Barack Obamas announcement of restrictions on executive pay gets it just right. Last week the White House issued regulations limiting compensation for the top brass of companies being bailed out to $500,000 per year, along with a variety of warnings about the luxury goodies that cronies on corporate boards often give to their executive buddies. Some folks worry that these new restrictions may backfire by discouraging firms from seeking federal assistance and making it harder for them to recruit top talent. Backfire? Discouraging firms from seeking federal assistance? Harder for them to recruit top talent? Hmm. I found myself wondering: Dont we want Bank of America to wither?
To answer this question, I must digress. In late September and early October, I angered some of my conservative friends by writing in support of the $700 billion rescue plan (“The Wall Street Crisis”), and then upbraiding Congress for dithering (“The Car Wreck”). Markets, I was told, need to be allowed to take their course. What about moral hazard? some asked me. The market needs to punish bad decisions. There was also an understandable rancor. Shouldnt we just let the jerks get sucked down into bankruptcy?
The problem in the fall, of course, was that all of us would have gone down the same rat hole as the Wall Street geniuses who brought us mortgage-backed securities and credit-default swaps. The gears of international finance were seizing, and we were hovering on the edge of a catastrophic global run on all financial assets, even the most credit worthy.
Experts can debate the merits of the ever-changing bailout plans. Maybe Henry Paulson should have done this and not that¯or that¯or that. Look at the editorial pages over the last few months. There are as many opinions as there are eminent economists. But one thing is clear. The U.S. government stepped up as the global backstop for financial markets, and we avoided catastrophe.
Now were sliding into an economic crisis, one caused (at least in part) by the rapid deflation of the American housing bubble. The bubble financed our artificially high rate of consumption over the last decade, a consumption binge that drove the global economy to record heights.
Why the bubble in the first place? One key source was the availability of trillions of dollars of international capital ready and willing to finance the bubble. The superheroes on Wall Street were inventing complex securities to meet a voracious global appetite for investment opportunity.
Because they didnt have enough local investment opportunities, the oil kingdoms in the Middle East needed to send profits somewhere. (Dubai very likely will be the mother of all real-estate collapses, since it was built solely in order to soak up excess Middle Eastern capital.) For political reasons, the Chinese government has withheld a large percentage of profits during its tremendous economic surge. End result: the money came to us. Europe is graying, and most countries have been in a savings mode in order to finance retirements. The money had to go somewhere, and a great deal came here.
The point should be clear. As we look back on the last decade, we should not be at all surprised that Wall Street bankers found lots of different ways for people to invest, including very risky and stupid ways that eventually put the global financial system at risk. That is what happens when too much money chases too little opportunity, something weve seen now for nearly two decades as a result (in part) of an accident of nature that puts vast oil reserves under economic black holes, official Chinese anxiety about the destabilizing consequences of allowing its vast wealth to transform its society too quickly, and slow growth in Europe that limits investment opportunity there. Our economy was like a duck being force-fed. And the housing market was the enlarged liver that investors wanted to believe would end up fine foie gras .
The money is still out there, which is why the U.S. government can entertain more than a trillion and a half dollars of additional spending (the original bailout money plus the new proposed stimulus package). Were able just to borrow the money¯and at a ridiculously low interest rate. This is not going to change anytime soon. Therefore, the only way to avoid another bubble is to put the fear of God into financial firms that are constantly tempted by the long line of people holding bags of money begging for investment opportunities.
This brings me back to those arresting phrases might backfire, discouraging firms, harder to recruit. These seem to me precisely what we need.
We could not allow the market to punish the executives, shareholders, and bondholders of AIG, Citigroup, Merrill Lynch, J.P. Morgan Chase, and Bank of America with bankruptcy. To do so would have also punished all of us with financial paralysis. The defenders of the market were quite right to protest. If there are no lasting long-term consequences for stupidity¯and plenty of short-term benefits¯then well get more of the same.
The political process saved these companies. Now Im happy to see the political process putting the lead weight of regulation on their backs. Id like to see Barney Frank signing off on all major decisions at Citigroup. That would guarantee counter-productive decision-making. In fact, Id like to volunteer for similar treatment the other big banks that are up to their necks in toxic assets and only survive now because of huge infusions of taxpayer money. After a few years they will become rat holes for capital, lumbering giants more eager to please regulatory masters than meet the needs of the market. They will become failed legacy corporations too rotten even for vulture investors¯ de facto bankruptcy.
I dont call that backfiring. If you believe in the need for some form of market discipline, then it is a good outcome.
Now some will argue that this will cost the taxpayers hundreds of millions of dollars. Probably. But the alternatives are more expensive. Sudden bankruptcy last fall would have led to global collapse. A revitalized Wall Street never punished on the scale of the problems it midwifed will very likely lead investors toward another bubble.
Others will argue that we need these major financial institutions. Perhaps today¯though only psychologically, in order to sustain trust in the global financial system¯but certainly not a few years from now. There are financial institutions today quite capable of growing in the present market, and quickly filling the void.
Here is the bottom line: Burdensome regulations for those taxpayers protected from the harsh discipline of the free market last fall is exactly what we need. (Crucial caveat: burdensome regulations only for those taxpayers saved from bankruptcy, otherwise the market losers end up insulated from the competitive disadvantages of burdensome regulations.) It would be great if Citigroup were unable to recruit top talent. We couldnt allow a quick, free market death last fall. So a slow death by regulatory sclerosis over the next few years will have to do.
If you believe in the need for some form of market discipline (as I do), then slow death by excessive regulation of the too-big-to-fail losers on Wall Street is a pleasant prospect. Im happy to have the president drive talent away from the Wall Street giants who served their clients and investors, and the common good, so poorly in recent years. I invite Congress to pile on. Nancy Pelosi should design social-justice norms for Bank of Americas lending program.
We know the end result. The Wall Street goliaths will wither and decline. Growth in the financial industry will emerge elsewhere. And a lesson will be learned. Rotting corporate carcasses focus the mind.
R.R. Reno is an associate professor of theology at Creighton University and features editor at First Things .
” The Wall Street Crisis ” by R.R. Reno
” The Car Wreck ” by R.R. Reno