The bailout plan that Congress will vote on this morning is an interesting mix of handouts to failing banks and market incentives to insure failing – or potentially failing – mortgage-backed securities. The latter objective, among others, is what hung up the bill on Friday. (You can download the plan from the New York Times’ website here and read some good commentary here.)
I haven’t read it all, but I’ve perused enough to worry about the future of the free market. Basically, the Act provides the Secretary of the Treasury with far-reaching authority to purchase nearly any asset he deems to be failing, including those assets held by foreign investors. One thing I did notice is that there is potentially a meaningful drafting issue with the executive compensation section (Section 111). I wouldn’t have come back to that provision had I not seen several interviews with congressional leaders this morning.
Both MSNBC and Fox are playing clips from Speaker of the House Nancy Pelosi where she speaks of “the end of the era of golden parachutes.” And Senator Judd Gregg, one of the GOP’s top budget experts, spoke of the same thing during an interview this morning on one of the news networks. I’ve written plenty of soundbytes for politicians to know that you can only trust them so much. But the finality with which they spoke about the end of excess executive compensation really struck me in light of the drafting issue I noticed in Section 111.
So what does the plan actually say about executive compensation?
Section 111 of the bill says:
(b) DIRECT PURCHASES.—
(1) IN GENERAL. Where the Secretary determines that the purposes of this Act are best met through direct purchases of troubled assets from an individual financial institution where no bidding process or market prices are available, and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards required under this subsection shall be effective for the duration of the period that the Secretary holds an equity or debt position in the financial institution.
Subsection (b) then provides three criteria for executive compensation:
(2) CRITERIA.—The standards required under this subsection shall include—
(A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution;
(B) a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and
(C) a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution.
Here’s the drafting issue…
Subsection (b)(1) purports to take effect when “the Secretary receives a meaningful equity or debt position in the financial institution” (emphasis added). However, at every other mention of the Secretary’s equity or debt position omits “meaningful.”
Read literally, then, the provision’s requirements are triggered upon purchase of a meaningful stake but allows the requirements to stay in force as long as the Secretary holds any stake in the company. It does not seem so far-fetched that a Secretary bent on lowering executive compensation would use this as authority to make that happen at least at the group of companies in which he has a financial stake. It also does not seem so far-fetched that this is simply a first step to a broader effort at controlling executive compensation, as it’s frequently a tactic to attack big issues in piecemeal fashion. (Whether or not limiting executive compensation is a good thing is another debate, what we’re arguing is the potential effect of drafting in this Act.)
In practice, I suspect this will mean very little in the short-term. There is a sunset provision (albeit one that allows the Secretary to extend his authority under the Act – Section 120) that will likely lessen this Act’s long-term effects. There are several qualifications on which assets the provision applies to and it’s likely that any doubt would be clarified by the regulations promulgated by Treasury.
But the force of the rhetoric on this particular issue, given how complex the entire plan is, concerns me. Getting a foothold on an issue like this could be just what the doctor ordered for those chomping at the bit to cut into executive compensation.
No related posts.
You can take a breath, at least for now. House Republicans torpedoed the bill. Good for them.
And bad for everyone who depends on credit of any kind for anything. Or in having a 401(k).
I don’t necessarily think its bad, doc, as long as a deal gets put in place by the end of this week. The way i see it, the more compromise and less political peacocking (and yes, i’m talking about BOTH parties), the better the bill will be for the public at large
Several thoughts:
1) This whole thing could not have come at a worse time, since every jerk in Congress is worried about saving their own skin. One of the most interesting points that I saw about the vote is that if you look at the nose count, everyone in a competitive race voted against it.
2) There is currently no bi-partisan way forward. Everyone needs political cover (because it’s an election year), and no one wants to stick their neck out in case this breaks bad. That, and the Bush administration seems to have no stroke at all.
3) LIBOR opened at an all time high today. There is little to no liquidity in the system, and this is very bad. Everyone is holding off on lending until this gets resolved.
Unless some agreement can be reached to clam the markets (both credit and equity), this will continue to deepen the mess we’re in.
#1 is not exactly true. Sure, there were a bunch of members in competitive races who voted against it. But there were also a bunch who are not in competitive races who opposed it too. (Roll Call Vote) I think this is probably true of most close votes – you have people who truly believe one way or the other (in this case primarily hard right and hard left elements) and people who may need to vote certain ways politically (either externally with voters or internally for party or personal reasons).
In terms of your other points, the liquidity issue is very bad and I have three friends working in the market who have been saying so for a year. And that’s where everyone involved has failed to explain why doing something is necessary. Maybe not $700 billion of “something,” but “something” at least to ensure enough liquidity to protect and assure investors, including those on “Main Street” (how ridiculous is the Main Street/Wall Street soundbyte, BTW?) This is not a vehicle for “reforms” but a short-term fix to inject liquidity (with appropriate oversight mechanisms). Addressing things like executive compensation, reporting, regulation of mortgage-backed securities can be debated another day.
I agree with Mojo, though I think it would have been better to pass something yesterday. Something will get done this week and it’s highly possible that it’ll be much better than we would have done yesterday.
That said, we’ll see. I don’t hear a whole lot of wisdom and reason coming from the Hill right now, only attacks and panic.
Doc:
I realized after posting that I read your point #1 exactly opposite of how you meant it – you said all members in competitive races voted against it and I read all members who voted against are in competitive races. Whoever said the competitive race thing is probably right, I haven’t been following the congressional races too closely this year.
I will say that having worked on the Hill for an office during the Member’s first re-elect in what was at that time a highly competitive seat it’s hard to ignore thousands of callers who are all saying the same thing, even for a Congressman who’s not afraid to vote his or her conscience. (I was fortunate to work for a Member in that case who could vote against that sentiment and was a gifted enough communicator to help voters see why they could still trust that person to vote on conscience and still represent them well).
Your second understanding is the point I was making. I think this graphic from the NY Times website sums it up.
I don’t want to belabor this point because its not the focus of our little enterprise here, but anyone who votes against this bill on “principle” is nuts. It’s like yelling at a guy who comes into the ER with chest pains about how he shouldn’t have eaten so much bacon.
And while I think the Main Street/Wallstreet dichotomy is bull, I think that people (including a number of members of Congress) don’t get the fact that inacction does not mean that it’s going to save the taxpayer money. Time’s Justin Fox made this point earlier:
And boom goes the dynamite.
It certainly is a fascinating time….a few thoughts on the above:
1) I don’t think the problem is as much as “people holding off on lending” as it is “even if they want to, the banks don’t have the cash to loan it to them.” When McDonald’s can’t even get a loan, I think its time the fed gov infuse some capital into the market to take the handcuffs off these banks.
2) Your hospital ER reference is a bit off. I do not think that many, if any, of the congressmen who voted against the bill on “principle” say that we should do nothing. To put it in the context of your hypo, it would be like if the guy with chest pains comes running into the ER, and opposing a segment of the hospital employees screaming that the guy needs a full heart transplant when other less drastic, less risky, and more effective means of treatment may be available. The problem is in the meatime the poor bastard’s going to have a heart attack.
3) If you want to point out a guy yelling about how he shouldn’t have eaten bacon, how about none other than the obamessiah himself? The only thing he consistently says about this whole mess is that its the republicans fault….eerily similar to when he was asked about the surge in Iraq last friday….
There is no problem that the government can’t make worse. Our economy is a perfect case in point. We’re in the mess we’re in because of government manipulation of the market. So how is more manipulation going to fix anything? Second, if the government does bail out the lenders, it will only set things up for a worse collapse later on. That’s because a bailout will only compound the underlying problem: too many loans with not enough collateral. Artificially inflating the value of worthless debt will not fix anything. All it will do it buy short-term peace. It’s a band-aid on a bullet wound.
Our economy is far too dependent on debt and credit in the first place. It’s about time the house of cards came crashing down.
Mojo,
There could be something better. The question is is the time exists to make that choice. While this jokers dither, we pay the price.
I think your characterization of Obama is a little disingenuous, since I don’t think that he’s expressly said “Republican’s caused this.” If you’re suggesting that his claim that an overly permissive culture of non-regulation that has pervaded Washington for the last 10 years contributed to this mess necessarily indicts Republicans, I can only ask “who has been running the shop?”
Lastly, I think we can all agree that recriminations on both sides are part of election year politics. What I’m frustrated with is the fact that these cowards are more interested in saving their jobs then they are in saving the economy.
Christopher,
Your contention that “we’re in the mess we’re in because of government manipulation of the market” is quizical. Pricipally because the Commodity Futures Trading Act of 2000 specifically exempted the credit default swaps that are behind much of this mess from government regulation.
I’ll grant you however that Alan Greenspan did not take the punch bowl away fast enough, and allowed too much liquidity into the marketplace. I don’t think this consitutes “manipulation.” The Hunt Silver Crisis was manipulation. This isn’t that.
While I think that you’re right that we have to go through a painful deleveraging, we can’t allow that to demolish the entire economy in the process. Small business need credit for purchases, law students need student loans. The absence of a properly functioning credit market means we might as well head back towards subsistence agriculture.
We could debate back and forth about who is to blame for all of this, but thats not really the point (and besides, theres enough blame to go around to everyone…including the homeowners who secured loans well above their means).
I just think the current state of everything in our country is pretty pathetic. We have a tanking economy with no end in sight, a Congress who is too concerned with partisan warfare to give two craps, and an election that likely is being heavily influenced (likely to the point of deciding the outcome) by a mainstream media that doesn’t even attempt to mask its rooting interest…its all just very depressing.
The root cause is a debt-based economy. Deregulation isn’t the problem. In fact, I think the only actually solution is even less regulation. And no government intervention.
I just read an article about a small business owner who is faced with the prospect of having to shut down his business because he can’t get more lines of credit for operating expenses. While sad for him personally, this is exactly the sort of thing we need to have happening, and on a large scale.
Call it economic Darwinism, call it the free market, it’s the same thing. If you don’t have the money to run a business, the business doesn’t get run. Why should this be a bad thing? Dave Ramsey has been telling us for years to cut up our credit cards and pay down our debts. For people who live debt-free, the headlines that have everyone in panic mode are passe and boring. Perhaps the collapse of the bankrupt economy is the best thing that could happen to this country.
Get back to the gold standard. Abolish fractional reserve banking. Tell the government to get itself the hell out of the market. Utopian ranting? Probably.
Christopher,
Sorry we can’t agree with you. We here at the Hypo support free coinage of silver and bi-metallism. We will not allow you to crucify us upon your cross of gold.
lol
I wanted to comment and thank the author, good stuff