Saturday, March 21, 2009

The Day Wall Street Dies


In less than a week, Congress reacted to the AIG bonus 'scandal' with competing House and Senate proposals that are draconian in concept. If anything remotely resembling either of them becomes part of the Tax Code, Wall Street in its current configuration will die.

That may not be such a bad thing. The compensation system was a leading (perhaps the leading) contributing cause to the current crisis, and rather than being tweaked or overhauled, perhaps it should be savagely dispatched.

As I understand the proposals, the House would impose a 90% tax on any bonus paid by any financial institution which has received funds greater than $5-billion from the Treasury under the Troubled Asset Relief Plan. The Senate proposal would impose a 70% tax on any bonus from any financial institution which has received more than $100-million. Either approach would severely limit the compensation to the highest paid employees of essentially all of the major capital markets banks.

That would certainly suck the oxygen out of the room at BofA, Citi, Goldman, JPMorgan, Morgan Stanley, etc.

Rather than accepting at face value the shrill protests of the leaders of those institutions about losing the best and the brightest, it's worth giving some balanced consideration to the likely consequences of enacting punative bonus taxation (particularly as some form of punative taxation certainly appears in the cards). First, the best and the brightest made the mess, but they may not be mission critical to cleaning it up. The honest and the competent, not the best and the brightest, may be what's called for. Second, in the short term, exactly where are the incumbents going to go if they lose their chance at great wealth? No one is talking about cutting these heroes back to the minimum wage. I think it's still possible to live well on a million dollars a year, even in New York.

Think back to Enron. After it collapsed, any number of high flying traders found themselves stuck, ruined financially, and occupied cleaning up the mess they had made for their base salaries, with no incentive comp to speak of. Yeah, most of them eventually moved on, but the entire industry sector melted down, so that process took awhile, and the cleanup wasn't in the least bit complicated by any lack of people to get the work done. So, it's safe to ignore the shrill bullshit of Ken Lewis, et al.

In the longer term, though, the result of effective limits on compensation paid by the TARP recipients may have a positive consequence for Wall Street. Right now, the TARP recipients are institutions comprised of three very different kinds of activities: a utility function (traditional banking intermediation), a casino activity (their capital markets operations, what sunk them) and a cruise line (providing various kinds of asset management, mergers and acquisitions advisory and similar services that are not particularly capital intensive).

The utility function can function effectively under salary caps. It may not be very exciting, but the work will get done. The casino gets shut down under salary caps. Actually, the hedge funds can continue to operate, but they'll have to produce alpha without leverage as the utility bankers will be incented to ration credit away from speculative and towards more socially productive activities. And the non-capital intensive advisory services will simply move out from under the umbrella of the financial supermarket model, and resume the independent existence they led prior to the great consolidation of financial services in the last fifteen years.

That last is probably where the money will be in the future.

Isn't life interesting after a sea change? So much for deregulation, and thank you, Phil Gramm, for your contribution to putting the politics back into political economics.

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