Leonhardt vs. Sorkin: Outside the Bubble

Yesterday, the NYT’s Andrew Ross Sorkin wrote a dog of a column arguing that AIG should get to keep its bonuses, a blinkered assertion I and many others ripped apart and one that sent him on a sputtering media tour as the business media’s Cramer of the Week.

Thankfully, the Times’s David Leonhardt has apparently talked to people outside the bubble and fires off a good rebuttal to his colleague.

I really love how Leonhardt skewers the Wall Street line here about “retention bonuses” needed to keep the “best and brightest” on the job. He gives us a brief jaunt through the last fifteen years of excuses for ginormous corporate pay and finds that the reasoning keeps changing, but the thrust somehow always stays the same:

In the booming 1990s, companies supposedly had to pay retention bonuses because executives had so many other job opportunities…

Then came the aftermath of Enron, when new scrutiny and regulations apparently made some chief executives wonder if they still wanted their jobs. “I’m thinking of actually getting out,” David D’Alessandro, the head of John Hancock Financial Services, reported hearing from one fellow chief executive.

Now we have to pay these geniuses because only they can unwind the catastrophic mess they created. What a racket!

But the latest excuse doesn’t hold much water, Leonhardt suggests:

A few years ago, when the economy was still expanding, I looked into every large company that had changed chief executives over the previous six months. Not a single boss at any of them had left for another job. Such departures are so rare that Booz & Company’s annual study of executive turnover doesn’t even include a category for them.

He points out that AIG’s explanation of its retention bonuses has shifted wholesale since the infamous contract was put in place, and, of course, that many have left anyway—and if I read the Times right yesterday, some bonuses went to people who had already left. How irreplaceable are these money-losers, anyway?

Simon Johnson, a former chief economist at the International Monetary Fund, has pointed out that in financial crises, bankers often exaggerate the difficulty of cleaning up their mess. They do so partly to justify their own continued importance and also to fight off calls for a government takeover of banks. In reality, Mr. Johnson says, the mechanics of cleaning up hobbled banks turned out to be fairly straightforward during other recent crises, like the Asian one in the ’90s.

Now, from everything I understand credit-default swaps are much more difficult to unwind than just about anything that’s come before them. Remember Warren Buffett’s difficulty with Gen Re’s derivatives, which took years and cost hundreds of millions during the good times.

Leonhardt also puts a match to Sorkin’s straw man—that the administration wanted to shred the law:

It’s entirely understandable, then, that the Obama administration, the Federal Reserve and Congress are looking for creative, legal ways to claw back some of the bonuses. That bonus money is really taxpayer money: absent a bailout, no A.I.G. would exist to pay bonuses.

Leonhardt points out what’s conventional wisdom by now—that enormous pay and its structure incentivized the reckless behavior in the first place. And he gets into some interesting solutions to the problem, including: Using tax policy to disincentivize outsized pay.

There are ways to do that by eliminating corporate tax breaks, which must be done. That stuff’s a no-brainer. The interesting question, and one I’ve been waiting for months to see in the mainstream press, is whether we should tax windfall earnings at a much-higher rate than we currently do.

Today’s tax code makes no distinction between income above $373,000 and income above, say, $5 million. Both are taxed at 35 percent.

That is a legacy of the tax changes of the early 1990s, when far less of the nation’s income went to millionaires. Today, you can make a good argument for a new, higher tax bracket on the very largest incomes. In the past, the economist Thomas Piketty says, higher marginal tax rates tended to hold down salaries and bonuses, because executives had less incentive to angle for multimillion-dollar pay.

This is almost verboten in the acceptable business press (and the political press, too, for that matter), but it’s a debate that we need to have. There are no good ways for the government to cap pay, it seems to me. The only way to regulate that is on the back end, through taxation. Should John Paulson, who made $3.7 billion in a single year, have to pay a higher tax rate than the doctor who makes $300,000?

You tell me.

Remember, as late as Ronald Reagan’s second term, the top tax rate was 50 percent. Last year, it was 36 percent. Capital gains taxes are far below income-tax rates for most who have capital gains.

The financialization of the economy has led to a brain drain of many our smartest kids who can’t resist the bucks on Wall Street (or the law firms defending Wall Street). That’s changing for the time being, but what about for the long haul? Could tax policy redirect them to lower-paying but more productive careers like medicine, engineering, teaching, entrepreneurialism? I don’t know, but clearly the whole shuffling paper (or stacking it, as in houses of cards) thing hasn’t done us much good.

Good for Leonhardt for opening this debate in the pages of the Times.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.