Dividends' End

Wednesday, October 15, 2008

THE TREASURY Department's $250 billion capital injection for nine of the nation's largest financial institutions -- with more to follow for other banks -- should help to ease the credit market panic that has prevented even blue-chip companies from financing their operations. Newly infused with federal cash, the big banks will be in a better position to lend and borrow; that all of them took the government's help, whether they thought they needed it or not, means none of them will suffer by invidious comparison. But the arrangement contains a dilemma. If the government provided money with no strings attached, banks could have hoarded it or paid it out to shareholders (as dividends) or to executives (as salaries and bonuses). If the government drove too hard a bargain, no one would have participated. Either outcome would defeat the program's purpose: to restore the flow of funds to creditworthy borrowers.

Treasury tried to strike a balance, but we're not sure it was the right one. The department's agreement with the banks focused its restrictions on executive compensation: no tax deductions on pay above $500,000 per executive per year (including deferred compensation allocated to performance in that year); a ban on golden parachutes; and a "claw-back" of dishonestly earned bonuses. We understand the politics: Huge salaries and bonuses for managers of what are now taxpayer-subsidized companies would inflame the public, and justifiably so. But, in real economic terms, executive pay, even at millions of dollars per year, represents a small percentage of what government is giving the banks. Meanwhile, the nine banks receiving Treasury's initial $250 billion infusion pay out roughly $7 billion to their shareholders every three months. That's a lot of potential leakage of public funds. Yet Treasury plans not only to allow the banks to pay dividends but even to increase those payments if they can get Treasury's approval.

The program needs firmer assurances that the government's cash will not be diverted to shareholders. At a minimum, for the duration of the program, participating banks should not be permitted to increase dividends, with or without Treasury approval. Or banks could be offered financial incentives to eliminate dividends to the public. Reducing or eliminating dividends could make financial institutions' common stock less attractive to investors in the short run. But as long as the same rules apply to all banks, none will be at a disadvantage with respect to competitors. Considering what a big subsidy the banks -- and their shareholders -- are getting, this does not seem too much to ask.

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