There's no sense trying to defend last year's Wall Street bonus package. Bonuses are supposed to be paid for performance, and last year was a financial disaster. Yet the 2008 payout – $18.4 billion – was the sixth largest ever.
Just for the record, the bonuses weren't just for executives. The number reported recently was for all employees at financial firms in New York, including support staff.
However one feels about Wall Street, the real worry is that Washington will go too far in its reaction. Sen. Claire McCaskill, a Missouri Democrat, was perhaps the most blunt. She referred to Wall Street bankers as "idiots."
McCaskill has drafted legislation that would cap the salaries of top executives at the same level as the president's – $400,000 – for banks receiving federal bailout assistance.
And the plan proposed by President Barack Obama would impose a salary cap of $500,000 on senior executives at companies receiving "exceptional" assistance, meaning aid beyond what's available in the main government bailout programs.
The larger issues raised here are troubling. In Washington we now have a lot of people who believe they "know" exactly how much bank executives "should" be making. The trouble is, once lawmakers think they know that, it's not a huge step to "knowing" how much those banks should be lending, and to whom.
And once that happens, we run the risk of politicians' trying to pressure banks into making questionable loans to politically preferred recipients or sectors. Billions of dollars in bailout money have been funneled to banks, and politicians are already griping that financial institutions are sitting on the money and refusing to lend it.
The Treasury has ordered the 20 largest recipients of bailout funds to provide monthly reports on their lending and investment decisions. Financial and monetary-policy consultant Bert Ely, writing recently in The Wall Street Journal, says these requirements could lead easily to lending mandates – a truly dangerous development.
Yes, lenders extended too much credit to weak borrowers. But now we're in danger of lurching from one problem to another – that of a politicized banking system.
As Ely put it in a telephone interview, "This is why I warned bankers about the downsides of taking (bailout) money, because of the strings that were going to be attached. It is very scary. It's why I hope we get an economic recovery soon so we can put this kind of nonsense behind us, or at least cool it off."
Ely pointed out in his Journal article that banks did not cut lending in 2008, despite the rhetoric on Capitol Hill.
The credit crunch continues and lending standards have tightened. For that matter, loan demand has fallen as well – normal for recessionary times. But banks aren't refusing to lend.
Citing Federal Reserve data, Ely noted that commercial bank lending rose by $386 billion last year, or 5.6 percent. Lending went up by 2.3 percent during the year's final quarter, even as the recession was intensifying.
Business lending rose by 10.6 percent, real-estate loans by 5.9 percent and consumer loans by 9 percent. Lawmakers should keep in mind that even as they're calling on banks to lend more, bank examiners are leaning on lenders to stiffen credit standards.
As for McCaskill's idea of limiting bank executives to the president's salary, Ely termed it "cheap populist demagoguery. … The president of the United States could not live the way he does on $400,000. The cost of running the White House is enormous."
Government aid for the banks was necessary; government had to step in to save the financial sector, otherwise the economy faced the risk of collapse.
But lawmakers should show a bit more humility in the face of the potential risks. Imprudent lending was a primary cause of the mess we're in. No one wants banks to lend in response to pressure from politicians, but that could well be the direction in which we're heading.