Shameful, Perhaps, But Treasury's Response Will Likely Cause More Harm Than Good

Barack Obama labeled the bonuses paid to officials at financial institutions taking funds under TARP as "shameful."  Senator McCaskill introduced a bill to cap compensation at the amount paid to the President ($400,000).  On Saturday, he described the payments this way:

• “we learned this week that even as they petitioned for taxpayer assistance, Wall Street firms shamefully paid out nearly $20 billion in bonuses for 2008.” The American people will not tolerate “such arrogance and greed,” the president said.

Apparently Treasury will rush out new rules or standards early in the week to deal with these payments.  The project approach appears to be a significant mistake. 

Treasury is only targeting payments/bonuses for companies taking funds under TARP.  Moreover, the proposals under discussion differentiate among companies receiving bailout funds.  According to the WSJ, only those companies receiving "exceptional" aid will "be banned from receiving any severance payments and they, along with the top 50 executives, will see their bonus pools shrink by about 40% from 2007 levels." 

If the Government treats companies differently with respect to executive compensation practices, it will trigger the rule of unintended consequences.  Those who are more mobile will go the companies and banks not participating in TARP (the WSJ reported that so far at least 50 financial institutions have already rejected TARP funds), or to the companies in TARP subject to the least restrictions.  As a result, the very class of financial institutions that need the Government's help the most will see an outflow of talented management, potentially undoing the Government's goal of strengthening the financial markets, thereby lengthening the period of economic instability.

This is not a TARP problem.  It is a systematic problem.  Excessive compensation is harmful, whether or not paid to a CEO of a company participating in TARP.  Treasury needs to come up with a solution that makes reasonable all executive compensation, not just for those companies taking federal funds.