Posted by Marc Hodak on January 27, 2009 under Executive compensation, Politics | 
The drama over John Thain and Ken Lewis, Merrill Lynch and BofA, and the government’s loan to Wall Street, gets juicier.
Chapter One: Merrill hires Thain to salvage what he can of the troubled hulk. Thain sells off toxic loans to a hedge fund, and then the dolled up Merrill to BofA, for many billions, all just before the fan is hit by a stinking mound.
Having just preserved a boatload of value for his shareholders, Thain wants to make sure his team is rewarded for it. He knows that BofA’s management won’t be sympathetic to getting taken for a ride once they figure it out, and would probably stiff the Merrill team when given the chance, so he pays out bonuses to his guys in advance of the sale.
Chapter Two: BofA’s stiffs Thain. Then they fire him, and unleash a barrage of bad press about him. The media laps it up.
Chapter Three: Enter Andrew Cuomo. Never content to leave criticism of high profile executive compensation to others, Andy subpoenas Thain over the Merrill bonuses. Ahh, the mystery deepens. What is Cuomo alleging? Under what law is he acting? What public interest is he seeking to protect? (Silence.) Oh yeah. Nevermind.
So, while New York state waddles toward its own spectacular bankruptcy due to the epic profligacy and rampant corruption of its legislators, Andy is chasing headlines about the pay of certain executives of a then-completely-non-state-owned company who had just pushed their grateful shareholders out of the way of a hollow-point bullet.
Why doesn’t Cuomo follow the path of his famous predecessor, and go after easier targets?
Posted by Marc Hodak on January 25, 2009 under Economics |
For this quiz, your choices are:
1) Because of his well-articulate vision for a reshaped country
2) Because of deep voter concerns about the state of the economy and strong disapproval of President Bush
3) Because the media was in love with Obama
4) Because he bought it
Would it be redundant to say my money’s on #4?
My favorite aspect of the ’08 election, by far, was the irony that McCain, running as a reformer, was shackled to campaign finance reform spending limits that he himself had created.
Obama, on the other hand, was able to go for the big bucks, outspending McCain 2-to-1. I know, the fact that Obama could ignore spending limits after promising not to do so perhaps points to #3 as a contributing factor. But it still comes down to the cash, baby.
Posted by Marc Hodak on January 23, 2009 under Uncategorized |
One of Obama’s first policies on entering the White House was a freeze on all salaries above $100,000. WaPo estimates that this will save taxpayers about $443,000, which I suppose will help pay for the $825 billion spending package he is considering. But of course the president is not really doing this as a cost savings; he’s making a symbolic gesture, albeit one being paid by his staff. It’s designed to make the nation feel better that other people are suffering along with them. It’s also, no doubt, meant as an example for the greedy businessmen that populate our executive suites.
I don’t know if this is a good idea.
Ordinarily, freezing pay would create retention risk, i.e., it would cause some number of people to leave who might otherwise stay. Presumably, the people who are there now are the best people Obama could find to fill those positions at those salaries, so turnover of those people on the basis of pay makes it likely that they will be replaced by “next best” people. It doesn’t appear that any of the 120 staffers affected by Obama’s order are having second thoughts about joining the White House as a result of this freeze, at least not yet. And turnover would eventually happen at the White House even without a freeze–most of the top people working there are already sacrificing pay relative to what they could make in the private sector. But a freeze makes turnover more likely. So, freezing pay sends a message that Obama doesn’t really care to have the best people working for him.
A company normally loses a little bit of it effectiveness with higher turnover as a result of incrementally poorer business decisions by “next best” employees. That’s not true of every company, of course, but it’s true on average over a large number of competing firms. The White House, being a political entity, loses a little bit of political efficiency. Those who are a bit cynical of the value of government might not think this is a bad thing, but it might be.
It might be that the White House balances the wasteful tendency of the truly, monstrously wasteful arm of government–Congress. If Obama really wanted to control spending, he would have someone study the impact of a better run White House on overall government spending. He might conclude that saving taxpayer dollars actually suggests a raise for White House staffers, in order to get the best people able to check the impulses of Congress. I could be convinced.
Posted by Marc Hodak on January 22, 2009 under Politics |
Apparently, a small Internet bank from Boston wanted to get hold of some of those sweet TARP funds. They approached Massachusetts Congressman Barney Frank, and asked for his assistance. Congressman Frank happens to be Chairman of the House Financial Services Committee. When he was approached by the bank, he told them, “Hey, I wish I could help you, but there are lots of firms like you in Wisconson and California and, well, I really can’t use my position to play favorites. Besides, I am dealing with trying to oversee a few hundred b-b-billion in disbursements, and you really can’t expect me to spend any mind space pushing for a $12 million loan, right?”
Pause.
Hahahahahahahahahahahaahahahahahahahahahahahahahaahhaaahh.
Ha.
OK, now that we’ve got that out of our system, you can read the real story, here.
At least someone is writing the story, because I think the story that businessmen are greedy isn’t really any more interesting, at least to me, than the story that politicians are political. Businessmen at least have to convince the people providing them money to voluntarily part with it, even if they’re lying and scheming to do so. Politicians don’t have that particular funding problem–they simply “ask” the taxpayers. The fundraising problem for politicians is getting support for their elections so they can keep their power. And if you’re the head of the Financial Services Committee, guess where that support is likely to come from?
All this, by the way, is not meant to blame Congressman Frank. He’s being rational, too. And legal.
Posted by Marc Hodak on January 19, 2009 under History |
to 
This is a fine couple of days to reflect on the transformation that has happened in my own lifetime from “Whites Only” signs to a black president. Today we praise the contribution of Martin Luther King, Jr. in the transformation that today makes old pictures of those signs seem as if they belonged to an alien civilization. Tomorrow we inaugurate a man who was judged by his fellow citizens on the content of his character.
Posted by Marc Hodak on January 17, 2009 under Collectivist instinct |
After Friday’s spectacular ditching and rescue of US Airways flight 1549, you’d think the safety nannies would be all smiles. The training of pilot and crew kicked in, and all 150 passengers were saved. Yet, the sub-header in today’s WSJ is:
US Airways Crew’s Lifesaving Role Bolsters Regulators’ Push for New Safety Rules
What would the regulators be pushing if the crew did not succeed?
Posted by Marc Hodak on January 14, 2009 under Invisible trade-offs, Unintended consequences |
Why, they create regulations, of course. But to what end? The nominal purpose of regulations is to create the impression of increased safety or security. For instance, regulating workplace safety nominally gets us safer workplaces. Regulating food safety nominally gets us safer food. Regulating financial service providers is supposed to make the markets safer for various participants. People vote for regulations because it makes them feel safer.
Of course, one would hope that regulations create more than the impression of safety. People want and expect that the safety is real. Goodness knows, the costs of regulation are real–one would hope we are getting the benefits.
Larry Ribstein notes a great example of how the impression of safety can actually create greater danger. When the SEC, the promulgators and enforcers of securities regulation, investigated then signed off on Madoff’s fund, they became an unwitting accessory to the confidence game that Madoff was playing with his clients. In the case of the Swiss bank UPB, the SEC literally created confidence in an operation the bank would have otherwise treated with suspicion, costing their clients hundreds of millions of dollars.
Economically speaking, one would like the benefits of regulation to be greater than the costs. Unfortunately, these things are difficult to measure. The benefits are largely speculative, e.g., accidents that don’t happen, while the costs are relatively dispersed, e.g., a few dollars per item that may be sold by the millions. The lesson, here, is that there is another cost–the cost of misplaced confidence. If one believes that someone else is bearing the monitoring and other costs to improve their safety, then one is likely to save on those costs for themselves. It’s easy to visualize that for every extra dollar I am forced to spend for regulatory compliance for a particular product, I might save a dollar or more that I would have otherwise spent for the Good Housekeeping seal on that product. In other words, by taking on the regulation of a product or sector, the government is socializing costs that would have been otherwise borne by private actors, possibly with a net negative effect.
I don’t rely on any private tester of milk or beef because the USDA is certifying it for me. I know that the SEC is watching over registered brokers and other market agents, so I can trust them. Even if I thought the regulators did an inferior job versus a private certificate of approval, I’m not going to pay double for the inspection. Government regulation will generally crowd out private regulation.
In the case of Madoff, UPB bore the private costs of regulation, but they also knew that the SEC actually looked into the fund’s operations, and gave it an OK. Absent that OK, the bank would have relied on its internal analysts who were sounding warnings about Madoff’s fund.
Unfortunately, these kinds of regulatory embarrassments rarely improve regulation. They more often end up increasing the costs of regulation on a thousand perfectly good firms for every crooked one out there, which can easily be a net drain on social welfare. And then, the government enhances confidence among the credulous voters who have somehow come to believe in the effectiveness of government.
Then, another $50 billion goes poof. And the regulators use that as proof that they don’t yet have enough money and power.
Posted by Marc Hodak on January 12, 2009 under Executive compensation |
The rumblings have been clear for a while now. This year will be big for activism on executive compensation.
The biggest complaint is “managers who walked away from the financial crisis with tens of millions of dollars despite big shareholder losses.” While some of this reaction references managers who were paid last year for performance that turned out to be unsustained, much of the reaction is to managers who left with huge “severances.”
The fact is that most of those severances were not really severances in the traditional sense of being paid to leave; they were deferred compensation that was earned in prior years and left in the company, and accumulated pension and other benefits after years or decades of service.
The main proponents of the compensation proposals are, naturally, the unions. The United Brotherhood of Carpenters and Joiners has submitted 23 resolutions to financial services firms. American Federation of State, County and Municipal Employees has submitted 36 proposals, 32 of which address pay practices. The proposals include ideas like having stock options indexed to peer performance, forcing managers to hold onto their equity until two years after retirement, and “bonus banking,” in which a portion of executives’ annual bonuses would be withheld for several years, and adjusted based on updated corporate results.
This last suggestion is actually a particularly powerful way to eliminate the short-termism that permeates much of corporate America. We advocate a version of bonus banking for most of our clients, and have implemented it at a number of them.
None of these suggestions are bad ideas for a board to consider. As specific shareholder resolutions, however, they attempt to force the hand of directors. We wouldn’t dream of giving shareholders a voice in any other kind of strategy; why do they merit one when it comes to compensation strategy?
Boards, in order to be effective, must be free to consider all trade-offs in making compensation decisions. For example, bonus banking can be a good idea, but it is expensive. Consider telling the union, “we’re going to take half of your pay, and keep it banked for three years, then pay it out later, if you’re still with us.” Right. Then add, “by the way, that amount is at risk. We’ll only pay it if we can afford to.” Riiiiiight.
Unions aren’t the only people who negotiate risk averse contracts. Whenever we’ve successfully implemented a bonus bank, we’ve had to offer higher target compensation in return for the extra deferral and risk. If we didn’t, we would have been taking on additional risk of losing the manager because, unlike union employees who could not possibly find other jobs at the rates they are being paid, managers can. That’s because of the most uncomfortable fact that union workers are paid way above market while managers are not, contrary to the impression given by the media.
But it’s easy to see whose side the media is on in all these stories about executive pay. In the WSJ article cited here, they spent eight paragraphs on the complaints before they got to the thee paragraphs defending what is going on. The WSJ is supposedly a business newspaper.
Posted by Marc Hodak on January 9, 2009 under Economics |
Yesterday, the Commonwealth Fund report was summarized under the headline “Health care overhaul needn’t break bank: study.” OK.
Of course health care overhaul doesn’t need to break the bank. Private sector firms overhaul their operations all the time, and it usually leads to some combination of improved service or lower costs. But the government is not a private sector entity. Social Security didn’t need to break the bank, but it has, several times. After two major overhauls, it’s liabilities still exceed its assets by nearly $9 trillion. We can’t even count that high on every finger and toe of every human that has ever lived. Medicare didn’t need to break the bank, yet it’s liabilities now exceed its assets by over $31 trillion.
If a company kept promising viable businesses, and kept going bankrupt, what weight would an economist accord to the idea that its next business idea did not need to go bankrupt?
The Federal government, of course, is not bankrupt yet. Unlike a bad business, the government can continue to take money from it’s “customers” by bundling bad businesses with social necessities, such as law and order. The government can take away our choice about which services we wish to pay for from this bundle and, in an increasing number of cases, which services we wish to use. If a private company had that kind of power, what would be the odds that it would even try to run its business efficiently? But such considerations are credulously left out of the assessment that a huge new government program “doesn’t need to break the bank.”
The worst part of this study, proffered by a supposedly economically sophisticated firm, is not even its ignorance of public choice constraints, but that it’s just bad economics. It’s not an economic analysis to say that if John pays Karen $90 instead of $100, then Karen will continue to offer the same benefit to John in the future. No health care proposal is complete, or even meaningful, without addressing all three major health care trade-offs: accessibility, cost, and quality.
The Commonwealth Fund’s report only addresses the trade-off between cost and access. The impact on quality is ignored. Personally, I would like to think that cancer treatments will be better as I get older, rather than the same or worse than now. That will almost certainly not be the case when the world’s last bastion of innovation is throttled by mandates that increase access without raising costs. The laws of economics are not subject to legislative amendment.
Posted by Marc Hodak on January 5, 2009 under Executive compensation |
Robert Frank, to whom I have been less than gracious on this page, today pays me the highest compliment. In an article about CEO pay, he notes that:
In large companies, even small differences in managerial talent can make an enormous difference. Consider a company with $10 billion in annual earnings that has narrowed its C.E.O. search to two finalists. If one would make just a handful of better decisions each year than the other, the company’s annual earnings might easily be 3 percent — or $30 million — higher under the better candidate’s leadership… That’s why companies where executive decisions have the greatest impact tend to outbid others in hiring the ablest managers.
Sound familiar? Here is what his NYU colleague said last May:
Consider that the average S&P 500 company has a market value on the order of $10 billion. If one had to choose among CEO candidates, and the board believed that one candidate’s leadership was likely to yield a return on capital just one percentage point better than the next best candidate’s, that difference would be worth $100 million per year to investors. A conscientious board with the shareholder’s interests at heart could hardly risk letting the best candidate go elsewhere over even a few tens of millions of dollars.
Thanks Bob. I feel bad now about the other thing.
