Paulson's socialism for the rich, Part 2

The Bush Adminstration's plan for partly nationalizing banks has no serious constraints on the structure of executive pay plans. That oversight is unfortunate, but not primarly because the average pay of executives is so high - the reason typically given.

Executives in financial firms earned tens of billions of dollars over the last half dozen years in large part by mislabeling cashflow as "earnings." Many of those cashflows came from selling various forms of insurance and then assuming the firms would never need to pay out claims. These forms of insurance were called "credit default swaps," "naked puts" and an endless variety of other names. What they had in common was cash arrived in the short run, even at the expense of the firm eventually. That mislabeling of cashflows as "earnings" is obvious now, as the banks report enormous losses.

Unfortunately, many of the executives who approved these transactions were responding to the incentives set out by their boards of directors: incentives to maximize current earnings and this and next year's stock price. Regardless of the average level of CEO and other bank executive pay, the U.S. taxpayers who own such a large chunk of the downside of these firms should make sure the firms do not keep paying executives to destroy value. Thus, the vast majority of executive compensation should be tied to long-term performance. Any reversal of performance -- particulalry if accompanied by fraud or accounting restatments -- should lead to a massive reduction in CEO pay and pensions.

The current financial mess had many causes. Improving corporate governance is only one part of the solution. At the same time, it is a necessary change that should benefit both private and public owners of all enterprises.