11/20/2009 05:12 am ET Updated May 25, 2011

Size Matters: Why the Obama Administration is Wrong About Wall Street Pay

The Obama administration opposes strict caps on pay, arguing that the size of the bonuses are not as important as the risk to the financial health of the bank that bonuses linked to performance can create.
-- New York Times, September 18, 2009

The size of the bonuses are not that important? For Wall Street elites, the size of your pay package is everything. It's why you're there. It's your plumage, your pecking order, your future and your legacy.

But the financial crash, which nearly pushed us into the Great Depression II, threatened to end pornographic pay. It finally dawned on the American public that our financial dons not only were wildly overpaid, but also were running the wildest casino ever. They were the house and they got to bet with other people's money. When the fantasy finance games crashed under their own weight (not because of unqualified home buyers or greedy consumers or big government), it became clear that the profits and pay schemes were built upon phony assets which turned toxic in a hurry -- but not before the bankers and traders safely took home their fantastic fees. (For more on this sordid story, please see The Looting of America.)

Just one year ago it seemed plausible that our government would do the obvious: bring the hammer down on sky-high salaries and bonuses, which clearly had no economic justification. The Europeans were ready to move and still are. But the Obama administration is holding out because Geithner, Summers and Bernanke don't see a necessary connection between systemic risk and obscene pay packages.

To preempt both the populist moves from Congress and from Europe, the Fed is putting forth new "principles" that will allow outrageous compensation packages to continue as long as they don't encourage risky financial behavior. These very flexible rules will pertain primarily to the twenty or so institutions that have been deemed "too big to fail." And they will be implemented in private, mano a mano between Fed regulators and the institutions. How considerate and chummy.

Crack open the Champagne! It's party time again on Wall Street. The financial elites are thrilled with the new "principles." In fact, they couldn't have come up with a more harmless regulatory effort if they wrote it all themselves (which perhaps they did). They don't care about the risk-averse rules. They don't care about clawbacks or delayed compensation. It will be kids play to work around them. That's what financial engineers are for.

You can bet that these rules will permit Andrew J. Hall, the oil speculator, to get his $100 million paycheck from CitiGroup, a bank effectively owned by the American taxpayer. Perhaps his pay package will be restructured or even stretched out, but in the end nothing really will change. He will get his $100 million even though he wouldn't have gotten a dime, if not for taxpayer intervention that prevented CitiGroup from going under.

The Obama Administration is just plain wrong. Size does matter. You can clearly value pay packages and limit them. But risk is a much more slippery concept: you can always find a way to fudge subjective risk calculations when big money is at stake. Take the big money away and you take away the risk. That's not regulation, that's human nature.

Here are the obvious ways to tame elite animal spirits:

  1. Because we have given more than 13 trillion to Wall Street in terms of taxpayer TARP funds, asset guarantees and liquidity programs, we should insist that no one on Wall Street earn more than the President of the United States, at least until the unemployment rate falls below 5 percent. That would be a fitting tribute to those 29 million who are now without work or forced into part time work, especially since Wall Street's crash created most of that unemployment. As for risk, few Wall Street dons will still stay up late at night dreaming up new scams for only $400,000 a year.
  2. If you think the President's Wage Cap is too draconian, how about a 90 percent progressive income tax on any compensation over $1 million a year? This would reduce Andrew J. Hall's compensation from1 $00 million to about $11 million. Still far too generous in my book, but more than enough for an oil speculator who has yet to explain how his work contributes any real economic value to society.
  3. Or we could put a 90 percent windfall profits tax on all Wall Street profits. Why? Because there would be no financial profits at all if we hadn't bailed out the entire gang with our $13 trillion worth of taxpayer gifts.
  4. And if you're really bold and adventurous, we could place a small transaction tax on high speed, high frequency speculative trading, as advocated by Lord Turner, Britain's chief financial regulator. That would serve as a powerful "just say no" damper on risky financial behavior.

That's how you deal with size. That's how you deal with risk. And that's what President Obama said last May, before he was afflicted with financial amnesia. Remember this?

What I think will change, what I think was an aberration, was a situation where corporate profits in the financial sector were such a heavy part of our overall profitability over the last decade.... That means that more talent, more resources will be going to other sectors of the economy. I actually think that's healthy. We don't want every single college grad with mathematical aptitude to become a derivatives trader. We want some of them to go into engineering, and we want some of them to be going into computer design.

-- President Obama, May 2, 2009, Reuters

That's the president I voted for, not the one who refuses to challenge Wall Street entitlements.

Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It, Chelsea Green Publishing, June 2009.