When these 'too big to fail' institutions have been broken up, when ALL of the MANY guarantees and backstops have been withdrawn, THEN they are welcome to engage in business with the rights of private companies again.

I'm an equity analyst that has followed the financial industry since the end of last systemic crisis (in 1992), andspent the middle part of this decade at a hedge fund that also had a large structured finance business, so you could say I've had a front row seat as much of the current problems have developed and come to fruition, if that's the right term.

Anyway, with your second principle, I think you are falling victim to the evidently common fallacy that market-based compensation above some level arbitrarily deemed "excessive" is contrary to the interests of shareholders (or other non-equity investors). In fact, artificially limiting comp in a free and reasonably efficient labor market is likely to penalize investors, by ensuring that their senior executive staff is adversely selected. Indeed, this is just what is happening – already one quarter of the execs under Feinberg's purview have left their firms for new positions not subject to government comp controls.

It is one thing to advocate that firms take steps – such as clawback clauses – to help ensure they get value for their compensation dollar. It is quite another to artificially limit comp levels. The former creates shareholder value, while the former destroys it.

First, I wish you and the Financial Crisis Inquiry Commission well in taking on this task. Our entire economy requires an effective and efficient financial services industry to continue to allow capital to move to the right enterprise. I am concerned that we are letting this crisis pass without thoughtful reform. Key is to make sure it’s thoughtful…

Here are some points to consider:
1. There will always be greed as it’s simply human nature. Let’s not allow anyone to believe that the FCIC can change human nature.
2. The issue that you should focus on involves whether or not and to what degree should the USG control financial services firms, especially by managing overall compensation.
3. But if you are willing to consider direct control, I think that you are not complete in your assessment of USG support. Clearly TARP funds are direct investments. But the USG provides significant benefits to financial services firms (especially commercial banks) that should also be included in “taxpayer support”. If you let the camel’s nose under the tent for TARP funds, why not for anyone who can borrow from the Fed or who has FDIC support?
4. No where do I see the discussion about mortgages and our USG policy around everyone owning a house. The USG has for too long put too much focus on home ownership and Fannie/Freddie got carried away – especially with their “special” status. The FCIC must address how to get the USG out of home mortgage market. While we can’t prevent every bubble, why not at least try and prevent families from being duped into gambling on housing?

"Our fundamental problem is not that institutions deemed too big to fail do not get sufficient scrutiny. Our problem is that some institutions are deemed too big to fail."

http://www.american.com/archive/2009/october/the-...

The problem is not "charging losses to the corporation" ("privatized" losses), which as you point out is part of how the market system works with its ups and downs. The problem is when banks charge losses to the American taxpayer ("socialized" losses, a.k.a. a "bailout"). In this case there is no downside risk to the corporation–the downside risk is taken on entirely by taxpayers–and this massively distorts the incentives in place which are supposed to lead to sound risk management.

Think about it this way. You are considering investing $1000 in an extremely risky project. The potential returns are enormous, and you stand to gain a lot of money if the project succeeds, but probability that the project will fail is also very high. You don't want to lose your $1000, and you aren't feeling lucky (as economists would say you are "risk-averse") so you decide not to make the investment. This is sound risk management–projects like this probably should not go forward.

However, consider the same situation in which you knew any losses on the project would be "socialized," i.e. the government would step in and spend taxpayer money so that investors don't lose everything they invested in the company. The threat of losing your $1000 has been entirely eliminated–the cost of any losses the project incurs will be spread out among a number of taxpayers rather than being concentrated on the investors who funded the project. You still only have a small chance of "winning" (making a lot of money when the project succeeds), but no chance of "losing" (losing your investment when the project fails). Who wouldn't want to take this bet? It's all upside and no downside! The problem of course is that this leads to extremely distorted incentives in the market. Investors put their money behind lots of ill-conceived projects that end up failing and it is the taxpayers, not the investors, who pick up the tab. This is a big waste of money and extremely inefficient!

You correctly identify the problem, Mr. Hennessey, that there is no way to reconcile your discomforts from your Question Number 2 above. You are uncomfortable with the government setting compensation limits because you believe in the principle of freedom of contract in a free market system–people should be free to expend their resources and enter into economic relationships as they wish. But you are also uncomfortable with the government not working to prevent taxpayer money from being transferred to an already wealthy executive because you would believe that would violate the principle of protection of private property–in this case, this would be akin to government-enforced theft!

The problem cannot be resolved because (as PMA points out above) the government should not have waded into the private sector in the first place. In this case especially, government intervention creates so many distorted incentives, creates too many obligations to meddle where they shouldn't be meddling, and really just screws up the proper relationship between government and the private sector.

I'm not trying to put words in your mouth because I'm just guessing here, but I bet ultimately your real discomfort resides in the government getting involved in something you believe it had no business in.

No to be a smart ass but isn't that how it's suppose to work? Banks take highly liquid low risk assets, and loan them out thereby converting them into non-liquid high risk assets. They take the difference between the interest they pay depositors and the interest they receive from debtors as profits. If they realize a net gain they distribute it to the shareholders, but; if they incur a net loss they write it off against bank capital.

In fact every corporation ultimately splits the profits among shareholders if they "win" [make money], and charges losses to the corporation [writes losses off against capital] if they "lose". That's how you run a business.

I think your last paragraph isn't an argument about compensation, it's a restatement of your first point, that government should not invest in private companies. I personally agree. From my perspective, once government makes the investment, it has enriched private interests regardless of what it might subsequently do on compensation. My point is that if you take an absolutist perspective on public money not enriching private interests, you have not choice but to not make the investment in the first place.

By the way, if that is your point, there's a whole host of other things government should not do, starting with subsidies of various sorts (farm bills as an example) and including tax breaks to companies for setting up shop in one place or another. Unfortunately a substantial portion of what government does will in fact enrich private interests and, depending on how far one wants to go on private interests, you could even lump transfer payments under that heading.

I think the problems here are twofold, without considering the principle involved in government intervention in salary determination.

1) Like David Scatino found out when he suddenly had Anthony Soprano as a partner, some partners do not have the best interests of the shareholders at heart. If the US government is primarily interested in preservation of shareholder value, employee retention would be a primary interest. Goldman Sachs has poached a significant amount of talent from competitors because they of the compensation issues at BAC, C, and AIG. However, the U.S. government has other broader policy goals that are, in some ways, contrary to the interests of other shareholders. One can't expect the government to behave as a rational actor as a shareholder or equity partner.

2) The current administration is undertaking some ambitious policy goals that require the taxes that these people pay. The people with the largest incomes also have the greatest discretion in realizing that income. Our progressive tax system is such that limiting pay on even a small segment of the very rich will have a disproportionate impact on taxes received.

You're hands-down the best mainstream conservative commentator on the economy, and I wish your views were exoteric as I think it would greatly benefit the voting public.

I have not read a convincing case, or been given a convincing reason, for TARP. Why was it necessary to prop-up these bunglers? The slippery-slope argument for TARP seems to rest on inductive reasoning which could not be proved. If you, or anyone other commenters, could cite a source as to why TARP was necessary, particularly without strings that would prevent a future bailout being attached, I'd be delighted to read it.

As far as #2 is concerned, as a hardcore liberal and I hope a fairly level-headed and rational person, I don't think there's any way around that position, because as you noted, the funding mechanism was democratized, and public money should never enrich private interests unless it can be rationally justified.