Rules For The Splurge

Tom Brokaw asked Hank Paulson on Meet The Press (I microblogged it here)  what rules should be put in place for the splurge (that’s my new favorite term for the wall street bailout). Hank was good at making the point that we need to act now, but he really punted on the rules that should be put in place. He acknowledged that rules and reforms are needed, but he wanted to stay on message and he did a good job of that.

Fortunately my friend Tom Evslin has come up with a set of rules for brokerages/banks/insurance companies that want to avail themselves of splurge-related bailouts. If, for some reason, you don’t want to click thru to Tom’s post, here they are:

Rule #1: Cut salaries now

Part of the bailout bill ought to be that any
organization which proffers securities for government purchase must
agree not to pay any employee or contactor more than $1 million per
year for the next four years. No cheating with trips to events on the
corporate jet or other perks with draconian penalties TO THE RECIPIENT
for violations.

Rule #2: No new golden parachutes

Some executives have contracts which entitle them to
huge golden parachutes – especially if their pay is cut. These need to
be annulled.

Rule #3: End payment on old golden parachutes

Payments on existing golden parachutes should be stopped.

Rule #4: No dividends for a year

This seems harsh to us shareholders who may have bank
securities in our portfolio, but it’s not. Clearly an organization
which is being bailed out needs to conserve cash to survive.

I like these rules. I bet you all have ideas for more. Please leave them in Tom’s comment thread if you can.


Comments (Archived):

  1. charlie crystle

    Absolutely–Tom’s right.And given US taxpayers will now own the bad mortgages and debt,1) we should get stock in the companies that sell off their bad debt2) we should remember that the average US income is around $40,000, so 25 times that doesn’t sound so draconian to most people3) we should establish permanent controls on executive compensation. It’s time to create a lasting framework that rewards good performance and punishes poor performance. There doesn’t seem to be a free market when it comes to executive compensation and perks.Tom’s suggestions are a good start, but let’s look beyond the crisis. Oh, and about that little thing–the crisis. It doesn’t end here. Remember the context for this–6.1% unemployment and growing (and that’s just what’s on the books), a clear recession when you remove Defense spending, declining pension funds, and 25% increases in cost of healthcare every year (4 years in a row for us).We’re not even close to being out of the woods.

  2. fnazeeri

    I’ll see your socialist move, and raise you a communist response!I think we’d be better off just raising the top tax brackets (which BTW, is what Obama has suggested).

  3. Gopi

    I agree the govt should get stock from the companies that sell bad loans…But i have doubts about the “salary cut” plan – if the payout is just 1 Million whats the incentive for any CEO to remain with the company?.Maybe “Salary Cut” would work with a increase in stock payout so that the incentive of the CEO is aligned with that of the shareholders.

    1. fredwilson

      That’s the right way to think about it.Cash comp is never as good as stock-based comp in my opinionYou need to pay people so they can afford to live, but beyond that compshould really be weighted toward equity to create alignment withshareholders

      1. fnazeeri

        Instead of capping the upside, I wonder about apportioning more of the downside. For example, instead of compensating with call options, have executives buy shares with cash or a loan that includes a personal guarantee. Call options create a scenario where it’s heads-the executive wins and tails-the shareholders lose…basically a huge incentive to take on risk. Can this be done w/o totally stifling innovation?

      2. Steven Kane

        agree, as long as the equity is “at risk” equity, e.g., not outright grants of shares with vesting but de-minimus strike prices.public companies have become extremely sophisticated in methods for delivering “equity” compensation that really has zero risk to the recipient

  4. LeeHoffman

    Hey Fred, In principal these sound like good ideas, but like most rigid sets of rules, they will likely have adverse effects if imposed in a top down manner. For example:Rule 1: A million dollars seems like a high bar, cutting off all salaries above that level seems like a good way to reign in on excess. And it might. But it will also incentivizes the great people to leave and the mediocre people to stay. Imagine a situation where you have a sales person or money manager who is generating $500M a year in revenue for the company. Capping their salary at $1M will just cause them to leave. Who won’t leave? The people that don’t mind 1) getting their salary capped because they know they can’t get paid more elsewhere, or 2) people not worth being paid that money in the first place.This isn’t to say that these ideas can’t be put into practice, but it has to be done on a more flexible, case by case basis. In other words, one rule doesn’t fit all. To turn these companies around and provide uncle sam the maximum ROI for its investment, many existing agreements, contracts, and compensation schedules will need to be modified. However it will likely need to be done by exceptional management at the top of each company.

    1. charlie crystle

      Capping executives is different from capping salespeople. And where would the execs go if this is a national law? China? The point is to make the incentive based on positive outcomes, instead of random bonuses for just being a good ol boy.If you made compensation a factor of performance, cash isn’t a terrible option but it should be in the form of dividends or options. The company does well, you do well. Company doesn’t do well, well, you can cry into your million-dollar-a-year beer.And Uncle Sam should definitely have a piece of the upside, given the outlay of at this point trillions.

  5. Kenosha_Kid

    If we recognize that once a financial institution surpasses a certain size its stability is not only a private sector concern but one of national security – as this week’s events have demonstrated – then such institutions should not be regulated in the same manner as the smaller segment of the peer group. There should be two sets of rules: one that is free market capitalist in nature, applying to the “middle market” (as it were) of financial institutions, and a second that treats the large banks as quasi government entities. Despite theories to the contrary, these large conglomerations of financial assets indeed are quasi government entities, as we have also seen this week. As such, strict balance sheet management should be enforced, and the lesser risk associated with federal protection should be accompanied by reduced investor return expectations and targets. Thus, leverage ratios should be reduced drastically, even if this results in lower equity returns… and shorting the stock of such entities should be disallowed.

  6. Nick Molnar

    What about things that will help prevent this from happening again, and that don’t seem quite so communist?1. Remove the term “off balance sheet” from our collective vocabulary. Force all banks (not just the ones being bailed out) to whole new levels of transparency2. Encourage companies to put 1/2 of all executive bonuses in a 5 year trust, only released upon the company not imploding over that time. Mandating executive salaries will just have the good CEOs run to hedge funds, we need to align them with long term interests.3. Bring back the short selling so that the market can figure itself out. Federal regulators shouldn’t be performing for the camera, and they all know that was a bad move for the market.4. Buy back the mortgage backed securities at a ridiculously low price (~20c/$, and include commitments for repurchases in 24 months with a pre-set floor price (assuming the banks survive). That way we know we aren’t getting fleeced.

  7. stone

    This is a good down-payment on the future but there needs to be more stringent action by the government. I believe this crisis is bigger than 9/11 and bigger than the war on terror. Wall Street has been allowed to rape and pillage the nations wealth — my parents, grandparents, teacher’s unions, pension funds, 401k’s and any other pool of capital. They have been able to collect massive fees while knowing — in many cases — that the best case scenario they used to “sell” their client has little to no chance of ever becoming reality. This has to end or confidence will be hard to re-establish. I was the only one on this board a few months ago stating that auction rate securities was a huge scandal waiting to happen. There are more shoes to drop in this crisis.Aside from the obvious oversight which is needed, the best way to do all this imho is to:1) Take the extreme compensation out of this business — permanently. 2) You can still make millions if and only if your clients make even more. This is critical for restoring confidence.3) If your clients lose money then you get your basic package — period. You cannot make millions if your clients lost millions.4) You cannot sell someone a long position in a stock if your same firm is using their own money to short the very same stock. This is a common practice and highly unethical.We have to clean up this industry if it is to prosper once more.

    1. togilvie

      This is in the right direction, but I think the extreme compensation is actually necessary and healthy. The problem is the timing of payments, since it can take some time before the flaws in some of these strategies will come due. I think there needs to be more responsibility for taking a series of actions that generate returns by simply piling on risk.Specifically, I’d like to see a bankruptcy rules change allowing us to “pierce the corporate veil” for any highly compensated employee over the 5-year period prior to a meltdown/bankruptcy/etc. This would allow us to disgorge the hundreds of millions in past-bonuses paid for taking highly risky strategies that performed well out of the gate.It would also have a risk-dampening effect, creating an incentive for those who were comped well to examine their current portfolio for meltdown potential. As bubbles grew, you’d have an increasing group of influential people with an incentive to ensure a smooth landing, rather than an incentive to get through January, bank the bonus and see what next year brings.

  8. William Woody

    I know; it’s terrible how those people like Sergey Brin, Bill Gates, and Lawrence Ellison make billions… oh, you’re talking about the banking sector. Sorry.(Or, to put it in different terms, to demand cutting salaries of a class of people in a particular industry is to open yourself to socialism in the guise of populism: the moment you give ground on the idea that there are “fat cats” out there who do not deserve what the market will offer is the moment you open the door to someone looking at you–your venture firm, your salary, etc.–and say “hey, there’s a fat cat; let’s force him to spend the money in his venture firm on something more socially worth while than funding the next silly little map program for the iPhone.”)

    1. fredwilson

      In general I agree with you. I am a capitalist and a fan of free markets too. But my venture firm and google and oracle haven’t gotten bailed out by the US taxpayersTom’s suggestions are for banks and other companies who take advantage of the splurge

      1. William Woody

        The problem that I see is this: if there is a bug in one bank or two banks, it could be a failure of the regulatory systems (and upper management, including CEOs and the Board of Directors as proxies for the shareholders, are part of that regulatory system) to do their job. But when its a systemic failure across all banks involved in a sector, as a software developer my hunch is to look for a common bug.And the populist nonsense of “those damned fat cats” strikes me as a convenient scapegoat.My point here is if you allow this convenient scapegoat to run loose and start calling for restrictions on compensation that is normally settled by the market, you open the door to other people who look at you as a convenient scapegoat as well, for whatever social ills they’re interested in “fixing.”This crisis was created by a regulatory atmosphere which encouraged making bad loans, wrapping them in CBOs by investment banks hurting for new revenue after being creamed by Internet savvy investment banks like E*Trade and selling them to Fannie Mae and Freddie Mac who signaled that they could absorb any degree of risk, all driven by a congress more interested in “social justice” than in investigating frauds at the twin GSEs about half a dozen years ago. The present failures have to do with downgrading to junk status what was previously evaluated as AAA or AA CBOs, which suddenly created capitalization requirements on firms like AIG (who was insuring these CBOs) beyond levels previously imagined.To then claim that this is a failure of the oversight of CEOs and the Board of Directors who, according to the best information they had, had charted a profitable and legal course through the regulatory thicket and mandates established by Congress strikes me as disingenuous. To figuratively call for their heads because of some perception they took unreasonable advantage or even broke the law (as called for in some quarters) strikes me as especially silly: if you assume they broke the law, then what new laws are going to fix it?I would think that this would be a call to make transparent social engineering requirements which are now being imposed on industry as unfunded mandates–for example, I would think that if we want to make loans to high risk, low income families, we’d separately call that out and fund it through a separate and regulated organization–that way we know how much its costing us and if we want to continue paying for it.But instead, the lesson here seems to be to blame “fat cats” and perhaps find a sacrificial CEO or two to toss in a jail somewhere in order to please the populist Gods.

    2. Gary Mckenzie

      William no disrespect, but you totally miss the point. Did you know that 38.9 billion, yes, that is right was spent on bogus bonues last year. Granted I recieved a part of that but more or less, people should be held accountable.Just like there are terms when you go to a bank or VC firm for money, the same should apply to “Wall Street”. I know personally because i worked as a trader for 4 years. There is more incentive to be dishonest, very little “control struture in place” and zero accountablity.To put it in “web 2.0” terms when your company pitches to Fred’s firm, looking for funding there is a “term sheet” plus he would recieve a couple of seat on the board. He will also help guide and dictate what people within your company (if he decides to fund you) will be paid. This “bailout” should not be any different.I am not too keen on this “blank check” idea, there needs to be some control, accountabilty. Just remember there can be no responsibility without accountablity.

      1. William Woody

        So… Are you going to give your bonus back?

  9. TM

    Fred, there have to be more important rules than ones just abot exec comp. I mean, yes, symbolically it should be dealt with. But let’s get real – the pay packages are a tiny fraction of what the taxpayer is being asked to swallow here. How about a real rule like the Treasury cannot pay more than 2 percent over market bid for any of this paper. The real oversight needs to be about what price we are buying this crap in at. Whatever the price, it needs to still result in more writedowns on Wall Street and at banks. It’s important that if we buy this stuff we get good prices and that the banks still have to take some real pain on their balance sheets going forward.Otherwise this is a farce.

  10. Kid Dynamite

    1) If you take advantage of the Splurge, you must receive a KITN (kick in the nuts)2) Polititcians who called a housing/debt crisis/market bottom 6 months ago or more get a KITN3) anyone who criticizes David Einhorn as being part of the problem for being a “short seller” when in reality he could have been the savior for being an early whistle blower on this crisis, gets a KITN

    1. fredwilson

      I love the acronym KITN, I sure hope I am not headed for one anytime soon!

  11. andyswan

    I rarely link to my blog in comments…but here goes:My thoughts on how to prevent this in the future….make sure the freakin government is never forced to be involved again!….if the government wants to restrict compensation of management, then government should do so through the same mechanisms as the rest of us…by speaking up as shareholders.Congress regulating compensation is insane. Are we REALLY trying to make sure no one worth over $1m/year gets involved with this industry? Populist class warfare garbage..

  12. Christian Cadeo

    Fred,Have you had a chance to read this 3 page agreement in detail? If not, I suggest you do as it is utterly ridiculous the wide latitude that Paulson has in implementing this bail out. Example:1.Paulson has right to draft and issue regulations. So no more checks and balance where only the legislative branch has the authority to draft regulations.2.Paulson can hire anyone to help him with this bailout and disregard any laws regarding public contracts. So no-bid contracts here we come.3.Paulson action are non-reviewable and cannot be reviewed by any court of law or admin agency

  13. erin

    did you hear tom interview bloomberg. it was very good. bloomberg was impressive.

  14. patmoore

    $1million is too high it should be $200K at most.To the people who complain about why would anyone stay at the company making “only” $1million… remember these are the same bozos that screwed up big time already… so who cares?

  15. stone

    Populist warfare garbage? I think the trash that keeps asking for a government bailout while lining their pockets needs to find a way to share their profits on the upside if we’re going to bail them out “each and every time” on the downside. Wall Street has ceased to be a respectable occupation. No longer should american’s admire people that work on Wall Street. Where is the next scandal? How many teacher unions will be bilked out of their money this time? It’s a disgrace.

  16. Banet

    God, I hate Hate HATE that all of this happened and that it was all soooo preventable. What did people think was going to happen when mortgages were clearly being given to people who ultimately wouldn’t be able to afford them?Ok, enough whining. I like the idea of certain rules for companies that take the buyout, unfortunately we’re gonna need smarter people than me to determine those rules. With what you proposed, I see many problems. To name a few that haven’t been mentioned:1. If there are too many restrictions on taking part on the Splurge then some companies will not take part. If not enough take part the market won’t get the stability it needs.2. How can you cancel golden parachutes that were already given to people who have left? That’s a contract. It’s one thing to renegotiate a contract with a current employee but to change the terms with a past employee?How would you feel if, after you sold Delicious to Yahoo, they called you up and said, sorry, we paid too much. We can’t afford it now that our stock is plummeting. We’re taking half the money back. And yeah, we’re keeping the company, too. Tough.”…Man, I’m usually an optimistic person but this mess is going to weigh us down for decades.Peterhttp://www.FlashlightWorthy…Recommending books so good, they’ll keep you up past your bedtime. 😉

    1. patmoore

      Your “delicious” analog is completely irrelevant. We are talking about people who took huge bonuses for doing exactly the things that are now blowing up in their faces.When they were taking those bonuses they were whining about “unnecessary” government involvement. Now that things are going south, those same “captains” of Wall Street have suddenly turned socialist and are whining that the government isn’t doing enough.I would limit any bail to exactly the amount of money that each firm paid in taxes, minus any campaign contributions to Phil Gramm and Charles Schumer, and any money to any lobbying firm.

  17. Andy Freeman

    ML sold its mortgage portfolio for $0.22 on the dollar.How many of you would have been thrilled to get in on that for $0.25-30?We’re not going to see 50% forclosure rates. Even if we do, we’re not going to see housing prices drop by 70%.The problem was that the “market” for these securities was too restrictive. If I’m not “qualified” to buy something for my own benefit, I shouldn’t be required to pay for it for someone else’s.

  18. Tom Evslin

    Thanks for the support on this.Treasury Secretary Paulson has just made clear that, given the broad discretion in the bailout bill he would NOT cap executive salaries. Says too many institutions wouldn’t participate. Tells you something about his opinion of his excolleagues but, more important, makes clear that he shouldn’t have these broad powers.more here

    1. fredwilson

      The fox is guarding the henhouse tom

  19. riozen

    I would add to these laudable objectives:To make this thing more relevant to working Americans we can begin an action to do these following three items:1 – Cap the interest rates that can be charged on all credit cards to say prime ( Fed. Funds Rate) plus 10%. Prime is currently 2%. This will undo the outrageous 30 plus % rates that too many working, working poor and poor Americans are forced into – usury.2 – End the credit card company practice of hiking their own rate if you are even an hour late on another card.3 – Scrap the personal bankruptcy law, that this Congress wrote, that makes citizens pay back ‘credit cards” even if they declare bankruptcy.Banks are over the top on credit card practices. These are commercial banks but they are all complicit in passing the junk up the line and this would impact consumers directly.

  20. Michael

    These rules are a great first attempt at sanity, for sure.But what terrifies me is that a week has gone by and there is an astonishing lack of debate — nearly zero — about how and why the bailouts are necessary. It’s as if Paulson spoke, and everyone instantly, unthinkingly acquiesced. I should note that Rasmussen just published poll results in which only 28% of the US agrees with what has been proposed so far.Am I suggesting a bailout is not necessary? No. I am suggesting that it’s a bad idea to make a decision this profoundly large without the merest hint of thorough inquiry.

    1. stone

      Agreed that we need real debate. Wall Street has is the most fined and most prone to fail industry in the United States. Only the auto industry is a close second. The major difference? They don’t steal from the accounts of widows and teachers.Wall Street is incapable of functioning for more than a decade without a massive bailout. They never seem to learn so I believe drastic action is required. Let’s have the debate!

      1. Michael

        $30 Trillion would scare the bejeezus out of anyone, for sure, but I am not sure if this is a completely honest argument given so many assumptions inside it:…The alternative viewpoint? Sen Norm Coleman said it best: “The government could make 10 or 20 times what it pays on this, possibly.” That’s right, kids! This ain’t a bailout, it’s a golden opportunity!

    2. fredwilson

      Fortunately, your point of view is now the accepted point of view

  21. Tony Alva

    Abso-fucking-lutely!!! These rules are a good start. I cut the max annual salary to $500k.

  22. kip

    I’ll say it again: LTCM 2.0 . The S&L bail out was public and LTCM was done on the QT by a bunch of banks. While public is the way the people want it , privately is the only way it will get done . Why? We need to pay the people that did this so that they can unwind the deals.It stinks but because of the consequences of time involved it needs to be done. Then what?These instruments need to exist and tempering the rules to how they can be leveraged would seem like a wise idea.

  23. bmclarty

    I would like you to recommend this type of plan for the needed government mortgage bailout the SPLURGE to you and your colleagues.The government would pay $25,000 to each mortgage holder (1 per househole only on the 1st mortgage) in the U.S. This money would be directly deposited to the mortgage company.1)Does not reward investors/speculators with multiple mortgages.2)Does not reward the investment firms who created the problem.3)It directly and significantly benefits upper working class to upper middle class to people, who are the most affected and being whipsawed by this crisis? 4)The payments would pump equity into almost all homes. Giving the owners the option to stay or sell without massive losses now for more affordable accommodations.5)Suspend the aggressive foreclosure practices and roll back the late fees and penalties.6)The new equity would be used by the responsible home owners to stimulate the economy via home equity loans.7)Clean up lending practices in general.Obviously, you, your staff and colleagues would make this type of proposal much more eloquent. I just want to make sure a taxpayer favored option is considered and not just the escape hole for Wall Street option.