that extra penny” at the end of each quarter.  The bill nominally imposes these limits on up to the top 20 “most highly-compensated employees” (on top of the five “senior officers”).

Now, here is where having a logic- and math-challenged Congress really begins to hurt.

The bill does not specify that the “highest-compensated employees” be a subset of “senior officers,” which is defined in the legislation.  The law just says “employees.”  Therefore, every employee at a major bank is limited to a bonus that does not bring their total compensation higher than 150 percent of the salary of the 20th highest salaried employee.

So, if Goldman’s 25th highest salaried employee under the new TARP regime makes $500,000, then that person’s total compensation can be no more than that salary plus $250,000 worth of restricted stock (unable to vest until Goldman goes off TARP).  Therefore, no banker, trader, or anyone else can earn a bonus that places them above that limit without they, themselves, becoming the 20th highest-paid employee, at which point, their bonus must revert to half of their salary (in restricted stock), which would once again place them well below the 20th highest-compensated employee, etc.  The end result is that the best-performing bankers and traders in the whole firm will be limited to total compensation of $750,000.  So, the first thing we should expect to see is a rapid increase in salaries of TARP firms.

But Dodd placed one more nugget in this law that the executive branch didn’t expect.  The TARP investment in the major banks had to be held for at least three years, and could only be repaid with capital from other sources.  The law now allows the banks to repay TARP funds “without regard to whether the financial institution has replaced such funds from any other source or to any waiting period.”

So, Congress has basically created a powerful incentive for any bank that really doesn’t need any of this crap cash to promptly check out of the whole morass.  They are then free to go on a hiring binge for the top talent of their shackled competitors.

I really don’t see Geithner being willing to let Goldman wander off the range, where they can safely deleverage without carping about “what are you doing with our cash,” and proceed to eviscerate their competition.  But this law encourages and enables them to do just that, and it ties his hands in preventing it.

Obama signs this law on Tuesday.  I expect an announcement from Goldman on Wednesday.