Exec compensation: "Heads I win tails you lose"
James Crotty: Financial execs make large bonuses and don’t care about risk; knew govt. would save them
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington, DC. And joining us now from Amherst, Massachusetts, is Jim Crotty. Jim teaches at the University of Massachusetts Amherst, and he’s associated with the PERI Institute, the Political Economy Research Institute. Thanks for joining us, Jim.
JAMES CROTTY, ECONOMICS PROFESSOR, UNIV. MASS. AMHERST: It’s a pleasure.
JAY: So you’ve been doing a lot of work on the issue of executive compensation in the finance sector and the role it’s played in the current crisis. There’s a quote from Attorney General Cuomo from New York about this. He says, "… our investigation suggests a disconnect between compensation and bank performance that resulted in a ‘heads I win, tails you lose’ bonus system." He went on to say that when there’s a boom, executives make a lot; when there’s not a boom, they still make a lot; and when there’s a bust, they still make a lot. So explain it. If I’m on a board of directors of a company like that, how on earth do I allow such a compensation system?
CROTTY: Well, I suppose there’s a couple of reasons. One is that people who are on the boards of such companies are generally appointed by the CEOs of such companies, and they serve at their pleasure, so they’re unlikely, just as in the nonfinancial sector, to do things that conflict strongly with the desires of top management. But the second thing is the way the system works is a bit pernicious, because top executives and other people in financial terms, traders and mergers-and-acquisitions people, tend to generate lots of revenues and lots of profits for the firms when the financial system is in good shape or is in an expansion or is in a bubble. So when it’s a bubble, there’s lots of profits. The stock prices tend to go up quite a bit. This keeps the shareholders happy, and the executives and the rest of the people I refer to as "rainmakers" get enormous amounts of income, mostly in the form of bonuses. So while the system is working well, which it might work for years—five, six, seven years—everybody seems to be doing well, and everybody seems to believe it’s going to last forever, and nobody complains very much. And even if they did complain, it’s not clear what difference it would make.
JAY: Well, let’s go back to the first question is about the relationship of the board of directors to the management. In many companies, I would think most companies, outside shareholders appoint the board, and more often than not, even though the CEO might own a lot of shares, it’s not the norm that the CEO and senior management actually control the board. Shareholders do. In this situation, you take the big companies, Goldman Sachs and the other big players, is it a case where the senior management also own most of the shares?
CROTTY: No, I don’t think that’s the issue. It’s just that the senior management, when the companies are doing well, have lots of power. And these shareholders, the representatives of shareholders, in the periods during which the financial system is doing well, are also doing well, so nobody complains about this. If you held a share of Goldman Sachs and, you know, you bought it in 1994 or 1995, by the time you got to 2000 you’d made tremendous capital gains; by the time you got to 2007, you’d made additional capital gains. This is also true of the other large companies. So during the expansion, normally in the financial markets, the shareholders, including institutional shareholders, are quite happy with performance. They’re being told by everyone—the financial press, the government, economists—that this is a very safe situation. Economists generally said during the period of the bubble from the mid-1990s till 2007 that this was all based on efficient financial markets, and these were long-term profits, and everybody was safe. They were told that by the Fed. They were told that by [Ben] Bernanke. They were told that by Timothy Geithner. They were told that by Lawrence Summers. I mention all those people because they’re important in Obama’s administration and they were making enormous capital gains.
JAY: So when in 2004 they significantly raised the amount of leverage these banks can use, which increases their risk, everyone says, well, it’s okay, because the government—the Fed is saying it’s okay, the government’s saying it’s okay, and we’re in good hands, and we’re making so much money, who cares?
CROTTY: Right. And economists said it was okay. You can’t leave economists out of this. I mean, basically, there were lots of people who had a self-interest in seeing that this didn’t stop and in continuing the deregulation process that was ongoing for a long time. But also everyone could legitimately say that economists tell us that this is the right thing to do, that we should lightly regulate financial markets, that financial markets are efficient, that they price risk correctly. And in the new system of the recent period, where banks didn’t hold a lot of their risky assets, they shipped them out to capital markets, that capital markets priced everything right.
JAY: Okay. So I’m a pension fund. I’m making lots of money. I’m a shareholder in Goldman Sachs. I’m making lots of money. What do I care what the executive compensation is, then, if that’s—and if I’m doing fine? Why does it matter?
CROTTY: I think that they didn’t care.
JAY: But why should we? Why should anyone care, then?
CROTTY: They should care, because over this period of time, the financial system got into an absolutely unsustainable condition in which there was massive risk, there was massive leverage. We were in a situation in which if anything went wrong in the system, if interest rates went up, or housing prices didn’t continue to go up, or profits went down, or there were bankruptcies, the system was so leveraged and so stretched and so fragile because of all the risk-taking that was done by the financial rainmakers in order to pursue profits and revenues, and therefore bonuses, that the system was ready to completely fall if anything went wrong. As soon as housing prices stopped going up so rapidly and eventually turned around, everything did start to go wrong, and we had a financial collapse which was spectacular. And if governments around the world hadn’t intervened massively with billions and billions of—trillions and trillions of dollars to save the system, we would have had a complete financial meltdown and a new global depression. So that’s the problem.
JAY: Isn’t that more or less what’s driving the banks to take such risks? Let me read you a quote from your own paper. "In response to economic problems and political pressure in the 1970s and very early 1980s, the US government began to accelerate an ongoing process of financial market deregulation. A combination of deregulation and fast-paced financial innovation led to a series of financial crises both in the US and elsewhere. These crises were met by government bailouts, which restored vitality to financial markets, but also created severe moral hazard. . . ." Isn’t that the real secret to all of this is they just knew that if this whole thing came tumbling down—and they knew eventually it would: we know Goldman Sachs was taking out insurance with AIG, betting against their own real estate bets, so that they know someday the ax will fall, but who cares, ’cause the governments are going to come save us?
CROTTY: I think that’s the logical structure of the system, that the system is such that when revenues and profits rise in financial markets, those people who are placed in important positions in financial firms get so much money, and there are so many of them that it actually makes logical sense for them to continue to take risk, continue to use excessive leverage, even if they know—which they don’t always know—but even if they knew that the system was going to collapse in three or four or five years, they would make so much money in the meantime that it wouldn’t make any difference. That is, they get their bonuses of $10 million or $20 million each year; when the system collapses, they don’t have to pay the bonuses back—they keep that. The shareholders get capital losses, but the rainmakers keep their bonuses. When the system finally does collapse, they do know that’s the moral hazard part, that the government will have to come in and rescue them, because to let them all crash would cause such damage to the general economy that they can’t possibly let it happen, and everyone knows this, so that it makes enormous sense for them to do what they do, to take actions that eventually crash the system. It is an awful, dangerous, risky system which is win-win for them.
JAY: They don’t leave this to chance, either. The big financial houses, particularly Goldman Sachs, their senior people are like a revolving door, going in and out of government, setting policy which establishes the framework for the bailout.
CROTTY: Yes, that’s true: Goldman Sachs in particular, but other financial institutions, have provided many of the most important people in the regulatory apparatus in the Treasury Department, at the Fed, in the presidents’ administrations. They lobby Congress from 1998 to 2008, Wall Street or financial services gave $5.4 billion to federal officials, either in the forms of lobbying or campaign contributions. So they’re everywhere. I mean, Robert Rubin, for example, who was Clinton’s secretary of the Treasury, was an ex-Goldman CEO. And Henry Paulson, who was Bush’s secretary of the Treasury, was an ex-Goldman CEO. They’re everywhere, and their influence is very powerful. But, again, it’s not just them; it’s the whole context of the conventional wisdom, supported by economists and by propaganda from financial institutions, that if you let the financial markets alone, they will provide the services that will enrich everyone and make the economy work very well, so that any reasonable person should support deregulation. Anyone who wasn’t and didn’t drink the Kool-Aid on this and was simply observing from the outside would see that this happens over and over again. It’s happened over and over again for hundreds of years. If you deregulate financial markets, then the financial markets eventually bubble. At some point they bubble so large that they can’t sustain themselves; then they crash. Then the question is: what you do about it? Do you regulate them so that they won’t do this? Or do you rescue them again and run the scenario all over?
JAY: Well, it’s an interesting situation where the Emperor can come out and someone can finally say, "You have no clothes." But it hardly matters, ’cause the government brings you a bathrobe pretty quickly. Jim, you mentioned in your paper that financial profits as a share of total corporate profits were about 10 percent in early 1980s and reached 40 percent by the mid-2000s. Give us some sense of how compensation related to that. And what size are we talking about when we’re talking these big bonuses? How much money are we talking about?
CROTTY: Well, we’re talking about a lot of money to a lot of people. An academic study in 2004 estimated that there were about 10,000 managing directors of investment banks in United States of America and that their average compensation was $2 million a year. That’s their average for 10,000 people. In 2006, Goldman Sachs paid its employees an average of $660,000 in bonuses, but that was among 25,000 or 26,000 employees, and most of those employees don’t—get little if any money. So the top people were making—traders might have gotten $40 million or $50 million that year; the CEO might have gotten $100 million that year. Let me give you a good example from firms that were so badly managed that they ended up crashing. There was another very recent study that showed that the top five executives at Bear Stearns, which destroyed itself, and at Lehman Brothers, which destroyed itself, from the period 2000 through the time that they crashed, received total compensation payments averaging a quarter of a billion dollars. The CEO at Bear Stearns, James Cayne, has got about $500 million over that eight-year period in which he destroyed the firm, and the CEO at Lehman Brothers, Richard Fuld, got about $500 million over that period which ended up destroying the firm. Angelo Mozilo, who ran Countrywide into the ground in his five-year term as CEO, also got about a half billion dollars in total compensation, and in fact sold $130 million worth of shares just before the firm crashed. So we’re talking about a lot of money. There’s $140 billion estimated for 2009 that will go in bonuses to financial corporations. These guys make enormous amounts of money. They have enormous incentives to take risk, to increase leverage, and to get their firms in trouble, because when the trouble comes, they still get big bonuses, and then the government bails them out.
JAY: Why is none of this considered criminal?
CROTTY: Well, it’s interesting. There are a lot of criminal activities which go on, but no one is really prosecuting that. You know William Black, who’s written a lot about that. But mostly because the same people who are creating these, what are, fundamentally, economic crimes, are also the people whose influence writes the legislation which decriminalizes everything. If you don’t have regulations and you don’t have laws that restrict what you do and you can get the Congress and the administration to do that, then you’re not committing legal crimes; you’re just committing moral crimes.
JAY: In the next segment of our interview, let’s talk about the concept of false value and how these executives created this essential mythology of profits to increase their bonuses and how that helped lead to the class. Please join us for the next segment of our interview with Jim Crotty.
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