Executive pay cuts (and Social Security)

A good friend writes:
The president's comments on executive pay. While it seems true that shareholders should have a voice in how their "employees" are paid and most shareholders would agree that they are being decidedly overpaid, there is a problem with the government limiting pay in this particular event. The government made a contract with the banks and car companies (which I did not and do not agree that they should have). Then after agreeing to the terms of that deal comes back and unilaterally changes the terms apparently for political purposes IE: the taxpayers deserve better. A notion that should have occurred to our politicians long before now but still flies in the face of contract law. Done properly, it should have been part of the original contract's terms not an afterthought. Worse, the decision to do this is not being made by Congress but by appointees of the current administration. By the way, this is not entirely without precedent as they did it to social security recipients by adding a tax to their benefits and are trying to be more egregious by trying to means test social security benefits. That would mean that in spite of paying premiums for forty plus years some bureaucrat will just decide that you already have enough retirement funds so you won't need any from your social security "insurance" fund.
http://online.wsj.com/video/obama-comments-on-executive-pay-caps/909115ED-8E6A-4195-B7D5-75363F247869..html

Was there a contract between the government and the banks? I don’t know. If so, you may have a point. I doubt that there was time to draw up contracts when Paulsen began bailing out the banks. The meltdown was occurring.

Let me address Social Security first, where there clearly is no such contract. Retirees’ benefits are paid for by current workers. It is an ongoing pay-as-you-go system that is already hugely welfare-oriented. That is, those who put in the most get a far lower return than those who put in little. Those who first got benefits got an even better deal; they didn’t pay in anything, which leads some to call it a ponzi scheme. However, I think Social Security has been a great idea. I think that those who can work ought to pay for our elders when they get old. The problem becomes that people live longer now and as boomers retire there are going to be fewer workers paying for more retirees. You have to raise the retirement age, lower the benefits or raise the FICA taxes. Geezers like me might think it is unfair to do either of the first two, but I imagine younger workers would think it is unfair to raise the taxes they pay (for a system they doubt will continue to exist because we can’t face our problems as a society).

My biggest beef about the pay cuts is that they will do little to change the incentives on Wall Street. John Cassidy had a good piece called Rational Irrationality about this. And I believe Henry Blodgett originally made the distinction between the risky deals that were being made and the career risk of a trader who wasn’t in on the action. So if people were being rational and taking these huge risks that almost melted down the economy and made the current recession much worse, then something needs to be done about the financial system from a regulatory or structural point of view. Does banker pay even matter?

A panel of business bigshots at the Aspen Festival this last year had some interesting thoughts on the short-term thinking that has become too common in the boardroom. Below is Steve Pearlstein’s take on its history (the link to the Aspen Festival report is here, too).

The roots of this short-termism go back to the 1980s, with the advent of hostile takeovers mounted by activist investors. This newly competitive "market for corporate control" promised to reinvigorate corporate America by replacing entrenched, mediocre managers with those who could boost profits and share prices. In theory, the focus was on increasing shareholder value; in practice, it turned out to mean delivering quarterly results that predictably rose by double digits to satisfy increasingly demanding institutional investors. Executives who delivered on those expectations were rewarded with increasingly generous pay-for-performance schemes.
As fund managers grew more demanding of the short-term performance of corporate executives, investors became more demanding of the short-term performance of fund managers. To deliver better returns, managers responded by moving money from bonds and blue-chip stocks to alternative investments -- real estate, commodities, hedge funds and private equity funds -- where there was more risk, higher leverage and bigger fees. In time, the managers of these alternative investment vehicles began looking for new strategies to improve their results, and Wall Street was only too willing to accommodate with a dizzying new array of products.

I will leave discussion about what should be done about Wall Street for another day as I barely have a clue other than making derivatives and hedge funds more transparent (and current proposed legislation seems be giving companies huge loopholes). Even if there was no contract, you may have a moral point. But it gets way harder to make. In the first place, the bankers had the information. Maybe the most critical thing I can say about the pay cuts is that many of the people who got the cuts have left and the rest just may go somewhere else. If the American public thinks these cuts are really going to solve any problems, then maybe that just shows how uninformed we are.