Obama can put brakes on big bank bonuses

With a little creative pressure, President Obama could put serious heat on banker bonuses without a long Congressional battle.

David R. Francis

If he wanted to, President Obama could discourage excessive Wall Street bonuses today.

No need for congressional action or new federal rules. All he has to do is tell the nine major banks rescued with taxpayer money that they will lose their status as a “primary dealer” unless they cap compensation at $200,000 a year, suggests economist Peter Morici. Any compensation above the cap would be taxed at 50 percent, he adds.

That would threaten big banks. Primary dealers buy and sell federal securities, dealing directly with the Federal Reserve and the Treasury. It’s a huge, lucrative business.

If that wasn’t persuasive enough, Mr. Obama could seek to take away their access to the Federal Reserve’s “discount window,” which loans money to banks suffering a temporary shortage of cash or other liquid assets, says Mr. Morici, a professor at the University of Maryland, College Park. That, too, would get bankers’ attention.

Although the White House is seeking a special tax on large financial institutions to recover Washington’s lost bailout funds, Obama has taken no decisive action to restrain Wall Street from handing its executives and other employees pay packages that easily could match those of the boom years. Many Americans blame the financial industry for the crisis that brought on the “great recession.” White House economic adviser Christina Romer recently called the bonuses “ridiculous.” Even the pro-business Wall Street Journal headlined a recent front-page story: “Banks Brace for Bonus Fury.”

The anger is palpable in Europe, too. Sweden’s minister of financial markets blasted banks there for boosting bonuses despite declining profits. France and Britain have moved to tax 2009 bank bonuses. The president of the European Central Bank last month said bonuses could move banks in the wrong direction.

To some economists, it’s not just an issue of fairness. It’s a matter of economic harm.

Research suggests that businesses that overpay also underperform. When Raghavendra Rau, a visiting finance professor at the University of California, Berkeley, examined 1,500 US companies from 1994 through 2006, he found that those companies handing out excess pay (relative to similar companies in their industries) got a lower return on their investments. This left shareholders in the “golden pay” companies poorer by an average $2.4 billion per year. Stock returns trailed their industry peers cumulatively over five years by more than 12 percent.

To avoid the Lake Wobegone effect of corporate directors deciding all their executives are “above average” and paying them all fat pay, Washington should make shareholder approval of CEO wages a requirement, Professor Rau says.

Wall Street compensation this year, says Morici, threatens to exceed the entire growth of the economy in the fourth quarter of 2009 and reach a huge 1 percent of gross domestic product. Such largess is taken away from the rest of us, including retirees who get less income from low-interest certificates of deposit. Top White House officials “are taxing grandma to subsidize” Wall Street with its big paydays, he charges.

One explanation for Washington lethargy on the pay issue could be the huge amounts of campaign contributions by the financial industry to both parties – nearly $500 million in 2008 alone.

Another reason may be widespread fear that tighter regulation of banks could damage the entire economy. Banks encourage that dubious view.