Business Law Prof Blog

Avoiding the Compensation Limits in the Bailout Bill

The PNC acquisition of National City provides yet another means of avoiding the prohibition on golden parachute payments to executives in banks that get government bailout money.  The National City executives will get healthy golden parachutes because the bailout money went, not to National City, but to the bank that bought National City, PNC.  The mechanics of forcing banks to breach employment contracts with executives in order to qualify for bailout money has always been a huge question.  Avoidance of the prohibition (rather than confrontion of its problems) will be the order of the day.

Government's Role in the National City Deal

We now have discovered that the government, in this case John Dugan in the Office of the Comptroller of the Currency, is forcing bank deals with the selective granting and withholding of promises to get government bailout money.  He promised PNC $7.7 million and refused to give National City anything, forcing National City to look for a buyer at distress prices.  The effect?  PNC buys National City at distress prices.  This puts a great deal of power in the hands of one person, Dugan, that is unrevealed and unaccountable.  It would be interesting to get Dugan before a questioner and ask him what investigation he had done on National City and what standards he had applied.  Would he apply them to other banks?  The opportunity for favoritism and cronyism here is obvious and dangerous.

Professor Says We Will Have to Close Securities Markets

A professor from New York, Nouriel Roubini, Dr. Doom, once a senior adviser to Treasury, in a talk in London at a conference on hedge funds has stated that hedge funds will start to crumble as cash-strapped investors demand redemptions.  Once the hedge funds fail, he states that we will have to close the markets for a week or two to sort out the mess.  Quite a dire projection.  He also notes that heavy regulation of hedge funds is now inevitable. 

PNC to buy National City with Your Money

PNC said it would sell $7.7 billion preferred shares to the government and then announced it would buy National City for $5.2 billion in stock.  The acquisition was a "take-under";  the value of the PNC shares exchanged for National City shares was under the closing price of the stock Friday.  In essence, the government financed the acquisition.

New York Times is Junk

Not the reporting, its debt.  S&P downgraded the companies bonds to BB-, junk.  The bonds can no longer be held by funds that must hold "investment grade" securities.

Character Comes Out In Times of Trouble

China has started to allow short selling in its markets; the UK has extended the ban on short selling. The leader of Argentina has nationalized all private pension plans.  The Democrats want to spend $300 billion, that we must borrow to get, on a long standing wish list of pork barrel projects to stimulate the economy; the Republicans want the government to buy stock in banks and run insurance companies.

Paulson Should Go

Can anyone, after reading the front page story in today's New York Times on Paulson, not believe that Paulson should be fired?  He is now spending time, in the middle of a crisis, recasting history to protect his reputation.

Bush's Bailout Justification

President Bush noted, in a speech Monday, that "we would get our money back."  True enough.  When the government sells bonds at 3.5 percent and buy preferred stock at 5 percent for five years (and then ten percent thereafter), the government makes money if firms pay the dividends.  The market demands 12 percent, but the government, with a lower cost of borrowing money and a very long time horizon for returns, can demand much less.  But this is always true, in good times and bad.  Why does the government decided to make such money now; why not always take advantage of such a money making strategy, lowering our tax burden???  The answer is in political economics.  It is socialism and socialism, in all countries that try a public company ownership strategy (even a partial ownership strategy) over an extending period of time do not do as well economically as those that rely on capitalism for economic growth.  Government officials cannot resist the temptation to reward political cronies and not performance.  Performance suffers and everyone suffers.  Can we keep the genie in the bottle with this "temporary program."  Milton Friedman said that no government programs are ever "temporary."  Hope he is wrong on this one. 

Paulson's Plans

Paulson's purpose in giving money to the banks is to encourage banks to lend money to others.  The problem?  The mechanics of the grant.  The government is buying preferred stock and warrants with cash and has no management authority.  Banks can take the money and do one of four things, all of which are not what Paulsen wants.  1) The banks can hoard the cash. 2) The banks can pay off their debt. 3) The banks can use the money to continue to pay dividends at existing levels. 4) The banks can use the money to buy other banks. Since Paulson has no management control, he cannot stop these other uses of the government's cash, none of which create the economic stimulus he wants (banks lending money).

Gretchen Morgenson On Bailout Bill Compensation Limits

Morgenson, in Sunday's New York Times, waxes approvingly about the compensation limits in the governments purchase of equity in banks.  The limits are more illusion than substance.  First, there is no cap or other limit on salary or bonuses. Just a vague requirement that whatever salary is paid give appropriate risk taking incentives.  Whatever that is.  A the government, without a vote as a shareholder, cannot have a say in defining the term once the money is paid.  Second, The clawback provision, in which bonuses must be returned if they depend on financial figures that later are shown to be wrong, will discourage incentives tied to specific performance goals.  Third,  the prohibition on golden parachute payments that are over three time salary is easy to circumvent.  A severance contract can vest after the repurchase of government stock or after the government sells its stock.  And fourth, and most important, the new tax limit on deductions for over $500,000 in salary will not stop the payments anymore than the old limit of $1 million did.  These compensation limits are toothless.