Will the Rule of Law Survive Obama?

Written by David Frum on Thursday October 22, 2009

The Obama administration plans to order financial firms that received bailout money to cut promised compensation payments to executives. What’s happening with these executive contracts is lawless and wrong.

May I associate myself with the remarks of the esteemed Professor Bainbridge?

The Obama administration has shown a shocking disregard for the rule of law when contract rights interfere with the administration's ability to reorder the American economy as it sees fit.

First it was the AIG bonuses. Then the Chrysler and GM bondholders. Now executive compensation.

From the New York Times:

Responding to the furor over executive pay at companies bailed out with taxpayer money, the Obama administration will order the firms that received the most aid to slash compensation to their highest-paid employees, an official involved in the decision said on Wednesday.

The plan, for the 25 top earners at seven companies that received exceptional help, will on average cut total compensation this year by about 50 percent. The companies are Citigroup, Bank of America, American International Group, General Motors, Chrysler and the financing arms of the two automakers.

Some executives, like the top traders at A.I.G., will face tight limits on their pay. In addition, the top-paid employees at all the affected companies will face new limits on their perks.

The plan will also change the form of the pay to align the personal interests of the executives with the longer-term financial health of the companies. For instance, the cash portion of the executives’ salaries will be slashed on average by 90 percent, and the rest will be replaced by stock that cannot be sold for years.

It's unsurprising that a public that has had to pay billions to rescue firms from bad investment decisions would resent paying big checks to senior executives. It's certainly conceivable that the form of compensation imposed by Ken Feinberg - more stock, less cash, with delays in the date the stock can be sold - might have encouraged more responsible behavior had it been in place beforehand.

But as Bainbridge puts it:

[M]any (most?) of the compensation deals the Obama administration is shredding were set in employment contracts. Granted, some of those employment contracts were signed after the law setting up pay "czar" Kenneth Feinberg's position and empowering him to review pay packages at TARP firms.

But a lot of them are pre-existing contracts and it's those contracts that are the main concern.

Feinberg in fact is trumpeting his success at forcing so-called renegotiation "even for contracts over which he did not have explicit authority."

The bottom line thus is that Obama is having his minion coerce TARP executives and employees into ripping up contracts Obama doesn't like so as to assuage the populist public.

Maybe an analogy helps. Suppose we discovered that during the tense days of September and October 2008, executives at the big banks were ordering lavished catered dinners for themselves at their offices. We'd all disapprove. Those executives should have been eating sandwiches at their desks! But would it be OK for the government to order the banks to refuse the invoices from the catering company?

The service was contracted by the people who had the legal authority to make the contract. The contract must be paid, unless the company goes into bankruptcy - at which point all creditors would have to be treated equally, without the government picking and choosing its favorites to be paid first.

What's happening with these executive contracts is the equivalent of bouncing the bills from some disfavored suppliers. It's lawless and it's wrong.

And the consequences of this wrong action will reverberate through a whole economy. Suddenly all creditors, suppliers, and contractors have to factor into the other uncertainties of business a new risk of arbitrary government abrogation of their legal rights. Suddenly the awful Chrysler case looks less like an emergency exception to an otherwise reliable rule, and much more like a harbinger of danger to come.

Category: News