A Terribly Helpless Gesture

Obama wants to cut top managers’ salaries by up to 90 percent. If that’s all he does, it will be a catastrophe.

An investment banker, a corporate CEO and a construction foreman happen to be sitting together in a waiting room. The banker says, “I got a bonus last year that I’m going to use to buy a villa on the French Riviera and a world cruise for myself and my girlfriend. With the rest, I figure I’ll be able to buy a Ferrari.”

“That’s great,” says the CEO. “I got a bonus, too. I’m going to use it to buy a condo on Park Avenue in New York. With the rest, I’ll be able to buy my wife a mink coat.”

They both turn to the foreman. “Well,” he says, “I got a bonus from my employer, too. I was able to take my wife out to dinner at a really good restaurant.” The other two ask him what he did with the rest. The employee shrugs and says, “I used it to tip the waiter.”

It would be easier to laugh at such a joke if only it weren’t so true. That’s why the public is so outraged about the global financial crisis that has been challenging governments, politicians and people in general for over two years now. That is to say, everyone except those who are responsible for all the damage that has been done; they’re making more money than ever.

Now, many are thinking that something is finally going to be done about it in the United States. At the behest of President Barack Obama, 175 top managers will have to forgo up to 90 percent of their windfall profits. Affected are the top managers at those financial institutions that got bailed out with taxpayer money, thereby avoiding the economic collapse they themselves brought on.

Thus, Washington is doing, in grand style, that which the German government had already done; namely, to cap salaries at 500,000 Euros annually. If a bank receives taxpayer assistance, it should at least not call attention to itself by paying excessive salaries.

Many economists are already warning of the dangers of banks’ freedom from government intervention. It’s exactly the opposite in America: Obama’s action is a terribly helpless gesture because those in authority don’t actually know how banks should be run in the future. Cutting salaries is simple, but controlling the finance industry is a difficult undertaking.

It’s clear, however, that banks cannot be allowed to operate with too large a measure of entrepreneurial freedom. They’ve proven in years past that greed always trumps common sense.

At the same time, it’s not about salaries alone, an idea that was already bandied about before the crisis as the “envy argument.” No, it’s also about the fact that the banking business has taken on a life of its own in a rather absurd way.

Because the classic business model doesn’t produce sufficient profit, financial institutions constantly develop new products. These have one single purpose: to increase costs for the customer while hiding those increases as effectively as possible. At the same time, they’re intended to better spread the risk (in plain language, to pass it on to private investors and, yes, to the less intelligent competition). For the banks that know the business best, that means higher profits with less risk – the best of all possible worlds.

An Interesting Model from Sweden

How this cycle (that will certainly result in another financial crisis) can be broken is still unclear. If changes are proposed, powerful Wall Street interest groups will make sure they are never implemented.

There are other proposals. The grand old man of U.S. monetary policy, Paul A. Volcker, suggests breaking large banks up into smaller units responsible not only to their shareholders, but also to the public. The former chairman of the Fed finds it a tough sell though, despite the fact that people generally listen to him.

In Sweden, on the other hand, all banks in the country pay into a common stability fund, to be used to support financial institutions that run into emergencies. The crux: the riskier a bank’s way of doing business, the more it must pay into the fund. Other countries may well begin copying the Swedish model.

No nation, however, has thus far come up with a universally right answer. Unfortunately, time is running out because the more the financial industry recovers, the more immunity it develops against regulation.

Having escaped mortal wounds, banks that are maneuvering well through the crisis but that also contributed largely to its cause are again casually engaged in business as usual. It’s already clear that they will pay out bonuses that put other banks at a disadvantage again.

Salary cuts in those bankrupt companies may be popular with the public, but when knowledgeable people take a closer look at what Obama is offering up, there will only be one word to describe it – pathetic.