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In New Dilemma, Banks Cite Two Paths to Disaster

By Binyamin Appelbaum and Tomoeh Murakami Tse
Washington Post Staff Writers
Friday, March 20, 2009

Some bank executives warned yesterday that the government is forcing them toward a disastrous choice between accepting restrictions on compensation that could cripple their ability to compete with rivals, or returning billions in federal aid, which could retard lending and damage the economy.

The possibility of a newly weakened banking industry also raised concerns among businesses in the wider economy that already are struggling to find financial firms willing to lend them needed money.

"We're all going to lose on this thing," said an executive at a large bank that took federal aid. He and other bankers expressed shock at the rapid progress of legislation that could impose large pay cuts on thousands of workers, and dismay that the industry is at the mercy of an angry Congress.

Some members of Congress, however, said those concerns were overstated and that limits on pay schemes tied to short-term profits were long overdue.

A wave of public fury, which is driving the bills before the House and Senate, was unleashed over the weekend by reports that American International Group had paid $165 million in retention bonuses to employees at the unit that gutted the company and forced a massive government intervention.

The legislative action could trigger the unraveling of the broader federal bailout of troubled banks, which has grown increasingly unpopular on Capitol Hill and across the country.

The problem is that bonuses play a central role in the way that banks compensate their employees. Almost everyone on Wall Street gets a bonus at year's end. While most American workers are compensated primarily by a fixed annual salary or through regular commission payments, people who work in the capital markets receive the majority of their annual income in a lump-sum payment based on their performance, the success of their unit and company profits.

Paying bonuses allows firms to tie employee compensation to performance in a given year, something management experts have long regarded as a good practice. But some experts believe that tying bonuses to short-term results encourages employees to take risks with long-term consequences.

The bill passed yesterday by the House would impose large pay cuts on thousands of employees at eight of the nation's largest banks, according to compensation experts. The version pending before the Senate would force dozens more banks to cut the pay of thousands of additional employees.

"This isn't a bill aimed at executives," said Alan Johnson of Johnson Associates, a compensation consulting firm. "If you're an experienced professional, there's a real good chance that this impacts you."

The average bonus for a Wall Street employee in 2007 was more than $180,000, but top employees make much more. Lloyd Blankfein, the chief executive of Goldman Sachs, topped the charts, collecting a salary of $600,000 -- and a bonus of $68 million.

Financial historians say such payments are rooted in the days when Wall Street firms were partnerships, and the profits were divided among the partners, but the practice has long outlasted the conversion of all the larger firms into publicly traded companies.

The great concern among banks is that the legislation singles out recipients of federal aid for new restrictions while other firms don't have this burden. Executives at U.S. banks already are worried about a flight of talented employees to other jobs, including those at unregulated financial firms.

The new legislation, which targets bonuses paid to employees of U.S. companies, also creates a competitive advantage for foreign banks such as Deutsche Bank, which is based in Germany but operates one of the largest investment banks in New York, business leaders warn.

"I honestly think TARP banks have a grave risk of losing just the people they need to keep to help get them out of trouble," said Pat Wieser, co-head of financial services at Rhodes Associates in Manhattan, a boutique executive recruiting firm.

The government has invested more than $200 billion in more than 500 financial firms, in a huge effort to heal their wounds and revive lending.

In February, after Congress imposed restrictions on compensation for senior executives at companies that accepted federal aid, several banks asked the Treasury Department for permission to return the government's investment. The much broader restrictions now being considered by Congress could add urgency to that exodus. Indeed, one industry official said the legislation would drive departures even if it does not become law because banks are worried about what Congress might do next.

Some banks that received government money don't need it. Others cannot afford to return it. The vast majority of aid recipients, however, fall in a middle category: They can afford to return the money, but they would be significantly weakened, restricting their lending.

Officials fear that if the healthiest banks begin to return the money, weak banks will be forced to follow. The weak banks would be even less able to make loans and the sickest could be in danger of failing if the stigma of remaining in the program costs them the confidence of investors, customers and businesses

So far, the government has prevailed on most banks to keep the money. Only four have asked to return it. But others are growing increasingly restive. "I think there will be a strong desire to pay the money back," said an executive at one major bank.

Industry groups were exploring ways last night to defuse the situation. The Securities Industry and Financial Markets Association, a trade group, was consulting a constitutional lawyer because the bill targets a narrow group of people and is retroactive in nature, sources said.

The association declined to comment last night.

Businesses already have concerns about attempts by Congress to impose restrictions on banks that took federal aid. Some bankers warned that the new legislation, even if it does not become law, still would damage the government's ability to engage with private companies, including its nascent plan to partner with private investors to buy toxic assets from banks.

The impact of such legislation would fall disproportionately on New York City, home to many of the nation's best-paid bankers. The city's economy is fueled by the major banks, and the yearly bonus payments collected by their employees have helped to fill the city's coffers, float its real estate market and produce annual spikes in sales of luxuries such as diamond jewelry and high-performance sports cars.

In a reflection of the political environment, however, the House legislation was sponsored by two Democrats from New York, Reps. Steve Israel and Charles B. Rangel, and the Senate bill had the support of Sen. Charles E. Schumer (D-N.Y.).

"Once firms take government money, they can't play by the old rules," Schumer said. "The legislation won't apply to these firms as soon as they pay back the government."

Among the major recipients of bailout money have been General Motors and Chrysler. But the legislation may have little effect on General Motors, which has eliminated raises, bonuses, stock options and contributions to employee 401k programs. Effective May 1, company executives are taking 10 percent pay cuts, with some of the top level accepting cuts of 30 percent.

"We get it, and we've taken a number of steps," company spokesman Greg Martin said. "We recognize that with the receipt of government aid comes a level of responsibility and accountability."

Chrysler's top 25 executives have signed waivers saying they would not accept any new bonuses after Jan. 2, the day Chrysler received TARP funding. But in 2007, when Chrysler was still part of Mercedes's parent company Daimler, the company offered to pay $30 million in bonuses to its top executives to stay in event of a sale. After Cerberus Capital Management, a private-equity firm, bought a controlling stake last year, it paid out 25 percent of the bonuses.

Rep. John D. Dingell (D-Mich.), who supports the legislation, said Chrysler should not be paying those bonuses.

Tse reported from New York. Staff writers Peter Whoriskey, Dana Hedgpeth, Kendra Marr, Thomas Heath, Neil Irwin, Steven Mufson and Ylan Q. Mui contributed to this report.

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