January 2012

The federal government has no problem paying exorbitant sums of money to people who head failed government agencies like Freddie Mac. Its CEO will receive compensation estimated at $5.5 million. The Federal Housing Finance Agency took direct control over Freddie Mac, a government-sponsored enterprise, after it ran up tens of billions of dollars in red ink buying risky mortgages, without adequate capital reserves. At the direction of the Obama administration, Freddie Mac is now running up $30 billion in losses to bail out mortgage borrowers, some of whom have high incomes. (Federal regulators sought to make Freddie Mac hide the resulting losses from the SEC and the public).

The federal government does, however, have a problem with big compensation packages at private banks like Bank of America and Citigroup, even for new executives and talented managers who had nothing to do with any financial mismanagement.  Obama’s pay czar, Ken Feinberg, a major donor to liberal politicians like Senator Chris Dodd (who recommended Feinberg for the job after he gave Dodd more than $9000), is now chopping compensation more at basically self-supporting institutions like Bank of America than at completely-bailed out entities like Chrysler.  (Many expect Chrysler to go under despite a $70 billion auto bailout.  Even the recently departed car czar, Rattner, admits Chrysler should perhaps have been allowed to go under, from a coldly economic point of view, given its gross mismanagement and dim prospects. Bank of America’s recently departed ex-CEO was a moderate Republican; by contrast, Chrysler is owned mostly by the left-wing United Auto Workers Union, which received majority ownership from the Obama administration at taxpayer expense, through a politicized bankruptcy process).

Some of the “bailed-out” banks subject to the pay czar weren’t really bailed out: they gave the federal government preferred stock in exchange for federal bailout money only under duress, after they were told that for them not to take federal bailout money would stigmatize the banks that truly needed it, and that if they failed to take the money, bank regulators would make their lives hell. As the Treasury Secretary told the banks, “if a capital infusion is not appealing, you should be aware your regulator will require it in any circumstance.” Regulators also forced Bank of America to take over failing investment bank Merrill Lynch, and pressured it to hide the resulting losses from its shareholders.

Feinberg’s actions have already left taxpayers worse off by forcing Citigroup to get rid of a profitable subsidiary. As finance professor Roy C. Smith noted in Sunday’s Washington Post, “Feinberg’s actions . . . are not going to improve either the government’s chances of getting its money back or the prospects of repairing these damaged companies. Because of his recommendations, Citigroup agreed to sell its profitable Phibro unit at an extremely low price of only one or two times earnings in order to avoid having to pay a talented trader a $100 million contractual share of the profits he had earned. The most successful of the remaining employees of Citigroup, AIG and Bank of America have been given an incentive to leave their posts, and the firms will be constrained in hiring replacements.”

Many competent executives whose pay is threatened by the pay czar are now leaving for other firms that (for the moment) are beyond his reach. The result is lousier management at banks that the FDIC insures, and that the federal government now owns stock in.

The pay czar’s political patron, Senator Dodd, received sweetheart loans from the reckless, bankrupt subprime lender Countrywide, and a massive gift from Edward Downe, in the form of a luxurious “cottage” in Ireland he received in a “cut rate real estate deal” for hundreds of thousands of dollars less than fair market value.

Banks will now be pressured to make even more risky, low-income loans. Obama has sent to Congress his proposal to create a politically correct entity called the Consumer Financial Protection Agency. “The agency would be in charge of enforcing the Community Reinvestment Act, a law that prods banks to make loans in low-income communities.”

Government pressure on banks to make low-income loans was a key reason for the mortgage meltdown and the financial crisis. Yet Obama’s disturbing proposal would empower the new agency to enforce the Community Reinvestment Act without regard for banks’ financial safety and soundness.  The Community Reinvestment Act was a key contributor to the financial crisis.

The mortgage crisis was also caused by the reckless government-sponsored mortgage giants (“GSEs”) Fannie Mae and Freddie Mac, and by federal affordable-housing mandates.

But Obama’s proposed financial rules overhaul does absolutely nothing about Fannie Mae and Freddie Mac, admits Obama’s Treasury Secretary, Timothy Geithner, even though he admits that “Fannie and Freddie were a core part of what went wrong in our system.” (The government-sponsored mortgage giants Fannie Mae and Freddie Mac went broke, costing taxpayers perhaps $200 billion.  Fannie Mae apparently has engaged in massive accounting fraud, and has used intimidation to fight reform).

Worse, Obama’s plan is “largely the product of extensive conversations” with two lawmakers responsible for the corrupt status quo, Chris Dodd and Barney Frank, and it expands the reach of regulations that have been used by left-wing groups to extort payoffs from banks.