The Spider, the Fly, the Bail-Out (2009 Mar)

by Barry A. Liebling

“‘Will you walk into my parlor?’ said the Spider to the Fly” is the opening line of Mary Howitt’s classic poem. The Fly knows she is doomed if she enters and replies, “to ask me is in vain, for who goes up your winding stair can ne’er come down again.” And the Spider, calculating that the Fly will not be able to resist temptation says, “I have within my pantry, good store of all that’s nice; I’m sure you’re very welcome — will you please to take a slice?” Of course the Fly succumbs to the Spider’s charms and is consumed.

Mary Howitt’s message is profound. Often you have all the information you need to recognize a disastrous course of action. Yet, some people refuse to use good judgement, make foolish decisions, and deserve the consequences. Today many businesses are accepting government bail-outs even though they should know where this will lead.

The official mission of the Troubled Asset Relief Program (TARP) is to inject federal money into financial services companies so they, and the financial infrastructure of the country, will be viable.

Of course, savvy observers understand that with government gifts there are always strings, or gossamer threads, attached. Some of the very largest firms have already accepted huge infusions of cash. And the program is designed to continue its interventions.

In February 2009 President Obama announced that there will be a $500,000 salary cap for top executives in companies that receive “exceptional financial assistance” from TARP in the future. This, of course, is a clear confirmation that the federal government will play an active role in firms that receive bail-out money. Once the funds are delivered the government – which becomes an investor and partial owner – has the power to call at least some of the shots.

To the populist audience the Obama proclamation is welcome news. It is about time something is done about the “excessive compensation of Wall Street fat cats.” When rich executives are cut down to size, or at least thwarted from getting much wealthier, those who are haunted with envy can savor their victory.

The reaction of the “pro-business” audience is mixed. Some are unimpressed because they understand that when the government invests in your business, you are the junior partner at the mercy of your new boss. Others indignantly complain that if the government can dictate compensation policies we are on the road to socialism. Resentful observers may not fully grasp that companies receiving TARP funds are no longer private and are already partially nationalized.

Now that it is more obvious than ever that accepting government assistance is like entering a cobweb how will management teams act? Some small and medium-sized banks, recognizing the importance of their independence, have publicly refused to participate in TARP. Many financial institutions, however, are calculating the best way to take advantage of TARP without getting trapped.

And the seductive, flattering, reassurances of the Spider can be detected when you scrutinize the details of President Obama’s proposal. Ben W. Heineman, Jr – a former GE senior vice-president for law and public affairs – writes in BusinessWeek (February 7, 2009) that the President’s policy is “more about procedure than substance and will allow most companies to self-govern.” His article suggests that TARP participants need not be alarmed.

Heineman explains that the cap applies to future recipients of TARP, not companies that have already received funds. Firms that obtain “exceptional financial assistance” can still pay top executives more than $500,000 providing the compensation takes the form of restricted stock that vests after the government is repaid.

Companies in less dire straits that participate in the TARP “generally available capital access programs” will be able to avoid the $500,000 cap if they explain their compensation policies to the government and prove that they do not “encourage excessive and unnecessary risk-taking.”

So, a company’s management might conclude that getting money from TARP may not really be so dangerous. Top executives will be able to get what they want by clever maneuvering. They can always use restricted stock to get around the hard half-million dollar limit. It should not be that difficult to explain that pay policies are not encouraging “excessive and unnecessary risks” – even though the explanation will be judged by a federal official.

Discovering these loopholes will be soothing to the management of some companies, but it should not be. Putting restrictions on compensation was the government’s first move with respect to TARP recipients – probably because it was calculated to please the crowd with the pitchforks. But compensation is just one of many areas where the government-investor-partner will wield power. What about general business strategy (should new products support governmental goals?), how the firm selects vendors (should green companies be favored?), what the standards are for originating loans (are the disadvantaged getting enough?), internal personnel policies (what protected groups need to be helped more?)?

And consider – if the government gets involved in more of the business decisions of a firm participating in TARP will it be easier or harder for the company to repay its TARP debt? If it fails to repay, those who would like to see financial services companies fully nationalized will be pleased.

Like Mary Howitt’s Fly, the managements of companies eligible for TARP have all the information they need to make wise decisions. If they choose the path to calamity they will have only themselves to blame.

*** See other entries at in “Monthly Columns.” ***

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