Smith Faculty Opinion Article

By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

September 29, 2008

Keys Flaws in the Bailout Legislation

On compensation, which is central to reforming the banks, and equity participation, which is essential for insulating the taxpayers from loss, the legislation is not what is being advertized by the Administration and the Speaker.

The bailout hardly restricts executive compensation. Those provisions are vague, except for golden parachutes, and really only apply to banks the government would take over.

For banks and securities companies that sell bad assets to the Treasury through the normal auction process, restrictions on compensation really only apply to golden parachutes for the top five officers--compensation that only applies if the banks fail and the CEO is pushed out. Restrictions on compensation do not apply to work performed by incumbent employees until a bank goes bust.

Hence the banks will be free to continue to pay executives through bonus systems that encourage reckless decisions as and get banks in further trouble. Only after banks get in trouble again, can the government get involved in compensation and management practices.

The same flaws apply to government warrants (equity positions in the banks).

If the government buys $100 billion of toxic paper from Citigroup, for example, and Citigroup recovers for now, the government will be able to do little to alter its management practices or participate in the benefits of its recovery. Only if Citigroup fails, after the bankers have been paid again, will the government be able to get involved in its business practices or get an equity stake--only when the bank is near worthless. 

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.