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Time to Scrap the Government's Pay Limits

There has been a lot of outrage lately about Wall Street pay. In part this is because Wall Street executives tend to make a huge amount of money by Main Street standards. And it rankles even more when the institutions these executives work for have received federal bailout money.

What provoked the latest outcry was a story in the New York Times that reported that workers at large financial institutions were on track to earn as much money this year as they did before the financial crisis began. The paper quoted Brad Hintz, an analyst at a Wall Street firm, Sanford C. Bernstein, as saying "Like everything on Wall Street Street, they're starting to sin again."

Paul Krugman, a noted liberal and a Nobel Prize-winning economist, was scornful of the news. "There's no longer any reason to believe that the wizards of Wall Street actually contribute any thing positive to society , let alone enough to justify those humongous paychecks," Krugman said. He went on to complain that Wall Street was no longer in the private sector and suggested that banks are little more than welfare queens.

This outrage has been around for a while and was behind the portion of the stimulus bill that dealt with executive compensation. An amendment introduced by Sen. Chris Dodd set pay caps for firms that receive federal bailout money. Top executives at those firms are barred from receiving bonuses exceeding one-third of their annual salary. Since most executives get little salary but a lot of bonus, this will hit many in the pocketbook.

"The decisions of certain Wall Street executives to enrich themselves at the expense of the taxpayers have seriously undermined public confidence in efforts to stabilize the economy," Dodd said.
Sen. Charles Grassley, a leading member of the Senate's Finance Committee, was equally upset with Wall Street titans. "These guys ought to come to Main Street, Iowa, and see how the real world lives," he said.

But here's how ludicrous this debate has become. Citigroup, one of the nation's weakest banks, has a subsidiary called Phibro that is in the energy trading business. The unit has produced hundreds of millions of dollars in profits to the bank at a time when it desperately needs the funds. But it has now gone cap in hand to Washington to ask permission to pay bonuses to executives at Phibro. Admittedly, a $100 million payment to the head of the unit last year seems rich. But these aren't entry level jobs with a huge pool of possible replacements. If Phibro is making all that money, the bank should be able to do everything in its power to keep it functioning properly.

What happens when Wall Street doesn't pay the money? Executives bolt for other companies such as private equity firms and hedge funds that took no bailout money and can pay top dollar. "Top bankers have been leaving Goldman Sachs, Morgan Stanley, Citigroup and others in rising numbers to join banks that do not face tighter regulation, including foreign banks, or start up companies eager to build themselves into tomorrow's financial powerhouses," according to one New York Times report.

The lesson seems clear: the federal government should not get into the business of establishing pay scales in any industry, especially one as complicated as financial services, where most legislator have little or no experience. The unintended consequence of this government action is to force the top talent on Wall Street to leave, just when it is really needed.

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