The Case for a Supertax on Big Bank Bonuses
The big banks are pretesting their main messages for bonus season, which starts in earnest next week. Their payouts relative to profits will be "record lows," their people won't make as much as in 2007 (except for Goldman), and they will pay a higher proportion of the bonus in stock than usual. Behind the scenes, leading executives are still arguing out the details of the optics.
As they justify their pay packages, the bankers open up a broader relevant question: How much bonus do they deserve in this situation? After all, bonus time is when you decide who made what kind of relative contribution to your bottom line—and you are able to recognize unusually strong achievement.
Seen in these terms, the answer is easy: people working at our largest banks—say over $100 billion in total assets—should get zero bonus for 2009.
The big bank executives make three points in favor of paying bonuses for 2009.
- If the bonuses are not paid, people will leave our major banks. It's unlikely that many good people will leave, but if they do move to smaller institutions that are not too big to fail, that's good for the rest of us.
- Big banks made these profits fair and square, so the bonuses belong to the workforce. This is wrong at two levels: (1) the profits in 2009 (and 2008) were solely the result of massive government intervention, designed at saving and recapitalizing big banks; and (2) the recapitalization part of that strategy only works if the profits generated are retained—not if they are paid out.
- You cannot now tax the bonuses for 2009 without violating all the norms of reasonable taxation—i.e., that it not be retroactive, not be confiscatory, and not mess seriously with incentives. Ordinarily, these are good arguments. But today's circumstances are so egregious that we need to take highly unusual steps. The banks and their key employees are so far from understanding what they did wrong, they don't even have a framework within which they can understand what they need to do right going forward. This industry needs a wake-up call.
The administration should immediately propose, and the Congress must at once take up, legislation to tax the individuals who receive bonuses from banks that were in the too big to fail category—using receipt of the first round of TARP funds would be one fair criterion, but we could widen this to participation in the stress tests of 2009.
The supertax structure being implemented in the United Kingdom is definitely not the right model—these "taxes on bonuses" are being paid by the banks (i.e., their shareholders—meaning you again) and not by the people receiving the bonuses.
Essentially, we need a steeply progressive windfall income tax—tied to the receipt of a particular form of income. This is tricky to design right—but a lot of good lawyers can get cranking.
And we should be honest about the distorting effect that even proposing such legislation will have on incentives. It will send a signal that income generated by working at big banks is less secure—all employees of these banks should be looking over their shoulders; sooner or later, the Internal Revenue Service is coming. This is particularly relevant for 2010, which looks set to be another bumper year for the financial sector.
At this stage, tilting the playing field toward smaller participants in financial markets is not a bug; it's a desperately needed feature.
Also posted on Simon Johnson's blog, Baseline Scenario. The following were previously posted:
Countdown to Goldman's Bonus Day
January 8, 2010
Sources say that Goldman Sachs' bonuses will be announced on Monday, January 18, and actually paid sometime between February 4 and February 7. In previous years, the bonuses were paid in early January—but the financial year shifted when Goldman became a bank holding company.
For critics of the company and its fellow travelers, the timing could not be better.
Anxiety levels about the financial sector are on the increase, even on Capitol Hill. The tension between high profits in banking and stress in the rest of the economy becomes increasingly a topic of discussion across the nation.
And you are hard pressed to find any government official who has not by now woken up—in private—to the dangerous hubris of big banks. To add insult to injury (and many other insults), the Bank for International Settlements is holding a meeting to discuss excessive risk taking in the financial sector; according to CNBC Thursday morning, Lloyd Blankfein of Goldman and Jamie Dimon of JPMorgan Chase were invited but are not planning to show up (they really are very busy).
The smart strategy for Goldman in this context would be to pay no bonus for 2009 (in cash, stock, or any other form), but this is not possible for three reasons.
- Goldman would need to make a credible commitment to employees to "take care of them next year." But any legally binding commitment would be as good as a cash bonus (who knows, they could even be traded over the counter). And any verbal promises would be completely noncredible—among other things, Goldman cannot know for sure how the coming perfect storm will play out: the supertax on bankers in Europe, Sheila Bair's good idea of tying deposit insurance premiums to the risk in banks' compensation structures, Hank Paulson's memoir on February 1, Chris Dodd's resignation, and the collapse of any meaningful Obama financial reform—allowing the Democrats to wake up to how they can run hard against big finance in 2010, etc. And besides, how much would you trust your boss at Goldman? The old culture there is gone.
- For all their communication blunders in recent months (internally they wince at "God's work"), the responsible executives think they can hide the size of the bonuses or talk more about how stock and option grants encourage the right kind of behavior or put in some sophisticated clawback language. Some of the best lawyers in the country are working very hard on this question, but it's all for naught. The headline bonus number will be at least $20 billion and if they try to hide this with sophisticated mumbo jumbo, that will only bring greater attention and spread the pain over many news cycles as we run through denials, further exposures, more denials, and damning details. When you're in a hole: stop digging—Goldman is talking with top PR consultants; perhaps they should bring in Tiger Woods to advise on this point.
- The most important reason is also Goldman's greatest weakness: throughout the organization, people really think they are worth the money. But remember these facts and keep track of how many times you hear them repeated: Goldman Sachs essentially failed in September 2008; it was saved by extraordinary and unprecedented government efforts at the end of September (particularly through its conversion to a bank holding company, which gave access to the Fed's discount window); partly this treatment was shaped by the special favor with which Hank Paulson viewed Goldman (documented in nauseating detail in Andrew Ross Sorkin's Too Big To Fail); and the strategy of allowing Goldman to recapitalize through taking huge risk with an unconditional government guarantee in 2009 only makes sense if they use the proceeds to boost their capital – not if they pay out massive bonuses. In any reasonable economic analysis, the entire bonus pool at Goldman should be paid—with gracious thanks—to the government.
The refrain that will be repeated by Goldman executives is: We need to pay the bonuses in order to keep the best people. But think about this like a stockholder for a moment—where exactly would these people go to work if this year's bonus is set at zero?
Among the casino banks, Goldman is currently the best place to work and, looking forward, that's where folks will make the most money. Hedge funds are not hiring in large numbers—most of the new financial sector jobs are at the other too-big-to-fail firms, who are now bringing people back (naturally).
Goldman's management should come to its senses and pay no bonuses of any kind to anyone; no good people would leave. Fortunately, while the executives who run Goldman are smart, they are not that smart. The bonuses they announce on January 18 and pay in early February will become the rallying point for real reform.
Hoenig Talks Sense on Casino Banks
January 7, 2010
Thomas Hoenig, president of the Kansas City Fed, has been talking sense for a long time about the dangers posed by "too-big-to-fail" banks. On Tuesday, he went a step further: "Beginning to break them, to dismember them, is a fair thing to consider."
Hoenig joins the ranks of highly respected policymakers pushing for priority action on too big to fail, including some combination of size reduction and/or Glass-Steagall type separation of casino banks and boring banks.
As Paul Volcker continues to hammer home his points, more policymakers will come on board. Mervyn King—one of the most respected central bankers in the world—moves global technocratic opinion. Smart people on Capitol Hill begin to understand that this is an issue that can win or lose elections.
Ben Bernanke still refuses to address "too big to fail" directly and coherently. He needs to make a major speech focusing on bank size, confronting the critics of today's big banks in detail (if he can) and specifying concretely how banks will be prevented from becoming even larger. Without such a clear statement, he will have lost all credibility even before his second term begins.
The independence of central banks is earned, not written in stone for all time. Mr. Bernanke seriously undermines the Federal Reserve system by remaining essentially silent on this crucial issue.
Still No to Bernanke
January 6, 2010
We first expressed our opposition to the reconfirmation of Ben Bernanke as chairman of the Fed on December 24 and again here on Sunday, January 3. Since then, a wide range of smart economists have argued—at the American Economic Association meetings in Atlanta—that Bernanke should be allowed to stay on.
I've heard at least six distinct points. None of them are convincing.
- "Bernanke is a great academic." True, but not relevant to the question at hand.
- "Bernanke ran an inspired rescue operation for the US financial system from September 2008." Also true, but this is not now the issue we face. We're looking for someone who can clean up and reform the system—not someone to bail it out further.
- "Bernanke was not really responsible for the failures of the Fed under Alan Greenspan." This is a stretch, as he was at the Fed 2002–05, then chair of the Council of Economic Advisers, June 2005–January 2006. Bernanke took over as Fed chair in February 2006, when tightening (or even enforcing) regulation could still have made a difference. He had plenty of time to leave a mark and, in a very real sense, he did.
- "Bernanke understands the folly of the Fed's old bubble-building ways and is determined to reform them." This is wishful thinking. There was nothing in his remarks this weekend (or at any time recently) to support such an assessment.
- "Bernanke will be tough on banks when needed." Again, there is not a shred of evidence that would support such a view—the markets like him because they see him as a soft touch and that's great, except that it encourages further reckless risk taking by banks considered too big to fail and leads to another financial meltdown.
- "Dropping Bernanke would disrupt the process of economic recovery." This is perhaps the strangest assertion—we're in a global rebound phase, fueled by near zero US short-term interest rates. Official forecasts will soon go through a set of upward revisions and calls for further worldwide stimulus will start to sound distinctly odd. Now is the perfect time to change the chair of the Fed.