Curbing a few bankers’ earnings is a small price

By John Gapper

The New Yorker once carried a cartoon of a man in a suit talking on the telephone: “No, Thursday’s out. How about never – is never good for you?” he was asking.

These days, I imagine that man as a federal regulator talking to the head of an investment bank: “No, a $30m bonus is out. How about nothing – is nothing good for you?”

Who would not like to be that regulator, getting the chance finally to tell a master of the universe that he must step off his private jet and take his place in normal society? Not many, I think.

Barack Obama’s decision to impose a salary cap of $500,000 (€388,000, £350,000) on the senior executives of financial institutions, including Wall Street banks, that need public money to prop themselves up is rough justice. There are objections, from the undesirability of politicians fixing wages to the barriers it could erect to financial recovery.

Ultimately, however, none of this matters because, rough as it is, it is also justice. The average US taxpayer, who earns $40,000 a year, has been asked to rescue institutions that he distrusts and resents, which have helped to bring chaos to the global economy. If the price of bail-outs being approved is some wage caps, the price must be paid.

For some time, a number of investment bankers (not all, it must be noted) have resembled cartoon characters who have run over the edge of cliffs and failed to notice that the ground beneath has disappeared. They have continued to fly in private jets and to divide up a large bonus pool among their staff.

There were two possible reactions to the disclosure last week that bonuses for financial services employees in New York had fallen 44 per cent from $33bn in 2007 to $18.4bn last year. One was the insiders’ perspective – that times are clearly tough. The other was the outsiders’ view – that $18.4bn is still a vast sum of money.

Claire McCaskill, a Democratic senator, spoke for most people outside Wall Street when she asked rhetorically: “What planet are these people on?” That indignation is even shared by chief executives of non-financial companies who are upset at being caught in a popular backlash against something for which they were not responsible.

The flaw in Mr Obama’s plan was summed up on Tuesday by Jamie Dimon, chief executive of JPMorgan Chase, who said that someone who took on a tough, intractable but vital job (which he dubbed “Vietnam”) needed to be rewarded.

Nobody thinks that the Wall Street executives who got their banks into trouble deserve big rewards. But what about those brought in afterwards to clean up the mess? If Citigroup, for example, decides to recruit a new chief executive in place of Vikram Pandit, what are its chances of catching the best leader?

Clearly, the job is risky since Citi could end up being nationalised, which would damage the executive’s reputation. In the past, people who have taken on such high-risk and difficult jobs got performance-based rewards that meant they were paid very well for success.

With a salary cap of $500,000, any potential CEO who is not rich already, and therefore available for a spot of public service, might choose to hang out for a job elsewhere. Within investment banks, it could pay to stay at the level below the salary-capped senior executive group.

These objections are reasonable but insufficient, for two reasons.

First, the plan unveiled on Wednesday by Tim Geithner, the Treasury secretary, is less draconian than it sounds. The $500,000 cap is only compulsory for the institutions in the worst trouble and only if they apply for more money than they have already been given.

Furthermore, it preserves the principle outlined earlier by Larry Summers, director of the National Economic Council, that senior executives can be paid more than $500,000 in stock, provided that this equity vests only after the bank he or she runs has recovered and has repaid the taxpayer.

In other words, there is still the chance of a private equity-like reward structure in which a restructuring expert gets paid relatively little for three or four years but gets a big reward in the end.

Second, politics is the art of the possible. Most US voters, if the issue had been put to a referendum, might reluctantly have kicked in money for Detroit’s auto companies but would have spurned a Wall Street bail-out. That is dangerous, since banks, love them or hate them, must be there to lend money for recovery.

The voters have now accepted this point but they remain extremely angry. It would not take many more provocations for them to take back their permission, at which point the US economy and financial system would plunge into crisis.

A few poorer bankers is a small price to pay for Mr Obama being able to maintain popular backing for his support programme. Even if the worst occurs and the most troubled banks end up being managed as boringly as utilities by mediocre executives, that is better than nothing.

The last conclusion I draw from Wednesday’s crackdown is that it is a shame. It was originally a shame that investment and commercial bankers, spurred on by a distorted bonus structure, rushed into taking risks that forced governments to step in and bail them out.

It is now a shame that, having done so, too few of them realised things would be different from that moment on. They could have avoided a second round of government intervention aimed directly at their wallets if they had reacted more quickly and smartly.

Instead, they have had to be told what is good for them.