Sunday, January 25, 2009

LIttle Change in Obama Reform Plan

The New York Times is reporting that "Obama Plans Fast Action to Tighten Financial Rules".

As predicted, the solution is going to be an expansion of Federal "oversight" activity, which is to say your tax money. It looks as though the incompetent Fed will be given greater power; this has it backwards. The Fed should lose power for enabling the housing bust and manipulating interest rates in chaotic fashion, almost always favoring borrowers over lenders.

Sadly, credit default swaps are going to be rewarded with a clearinghouse. They should instead be banned. Either they should be out-and-out insurance products and regulated within the existing insurance framework, or if they are between two parties neither of which has an economic interest in the loan failing, then they are gambling and are illegal depending on the jurisdiction; but in any case they then serve NO purpose.

In another disastrous trial balloon/shakedown/statist solution, "Administration officials have begun to study ways to control executive compensation".

Let us recall how the stock options craziness of the 1990s got going. The Democrats under George Mitchell (Senate Majority Leader) forced/persuaded Bush I to sign legislation eliminating deductibility of salaries over $1 M yearly. (Of course, Democratic-leaning high earners such as movie stars had their multi-million dollar salaries remained deductible.) In response, companies went to a "best practices" option-enhanced salary package. This led to an excessive effort to drive up the stock price, helping to lead to crazy stock valuations that had to fall.

Let us also recall that the non-scandal "scandal" that some wealthy people had enough tax deductions from time to time to legally pay no income tax some years led to the disgusting and widely-hated Alternative Minimum Tax.

There they go again. First the Government pushes money on banks, which either really, really needed it because they were insolvent and could have simply failed (and may yet fail), or which didn't need it and therefore were given an unnecessary and inappropriate gift from you and me; then it takes this poorly-thought out preferred stock position in these companies to propose to control what the executives earn. As with the AMT, let's think the implications of this control through. In one way or another, the Government is our partner in every legal business. Does that give it a right to control compensation? Even if the Government owns preferred stock, what right does that give it to influence salaries?

A much better solution is that companies that overcompensate their executives will pay the price in a free market.

While undoubtedly there will be positive aspects of the Obama/Democratic plan, the first quick take here is disappointment that it further legitimizes credit default swaps rather than getting rid of them or calling them insurance contracts plain and simple; that it apparently does not call for a real simplification of what derivative products can be marketed; and that it wants to be on compensation committees along with the elected directors of companies.

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