Unintended Consequences of Salary Caps

The public has spoken, and senator Dodd responded to the anger of the electorate by putting a clause capping salaries into the stimulus bill.

I have heard the responses:

“Those crooks wrecked the companies, why should they benefit”

“Good! My money should not go to pay those fat cats.”

There is much truth to these reactions.

Unfortunately, the unintended consequences of the Dodd amendment are likely to cost tax payers more money than they anticipate.

 Here's why:

First off, it will drive the people that can leave out of these companies. These will be the people with the skill and the capital to start their own firms.  So at the time when the best and brightest are needed to turn these financial institutions around, those are the people that will flee first.  The banks will be left with exactly the people that have generated the most public outrage, the people that can’t get anything better.

While it may be interesting to see the “too big to fail” shrink and be replaced by new firms and banks, that was not the intention of the amendment.

Secondly, it substantially weakens the collateral being held by treasury.

In the original TARP, treasury secretary Paulsen strong armed ALL the major banks to take money, even the ones that wanted to refuse it.  Many people may disagree with his strategy, but the idea was to have all institutions take the funds to avoid singling out some as sound and others as insolvent.  The object at the time was to stop the run on these banks.

Now, the terms of the TARP money are changing.  The stronger institutions (namely JPMorgan Chase and Goldman Sachs) and  are balking at these changes, and plan to return the money ASAP.  The original TARP had capital restrictions as well as a 3 year commitment that made that difficult, but not impossible.

Well government being what it is, just changed the rules again, allowing the return of the money without replacing it with outside capital.  This makes it much easier for strong banks to back out.

Most people say “Good! Why should the public fund profitable businesses?!”

That’s a reasonable reaction, except for one detail.  The government did not load out the TARP money.  They traded it for equity, namely preferred stock.  So the treasury will return the stock of the strongest companies (the ones most likely to go up), and retain the stock of the companies that are least likely to survive(making the stock worthless).

So senator Dodd. in his attempt to stem populist anger, has cost each and everyone one of us even more money. 

The public may vindicated, but I personally would rather not foot the bill for the fleeting satisfaction.