Fire, Ready, Aim: The Financial Reform Act and the First Law of Unintended Consequences

A WSJ summary of the Financial Reform Act can be found here and is worth a read.

The President proposes significant regulatory remedies to the financial crisis without a full understanding of the root causes of the problem: hence, Fire, Ready, Aim.

Much has been said about the pay excesses of the various bank executives. I would remind everyone that Japan suffered a banking crisis in the 1990's with low paid executives.

It is my opinion that there are bound to be unseen consequences of hurrying this bill through Congress. These consequences could easily be mitigated by upping the staffing at the various regulatory agencies which already exist (SEC, FDIC, etc) without upsetting the apple cart completely.

Without fully comprehending the problem, we are developing an overly complicated solution. And, it is my fear that this medicine may be far worse for the patient than the illness which it purports to remedy.

This Time I Agree with Krugman

Not often. But this time I do agree with Krugman.

"No modern American president would repeat the fiscal mistake of 1932, in which the federal government tried to balance its budget in the face of a severe recession. The Obama administration will put deficit concerns on hold while it fights the economic crisis.

But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future."

Full story at the NYT.

Pay Czar: I Think You are Earning too Much

Make no mistake. The appointment of a federal official reportable only to the President to oversee the pay of corporate executives is an un-alloyed power grab. Congress and the President have been unable to restrain their zeal in creating financial and process controls on companies who have received funding under the TARP program. That the Pay Czar will endure long after the last TARP dollar is repaid is a virtual certainty.

There is an “agency” issue disguised in here which is worthy of consideration. Agency problems occur when incentives are created (in this case by the President and Congress) which create a difference between that which is best for the shareholder and that which is best for the corporate officer. In this case, it is the harsh terms of the President, Congress and the Pay Czar which are colluding to create the mother-of-all agency problems.

Imagine the situation: You are the CEO (or other highly compensated employee) of a major bank and your pay and benefits are severely limited until such time as the bank pays back the TARP money plus interest to the Treasury. Now being a prudent businessman, you are confronted with the dilemma: do what is right for the company or do what is right for the CEO. There is no doubt that having a couple hundred million dollars of government funds on the balance sheet is comforting to shareholders and customers alike and that paying back those dollars will create some (however minor and transient) concerns with the aforementioned groups. Maintaining those TARP funds may be fiscally prudent. However, maintaining those funds will also mean that highly compensated employees will suddenly become formerly highly compensated employees.

Highly compensated employees are treated that way for one and only one reason: they bring profits to the bank. In an environment where some banks are limited in their ability to pay and others are not, those with the limitations will contribute to the loss of the very individuals they need the most to earn their way out of trouble. Highly compensated employees (read that as highly profitable employees) will follow market forces as the inexorable hand of capital rewards those who produce and punishes those that do not. The most skilled, the most profitable employees will depart.

You need only look at the punitive measures levied on the banking industry as a set of negative incentives. While the President and Congress seem to be trying to punish the recent excesses of the banking community they are actually creating a set of incentives which will move the banks which received TARP funding to prematurely pay back their government funding to the Treasury.

I suspect that we’ll shortly see a former-TARP bank in dire financial straits due to their response to the Presidential and Congressional dis-incentives.

Bottom line: The President and Congress appear are making the most of this crisis. Mr. Chavez’s comments about being to the Left of the President were prescient.

Random Thoughts

1. Salary Czar. The President is appointing Mr. Kenneth Feinberg to be the Salary Czar to oversee executive compensation in those companies which the Federal Government has taken and equity position or bailed out with funds. Bad idea. I am sure that there are a large number of anti-capitalists out there who are happy to see executive compensation being controlled by the government. I would remind those individuals that it is a competitive marketplace for executives and that a company gets what it pays for. While wholly satisfying it might be to punish the executives at GM, it is unlikely that low pay (relatively speaking) and Congressional oversight will be a recipe for success.

2. Iran. The apparent theft of the recent election by hard-liners in Iran has set in motion the eventual demise of the Islamic revolution: or so I would hope. The Boston Globe web site “The Big Picture” and the BBC web sites both have great images and some text regarding the mess over there. Yesterday when I checked the BBC had a short clip taken from an individual’s cell phone of gun fire coming out of government offices. Nice.

3. Software. When I was in b-school at University of Maryland I was able to use the Oracle software product “Crystal Ball”. It was great stuff. Now I’d like to have a copy for my own use and am dismayed that the user cost is $1,995 per copy. Yikes. Far be it from me to criticize Mr. Ellison, but it would seem that this price point limits the adoption of the product from a wider array of users – other than hard-core financial wonks.

Bottom line: I will be investigating further and posting later on the Salary Czar. This is going to end badly.

Lakeview High School Class of 1973

When I was a senior at Lakeview High School (Lakeview, Michigan) I drove a 1965 Mercury Monterey sedan. It was red in color and in the days of 19 cents per gallon gasoline it was expensive to drive. It's one redeeming characteristic was the the rear window would go up and down. I am not talking about the rear passenger window, I mean the REAR WINDOW would go up and down. That was cool.



A friend of mine had a dentist father. For his 16th birthday he was given an almost new 1972 Dodge Challenger Hemi similar to this one below. I remember at the time being envious of him: geeze it had a hemi.


Now it looks like Fiat is going to buy the Chrysler brand and no one know what the *&^% that is going to mean - the details are not yet clear. In 1973 Fiat was famous for it's model 500 which was a very small, very unexciting automobile. In Boolean terms: think "challenger not".



Bottom line: The castration of American automobile manufacturers by foreign ownership sucks. It is better than going out of business, but it still sucks.