Wall Street Welfare Reform

By the time a good idea makes it to Congress — and actually gets some serious consideration — it is no longer an idea whose time has come, but one whose time is way overdue. Such is the case as Congress takes up the issue of CEO pay [1], while staring in the face yet another expensive, and all but inevitable, taxpayer-financed corporate bailout.

Democrats and Republicans queasy about a federal rescue of mortgage giants Fannie Mae and Freddie Mac are coalescing around the idea of letting the government slap limits on the multimillion-dollar pay packages of their executives.

Seems reasonable, at a time when the government — with funds provided by you and me — is stepping in with a bailout that could cost upwards of $25 billion [2], and even $100 billion. It seems even more reasonable when considered alongside the reality that Freddie Mac's CEO made around $19.8 million in compensation even after the company's stock lost half its value. Fannie Mae's CEO didn't do so bad either, with a $12.2 million paycheck and a $2.2 million bonus.

Earlier this year, Congress dragged three of the biggest "subprime CEOs" in [3] for a good talking-to about their compensation packages, which they got even after running their companies aground in mess that Congress is now attempting to clean-up with tax-payer dollars. (For example, Countrywide's Angelo Mozillo got bout $22.1 million 2007 [4], and about $10 million in stock [5] on his way out the door, when his company was sold to Bank of America in a sale approved by the Fed [6]. Bear Stearns' James Cayne made about $232 million [7] during the years his firm helped drive the subprime debacle, and got out just before the Fed ponied up guarantees of $30 billion to bet J.P. Morgan to buy it.) As far as anyone knows, the CEOs left with their ears burning, but their paychecks pretty much intact.

Earlier this month, Jack and Suzy Welch [8] had this to say about CEO paychecks in their column at Businessweek.

Now, is this free-market system of pay perfect? Absolutely not, which is why underperforming CEOs sometimes end up getting huge sums of money just to go home. While such situations enrage many, they can be hard to avoid, given market dynamics. Some chief executives—Carly Fiorina at HP (HPQ), for example—are given large severance deals at the front end as an incentive to sign on. Other CEOs, such as Chuck Prince at Citigroup (C) and Stan O'Neal at Merrill Lynch (MER), exited their troubled companies with more money than some people liked because of stock grants and compensation earned over many years when results were good. Such endings look wrong and quite understandably give critics a platform.

But from where we stand, no overall system of setting pay is better than the free market. Indeed, one of the best things about it is that it rewards companies that perform well, and those tend to be the talent magnets that pay everyone well, from the CEO to the front lines. Moreover, there's just no better alternative. Government involvement? Forget it! What a mess that would be, with grandstanding politicians vying to outdo each other with vows of putting chief executives in the poorhouse and CEOs (and their lawyers) appearing at Capitol Hill hearings every year to explain their business models, describe their competitive situations, and defend pay packages as they relate to both. Now there's a productive use of everyone's time!

Yeah, but the government is already involved the tune of hundreds of billion, between bailouts and extending loans to Wall Street [9]. It turns out that the free market isn't all that free. In some rather well known cases, the government steps in and rewards companies that don't perform well with bailouts rather than just letting them fail. In a true "free market" companies that made disastrous financial decisions would simply cease to exist [10].

If we were truly a capitalist society Chrysler would not exist today, making cars that don't sell. It would have gone out of business decades ago. By passing the $1.5 billion "Chrysler Corporation Loan Guarantee Act of 1979," Congress allowed Chrysler to avoid bankruptcy, stay in business, and save jobs.

However one feels about the Chrysler bailout, it was not capitalism. But recent Wall Street financial fiascos may cause us to long for the return of the Chrysler K-car.

Congress is now on the verge of bailing out Fannie Mae and Freddie Mac, the government created but privately owned, profit-making housing finance companies responsible for nearly half of the U.S. mortgage market. Collectively, they own or guarantee an estimated $5 trillion of debt.

But Fannie and Freddie, even after their bookkeeping boo-boos in 2004 [11], ignored warnings of their impending implosion [11]. The $200 million spent in lobbying and campaign contributions [12], over the past decade, bought them enough influence to deflect critics who demanded more power government regulators to set capital requirements for the two mortgage giants. Now, Freddie/Fannie/Bear/(fill-in-the-blank-with-the-next-bailout-recipient) had to be bailed out because they're "too big to fail." [13]

In the narrative that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government's job description. Economic policymakers in the United States took swaggering pride in the cutthroat but lucrative form of capitalism that was supposedly indigenous to their frontier nation.

...There have been recent interventions in America, of course - the taxpayer-backed bailout of Chrysler in 1979, and the savings and loan rescue of 1989. But the first happened under Jimmy Carter, a year before Americans embraced Ronald Reagan and his passion for unfettered markets. And the second was under George H.W. Bush, who did not share that passion.

So it made for a strange spectacle last weekend as the current Bush administration, which does cast itself in the Reagan mold, hastily prepared a bailout package to offer the government-sponsored mortgage companies, Fannie Mae and Freddie Mac. The reasoning behind this rescue effort - like the reasoning behind the government-induced takeover of Bear Stearns by JPMorgan Chase just a month before - sounded no different from that offered in defense of many a bailout in Japan and Europe:

The mortgage giants were too big to be allowed to fail.

And they won't fail, no matter what it costs us.

Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticized as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.

For one thing, this argument goes, taxpayers - who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel - will ultimately pay the costs. To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money - a step that encourages further inflation.

"They are going to raise the cost of living for every American," said Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house that focuses on international investments. "The government is debasing the value of our money. Freddie and Fannie need to fail. They are too big to save."

Well, maybe not. There are valid arguments for not allowing Freddie and Fannie to fail. They're the same arguments for now allowing Bear Stearns to fail. But accepting those arguments, as Dean Baker put it a few months ago, doesn't mean that no-strings-attached bailouts should be handed out [14].

While the Fed deserves some credit for preventing worse financial distress in the face of the collapsing housing bubble, government handouts for the very richest people in the country are difficult to justify. In other areas, we usually expect to see some quid pro quo, for example serious regulations on lending and perhaps some restrictions to accomplish social goals, like a cap on executive compensation ($1m a year should attract a much more competent crew). Thus far, the rich have only been on the receiving end. It remains to be seen whether this will stand.

He's only slightly more generous to Fannie's and Freddies CEOs [15].

Some people say that we had to hand tens of billions of dollars to the country's richest people to prevent a financial collapse. This is simply not true.

We had to keep Fannie and Freddie in business, but we could have done this by putting conditions on the bailout. The government uses conditions all the time when it offers help to low and moderate income people. Unemployment insurance, TANF, food stamps, and even student loans come with all sorts of conditions.

It is only when it comes to giving money to extremely rich people that we find it impossible to impose conditions. Again, we could have told Fannie and Freddie that no executives will get more than $2 million a year in total compensation. We could have told their shareholders that they are out of luck, because that is what is supposed to happen when you invest in a bankrupt company.

Instead, we told the people who work as truck drivers, school teachers, and fire fighters that they will have to pay more in taxes to help some of the richest people in the country escape the consequences of their own stupidity. While kicking the poor is always fun for politicians, neither the Bush administration nor Congress are prepared to tell the very rich that they are on their own.

Not when there's millions in lobbying dollars and campaign contributions in the air. (Not to mention invites to the big Fanny/Freddy fete at the Republican Convention [16].)

The Fannie/Freddie bailout is all but a done deal. Bush has dropped his opposition to the housing bill [17] that's set to pass the House. He also dropped his opposition to a $3.9 billion emergency aid package to cities battling the blight of foreclosed properties [18]. The price? Remember that $25-to-$100 billion Fannie/Freddie bailout?

The Bush administration and lawmakers in both parties teamed to negotiate the measure, which pairs Democrats' top priorities - federal help for homeowners facing foreclosure and $3.9 billion for devastated neighborhoods - with Republicans' goal of reining in mortgage giants Fannie Mae and Freddie Mac while reassuring financial markets of their stability.

Bush had objected to the neighborhood grants, which would be for buying and fixing up foreclosed properties, saying that they were aimed at helping bankers and lenders, not homeowners who are in trouble.

...The measure hands the Treasury Department the power to extend the government-sponsored mortgage companies an unlimited line of credit and buy an unspecified amount of their stock, if necessary, to prop up Fannie Mae and Freddie Mac, two companies chartered by Congress. The two companies back or own $5 trillion in U.S. mortgages - nearly half the nation's total.

(Nevermind that fixing up foreclosed properties might help homeowners whose trouble isn't that they got loans they didn't understand for houses they couldn't afford, etc., but the blight that's infecting their neighborhoods. That's a consequence of foreclosures that hurts even non-subprime homeowners.)

Now that that's out of the way, it's a good time to (finally) talk about accountability in the same breath as bailouts, especially since we're all now practically shareholders in both companies.

Last week, I was on the Peter B. Collins radio show [19] to talk about the Fannie /Freddie bailout as the latest incarnation of what Robert Borosage called "Wall Street Socialism," [20] when the host made the point that, basically, when a private corporation makes financial decisions so egregiously bad that it needs the public — that is, taxpayers like you and me — to bail them out, that public help should come with a few conditions, starting with the multi-million dollar salaries paid to CEOs who have driven their companies into the ground or at least failed to put on the brakes before the downhill ride started.

In other words, it's time — way past time — for some Wall Street welfare reform.