Can Obama's Executive-Pay Limits Tame Wall Street?

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Lucas Jackson / Reuters

Earnings have become so unpredictable that it requires as PhD in chaos theory to make forecasts.

You were probably shocked by the news last week too: bonus payouts on Wall Street fell 40% in 2008, to levels not seen since 2004. Oh, the pain, the humanity! Some media outlets, however, reported this data another way: Wall Street Gluttons Get $18.2 Billion in Bonus Money While Economy Implodes.

In response to public outrage over just about everything the financial industry has done in the past few years — from selling us trick mortgages and flimsy securities based on those mortgages to paying themselves astronomically while enjoying perks like private jets — the Obama Administration has proposed a $500,000 pay limit for the top honchos of any company that accepts money from the government's Troubled Asset Relief Program (TARP). Said President Barack Obama: "We all need to take responsibility. And this includes executives at major financial firms who turned to the American people, hat in hand, when they were in trouble, even as they paid themselves their customary lavish bonuses." (See the worst business deals of 2008.)

It's a two-tiered program, with extra restrictions applied to basket cases like AIG, Citigroup and Bank of America, all of which tapped the federal till for hundreds of billions of dollars to recapitalize their broken balance sheets. In addition to the cash limit, the "maximum wage" plan allows companies to reward "senior management" — a complement of no fixed definition — with restricted stock, but it can only be cashed in after the government is paid back. There are also prohibitions against golden parachutes as well as a clawback provision — the company may reclaim that stock if its results subsequently tank — that can extend to as many as 25 top executives.

For the second-tier companies that want government money, there's a golden-parachute limit of a year's compensation. The $500,000 pay and restricted-stock limits still apply, but shareholders (not a friendly constituency these days) can waive them in a nonbinding advisory vote, and management can act accordingly. (Read "Why Your Bank Is Broke.")

The maximum-wage plan is not retroactive, applying only to companies that tap TARP in the future. The restrictions will apply until a bank pays off its TARP tab and starts behaving. According to an Administration source, "If a bank has restored viability, has paid back the United States government with interest, and is now a completely private-sector bank ... then we can return to a time when this is between them and their shareholders."

In an effort to carve some of the excess behavior out of the system, companies that take TARP will be required to create an internal panel on "luxury" purchases, the definition of luxury — a jet, fancy office or glitzy sales conference? — being left vague under the "you know it when you see it" rule. It also allows employees to "name and shame" abusers. There's a dose of shareholder democracy too. Companies will have to subject their compensation packages to a nonbinding shareholder vote, popularly known as "say on pay." (See the top 10 scandals of 2008.)

That's for future users of TARP. Banks that have already taken TARP money — including some well-run banks that did so at the "urging" of the government so there wouldn't be a stigma attached to the crippled banks that needed the money — won't have to give anything back to fly under the federal paydar. "We need to be tough and strict but sensible," President Obama said. "We do not want to deny companies the ability to attract the talent pool they need." That's not good enough for some Senators, like Missouri's Claire McCaskill, who want to make the pay caps retroactive and intend to make that part of the stimulus bill.

But President Obama recognized the real risk here: some very good bankers might not want to work for maximum-wage pay and could bolt their TARP-constrained companies. Why, for instance, would JPMorgan Chase CEO Jamie Dimon, perhaps the most astute operator in banking, want to labor for a measly 500 large to run a company with $2.2 trillion in assets?

None of the restrictions the President is proposing will stop the Wall Street pay wagon, and a number of folks argue that they shouldn't. An Administration source admitted as much, sort of: "We have to, in governing, be tough in protecting the public trust, making sure money is not inappropriately used. But to do measures that would make it impossible for one of these companies to actually have the talent pool and function to survive, and pay the government back, would be self-defeating in any responsible policy." (See pictures of TIME's Wall Street covers.)

You don't get paid to show up for work on Wall Street; you get paid by what you produce, as a year-end bonus. But it does the raise the question: What, exactly, does a Wall Streeter produce? If a banker or a trader brings in $10 million of profit for his or her firm, it seems reasonable that the individual should get a cut of it. There's also a scarcity premium involved. Presumably, there are only so many folks out there who can bring in $10 million or $100 million in a given year, so you have to include some pay-to-stay money.

The fallacy, says one Wall Street veteran I talked to, is that anyone who occupies one of those golden chairs — global equities, say, or convertible bonds — is almost guaranteed to bring in business and get paid for it. "I could put a monkey in that chair and get a certain level of business," he said. With 46,000 financial jobs having been lost in New York City already, demand is falling, so the risk of losing talent to rivals is declining. The bigger question that should be asked of these big earners, says the Wall Street vet, is this: What is your alpha relative to a monkey? Alpha refers to the measure by which you beat the expected return. In other words, how much better could you do in the job than an average simian that is plopped in the chair? What's your alpha-monkey ratio?

Last week President Obama joined the chorus of outrage at the $18.2 billion in Wall Street bonus bucks, wondering just what these guys were thinking after a year in which the Federal Government had to put up $770 billion to save their custom-suit-wearing butts. The answer is that they were thinking about the same thing they always think about: more. Wall Streeters follow the Principle of More. I want more than I made last year; I want more than you made; I want more stock; I want more toys. And don't we all? It's just that their more is a lot more more than nearly everyone else's. Which is why President Obama is trying to say "No more."

With reporting by Michael Scherer / Washington

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