    [House Hearing, 111 Congress]
    [From the U.S. Government Publishing Office]

                     COMPENSATION IN THE FINANCIAL INDUSTRY

    =======================================================================

                                    HEARING

                                   BEFORE THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                         ONE HUNDRED ELEVENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                JANUARY 22, 2010

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 111-98

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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                     BARNEY FRANK, Massachusetts, Chairman

    PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
    MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
    CAROLYN B. MALONEY, New York         PETER T. KING, New York
    LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
    NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
    MELVIN L. WATT, North Carolina       RON PAUL, Texas
    GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
    BRAD SHERMAN, California             WALTER B. JONES, Jr., North
    GREGORY W. MEEKS, New York               Carolina
    DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
    MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
    RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West
    WM. LACY CLAY, Missouri                  Virginia
    CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
    JOE BACA, California                 SCOTT GARRETT, New Jersey
    STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
    BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
    DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
    AL GREEN, Texas                      TOM PRICE, Georgia
    EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
    MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
    GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
    PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
    KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
    RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
    CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
    ED PERLMUTTER, Colorado              BILL POSEY, Florida
    JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
    BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
    ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
    JACKIE SPEIER, California            LEONARD LANCE, New Jersey
    TRAVIS CHILDERS, Mississippi
    WALT MINNICK, Idaho
    JOHN ADLER, New Jersey
    MARY JO KILROY, Ohio
    STEVE DRIEHAUS, Ohio
    SUZANNE KOSMAS, Florida
    ALAN GRAYSON, Florida
    JIM HIMES, Connecticut
    GARY PETERS, Michigan
    DAN MAFFEI, New York

            Jeanne M. Roslanowick, Staff Director and Chief Counsel

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        January 22, 2010.............................................     1
    Appendix:
        January 22, 2010.............................................    41

                                   WITNESSES
                            Friday, January 22, 2010

    Bebchuk, Lucian A., William J. Friedman and Alicia Townsend
      Friedman Professor of Law, Economics, and Finance, and Director
      of the Corporate Governance Program, Harvard Law School........     9
    Minow, Nell, Editor, The Corporate Library.......................    12
    Stiglitz, Joseph E., University Professor, Columbia Business
      School.........................................................    10

                                    APPENDIX

    Prepared statements:
        Bachus, Hon. Spencer.........................................    42
        Bebchuk, Lucian A............................................    45
        Minow, Nell..................................................    52
        Stiglitz, Joseph E...........................................    68

                  Additional Material Submitted for the Record

    Hensarling, Hon. Jeb:
        Written statement of the Center On Executive Compensation....    76
        ``Bank CEO Incentives and the Credit Crisis''................    82

                              COMPENSATION IN THE
                               FINANCIAL INDUSTRY

                                  ----------

                            Friday, January 22, 2010

                 U.S. House of Representatives,
                       Committee on Financial Services,
                                                       Washington, D.C.
        The committee met, pursuant to notice, at 10:05 a.m., in
    room 2128, Rayburn House Office Building, Hon. Barney Frank
    [chairman of the committee] presiding.
        Members present: Representatives Frank, Kanjorski, Sherman,
    Moore of Kansas, Miller of North Carolina, Green, Cleaver,
    Bean, Perlmutter, Donnelly, Foster, Carson, Kilroy, Grayson;
    Bachus, Hensarling, Garrett, Neugebauer, Campbell, Lee, and
    Lance.
        The Chairman. The hearing will come to order. And we have
    10 minutes on each side. Since there are not many members here,
    we can get right into the questioning and have some
    significant--everybody will be able to ask questions. I will
    say that I want to announce that on February 5th, we are going
    to have a joint hearing with the Committee on Small Business on
    the question of why more money isn't being lent. And we are
    picking February 5th because we agreed to have a joint hearing
    which means that 100 Members of the House will be the operative
    body. So this will be one day where, if Members come to us and
    say I can't make it, we will not be totally unhappy; but we did
    feel that this is something that the Small Business Committee
    has a very real interest in this as well.
        We have the chairman and the ranking member of the Small
    Business Committee on this committee so we will do that one
    together.
        And this hearing will now begin. We have 10 minutes on each
    side for opening statements, and I begin by recognizing for 2
    minutes the gentleman from Indiana, Mr. Carson.
        Mr. Carson. Thank you, Mr. Chairman. As we all know, the
    American taxpayers are angry that their tax dollars lifted many
    financial firms in the time of crisis while some of these same
    firms now have reported record profits and are handing out
    lavish bonuses. Some of these firms have not turned around but
    continue to follow reckless compensation practices. This is
    because we currently have an irresponsible corporate culture
    where American CEOs are awarded large bonuses and generous
    stock options even when their companies perform poorly.
        There has been an increase in the typical CEO pay in the
    United States during the past 25 years. The total real
    compensation of CEOs in large publicly traded companies grew
    sixfold during this period. The case against the pay of
    American CEOs looks even more powerful by recognizing that the
    typical American company head receives greater total
    compensation than company heads in Great Britain, Canada,
    Japan, Spain, and in much of all developed countries. Clearly,
    American CEOs are being rewarded over CEOs elsewhere, even when
    per capita income of the countries do not differ by very much.
        While recent headlines on executive compensation are
    focused on financial firms, we cannot ignore other sectors. In
    fact, the corporate library recently ranked five CEOs, all
    outside of finance, the highest paid, worst performers. These
    CEOs are taking home more pay, despite the fact that their
    businesses have done so badly, that their stocks have tanked,
    and they have laid off many employees.
        American compensation structures are out of control and the
    existing compensation structure cuts to the ability of our
    corporate governance system to function. As we work to issue
    new guidelines on executive pay, we need to ensure firms begin
    to better align pay with stockholder value.
        I suggest moving beyond a nonbinding shareholder vote on
    executive compensation. There is continued frustration with
    company boards that either failed to act in response to a
    successful nonbinding shareholder resolution or a watered-down
    implementation of proposals. Boards can too easily amend or
    rescind board-adopted policies under the umbrella of fiduciary
    duty obligations.
        While I encourage open dialogue between shareholders,
    directors, and management, I do feel shareholders have the
    incentive to act responsibly in determining fair and equitable
    pay for executives of firms.
        Thank you, and I yield back the balance of my time.
        The Chairman. The gentleman from Alabama--I believe the
    gentleman used 2\1/2\ minutes, so we will have 7\1/2\ left. The
    gentleman from Alabama for 2\1/2\ minutes.
        Mr. Bachus. Thank you, Mr. Chairman. Mr. Chairman, since
    you have been chairman, I think you have been very fair to
    committee Republicans. You have invited witnesses that we have
    requested and often invited more than just one of our choices
    at certain hearings. Of course, it is traditional that the
    Republicans get to call one witness at a hearing. I have always
    appreciated your consideration and I know my colleagues have
    too. Because you have always been accommodating of our
    requests, the decision to deny Republicans our witness choice
    for this hearing is both disappointing and puzzling. I am not
    sure what makes this hearing any different from any other one.
        So I would ask why we were denied our choice of witness.
    That witness was Ed DeMarco. He is the acting director of the
    Federal Housing Financial Agency, which oversees Fannie Mae and
    Freddie Mac. He is the person who, along with the Treasury
    Department, approved a $42 million payday for 12 executives of
    the failed GSEs, including $6 million to the chief executives.
        During this hearing on compensation in the financial
    industry, we assumed we would be permitted to examine a real-
    life case of excessive unreasonable executive pay at the two
    companies which have received more extraordinary taxpayer
    assistance over--$110 billion and counting--than any others.
    But we were wrong.
        Mr. Chairman, $6 million is 15 times more than what the
    President earns and 30 times more than what a Cabinet Secretary
    earns. The Christmas Eve announcement of these bonuses was
    greeted by one commentator by saying the taxpayers got
    scrooged. Because the regulators failed to use their authority
    to block these colossal paydays of government employees--you
    have referred to them as public utilities--Congress should step
    in.
        I and several of my Republican colleagues have introduced
    legislation to protect taxpayers from having to foot the bill
    for any more multibillion-dollar tax packages.
        Mr. Chairman, I think the taxpayers are right. Whether it
    is any financial company, if the government is heavily
    subsidizing that company, they have a right to ask--
        The Chairman. If you wish to continue--
        Mr. Bachus. Another 30 seconds. They have a right to ask:
    Are my tax dollars subsidizing these large salaries? And they
    certainly have the right to hear Mr. DeMarco and find out why,
    on Christmas Eve, they learned that they would be paying some
    tremendous bonuses.
        The legislation also expresses a sense of Congress that
    each executive should return the executive pay they received in
    2009 so we can reduce the Federal budget.
        Mr. Chairman, I do appreciate your pledge to invite Mr.
    DeMarco to testify at a hearing in late February, but I am
    disappointed that the American taxpayers will have to wait
    another 5 weeks for an explanation from the Obama
    Administration about this Christmas Eve raid on the Treasury to
    pay these executives.
        I yield back the balance of my time.
        The Chairman. The gentleman consumed 3 minutes. There will
    be 7 minutes on his side and 7\1/2\ on this side. I recognize
    the gentleman from California.
        Mr. Sherman. Thank you.
        The Chairman. For 2\1/2\ minutes.
        Mr. Sherman. Yes. I believe in capitalism, that means
    shareholder control, shareholder risk. That is why we should
    have a say on pay and it ought to be binding. After 13 years in
    Congress, I am not a real fan of nonbinding resolutions. There
    is a special circumstance where a company is too-big-to-fail
    because at that point, they have a quasi-Federal Government
    guarantee. The best solution is to break them up so that we
    don't have anyone who is too-big-to-fail.
        I commend the gentleman from Pennsylvania whose amendment
    would at least allow the Administration to do just that. Until
    then, those that are too-big-to-fail should face fees to recoup
    for the taxpayer the benefits that the organizations get from
    their implicit Federal guarantee.
        The bill we passed in this committee, in this House, does
    that, and, with Peter's amendment, allows those firms to pay
    for the past cost of the too-big-to-fail as well as provide it
    a before-the-fact fund to pay for the too-big-to-fail problems
    of the future. It also makes sense as long as there are those
    that are too-big-to-fail and enjoy the implicit Federal
    guarantee, if they are quasi-government entities or quasi-
    federally guaranteed, they should play by government salary
    rules, which are a lot different from those that Wall Street is
    familiar with.
        The best solution is for these firms to voluntarily divide
    themselves so they are not too-big-to-fail. And we can go back
    to real capitalism--shareholder control, shareholder risk--and
    a Congress and a Federal Government that doesn't have to
    concern itself with salaries and other aspects of internal
    corporate decisionmaking
        I yield back.
        The Chairman. The gentleman has consumed, I believe, 1
    minute and 20 seconds. So that will leave us on this side about
    6\1/2\ minutes. And the gentleman from Texas is recognized for
    2\1/4\ minutes.
        Mr. Neugebauer. Thank you, Mr. Chairman. Let me see if I
    can get this straight. We are going to regulate the
    compensation for companies that paid the TARP money back, but
    we approved a multimillion-dollar pay package for Freddie and
    Fannie who will never pay any of that money back. Now, that is
    what I call picking winners and losers. And in this case,
    unfortunately, the losers win.
        Since the American people now own almost 80 percent of
    Fannie Mae, we need good management to stop the bleeding and
    see if we can recoup at least some of the taxpayers' money. But
    more importantly, we need consistent policy in this country.
        I think it is important to kind of reflect on what is going
    on today. We are going to regulate compensation, tell companies
    what they can and cannot do, break them up if some bureaucrat
    thinks they are too big, tax their products. By the way, I am
    not taking about Venezuela, I am talking about what is going on
    in the United States. The American people are getting tired of
    the government telling them what to do.
        So today, we are going to talk about more big-government
    intervention into America's companies. We are going to try to
    look tough on the financial institutions so we can appease the
    anger of the American people for committing trillions of their
    hard-earned money to bail these entities out in the first
    place.
        If any colleagues were so concerned about the taxpayers and
    not Wall Street, why did they bail out Wall Street at the
    expense of the American taxpayers?
        What the American people really want us to focus on is how
    can we raise their wages and create jobs for those who have
    lost theirs, instead of focusing on issues that don't create
    jobs and, in fact, are going to cause the American people to
    lose their jobs.
        Mr. President, we need you to focus on jobs, not raising
    taxes, growing government, and spending money we don't have on
    flawed stimulus packages. Where are the jobs you promised the
    American people? Instead of more government, the American
    people want more jobs. They sent you a wake-up call on Tuesday
    in Massachusetts, Mr. President. I hope you were listening.
        With that, I yield back.
        The Chairman. The gentleman from Kansas is recognized for 2
    minutes.
        Mr. Moore of Kansas. Thank you, Mr. Chairman. Just like
    reasonable executive compensation rules to increase financial
    stability should not be bipartisan, reforming Fannie and
    Freddie should not be either. I am disappointed that some of my
    friends on the other side forget that when they controlled
    Congress for 12 years, they did not enact meaningful reform of
    Fannie and Freddie.
        Last year, the former chair of this committee, Mike Oxley,
    said, ``We missed a golden opportunity that would have avoided
    a lot of problems we are facing now if we hadn't had such a
    firm ideological position at the White House and the Treasury
    and the Fed.''
        I hope we can come together this time, Republicans and
    Democrats, to explore good policy options to deal with Fannie
    and Freddie later this year.
        Turning back to executive compensation, I have always felt
    that financial firms receiving taxpayer assistance should
    receive the most scrutiny with respect to their executive
    compensation practices. One example involves reports of large
    salaries for Fannie and Freddie executives. I wrote them about
    this last March when we first learned about it, and after
    receiving an unsatisfactory response from FHFA, I joined
    Chairman Frank and others to vote for H.R. 1664 to stop those
    unfair pay practices of TARP recipients. Protecting taxpayers
    should not be a partisan issue. So I was disappointed that some
    of my friends on the other side didn't join us to support that
    commonsense measure.
        Finally, for firms who have repaid TARP, I don't think the
    government should go in and set specific pay levels, but to
    better protect investors and taxpayers in the future, the
    government does have a role in looking at how pay is structured
    more broadly to ensure risk-taking is properly aligned with
    rewards and doesn't pose a systemic risk.
        I look forward to hearing from our witnesses and exploring
    issues in further detail, d I yield back the balance of my
    time, Mr. Chairman.
        The Chairman. The gentleman from Texas, Mr. Hensarling, for
    2\1/2\ minutes.
        Mr. Hensarling. Thank you, Mr. Chairman. After upset
    defeats in the States of New Jersey and Virginia, and a
    stunning upset defeat in the Commonwealth of Massachusetts, I
    would have hoped that this Administration and this Congress
    would have gotten down to job number one, and that is to help
    create jobs for the American people. Instead, it really appears
    that the Administration is set upon an adventure in
    scapegoatism: Let's see if we can find an entity that perhaps
    is more unpopular than our Administration in the United States
    Congress. Thus we have this launching of the assault upon the
    investment community.
        Now, are there outrageous compensation systems out there?
    Yes. I am outraged by late-night comedians who make tens of
    millions of dollars to be mean to each other. I am outraged by
    professional athletes who make tens of millions of dollars and
    abuse their spouses and girlfriends. And, yes, I am outraged by
    compensation packages on Wall Street as well. But none, none,
    are more outrageous than those who use taxpayer funds to reward
    the execs at Fannie and Freddie.
        And so on Christmas Eve, this Administration decided to
    take out all the goodies from the stockings of the American
    taxpayer and hand it over to the executives of Fannie and
    Freddie, which are functionally owned by the United States
    Government, and hand them out, the two CEOs, $6 million pay
    packages, $42 million for the rest of their execs. And so we
    are paying these people bonuses to lose tens of billions of
    dollars for the United States taxpayer. Now, what people do
    with their money is their business; what they do with the
    taxpayer money is our business.
        And so I echo the comments of our ranking member. I have
    said privately and publicly that this is a committee that has a
    reputation for fairness under Chairman Frank.
        Now, I am unaware under his leadership, or his Republican
    predecessor in the 7 years that I have been here, that the
    Minority has ever been denied their request to have a witness.
    So we requested a witness, Ed DeMarco, the acting head of FHFA
    to ask a simple question--
        The Chairman. The gentleman's time has expired. If you want
    to take more time, it will come out of the 10 minutes.
        Mr. Hensarling. I yield back the balance of my time.
        The Chairman. Well, unanimous consent for an additional 15
    seconds to finish that thought, that wouldn't come out of
    everybody's time, if the gentleman would like.
        Mr. Hensarling. I was hoping that Mr. DeMarco could be here
    to answer the question why he has spent millions for bonuses to
    pay people to lose billions of dollars for the taxpayer, and
    unfortunately again for whatever reason, that request was
    denied. Thank you, Mr. Chairman.
        The Chairman. I yield myself my remaining time which I
    think is 3\1/2\ minutes; is that correct?
        I want to thank both the gentlemen from Texas and the
    gentleman from Alabama for their comments about the fairness of
    the committee. I am very proud that I think this committee
    holds the record for the number of amendments that we are
    debating on the Floor at markup time.
        We do have one difference here. The members of the
    Republican side have made the distinction between private
    sector and public sector entities when it comes to
    compensation. That is why I wanted to defer Mr. DeMarco to a
    hearing we will have with Mr. DeMarco, and I hope Mr.
    Lockhart--a Bush appointee who had that position before and it
    was was a holdover--and Mr. Feinberg, and probably Sheila Bair
    and Dan Tarullo. That is, I think it makes sense to separate
    the issues of what we do about private sector compensation
    where our role is a more limited one, as we all agree, and
    public sector compensation.
        The question for Mr. DeMarco is what do we do about public
    sector compensation?
        Now, I also want to say I am not usually the one who
    welcomes converts. That has generally not been my side of the
    street. But I do want to welcome my Republican colleagues to
    conversion to the notion that we should regulate the pay of
    Fannie Mae and Freddie Mac.
        Last year, this committee twice reported bills to the Floor
    which explicitly proposed restrictions on the pay of Fannie Mae
    and Freddie Mac, and the Republicans opposed it in committee
    and opposed it on the Floor. Indeed, in the case of one of the
    bills that wasn't on the private sector, because it wasn't
    clear what the status was at the time. The gentleman from
    Texas, Mr. Hensarling, offered an amendment to make sure that
    they were explicitly covered. We adopted the amendment. But
    that did not persuade the gentleman from Texas to vote for the
    bill on the Floor.
        So we have had two bills which passed the House which
    explicitly authorized regulation in the pay of Fannie Mae and
    Freddie Mac, and all the Republicans on this dais here voted
    against it both times. One Republican, Mr. Jones, voted for it
    one time. So I am a little skeptical as to why we have all of
    this coming up now.
        By the way, when we passed the bill that specifically would
    have done it for public-funded companies, we got a letter on
    March 20th--which I will put into the record--from James
    Lockhart, the Bush appointee who was running the Housing
    Finance Agency, held over, strenuously objecting to it. So it
    was the Bush Administration that first raised the objections of
    the Bush Administration holdover.
        I think the pay that was given to Fannie Mae and Freddie
    Mac was too high, and I think this: We will have a hearing with
    Mr. DeMarco, and others who administer pay schemes for public
    employees in a month. My colleague from Texas said he wanted to
    know the answer. I know he is a man of great patience and he
    has a very strong attention span. I don't think a month from
    now he will have forgotten the questions he wanted to ask. He
    could write them down and we will preserve them. But, yes, we
    will have this.
        I also believe what we have here is an embarrassment on the
    part of my Republican colleagues because they don't want to do
    anything about the excessive pay in the private sector, nor do
    they want to appear to not be doing anything about it, so they
    are changing the subject.
        By the way, we do not propose any specific limits on the
    pay in the private sector. We do say that the shareholders
    should vote--radical motion--but we also say that there is a
    public spillover effect; namely, that the structure of those
    compensation packages often incentivize excessively risky
    behavior. And we have mandated that the regulators end this
    ``heads they win,'' ``tails they break even at worst.'' So that
    is what we are talking about, private and public sector. We are
    dealing with the private sector today, to the discomfort of my
    Republican colleagues. We will get to the public sector in a
    month.
        The gentleman from--the gentleman's side has 2\1/2\ minutes
    left. Does the gentleman wish to use it?
        Mr. Bachus. I would ask--
        The Chairman. We have 10 minutes for debate.
        Mr. Bachus. I would like to claim 15 seconds.
        The Chairman. The gentleman is recognized for 15 seconds.
        Mr. Bachus. The executive compensation the chairman refers
    to covered all companies, both private and public. It covered
    community banks and it covered all employees, not just top
    executives. It was a political response to AIG, but it was
    poorly written--
        The Chairman. Does the gentleman yield?
        Mr. Bachus. The Senate has never taken up that bill, and
    the last time I looked, the Democrats controlled the Senate.
    They realized it was a bad bill.
        Thank you, Mr. Chairman.
        The Chairman. Does the gentleman yield?
        Mr. Bachus. No, my time has expired.
        The Chairman. The gentleman from New Jersey is now
    recognized for 2 minutes and 15 seconds.
        Mr. Garrett. I thank the chairman, and I thank the ranking
    member. And as the ranking member has already outlined, and I
    concur with his position with regard to the appropriate request
    for someone else at this hearing, the acting head of FHFA, and
    I appreciate the chairman's explanation of why he thought we
    should segregate the panels in this manner. But that really
    doesn't go to the comment that I think the gentleman from Texas
    made that no one up here can remember the last time that a
    member of the Minority requested someone to come to the panel,
    be a witness, and a Majority party refused that appropriate
    request. As of this point, the chairman has yet to fully
    explain why they refused that request.
        As the gentleman from Texas also points out, Fannie and
    Freddie are different from these; they are under government
    control. The chairman of this committee, as a matter of fact,
    has recently stated they are basically, ``public policy
    instruments of the government.'' Fannie and Freddie are.
        So while I may think the Majority's initiatives in the area
    of executive compensation in that April legislation are
    examples of government overreach into the private sector, if
    there is one example, one case, one line of executive
    compensation that should be looked at, it is where taxpayer
    dollars are being used, and that is in the area of Fannie and
    Freddie.
        And beyond this point, the area of executive compensation,
    there is a bigger issue that really we should be looking at.
    That is the Christmas Eve announcement, when the Administration
    took action, without any congressional input whatsoever, of the
    unilateral lift of the $400 cap on Fannie and Freddie's bailout
    and authorized unlimited taxpayer funds to use, both firms,
    over the next 3 years. Again, we have requested a hearing on
    this, or the chairman to allow a witness on this, and again he
    has refused.
        Meanwhile, however, the Republican Party has come back with
    our proposals, but they have been ignored. The Republicans in
    this committee have put forth proposals to reform these
    institutions, because it is indisputable that Fannie and
    Freddie were the central role in the mortgage meltdown that we
    have experienced. They helped ignite the economic crisis that
    has left millions of Americans unemployed. So passing stronger
    GSE reform legislation should be at the very top of this
    committee's agenda.
        Thank you.
        The Chairman. The gentleman's time has expired.
        We will now proceed to hear from the witnesses, repeat
    witnesses in every case, who are always welcome in this
    committee because they are people who make very significant
    contributions not just in this testimony but even more
    importantly, obviously, in the debate over important public
    issues in the country and the world.
        We begin with Professor Lucian Bebchuk, who is a professor
    of law, economics and finance, and director of the corporate
    governance program at Harvard Law School.

    STATEMENT OF LUCIAN A. BEBCHUK, WILLIAM J. FRIEDMAN AND ALICIA
    TOWNSEND FRIEDMAN PROFESSOR OF LAW, ECONOMICS, AND FINANCE, AND
       DIRECTOR OF THE CORPORATE GOVERNANCE PROGRAM, HARVARD LAW
                                 SCHOOL

        Mr. Bebchuk. Chairman Frank, Ranking Member Bachus, and
    distinguished members of the committee, thank you very much for
    inviting me to testify here today.
        I would like to devote my introductory comments to making
    four points.
        First, there is a growing acceptance, including among
    business leaders, that compensation structures have provided
    perverse incentives. They have encouraged financial executives
    to seek to improve short-term results even at the expense of an
    elevated risk of an implosion later on. Let me illustrate this
    problem with the example of Bear Stearns and Lehman Brothers,
    the two investment banks that melted down in 2008.
        Many commentators have assumed that the executives of these
    firms sold their own compensation, their own wealth wiped out
    together with the firms', and then inferred from this assumed
    fact that the firms' risk-taking could not have been motivated
    by perverse incentives created by pay arrangements.
        In a recent paper, my coauthors and I did a case study of
    compensation at those two firms between 2000 and 2008, and we
    find that this assumed effect is incorrect. We estimate that
    the top five executive teams of Bear Stearns and Lehman
    Brothers derived cash flows of about $1.4 billion and $1
    billion, respectively, from cash bonuses and equity sales
    during 2000 to 2008, and these cash flows substantially
    exceeded the value of the executives' initial holdings in the
    beginning of the period. As a result, unlike what happened with
    the long-term shareholders, the executive net payouts for 2000
    to 2008 were decidedly positive.
        The second point I would like to make is that we cannot
    rely solely on existing governance arrangements to produce the
    necessary reforms. To be sure, some firms have announced
    reforms of the compensation structures. For example, they
    indicated that bonuses would be subject to clawbacks. But firms
    have generally not provided information that would enable
    outsiders to determine whether the clawbacks would be
    meaningful and affect behavior or would be merely cosmetic.
        This is an area where the devil is in the details. Because
    the changes that firms adopt appear to be at least partly
    motivated by desire to appear responsive to outside criticism,
    there is a basis for concern that arrangements with details
    that are not disclosed might not be sufficiently effective.
        What else should be done? The point I would like to stress
    is to improve arrangements, pay arrangements in particular, in
    governance more generally. We have to strengthen shareholder
    rights.
        In addition to introducing say on pay votes, which H.R.
    3269 would do, there are other things that need to be done to
    bring shareholder rights to the same level as the shareholders
    in the U.K. and other English-speaking countries enjoy. In
    particular, the following aspects of their existing state first
    deserves the Commission's attention. Many publicly traded firms
    still do not have majority voting. Shareholders still like the
    power to place director candidates under corporate bylaws. Many
    privately traded funds still have staggered boards, and many
    such firms have supermajority requirements that make it
    difficult for shareholders to change governance arrangements.
        Finally, in addition to strengthening shareholder rights,
    it remains important to have regulatory supervision of pay
    structures in financial firms, as the provisions of H.R. 3269
    would require.
        Opponents of regulatory intervention argue that such
    regulatory supervision would drive a talent away. However, the
    regulation under consideration focuses on structure, not on pay
    levels, and firms would still be able to offer packages that
    are sufficiently attractive in terms of pay levels. One of the
    established insights in economics is that it is never efficient
    to compensate agents using perverse incentives; in the
    financial sector, an especially important context to apply this
    established insight. Thank you.
        [The prepared statement of Professor Bebchuk can be found
    on page 45 of the appendix.]
        The Chairman. Next, we have Professor Joseph Stiglitz,
    university professor at the Columbia Business School.

    STATEMENT OF JOSEPH E. STIGLITZ, UNIVERSITY PROFESSOR, COLUMBIA
                            BUSINESS SCHOOL

        Mr. Stiglitz. It is both a source of pleasure and sadness
    to testify before you today. I welcome this opportunity to
    testify on this important subject, but I am sorry that things
    have turned out so badly thus far.
        In this brief testimony I can only touch on a few key
    points, and many of these points I elaborate in my book,
    ``FreeFall,'' which was published just a few days ago.
        Our financial system failed to perform the key roles that
    it is supposed to perform in our society: managing risk; and
    allocating capital. A good financial system performs these
    functions at low transaction costs. Our financial system
    created risk and mismanaged capital, all the while generating
    huge transaction costs, as the sector garnered some 40 percent
    of all corporate profits in the years before the crisis.
        So deceptive were the systems of creative accounting the
    banks employed that, as the crisis evolved, they didn't even
    know their own balance sheet, so they knew that they couldn't
    know that of any other bank. We may congratulate ourselves that
    we have managed to pull back from the brink, but we should not
    forget that it was the financial sector that brought us to the
    brink of disaster.
        While the failures of the financial system that led the
    economy to the brink of ruin are by now obvious, the failings
    of our financial system were more pervasive. Small- and medium-
    sized enterprises found it difficult to get credit, even as the
    financial system was pushing credit on poor people beyond their
    ability to repay.
        Modern technology allows for the creation of an efficient
    low-cost electronic payment mechanism, but businesses pay 1 to
    2 percent or more for fees for a transaction that should cost
    pennies or less. Our financial system not only mismanaged risk
    and created products that increased the risk faced by others,
    but they also failed to create financial products that could
    help ordinary Americans face the important risk they
    confronted, such as the risk of homeownership or the risk of
    inflation.
        Indeed, I am in total agreement with Paul Volcker. It is
    hard to find evidence of any real growth associated with many
    of the so-called innovations in our financial system, though it
    is easy to see the link between those innovations and the
    disaster that confronted our economy.
        Underlying all the failures a simple point seems to have
    been forgotten: Financial markets are a means to an end, not an
    end in themselves. We should remember, too, that this is not
    the first time our banks have been bailed out, saved from
    bearing the full consequences of their bad lending. Market
    economies work to produce growth and efficiency, but only when
    private rewards and social returns are aligned. Unfortunately,
    in the financial sector, both individual and institutional
    incentives were misaligned, which is why this discussion of
    incentives is so important.
        The consequences of the failures of the financial system
    are not borne by just those in the sector, but also by
    homeowners, retirees, workers, and taxpayers, and not just in
    this country but also around the world.
        The externalities, as economists refer to these impacts and
    others, are massive; and they are the reason why it is
    perfectly appropriate that Congress should be concerned. The
    presence of externalities is one of the reasons why the sector
    needs to be regulated.
        In previous testimony I have explained what kinds of
    regulations are required to reduce the risk of adverse
    externalities. I have also explained the danger of excessive
    risk-taking and how that can be curtailed. I have explained the
    dangers posed by underregulated derivative markets. I regret to
    say that so far, more than a year after the crisis peaked, too
    little has been done on either account. But too-big-to-fail
    banks create perverse incentives which also have a lot to do
    with what happened.
        I want to focus my remaining time on the issue of
    incentives and executive compensation. As I said, there are
    also key issues of organizational incentives, especially those
    that arise from institutions that are too-big-to-fail, too-big-
    to-be-resolved, or too-intertwined-to-fail.
        The one thing that economists agree upon is that incentives
    matter. Even a casual look at the conventional incentive
    structures, with payments focused on short-run performance and
    managers not bearing the full downside consequences of their
    mistakes, suggested that they would lead to shortsighted
    behavior and excessive risk-taking. And so they did.
        Let me try to summarize some of the general remarks that I
    make in my written testimony that I hope will be entered into
    the record. Flawed incentives played an important role, as I
    said before, in this and other failures of the financial system
    to perform its central roles. Not only do they encourage
    excessive risk-taking and shortsighted behavior, but they also
    encourage predatory behavior.
        Poorly designed incentive systems can lead to a
    deterioration of product quality, and this happened in the
    financial sector. This is not surprising, given the ample
    opportunities provided by creative accounting. Moreover, many
    of the compensation schemes actually provide incentives for
    deceptive accounting. Markets only allocate resources well when
    information is good. But the incentive structures encouraged
    the provision of distorted and misleading information.
        The design of the incentives system demonstrates a failure
    to understand risk and incentives and/or a deliberate attempt
    to deceive investors, exploiting deficiencies in our systems of
    corporate governance.
        I want to agree very much with Professor Bebchuk's view of
    the need for reforms in corporate governance. There are
    alternative compensation schemes that would provide better
    incentives, but few firms choose to implement such schemes. It
    is also the case that these perverse incentives failed to
    address adequately providing incentives for innovations that
    would have allowed for a better functioning of our economic
    system.
        [The prepared statement of Professor Stiglitz can be found
    on page 68 of the appendix.]
        The Chairman. Nell Minow, who is the founder and editor of
    The Corporate Library.

         STATEMENT OF NELL MINOW, EDITOR, THE CORPORATE LIBRARY

        Ms. Minow. Thank you very much, Mr. Chairman, and members
    of the committee. It is a real honor to be back here again,
    and, like Professor Stiglitz said, I wish I had better news for
    you. In previous appearances, I have called executive
    compensation both the symptom and the cause of the instability
    of the financial services sector and our capital markets. I
    regret to say that the problem continues.
        Yesterday, the Supreme Court told us that a corporation is
    a person with First Amendment rights, but as Baron Lord Thurlow
    told us hundreds of years ago, a corporation has no soul to be
    damned, no body to be kicked, and that is why corporations
    essentially get away with murder in matters like compensation.
        The boards of Wall Street financial institutions
    implemented pay plans that were a major and direct cause of the
    financial meltdown. These purported bastions of capitalism
    protected themselves from risk by limiting their downside
    exposure and taking their pay off the top. Second, rinse
    repeat. They took bailout money and kept paying themselves as
    though they earned it. What they did before the bailout was
    counterproductive and misguided. What they have done since the
    bailout is an outrage, or, as my grandmother would have said, a
    ``shanda.''
        Since the only portion of pay that TARP did not restrict
    was base pay, everybody got a raise. For example, Wells Fargo's
    board approved a 522 percent salary increase for the CEO from
    $900,000 to $5,600,000. The extra was paid in stock, and we
    have seen this throughout the center. They took the
    opportunity, when the stock market was at its rock bottom, to
    load everybody up with buckets of new stock and options. So I
    am predicting now that the next time you have me back here to
    speak, we will be talking about how outrageous it is that they
    got insane pay packages again; but now is when they are
    happening. And we will see the payout later on.
        These enormous grants of stock issued at historic low
    prices are resulting in enormous payouts based on the infusion
    from the bailouts in the overall market. I completely agree
    with what the members of this committee have said about
    taxpayer money. This is taxpayer money. They are getting paid
    as though they earned that money, the money that the taxpayers
    put into it. They are taking a piece off of the top of the
    taxpayers' money. That is absolutely right. That is an outrage.
        So the clawbacks that were required as a result of this
    committee's work are also being subverted. As Professor Bebchuk
    said, there is a lot of weasel language being instituted into
    the clawbacks, saying that bad faith has to be required, or
    some kind of emotion or feeling or intention has to be
    required. Clawbacks should apply no matter what the reason for
    the correction; otherwise, as Professor Siglitz said, they
    create a perverse incentive.
        I ask this committee to lead the way to put an end to too-
    big-to-fail, the term and the concept. If a company is too-big-
    to-fail, it is too-big-to-succeed, or, as the title of a
    thoughtful new book by Robert Pozen puts it, it is ``too-big-
    to-save.'' If an enterprise is too-big-to-fail, it is a utility
    and it should be regulated like one and executives should be
    paid like public servants.
        Wall Street boards and executives have abused shareholders
    by creating perverse incentives for themselves, through their
    pay plans.
        The IMF has a very important new study linking lobbying
    expenditures and high-risk lending. In other words, it is
    another example of externalizing the risks onto everybody else
    and keeping the pay plans. They are now doing their best to
    perpetuate this system by pouring over $70 million so far into
    fighting any meaningful reform. This is just another example of
    diversion of assets to perpetuate the externalization of risk
    onto the shareholders and the taxpayers.
        I hope that Congress will address this attempt to subvert
    the efficient oversight of the market and restore the
    crediblity of our financial sector by removing obstacles to
    effective shareholder oversight of pay.
        [The prepared statement of Ms. Minow can be found on page
    52 of the appendix.]
        The Chairman. Thank you. Let me begin the question and--I
    want to give my Republican colleagues credit. They
    fundamentally want to take the attention away from the subject
    of excessive compensation, which is a legitimate public sector
    issue, probably because, as Ms. Minow just noted, they are
    paying money which they are able to have in part because of a
    significant public intervention; also because there are effects
    on the economy as a whole as to the way in which it is
    structured. And also, of course, because the notion that we are
    interfering in a private sector sphere when we set the laws for
    corporate governance is nonsense.
        Corporations are a creation of the law, even though the
    Supreme Court thinks God made them, and this can be regulated
    by us in many ways. They simply don't want to do anything that
    would interfere with that, but they have raised the Fannie/
    Freddie thing.
        I want to respond to one point that the gentleman from
    Alabama raised when I pointed out that the Republicans twice
    voted in committee and on the Floor against legislation to give
    regulators the power over Fannie Mae and Freddie Mac salaries,
    which they now say they want. He said, well, that was in the
    bill that covered all the private sector. But there were two
    bills. The gentleman from Alabama forgot to mention one. The
    first bill that came forward was H.R. 1664, which specifically
    covered only those financial institutions that were receiving
    financial assistance--TARP money and Fannie and Freddie. It had
    nothing to do with the rest of the private sector.
        Page 2 of that bill: No financial institution has received
    or receives a direct capital investment under the TARP program
    or with respect to the Federal National Mortgage Association,
    the Federal Home Loan Mortgage Corporation or Federal Home Loan
    Bank, etc.
        So we had a bill that dealt only with TARP recipients,
    Fannie and Freddie, and put tough restrictions on them to be
    administered and they voted against it. So it is not my fault
    that there wasn't the power to do that more.
        Yes, I think they got too much money over the Christmas Eve
    period. I believe, though, that the remedy here is to in fact--
    as I believe this committee will be recommending--abolish
    Fannie Mae and Freddie Mac in their current form and come up
    with a whole new system of housing finance. That is the
    approach, rather than the piecemeal one.
        But the fact is, there were two bills, and Republicans
    voted against both of them. One covered all private sector and
    public sector, but one bill they voted against specifically was
    limited to TARP recipients in Fannie Mae and Freddie Mac, and
    it passed the House and it failed. The gentleman is right; the
    Senate didn't take it up. If they want to blame the Senate,
    that is okay, I guess, for them to say it, but I don't know why
    the fact that the Senate might not be taking something up is a
    justification for a Member of the House to vote ``no.''
        So it is very clear, we put forward a bill that would have
    toughened restrictions on compensation at the TARP recipients
    and at Fannie Mae and Freddie Mac in April. They voted against
    it. Now, to divert attention from this subject which makes them
    uncomfortable because they don't want to do anything about it,
    they bring it up.
        Let me ask one question to Professor Stiglitz and the
    others. One of the arguments we have gotten against the
    President's proposal to tax large financial institutions to
    recoup the money that was paid out through the TARP and
    elsewhere that was of great assistance to the financial sector,
    this will diminish the amount of money they have available for
    loans and it will force them, over their great reluctance no
    doubt, to raise credit card and other fees.
        Does the size of the bonus pool and the amount of
    compensation have any relevance to that argument? Professor
    Stiglitz?
        Mr. Stiglitz. Yes, obviously funds are fungible, and money
    going out to bonuses reduces the capital base of the banks, and
    to an extent the money that has been paid out in bonuses,
    whatever the form, reduces their ability to lend. That is
    obviously a much more significant amount.
        Let me just emphasize one point, since we are talking about
    incentives. The intent of the President's proposal here is
    changing the current incentives of the banks to have excessive
    risk-taking, and excessive risk-taking led to the economy being
    brought to the brink.
        The Chairman. Tax structure--
        Mr. Stiglitz. That is right, these incentives partly arose
    from the fact that the tax structure was based on the amount of
    liabilities that they had. It was directed at--
        The Chairman. Tier 1 capital money.
        Mr. Stiglitz. Exactly.
        The Chairman. What is the relationship between the board of
    directors and the CEO currently?
        Ms. Minow. I know it is difficult for people who know what
    real elections are to understand that, but we use the term
    ``election'' when we talk about boards of directors, even
    though essentially the CEO controls who is on the board. These
    arrangements are often very cozy.
        It was not that long ago that CEOs of Cummins Engine and
    Inland Steel served as chairs of each others' compensation
    committees. At another company, the CEO is the chairman of the
    local university's board of directors. The provost is on his
    compensation committee, etc. So therefore it is a very close
    circle. And until shareholders can replace directors who get it
    wrong, we are not going to see any change. So many of the
    directors, almost all of the directors of the bailout companies
    continue to serve.
        The Chairman. Thank you. The gentleman from Alabama.
        Mr. Bachus. Thank you. Ms. Minow, you have heard the
    chairman talking about his executive compensation bill that was
    introduced last year that the Republicans voted against along
    with many Democrats. You published an article on The Corporate
    Library Web site entitled, ``Right Question, Wrong Answer''
    that was critical of the executive compensation legislation,
    and that was the legislation that Chairman Frank incorporated
    into the bill. He talks about criticizing us for not voting for
    it.
        In the article you say, ``I have the utmost respect for
    politicians and bureaucrats but I also recognize their limits.
    The government should not micromanage pay.''
        I happen to agree with that position. Could you elaborate
    to committee members on your specific concerns about entrusting
    political figures and government bureaucrats with the
    responsibility for designing incentive-based compensation
    structure?
        Ms. Minow. Certainly, as I said repeatedly before this
    committee, I do not believe that the government should set pay.
    I do believe in removing obstacles to allowing shareholders to
    provide that kind of feedback, as I just said to the chairman,
    by removing directors who do a bad job through say on pay. I
    think the bill was perhaps necessary but not sufficient, and I
    do share the concern of the members of the committee that some
    of the terminology in the bill was not--did not give enough
    guidance.
        Mr. Bachus. Thank you, I appreciate that. Obviously, the
    bill gave the Treasury Secretary really carte blanche authority
    to define unreasonable excessive compensation, and it wasn't
    just for top executives, it was for all employees. And I would
    vote against that bill today if it were up before me.
        Professor--is it ``Bibcock?''
        Mr. Bebchuk. ``Bebchuk.''
        Mr. Bachus. Okay. In the past, you have criticized GSE
    executive compensation packages as being decoupled from
    performance. Under the terms of the GSE executive compensation
    package that was announced Christmas Eve, two-thirds, or $4
    million of the $6 million cash compensation for each of the two
    CEOs, is completely unrelated to firm performance or any
    performance manager.
        Would you agree that the latest GSE executive compensation
    awards still failed to adequately link pay and performance?
        Mr. Bebchuk. The study you mention was one that was
    probably several years ago, and it was a careful analysis of
    compensation arrangements at the time, mainly with respect to
    the chairman at the time, Raines. And those were the
    conclusions then. I have not studied the most recent decisions
    and therefore I am not in a position to evaluate them.
        Mr. Bachus. If I say $4 million of that was not linked to
    performance and does not link pay and performance, you would
    still think that--you would still have your same objections to
    those compensation packages?
        Mr. Bebchuk. I don't think I can really offer a view about
    a package that I haven't really studied.
        Mr. Bachus. All right.
        Ms. Minow, in your written testimony you decry compensation
    arrangements that widen the gulf between pay and performance
    and between integrity and outrageousness. In your view, do the
    pay packages of Fannie Mae and Freddie Mac executives, most
    particularly the $6 million awarded to each of the CEOs,
    adequately link pay and performance?
        Ms. Minow. I have been a consistent critic of the pay
    packages at Fannie and Freddie, going back before the financial
    meltdown. And, again, they have a corporate governance
    nightmare. You can't be both a public and a private enterprise
    at the same time.
        Mr. Bachus. Do they meet your definition of outrageous?
        Ms. Minow. They are not as outrageous as the previous pay
    plans at Fannie and Freddie, but I think they are wrong.
        Mr. Bachus. They are wrong, but how about outrageous? Do
    they meet your definition of outrageous?
        Ms. Minow. No, no. If I am calibrating the word
    ``outrageous,'' they are nowhere near the category of
    outrageous--
        Mr. Bachus. It might be like a class 4 instead of a class 5
    outrageous?
        Ms. Minow. They are troubling; how is that? They are
    troubling but not outrageous.
        Mr. Bachus. Thank you. I appreciate that very much. I yield
    back the balance of my time.
        The Chairman. The gentleman from Pennsylvania, and I want
    to take 15 seconds, if he will yield to me.
        My friend from Alabama continues to ignore the fact that
    there were two bills, one on executive compensation involving
    the private sector, another that only dealt with TARP and
    Fannie Mae and Freddie Mac, and he voted against it. So what he
    talked about before, what he quoted Ms. Minow about, was the
    one about general compensation.
        But there was a separate bill for Fannie Mae, Freddie Mac
    and the TARP that came after this question, and that is the one
    he voted against. There is one bill.
        It is not my time. The gentleman from Pennsylvania.
        Mr. Kanjorski. Thank you, Mr. Chairman. I will just open up
    first with some remarks to the panel, and I appreciate your
    opinions when I get to conclude. Very often, I have had the
    occasion over the last 6 to 9 months to make a speech in my
    district because I am trying to reach constituents to
    understand the overall complex problem of salaries and wages.
        Now, as a given factor in my congressional district in
    Pennsylvania, the average wage is about $13 an hour. And if you
    multiply that times 2,000 working hours a year, that comes to
    an annual income of, on average, $26,000.
        In the last 9 months or a year, I have had several
    witnesses who have appeared before my subcommittee, and we have
    gotten to this question of salary and compensation, and what we
    do about it. I, for one, am not certain that we put enough
    direct attention to the matter, and could get into difficulty
    if we start deciding that we are the final arbiter of what a
    fair salary is, because quite frankly, I will confess, I don't
    know.
        If hiring a brain surgeon, I guess, and I need brain
    surgery, there is no amount too excessive until after the
    success of the operation. Then I will be annoyed, whatever the
    bill.
        The reality is--that is not the topic of our discussion
    today--but in the hedge fund industry, they report--I remember
    one witness who was a little annoyed involving a cross
    examination: What did he make and what is his relationship? He
    earned about $2.5 billion a year, and I pressed him because I
    was offended that he only paid a tax rate of 15 percent because
    of the structure of his salary, putting him in capital gains as
    opposed to regular tax. After 15 or 20 minutes, with great
    annoyance, he finally put his hand in his pocket, leaned back
    and said, ``Congressman why are you picking on me? What did I
    do to you?'' I said, ``You did nothing; you happen to be a
    witness and I am trying to extract some information.'' He said,
    ``Well, I want you to know I am only the 51st highest-income
    person in this country.'' This astounded me. I thought we had
    located the highest-income person. I found out he actually was
    not and is not, and there are some who make a great deal more.
        I guess the first question that I would ask is, what is too
    much? What is too high? Is it $5 billion, or $50 billion? And
    now I pose that question, because we always use numbers, and I
    go back to my congressional district of $13 an hour wage. The
    gentleman who was testifying before me, his hourly wage is
    $1,300,000. That is what he makes every hour of the year.
        Now, when you do the mathematics of that, he makes 100,000
    times the average wage of an average worker in my district. How
    do we get a sense? Regardless of what compensation we pass here
    or do on Fannie Mae, they are chickens; what do they get paid,
    $6 million a year? That is peanuts.
        I am wondering if we are approaching this from perhaps the
    incorrect direction. Should we be looking at, first of all,
    what do we need to get to a balanced budget? Because these
    people aren't just earning and taking corporate money or
    profits. These people are not picking up their burden in
    society in proportion to their income. And as a result now this
    year, we are ending up with a shortfall that we could make up
    if we didn't have these extraordinary ways of avoiding income.
        I am just wondering, should we approach this from changing
    the tax structure and perhaps get to a level field that way, as
    opposed to identifying particular people where we may be able
    to exercise power and those so that we cannot. And I am just
    curious. Let me throw that out there very quickly.
        The Chairman. Maybe 30 seconds for an answer.
        Mr. Stiglitz. I agree with you that the basic framework for
    thinking about equity should be through our tax system.
    Incentives are related, because the question is, would they
    work a little bit less hard if they paid higher taxes? I think
    the answer is clearly no, it would not have a significantly
    adverse affect.
        The issue that I talked about in my testimony is that the
    structure of the pay of the executives in these banks has
    strong effects. The reason we are interested in them is because
    those effects affected the taxpayers because it led to the
    economy falling apart. These pay structures imposed huge costs
    on the rest of us, and therefore they are a legitimate source
    of concern, as opposed to lots of other areas where people get
    high pay but are not as much a legitimate source of concern.
    The way we deal with that is through the tax system.
        The Chairman. The gentleman from Texas.
        Mr. Neugebauer. Thank you, Mr. Chairman. I think we have
    heard from the panel on where they think that there have been
    abuses in the pay structure, the corporate pay structure. I
    think one of the things that I would like to hear from the
    panel is who is doing it right? Where is the model that other
    companies should follow? Mr. Bebchuk?
        Mr. Bebchuk. Yes. I think that there is evidence that firms
    with shareholder rights are stronger, where you have less
    arrangement that would make it difficult to pay directors.
    Compensation in those firms is more sensitive to performance
    and also CEO turnover is more sensitive to performance. So we
    have evidence that relates, empirical evidence that relates the
    level of shareholder rights, both with firm value in general
    but also with the quality-of-pay structures.
        Ms. Minow. If you would like to have a specific example, I
    can tell you that Home Depot went from the very bottom of the
    list to near the top of the list by going from a CEO where 90
    percent of his pay was not related to performance to a CEO
    where 90 percent of his pay is related to performance.
        Mr. Stiglitz. I want to make one remark because we keep
    talking about pay related to performance. It is very difficult
    to identify what you mean by performance. When a company does
    well as measured by the stock going up, but the reason the
    stock is going up is because the stock market is going up, then
    it wasn't what an employee did that led to the company's stock
    going up. One of the points I make in my written testimony was
    that, in fact, if you look at the design of many of the so-
    called ``pay for performance,'' they are not pay for
    performance. They merely have that in their name.
        Ms. Minow. I cover that in my written testimony as well.
        Mr. Neugebauer. One of the things that concerns me is when
    you start down the road of government designing these
    compensation plans--and now really what we are doing is we are
    saying, there are a few companies out there, and I think
    everybody is trying to point to the financial institution--but
    the question is, what about all the other companies that are
    actually doing it right? How do we justify whether we are going
    to pick the ones we don't think are doing it right and we are
    going to let the others fall?
        Mr. Bebchuk. Nobody is talking about the government really
    prescribing what the pay arrangements would be but, rather,
    giving shareholder rights and improving corporate governance
    arrangements. And if that happens, then the firms that are
    doing it right will continue to do it right, but those firms
    that didn't do it right because those were not sufficiently
    focused on shorter interest would hopefully improve their pay
    arrangements.
        Mr. Neugebauer. But the shareholder has the ultimate right,
    don't they? That is whether to own a share of stock or not. And
    if I I think that company CEO is making too much money and the
    boys are dividing the pie and the shareholders aren't getting
    much return, I just sell my share of stock and I move on.
        Mr. Bebchuk. Your ability to sell the share provides you
    with no protection. It providers insiders with no incentives to
    behave well. Why? Because let's suppose the price right now is
    $100, and you believe that if managed well, the company would
    be worth $120. If you sell, you would be getting--you would be
    passing this imperfectly managed share to somebody else who
    would pay $100. But your concern is that you should be getting
    to $120, and the ability to sell the share on the market for
    $100 in no way provides you access nor makes it likely that you
    will be able to capture the $120.
        Ms. Minow. I just want to say that is also kind of an
    outdated approach since up to 70 percent of the stock in most
    major companies are held by institutional investors that don't
    have the luxury of selling out every time; because of
    transaction costs and other issues, they are pretty much stuck.
    And so the question is, is it more beneficial for them
    economically to pursue better pay than to just abandon it and
    leave and invest in some other company that overpays their
    executives?
        Mr. Neugebauer. I don't think I can agree that people are
    stuck in any position. If you own a share of publicly traded
    company stock, you can send a message to the management. In
    fact, some of those larger investors can actually send a very
    strong message. If a large investor in a company moves a very
    large block of stock, sells that stock, that sends a signal to
    the rest of the market: Why did he or she do that? So to say I
    think people are stuck in a position is a little--
        Ms. Minow. The data actually goes the other way on that.
    And as far as large investors making a difference, you are
    right; they can call up the board of directors and ask for
    better. All we are asking is to make it more possible.
        Mr. Stiglitz. Can I make a general point, which is that
    corporations are a creation of the State. We write the laws
    that define a corporation. What I think Mr. Bebchuk and Ms.
    Minow have been emphasizing is that we want to think about how
    we write those laws to make sure that our whole corporate
    sector works more efficiently, which has to do with the systems
    of corporate governance. But what are those systems?
        I think that is really the debate here. There is going to
    be one system or another, so the question is, can we create a
    system that is better than the current system?
        The Chairman. The gentleman from California.
        Mr. Sherman. Thank you. Responding to the gentleman who was
    just speaking, I would say selling the stock is an imperfect
    way for shareholders to control things. First, they pay a big
    capital gains tax when they sell. Then they have transaction
    costs. As the witness pointed out, they get a low price for the
    stock because whomever buys it is buying into a company with
    miscompensated executives. And then finally, they have the
    opportunity to invest the proceeds into another company which
    has bad corporate governance and overpaid executives.
        I would like to start with an observation. It is obvious
    that the establishment in this country is under attack by
    populism in a way that has not occurred in most of our
    lifetimes. The results in Massachusetts were not the victory I
    think mostly for any one political party, but a victory for
    populism against the establishment. And it is not a coincidence
    the Supreme Court decided yesterday to overrule 100 years of
    precedents, something they would ordinarily find very painful,
    in order to arm the death star so that the empire could strike
    back; and whatever we do, whatever we say here today, could
    easily be drowned out by unlimited corporate publicity and
    propaganda.
        I want to pick up on the comments of the gentleman from
    Pennsylvania. I think this committee has done a good job on
    executive compensation when compared to the Ways and Means
    Committee which has continued to allow hedge fund managers to
    pay taxes at only 15 percent unless--I yield to the gentleman.
        The Chairman. If the gentleman would yield. The House in
    fact voted for the bill the gentleman is talking about. It is
    in the Senate. In fairness to our colleagues, they did bring up
    the right bill from our standpoint, which we voted for and sent
    over there.
        Mr. Sherman. It is always the Senate. In any case, the tax
    laws of this country not only allow a 15 percent tax on hedge
    fund managers, but a zero percent tax if they incorporate their
    hedge fund in the Caribbean. And you compare that to the
    probably 28 percent rate paid by the gentleman's constituents
    in Pennsylvania, and you see that we don't exactly have a fair
    tax system.
        I don't think that the gentleman who makes $1 million an
    hour is going to work less hard if his after-tax compensation
    is reduced to a paltry $600,000 an hour.
        When we talk about compensation, we ought to be talking
    about the entire compensation package, not just bonuses. And in
    this committee, we have made life a little difficult for top
    executives, particularly those who got TARP money. There is
    some social utility of that, beyond its obvious psychological
    benefits to those of us in the room. And that is, we have
    inspired these companies to pay back the TARP money far more
    quickly than they would have, and now we are focused on those
    who are too-big-to-fail. We are inconveniencing them to the
    greatest extent we can right now, and hopefully that will
    inspire them to break up so that we will have financial
    institutions, the demise of any one of which will not imperil
    the system.
        And so here we are, talking about their compensation. Last
    month, we imposed fees on those of over $50 billion in size.
    And I hope that they will get the message and become medium-
    sized institutions.
        The problem I have is in this effort to try to design
    compensation systems that do not incentivize excessive risk and
    that properly reward performance; I am not sure we can do it. I
    would hope that there would be none of these companies getting
    Federal subsidies or implicit Federal guarantee, in which case
    I don't think we have to do it. But my problem relates to a
    circumstance where, let's say, you are trading a portfolio. And
    your aim, of course, might be to have one great year and get an
    enormous bonus, because in this country, we tend to tally
    things up at the end of the calendar year and give you
    something valuable. Now it said, well, we will give you
    restricted stock. But that still provides a pretty good
    incentive to take the big risk and to get the big bonus unless
    you believe the risks you are taking: (A) will turn out poorly;
    and (B) will turn out so poorly that they dramatically affect
    the value of the entire company or that they inspire your other
    executives to take equally enormous risks.
        So assume that somebody is managing 1 percent of the
    company's money. They do not believe that their behavior will
    affect their colleagues, and they choose to take enormous
    risks. They pan out as of the end of the year, they get a
    gajillion shares of restricted stock. How are they
    disincentived by getting restricted stock? I don't know if
    there is time for the answer.
        The Chairman. Let's take 30 seconds for an answer. We don't
    have an overburdened day.
        Mr. Bebchuk. The Congressman is exactly right. For
    executives who manage a limited part of the company, like 1
    percent, paying them with restricted stock does not give them
    incentives to avoid taking risks that might implode later on.
    The only way to do it would be to subject them to a clawback or
    to put their bonus in the bank that would be adjusted downward,
    not if the company does not do well on the whole, but when
    their own unit doesn't do well in the subsequent year.
        The Chairman. The gentleman from Texas, Mr. Hensarling.
        Mr. Hensarling. Thank you, Mr. Chairman. Before I make my
    comments, I would ask unanimous consent to enter two studies
    into the record relative to the subject: one is entitled,
    ``Compensation in the Financial Industry'' by the Center on
    Executive Compensation; and the other is entitled, ``Bank CEO
    Incentives and the Credit Crisis'' from the Fisher College of
    Business from Ohio State University.
        The Chairman. Without objection, they will both be entered
    into the record.
        The gentleman is recognized.
        Mr. Hensarling. Thank you, Mr. Chairman. Again, the
    American people were presented with a great outrage on
    Christmas Eve when this Administration decided, after tens of
    billions of dollars in losses, $110 billion now, now to
    announce unlimited taxpayer exposure to the Government-
    Sponsored Enterprises, those that are at the epicenter of the
    financial crisis, and to simultaneously--for all these losses
    that are costing the taxpayers all this money--to announce
    bonus structures of $6 million to each of the CEOs, $42 million
    in total for the executives.
        So again, as I said in my opening statement, I had hoped
    that we would have an opportunity to ask questions of the
    acting head of FHFA, Mr. Ed DeMarco, about this.
        And now I know the chairman in his comments said that we
    would have that opportunity next month. And he said that I am a
    patient man. Well, perhaps I am patient, but I am not sure,
    after the election results in the Commonwealth of
    Massachusetts, that the American people are patient. They don't
    want answers a month from now, they want answers yesterday.
        And so I am disappointed, again, that for whatever reason,
    the American people are going to have to wait a month to find
    out about the bonuses at the Government-Sponsored Enterprises,
    Fannie and Freddie.
        The questions, again, I had were for Mr. DeMarco, I was
    going to ask, in light of the fact that the companies have
    averaged $11 billion in taxpayer subsidized losses over the
    last 5 quarters, how were the executives chosen to receive the
    bonuses? Since Mr. DeMarco isn't here, I doubt this panel can
    answer that question. But if somebody knows Mr. DeMarco, has
    spoken to him, maybe he has insight.
        If not, the second question I had for Mr. DeMarco is, why
    were the bonuses to be paid in cash? This is an Administration
    that says, no, we have to make sure that payments are made in
    stock. We have to have longer-term vesting dates for everybody
    else, apparently, except the Government-Sponsored Enterprises.
    So why cash for them and stock for everybody else? I was going
    to ask Mr. DeMarco that question. Again, I assume you haven't
    spoken to him. Is anybody qualified to answer that question on
    Mr. DeMarco's behalf? I assume not.
        I don't have to be convinced that there are pay structures
    that can be poorly designed that can cause companies to fail. I
    know that. I used to serve on a compensation committee of a
    publicly traded company, traded on the New York Stock Exchange.
    I at least have some experience with these matters. I have
    studied some of these issues. So I know that poorly designed
    compensation packages can cause companies to fail. You don't
    have to convince me of that. But you do have to convince me
    that any one company in America is too-big-to-fail.
        And guess what? If you don't bail them out with billions of
    dollars of taxpayer money, then you don't have to use the heavy
    hand of government to impose pay structures.
        I know the chairman has brought up, on a couple of
    occasions now, H.R. 1664. I have a couple of observations.
    Number one, if this Democratic Administration, this Democratic
    Senate, this Democratic House, were serious about doing
    something about Fannie and Freddie pay, I assume they could
    have done it by now.
        Second of all, as I think the chairman knows, this just
    didn't deal with the execs. This was a bill that would have
    regulated the pay of the janitor at Goldman Sachs and provided
    a role for the Congressional Oversight Panel in policy matters.
    And as a former member of that panel, I assure you they are
    singularly unqualified for the task.
        So again I don't see why--the basic proposition is this,
    again. In America, the principle ought to be what you do with
    your money is your business; what you do with taxpayer money is
    our business. And if your compensation structure causes you to
    fail, don't take money away from the farmers, school teachers,
    and the firemen to bail them out. The purpose of government is
    not to bail out. The purpose of government is not to place
    artificial limits on the American Dream. It is to preserve
    freedom. I yield back.
        The Chairman. The gentleman from Kansas.
        Mr. Moore of Kansas. Thank you, Mr. Chairman. I believe
    financial firms receiving taxpayer assistance should receive
    the most scrutiny with respect to their executive compensation
    practices. The most obvious and troubling case was AIG that
    provided $165 million in bonuses last year after taxpayers
    invested billions of dollars to keep the company solvent. I and
    others asked Ed Liddy, the CEO of AIG at the time, if he would
    encourage his employees to voluntarily return their bonuses. He
    said he would, and executives later agreed to pay back $45
    million of $165 million of those bonuses. But in December of
    last year, we learned that only $19 million has been repaid.
        I have joined Representative Mike Capuano and others to
    write Secretary Geithner about this, especially in light of
    another round of bonuses to be issued to AIG in March of this
    year.
        If as much in taxpayer dollars were immediately recovered
    today and AIG were allowed to go through bankruptcy, I doubt
    those bonuses would be paid. So I hope we can get some answers
    soon.
        Taking a look at these AIG bonuses, Professor Bebchuk, it
    is obviously frustrating to taxpayers, because if it were not
    for them, AIG wouldn't be around to pay out those bonuses in
    2009 and 2010. Are there specific things we should learn from
    the government's intervention with AIG as it relates to
    executive compensation, sir?
        Mr. Bebchuk. I think I would share your general sentiments
    that taxpayers have not charged financial firms sufficiently to
    make up for the substantial level of support that has been
    extended over the last year. And, more generally, I think that
    we can think about the pie that is being produced by the
    financial sector as being a result of contributions by
    taxpayers, by shareholders who provide capital, and by
    financial executives. And until now, the taxpayers have not
    been charging enough and shareholder interests have not been
    sufficiently protected. And the ultimate result of that is that
    financial executives--and AIG would be just one example, but
    more generally the sector--the financial executives might be
    getting an excessive fraction of this pie.
        Mr. Moore of Kansas. Ms. Minow, do you have any thoughts?
        Ms. Minow. Yes, I do. In the future, I hope we never have
    to do another bailout, but if we do, I hope we impose some
    conditions before we turn over the money. And condition number
    one should be that you take a discount on any incentive
    compensation for the amount that was subsidized.
        Mr. Moore of Kansas. Thank you. Mr. Stiglitz?
        Mr. Stiglitz. I would like to emphasize two things that we
    did not do when we turned over money to these banks. First, we
    didn't relate giving them money to their behavior, not just
    with respect to the issue of compensation schemes, but also
    with respect to lending, which was the reason we were giving
    them money. That relates to the issue of jobs that has come up
    here a number of times. The fact that compensation went out
    meant there was less money inside the banks and therefore less
    ability or willingness to lend.
        The second point is that the U.S. taxpayer was not, when it
    gave the banks money, compensated for the risk that they bore.
    In some cases, we got repaid. But we ought to look at the
    transaction that Warren Buffet had with Goldman Sachs, which
    was an arm's-length transaction. If we wanted what would have
    been a fair compensation to the taxpayer, the bailouts would
    have reflected the same terms, and we would have gotten back a
    lot more.
        Mr. Moore of Kansas. Thank you, sir. I am interested in
    better understanding how the culture of excessive lending,
    abusive leverage, and excessive compensation contributed to the
    financial crisis. This applies across-the-board for consumers
    who are in over their head with maxed-out credit cards and
    homes they couldn't afford, to major financial firms leveraged
    35 to 1.
        Is there anything the government can and should do in the
    future to prevent a similar carefree and irresponsible mindset
    from taking hold and exposing our financial system to another
    financial crisis? Professor Bebchuk?
        Mr. Bebchuk. Two things. One is, I think in retrospect it
    is clear that leverage ratios were allowed to be too high and
    we need to regulate those to be at the lower level. And
    stopping short of that, the approach that the Administration is
    proposing of imposing levies on liabilities is a useful
    approach, and that approach could be useful going forward,
    regardless of the issue of making up for a past contribution of
    the taxpayers just in terms of charging financial firms for the
    risk that larger liabilities are posing to the system and to
    taxpayer.
        Mr. Moore of Kansas. Thank you. Ms. Minow, do you have any
    comments?
        Ms. Minow. I agree with Professor Bebchuk.
        Mr. Moore of Kansas. Mr. Stiglitz?
        Mr. Stiglitz. Yes. Three things very briefly. It is very
    important to change the incentives, which is the subject of
    this hearing. If you have incentives for excessive risk-taking,
    you will do it. These incentives are both at the individual
    level and the organizational level, which is why the too-big-
    to-fail bank issue is so critical. Even when we realign
    incentives, we will never do it perfectly, which is why we need
    constraints on leverage, on behaviors, and on products like
    derivatives.
        Finally, in order for our economic system to work, there
    has to be transparency. The way the system is set up right now,
    it is impossible for capital markets to exercise the discipline
    that is needed to make our system function well.
        Mr. Moore of Kansas. Thank you, sir. Thank you, Mr.
    Chairman.
        The Chairman. The gentleman from California.
        Mr. Campbell. Thank you, Mr. Chairman. I am going to throw
    out a few thoughts here on which I would like the panel's
    observations, or your thoughts. I am going to suggest to you
    that the executive compensation issues on which we all agree,
    the excessive risk, the excessive period, the short-term focus,
    etc., are more the symptom than the disease, and that if we
    treat the symptom we will be, at best, ineffective and, at
    worst, perhaps counterproductive. And that includes bills like
    the one the chairman talked about that was passed, whenever it
    was last year, the year before, and that the root of the
    problem--to get at the root of the problem, two things, one of
    which Ms. Minow already alluded to; and one is the greater
    ability for shareholders to express their displeasure with
    executives, the performance of the company, or executive
    compensation through the board by having an alternative vote of
    directors, given appropriate thresholds, so that ability is not
    abused.
        And so that would be one suggestion I would have as to get
    to the root of the problem. Rather than trying to micromanage
    the pay, give the shareholders a greater ability to express
    their displeasure, and the way that I think is appropriate is
    through the board rather than through direct control of the
    pay.
        And the second--and I know the chairman is going to have a
    hearing on this subject--is the short-term focus on pay, I
    would like to suggest, is perhaps simply a reflection on the
    short-term focus of the markets, and that maybe the problem is
    not so much the pay but the fact that ``buy and hold'' is dead
    and all kinds of other things like that, such that we are
    focused on quarterly earnings, quarterly earnings, and I too
    operated inside a public company at one time and it was all
    about this quarter. Everything was about this quarter. The
    whole world revolved around this quarter, next quarter, next
    year be damned. And that short term, that the short-term pay
    and excessive risk-taking in pay is simply a reflection of the
    short-term focus on the markets; that perhaps we should be
    looking at are there other things we can do to change that
    short-term focus on the markets? One of which I suggested is
    going to semi-annual financial statements rather than
    quarterly. Now, that is not a panacea, but there may be other
    things. So I will throw those out and love to hear the panel's
    thoughts on those thoughts.
        Mr. Bebchuk. The first issue, I completely agree with you,
    it is actually the main thesis of the book, ``Pay Without
    Performance,'' that Jesse Fried and I published 5 years ago, is
    that executive compensation is a symptom. It is a manifestation
    of underlying corporate governance problems, and all the panels
    have been discussing about changing governance arrangements in
    the ways you mentioned so as to produce better compensation
    outcomes, rather than micromanaging and dictating them.
        Mr. Stiglitz. Let me add two points. One of them is that I
    agree with your second point that the deeper problem of trying
    to make our markets less short-sighted has itself been a long-
    term problem, but it has gotten much worse. One of the things
    that can fix this is tax policy. A capital gains tax structure
    that encouraged longer-term holding and discouraged shorter-
    term holding is one of the few things we can do to move in that
    direction.
        Mr. Campbell. What would you define as ``long term?''
        I am curious. It used to be 1 year.
        Mr. Stiglitz. I would define it as longer than 1 year; 2 to
    5 years is longer term.
        The second point is that, while the reforms in corporate
    governance are the root of the problem that we have to deal
    with, we are always going to be imperfect on that. The result
    is that when it comes to institutions, like the financial
    institutions, which can put taxpayer money and our whole
    economic system at risk, we have to not only get at the root
    causes and reform corporate governance, but we actually also
    have to control, try to effect the actual behaviors.
        Mr. Campbell. Only basically for those systemically
    significant?
        Mr. Stiglitz. Exactly, for those that represent a risk to
    our systemic system. But that may be broader than just the big
    banks.
        The Chairman. Before we get to the gentleman, particularly
    with her concern with investors, this is a very important
    question. I am just going to allow Ms. Minow to go beyond.
    Please don't be concerned by the red light. I think your input
    on this issue, the quarterly, semi-annual, is something we very
    much want.
        Ms. Minow. Thank you, Mr. Chairman. I think that is a
    crucial question, and I think that one drives the other. I
    think the short-term focus on pay drives the short-term focus
    on numbers. It is really important to remember that the
    financial institutions themselves are very, very large
    shareholders, and so they look at their own quarterly
    performance in terms of the money that they invest, you know,
    so it creates a vicious circle. Clawbacks is one way of
    addressing that as an issue, because if you know that no
    matter, 10 years into the future if your numbers are revised,
    you are going to have to give the money back. That keeps people
    focused on the long term.
        But with regard to the issue of a holding period and
    looking at that in terms of taxes, I just want to remind the
    committee that the largest collection of investment capital of
    all, $6.3 trillion, is under ERISA, which is indifferent to tax
    consequences, so they are not going to be affected.
        The Chairman. Would you address the--because you represent
    investors, and I am attracted by the notion of not requiring
    quarterly reports, going to semi-annual. The counter argument
    is that the investors would feel maybe deprived of information.
        If the gentleman wouldn't mind, I would interested. We will
    probably get back to you. But I want to know your view on that,
    if that is all right with you.
        Mr. Campbell. Sure. That is fine.
        Ms. Minow. There is something sort of charming and poignant
    about making that suggestion in a world of Twitter and instant
    messages, everything else is becoming faster, and trying to
    slow that down. I think the fact is that one way or another,
    investors are going to get day-to-day information.
        We are very close to a point now where company financials,
    which are internally available on an almost real-time basis may
    someday become available to everybody. So I am not sure that
    really solves the problem, but I agree with you that is the
    right question to ask.
        Mr. Campbell. On clawback--
        The Chairman. Take 10 seconds.
        Mr. Campbell. We will discuss that another day when we have
    another hearing. I just wanted one thing on a clawback that I
    wanted to ask real quick was, you said that if someone--if it
    is restated. I don't know how that changes the short-term
    focus. If I am paid entirely on what happens in the next 30
    days, that would change the focus on accounting for it,
    perhaps, but if the consequences of that decision are very bad
    for a long term, you are not going to claw me back, so that
    doesn't change my behavior, does it?
        Mr. Bebchuk. Clawbacks cannot be based--to be effective
    they cannot be based only on accounting restatements. Even if
    the accounting was correct, but it turns out that the
    performance was illusory, the money should be adjusted.
        The Chairman. With the acquiescence of the charming and
    poignant gentleman from California, we will move on. But that
    is a question we will be dealing with, and I thank him for
    raising it. The gentleman from North Carolina.
        Mr. Miller of North Carolina. Thank you, Mr. Chairman.
        Not only do I find myself agreeing with much of what Mr.
    Campbell had to say, but also with what David Stockman, the
    Director of OMB under the Reagan Administration, had to say the
    other day. I am pretty sure the Book of Revelation said that
    when I agree with both Mr. Campbell and Mr. Stockman, it is one
    of the signs of the Apocalypse.
        Mr. Stockman wrote the day before yesterday in the New York
    Times in op-ed, ``The economy desperately needs less of our
    bloated, unproductive and increasingly parasitic banking
    system.''
        Make no mistake, the banking system has become an agent of
    destruction for the gross domestic product and of
    impoverishment for the middle class. Mr. Neugebauer asked
    earlier, why didn't we have a hearing about jobs? This is a
    hearing about jobs. How do we stop the excess, the vulgar
    excess that is not rewarding productive conduct, but is
    rewarding what economists call ``risk seeking,'' what Dr.
    Stockman called ``parasitic,'' that is taking money from the
    middle class and taking money from the real economy. And it is
    certainly undermining all that we need to be doing to build a
    sustainable economy that works for the middle class, works for
    ordinary Americans.
        I have a couple of questions. Is the focus on executive
    compensation part of a bigger problem? I don't really want to
    regulate compensation. I would much rather the market regulate
    compensation. But the way the market is supposed to work, where
    there are competitive forces in place, is that competition
    squeezes profits and squeezes costs, including compensation;
    and, instead, in the financial industry we have seen, despite
    the fact that there are 8,000 banks, or more than 8,000 banks--
    and God only knows how many other kinds of entities that were
    doing bank-like things, and four, five, six big banks, profits
    in that sector ballooned to, a couple years ago, or
    metastasized a couple of years ago, to more than 40 percent of
    all corporate profits and compensation was almost twice what
    ordinary Americans were making, when historically it had been
    about what ordinary Americans made.
        Are competitive forces working? And why not?
        And second, where were the boards of directors? Of all the
    institutions that failed in the financial crisis, the board of
    directors has to be near the top. Gretchen Morgenson wrote an
    article, a column, 3 or 4 weeks ago that looked at what had
    happened to the board members from all the companies that had
    failed, and found out they had gone out to serve on other
    boards with no apparent diminution in their reputation. They
    were not tarnished in any way.
        There was an article in the New Republic that I read last
    night that was very critical of General Tommy Franks for not
    having captured or killed Osama bin Laden in Tora Bora in
    December of 2003. And without necessarily agreeing with
    everything that he had to say, there was a snide reference he
    had now retired and joined the board of directors at Bank of
    America and Chuck E. Cheese, which gave me the impression that
    boards of directors were really more a part of celebrity
    culture than they were corporate governance, that a board of
    directors meeting was a celebrity appearance.
        What can we do to make boards of directors a full-time job,
    a real job, and we don't have people on there who just treat it
    as a celebrity appearance?
        Mr. Bebchuk. I think, actually, making directors full-time
    employees is not a good idea because that would make them like
    insiders, would make them more dependent on the firm.
        What we need to do is obviously have them spend enough
    time, but the most important thing is to make them dependent on
    the shareholders in a way that would give them the right
    incentives and the kind of governance arrangements we were
    discussing. Arrangements that enabled shareholders to replace
    directors more easily would produce such an outcome. And this
    would be not replacing market outcomes, it would just enable
    the market to work better.
        Mr. Stiglitz. I want to make two comments on what you said.
    The first is when you were talking about that 40 percent of all
    corporate profits were in the financial sector, we have to
    remember that a lot of that was phantom profits; that is to
    say, they weren't real profits. That shows the difficulty of
    measuring performance in the financial sector. They have
    enormous discretion to create money, as it were, to create
    profits, and then later on to have losses, making all the more
    important the issue that we have been talking about of a long-
    term perspective.
        On the second point, I couldn't agree more. The fact that
    there is imperfect competition leads to sustainable above-
    normal profits, and that is particularly true in the big banks.
    The point is, there has been a large increase in concentration
    in the financial industry, and when it comes to particular
    issues like credit cards, it is very clear that they are
    engaged in anticompetitive practices that allow them to garner
    those profits and then, obviously distribute those profits to
    the officials.
        Ms. Minow. May I address the issue of the boards of
    directors? I feel very strongly about it. My company rates
    boards of directors like bonds, A through F. And we have really
    encouraged our clients, to include director and officer
    liability insurers, to raise the rates, sometimes to raise them
    to make it prohibitive for repeat offenders to continue to
    serve. And I will continue to try to do that.
        But when I first came into this business, O.J. Simpson was
    on five boards. He was on an audit committee. So we have made a
    little bit of progress. I think Tommy Franks probably was a
    better director than O.J.
        The Chairman. The gentleman from New Jersey.
        Mr. Lance. Thank you, Mr. Chairman. Good morning to you
    all.
        Regarding your point, Professor Stiglitz, that Warren
    Buffet had an arm's-length transaction with Goldman Sachs, why
    don't you think the American people have that same arm's-length
    transaction? Was it just missteps by those in the Executive
    Branch?
        Mr. Stiglitz. You might say ``missteps.'' They were very
    much taken into the view that at that point, they had to give
    money to the banks; because they thought it was imperative so
    that the banks could return to the usual role that they had
    had. But the government officials were captured in an
    intellectual sense by the banking system. It was a very big
    mistake.
        Mr. Lance. And do you see improvement with Federal
    officials at the moment in this area?
        Mr. Stiglitz. If I look at the proposals that are being
    discussed recently, I see a very marked change. But if you
    looked at the bailouts that occurred in January, February, and
    the beginning of this year, they were as bad as those that
    occurred earlier.
        Mr. Lance. That is my point. And I began my questioning
    with what occurred at a prior time. But from what I have seen
    so far this year, there doesn't seem to me to be much of a
    change, and certainly in both last year, a year-and-a-half ago
    and in 2009, we the people, you and I together, the American
    people, were on one side and Warren Buffet with his arm's-
    length transaction was on another side, a much preferable side.
    And it seems to me we ought to learn from mistakes. And so far,
    I haven't seen any great learning curve in this regard.
        Ms. Minow, your comments perhaps in this area?
        Ms. Minow. I have seen a learning curve. I think that the
    initial transaction, the initial bailout transaction was made
    in a moment of sheer panic, and it reflects that. But I think
    that the subsequent negotiations, and particularly the
    Administration's proposal of this week, do show that some
    lessons have been learned.
        Mr. Lance. Regarding Fannie Mae and Freddie Mac, how could
    these bonuses possibly have been given, in your opinion, as a
    matter of the court of public opinion, and what should we do?
        Ms. Minow. Mr. Lance, if these people could be embarrassed,
    we wouldn't be here talking about them. They seem to be
    unembarrassable. So the court of public opinion doesn't seem to
    matter to them.
        Mr. Lance. So what should we do to make sure this doesn't
    happen again?
        Ms. Minow. With regard to Fannie and Freddie?
        Mr. Lance. Yes.
        Ms. Minow. I support the chairman's notion of essentially
    rebooting the entire concept.
        Mr. Lance. Professor Stiglitz, your views?
        Mr. Stiglitz. I agree. I think that we really have to
    reexamine the whole structure of the GSEs: the concept of an
    institution that was in the private sector, which is what they
    were, and yet seemed to have by some people's account this kind
    of public role, which is a very peculiar mixture. We have been
    talking about corporate governance, and it was a system of
    governance that was almost bound to fail.
        Mr. Lance. Thank you. Is my time expired?
        The Chairman. No.
        Mr. Lance. Following up on Congressman Campbell, the short-
    term focus versus the long-term focus, isn't this true
    throughout the whole society? People don't let me finish a
    sentence.
        The Chairman. Would the gentleman hurry up, please?
        Mr. Lance. I can never be as witty as the chairman.
        Isn't this the nature of society? And how are we going to
    overcome this? Ms. Minow, your point of view?
        Ms. Minow. It is the nature of humanity, I am afraid, but I
    do think that we have some structural perversities in the
    system that can be regularized to calm things down.
        Mr. Stiglitz. We will never perfectly overcome it. But I
    think some of the things that we have been talking about are
    ways to mitigate some of the consequences, and we have to
    recognize that in some ways things have gotten worse; and that
    shows that whatever it was, you know, is not inevitable.
    Changes in the rules, the tax structures, and so forth do
    affect the extent to which there is that shortsightedness.
        Mr. Lance. Thank you. I yield back the balance of my time,
    Mr. Chairman.
        The Chairman. The gentleman from Texas.
        Mr. Green. Thank you Mr. Chairman. Mr. Chairman, we are
    dealing today with the irony of ironies, because most who
    opposed raising the minimum wage to $7.25 an hour were
    supporters and are supporters of maintaining a bonus structure
    that creates systemic risk.
        Now, the public may not understand systemic risk and
    perverse incentives and proprietary trading, but the public
    does understand this: that it took us 10 years to raise the
    minimum wage to $7.25 an hour. And if a person--and there is
    such a person--who gets a bonus of $69.7 million, it will take
    a minimum wage worker 4,622 years to make $69.7 million. Some
    things bear repeating, 4,622 years.
        The public understands that when you explain that the CEO
    or the CEOs of the biggest companies make more in 1 day than a
    minimum wage worker makes in a year, and this CEO has reason to
    envy the hedge fund manager who makes more in 10 minutes than
    the average worker makes in a year, and only pays 28 percent--
    pardon me, 15 percent, capital gains, not ordinary income.
        I am one who supports allowing people to make bonuses as
    large as they can make, as long as they don't do it based upon
    perverse incentives that create systemic risk. And that is what
    this is all about--perverse incentives that create systemic
    risk.
        Let people make as much they can. But let's not allow them
    to create perverse incentives that will bring down this
    economy. Enough already with this notion that we should just
    let the economy collapse. If we had not bailed out AIG--and I
    did not want to do it, I had to hold my nose and close my eyes
    to cast a vote--but if we had not bailed out AIG, Bear Stearns,
    the auto industry, would the world be a better place today, Ms.
    Minow?
        Ms. Minow. I think we could have done a better job of
    bailing them out, but I think we should have bailed them out.
        Mr. Green. Would the world have been a better place?
        Ms. Minow. No.
        Mr. Green. Sir, Mr. Stiglitz?
        Mr. Stiglitz. I agree that the way we bailed them out
    leaves a lot to be desired.
        Mr. Green. Leaves a lot to be desired. Would the world have
    been a better place if we had not?
        Mr. Stiglitz. I think that at the time, the perspective was
    that we thought we had to.
        Mr. Green. I want speculation. If I may intercede, my time
    is limited.
        Would the world be a better place today? Give me your
    speculation.
        Mr. Stiglitz. My speculation is the world would be a better
    place if we had let AIG fail.
        Mr. Green. The auto industry, Bear Stearns, and AIG?
        Mr. Stiglitz. I think we were forced to have some kind of a
    bailout for some of these.
        Mr. Green. Mr. Bebchuk?
        Mr. Bebchuk. I feel the world would have been better had we
    done a ``partial bailout,'' for example. Having some of AIG's
    counterparties--
        Mr. Green. If we had taken a laissez-faire, hands-off
    attitude and let things go, would the world be a better place
    today?
        Mr. Bebchuk. Compete laissez-faire, no. It would not have
    been a better place if we just took our attention completely
    away from those firms. The answer is no.
        Mr. Green. Just laissez-faire, let the world go wherever it
    is going.
        Mr. Bebchuk. That would have been a worse outcome.
        Mr. Green. Do you understand that we have Members of
    Congress who are advocating we should have just let the world
    go, just left it alone? Can you imagine where we would be if we
    had done nothing? Is it irresponsible to do just nothing at a
    time of crisis like this? Ma'am?
        Ms. Minow. Yes.
        Mr. Green. Sir?
        Mr. Stiglitz. I agree it would be irresponsible.
        Mr. Green. Is it irresponsible to do nothing?
        Mr. Bebchuk. It is not the right thing to do.
        Mr. Green. It is not the right thing to do. All right. I
    will help you. It is irresponsible.
        Friends, we at some point have to become adults about what
    we are dealing with. We are talking about perverse incentives
    that create systemic failure. Give me an example, please,
    ma'am, of a perverse incentive that creates systemic failure,
    please.
        Ms. Minow. Certainly. In the subprime industry, the
    individuals were paid on the number of transactions rather than
    the quality of transactions. So they had a perverse incentive
    to create as many transactions as possible.
        Mr. Green. Mr. Chairman, may I, with unanimous consent, ask
    that each other witness just give one example of perverse
    incentive?
        Mr. Stiglitz. The fact that the incentives in the financial
    sector were based on pay as measured by performance, whether it
    was through excessive risk-taking, increasing beta, or whether
    it was the result of greater efficiency, increasing alpha.
        Mr. Bebchuk. The fact that the top executives at Bear
    Stearns and Lehman Brothers were able to get in 2006 very large
    bonuses based on earnings which then they were able to keep and
    they were not clawed back, even though all those earnings, and
    more, were evaporated in the subsequent period.
        Mr. Green. Thank you, Mr. Chairman.
        The Chairman. The gentleman from Missouri.
        Mr. Cleaver. Thank you, Mr. Chairman. I have a number of
    questions so I am going to try to ask them quickly. But before
    I ask the questions, I was appointed to this committee in 2005
    with Mr. Green--I had to just recheck--and my recollection is
    that at the time, Mike Oxley was the chairman of this committee
    and our current chairman was the ranking member. And one of the
    first things we dealt with when I came on this committee was
    some proposed reform, assuming by Mr. Oxley, maybe both Mr.
    Oxley and Mr. Frank, dealing with Fannie and Freddie.
        I was talking to a reporter 2 days ago who said one of the
    problems in Washington is that the truth doesn't matter; it is
    whether or not you can say a lie over and over and over again
    so that everybody buys it. So my concern is that history has
    been a little distorted, because Mr. Oxley proposed trying to
    deal with the issue of Fannie and Freddie compensation, and as
    I recall, they didn't get any support from the White House. If
    I have misspoken, I would like to be corrected.
        The Chairman. If the gentleman would yield, Mr. Oxley's
    quote in the Financial Times was that what he received from the
    White House was the ``the finger salute.''
        Mr. Cleaver. I take that to mean I am correct.
        Mr. Bachus. Would the gentleman further yield?
        Mr. Cleaver. Certainly.
        Mr. Bachus. Chairman Frank opposed that legislation.
        The Chairman. Would the gentleman further yield?
        Mr. Cleaver. Yes.
        The Chairman. The gentleman from New Jersey and the
    gentleman from Texas derided it as very ineffective and weak,
    and it failed in the Senate. I voted for the bill in the House
    and in the committee. When it got to the House Floor and the
    Republican leadership put in an amendment restricting
    affordable housing, unrelated to the structural organization of
    Fannie and Freddie, I then voted against that. But I voted for
    the bill until they put that amendment in.
        I thank the gentleman and he will get an additional minute
    for yielding.
        Mr. Cleaver. The point I was trying to make, as somebody
    had said earlier, had transferred the conversation to Fannie
    and Freddie, and that we had not tried to deal with
    compensation with Fannie and Freddie. I wanted to try to clear
    it up as this reporter told me. It doesn't matter; people are
    going to continue to say it, just like we will hear over and
    over again that I guess President Obama started the bailouts.
        But where I want to go now is that the too-big-to-fail is a
    problem because I think they understand clearly that they have
    what it takes to take what we have. And if that is the attitude
    they have, which I think it is, we are going to lose.
        My questions are though--and I don't know the answer to
    this, and in this committee you probably should know the answer
    before you ask the question--but did the firms with better
    compensation perform better? Those with the better compensation
    structure, did they end up performing better? Did they get into
    trouble? Do any of you know that answer?
        Mr. Bebchuk. This is a subject that still needs to be
    investigated. What makes it not a straightforward question to
    answer is the question is, what does it mean to be compensated
    better? So if you believe that better compensation is one that
    provides less incentives to focus on short term, then you have
    to measure those dimensions and then to find how they have
    correlated with performance, and that is not something that has
    yet been kind of fully done.
        Mr. Cleaver. Don't you think that would be a worthy project
    to--
        Mr. Bebchuk. Definitely.
        Mr. Stiglitz. Part of the problem is that almost all of the
    big banks, those that are too-big-to-fail, had similar
    compensation schemes, so that you probably won't be able to get
    clear results. The differences were not big enough to overwhelm
    the perverse incentives that really dominated the whole
    industry.
        Mr. Cleaver. I was wondering if you could do an overlay
    with what happened with the mortgages--the banks, mortgage
    companies, that did not go into the subprime scam even though
    they didn't make as much money. Now, if you look at their
    books, they did better. And so the question that I raise was
    based on what I have seen with the subprime industry.
        And do you think that the--particularly the Wall Street so-
    called investment banks will change their compensation
    structure without congressional legislative encouragement?
        Ms. Minow?
        Ms. Minow. As I discussed in my testimony, the fact that
    following the bailout just over the last year, they have
    essentially poured gasoline on the fire of excessive
    compensation suggests to me that they need a much stronger
    message from Congress.
        Mr. Stiglitz. I agree. There will be some cosmetic changes,
    but the question is, will the depth of those changes be
    anywhere near sufficient to address the kinds of concerns that
    have been discussed this morning?
        Mr. Cleaver. My final question. In talking with an
    investment banker in my district in Kansas City, Missouri, I
    found out that what the investment bankers like to do is--not
    the people out trying to make the deals, but the execs--give
    bonuses that stretch over a number of years. And my assumption
    is that they invest, you know, they give a bonus over the next
    4 or 5 years, and then they invest what they gave, they keep
    and invest what they gave. And so I am wondering whether or not
    that kind of system should be outlawed. The executives don't
    want to give compensation, all compensation in cash up front.
    They want to stretch it out over the years. Do you understand
    when I am saying?
        Mr. Stiglitz. Let me make one comment, which is they are
    very creative in trying to subvert the intention--that we have
    been concerned with--of getting better incentive systems. One
    of the concerns is that, if you look in more detail across
    corporations, much of what is called ``incentive pay'' is not
    incentive pay. It is a charade. If you look at overall
    performance and overall compensation, they are much less
    closely linked than the name would suggest.
        That was evidenced in the AIG case where, when they began
    to have problems, they just changed the name from ``performance
    pay'' to ``retention pay.'' They are very clever in undermining
    what we are really concerned about.
        Mr. Cleaver. I know you weren't trying to suggest this, but
    it almost sounds like you were saying they are trying to trick
    Congress and the public. Thank you, Mr. Chairman.
        The Chairman. The gentlewoman from Ohio.
        Ms. Kilroy. Thank you, Mr. Chairman, and thank you to all
    of the witnesses for your thoughtful testimony. And I thank my
    colleagues for their questions and discussion that we have had
    since then. It has been very useful and thought-provoking, and
    still the whole issue is still difficult to get your arms
    around here.
        Despite the financial crisis in the fall of 2008, and the
    resulting bailouts and further infusions of cash along the way,
    here we are again with the public outraged and Wall Street
    handing out this year a record $140 billion in bonuses.
        When we take a look at that kind of money and try to put it
    in some kind of perspective, in context, according to the
    Washington Examiner, this is 10 percent of the entire U.S.
    deficit, or 3 times the amount budgeted for education, or 4
    times the amount for Homeland Security. It is vastly more money
    than we have pledged for the reconstruction of Haiti and an
    amount that could prevent millions, hundreds of millions of
    home foreclosures.
        So it is no wonder that hardworking Americans who thought,
    as was brought out in questioning, that okay, we need to bail
    out Wall Street, we don't want to go over the cliff, and
    understood it was their hard-earned dollars that were going
    towards that, nevertheless wanted to see something other than
    banks buying up banks and handing themselves out bonuses as a
    result of trading activity, rather than making those loans or
    renegotiating those mortgages.
        So families understand that they have lost jobs and they
    have lost homes, and bankers still are getting billions of
    dollars, and we still haven't gotten a hold over all of the
    issues about the risky behavior that has brought us here to
    this date.
        Now, I listen to the bankers, and sometimes they tell me
    that they are offended that we are even talking about
    regulating their bonuses and their compensation, that we don't
    understand that they are the best and the brightest, or that it
    has to be now for retention; otherwise they would, I don't
    know, go do I don't know what. I get offended when they tell me
    they are the best and the brightest, because I happen to think
    that there are a lot of people who are very bright and very
    good. In fact, the best are involved and teach for AmeriCorps,
    in our public schools, or in our hospitals, or social workers,
    and they seem to work very hard with substantially less pay.
        So, you know, I serve on the Homeland Security Committee,
    and we had the Salahis in last week and they were all primped
    and dressed up and made up and these gate crashers struck me as
    incredibly self-centered and without regret, and sometimes,
    like some of the people that I hear saying that we can't touch
    their pay, they don't get how angry hard-working Americans are
    and how people in central Ohio think pay should somehow relate
    to your productivity. And they don't get it that when you ruin
    an economy, you get these kind of bonuses.
        So, you know, I know we have been around this a few times
    already, but what advice do you have for us so that we can
    fairly compensate people and try to define performance? And if
    the issue is, Ms. Minow, as you suggested, the central issue,
    board governance, if boards have this attitude that we all
    deserve that in the financial sector, that kind of
    compensation, how do we really get into, you know, changing the
    practices, both in order to protect us from further damage down
    the road, and to have a better handle on corporations and their
    governance?
        Ms. Minow. The focus on the post-Enron reform legislation,
    Sarbanes-Oxley, and the regulations has all been on what I call
    the supply side of corporate governance, what managers have to
    do, what accountants have to do. We have not really focused on
    the demand side, on what shareholders have to do. And the fact
    is that you should have in here the heads of all the mutual
    funds, the Assistant Secretary responsible for ERISA, these are
    people who routinely vote in favor of these boards of
    directors, in favor of these pay plans because no one is
    looking at them, no one is paying attention to them. I think we
    need to remind them what fiduciary obligation is all about and
    that it is in their economic interest to look at pay as a risk
    factor, and I think that would make a big difference.
        Mr. Stiglitz. I think the reforms in corporate governance
    that we have been talking about, both on the demand and supply
    side, are essential, but in the end I think they won't go far
    enough, for two reasons. One, those aspects of the structure of
    the compensation schemes that put at risk the national economy
    and the taxpayers' money have to be regulated in a whole
    variety of ways.
        The second point is that the tax structure as a whole has
    to be designed better to address the sense of equity in our
    system. The arguments that have been made before, that more
    progressive taxation or that taxing capital gains would have
    adverse incentive effects, are just wrong. We can have a fair
    tax system that actually would encourage greater efficiency.
        Mr. Bebchuk. I would put the $140 billion figure that you
    mentioned in context, not just by comparing it to the Homeland
    Security budget, but I would compare it, that would be the most
    relevant comparison, to what shareholders have received during
    this period and what taxpayers have received during this
    period. So what is disproportionate is the $140 billion
    relative to the contribution of the financial sector to the
    performance of the economy over the last decade. If you look at
    the numbers, you see that shareholders in the financial sector
    over the last 10 years still see somewhat negative returns over
    this long period. And we know about taxpayers.
        So what we need is to reallocate the pie, so to speak, in a
    more efficient way between shareholders, taxpayers, and
    financial executives, and the way to do it would be for
    shareholders to have stronger rights so that they can claim
    their share of the pie, and for taxpayers to begin going
    forward charging banks adequately for the support the taxpayers
    are providing.
        The Chairman. The time of the gentleman has expired. I just
    want to makes an announcement to others. And this again, the
    gentleman from California, Mr. Campbell, the gentleman from
    Michigan, Mr. Peterson, there has been a lot of interest in
    corporate governance. We tried to minimize the involvement of
    it with the financial regulatory programs. We want to deal with
    that. We are going to get into the corporate governance issue,
    and that includes, by the way, I would just say to Ms. Minow,
    jurisdiction being what it is, I don't think I can summon the
    Assistant Secretary of Labor before this committee who was the
    ERISA guy or woman. But we are going to continue with one of
    the things that the SEC did, which is to require that all these
    institutions publish how they vote. As you know, there was a
    lot of resistance to that. And the fact that it was kind of
    partisan is true, so it was imposed on the mutual funds, and we
    believe it should be imposed on any fiduciary. If you are the
    owner of the shares in your own right, you have a privacy
    right. But if you own shares as a fiduciary, we, I hope, will
    pass legislation that will require that you have to make public
    how you voted on all the proxies. We can't force them to do
    more, but I think that would be useful.
        Ms. Minow. No question about it. I would be delighted and I
    hope you will allow me to come back and testify in support of
    that.
        The Chairman. And we will be inviting people to that
    hearing. Before we get to the last questioner, the gentleman
    from Florida, one other question, I talked to the gentleman
    from Alabama, if I have just like 2 minutes, unanimous consent
    to say, one of the things we are told is well, we are given two
    arguments on compensation. One, we will all go to some other
    country. Well, the rest of the world is getting tighter than
    us. So now the argument is okay, we will go do something else.
    We will go into some other profession and won't you be sorry,
    all billion of us will no longer be trading CDSs with each
    other.
        My response is in part, well, I am not sure where you are
    going to go for that kind of money. But two, what if they did,
    if, in fact, fewer of the very brilliant people that the
    gentleman from Ohio was referring to decided that there was no
    longer enough money to be made in bond trading and went into
    other lines of work, would that be a social loss? Not that we
    would drive them away, but is that a by-product that we have to
    try to avoid?
        Ms. Minow. I was supportive of the remarks you made on this
    subject earlier this week, Mr. Chairman, when you talked about
    scheduling this hearing. And in my written testimony, I said I
    would love to see the demand curve on that one if all of the
    Wall Street guys rush out into the market. I think the pay
    package--
        The Chairman. Well, I think it is twofold. One, what is the
    demand curve and, two, even if there is a demand what is the
    social loss?
        Professor Stiglitz?
        Mr. Stiglitz. I addressed that in my written testimony. I
    said that not only is there a misallocation of financial
    capital, but there is also a misallocation of human capital
    that is costing our society even more. It would be a good thing
    for our society to reallocate this human capital.
        The Chairman. Professor Bebchuk?
        Mr. Bebchuk. There is a very interesting study by Claudia
    Goldin and Larry Katz from Harvard, and they track what
    happened to Harvard college graduates over a long period of
    time, and they report that a huge increase in the fraction of
    the class, the best and the brightest, they go into finance
    relative to what happened 30 years ago when larger numbers were
    going into science, engineering, medicine, and so forth. And
    this partly reflected response to market incentives, and now
    that we are reconsidering the contribution of financial to the
    wellbeing of the economy, we might conclude that having a
    smaller fraction going into finance might not be a bad thing.
        The Chairman. Thank you. Does the gentleman from Alabama
    want to take 2 minutes?
        Mr. Bachus. Yes, I do want to say this. I think we are
    dealing with executive compensation, and I think one thing that
    does trouble most Americans and Members on both sides of the
    aisle is that some of the very large banks do borrow very
    cheaply from the Fed, and that is taxpayer subsidized in one
    way or the other. Whether they invest them in Treasury bonds or
    carry trade, or whether they use them to trade and make
    additional profits, the original premise was that money would
    be loaned, and it is not.
        Now, I will say this: The flip side of the argument is that
    they are using those trading profits to cover some of their
    lending losses, and in some ways that makes the banks stronger
    and it may avoid the government having to come up and pick up
    liability. You know, that is one of their answers.
        Another one that they say is that there are no borrowers;
    they can't find borrowers who are qualified. Now, I talk to
    many people back in Alabama, and they say when they deal with
    the large banks, they say they are not interested in loaning
    someone $200,000. They are interested in $100 million deals. So
    I think that is a real problem. Particularly as banks get
    bigger and bigger, they are not lending on Main Street. They
    are lending to large corporations, but smaller businesses can't
    get loans.
        And I do think the American people do believe that by being
    able to borrow cheaply from the Fed and some of the guarantees
    that have been extended, that money is finding its way into
    compensation, which gives the appearance of being excessive.
    And so I think these are valid concerns.
        And also, the last concern, and I will close with this, and
    I think it is a concern we all have, as they do this trading
    they tend to be going back and doing what got them in trouble
    in the first place, and that is speculating, leveraging, and
    what happens, do we get right back into the problem we had? And
    if they are going to get in trouble, they say, you know, you
    don't want us to make bad loans. That is true. We also don't
    want them to make trades that are risky. And if anything, the
    trades benefit themselves, proprietary trading, whereas the
    lending at least gets the economy going.
        The Chairman. If the gentleman would yield, if they can
    make enough money doing everything but lending that may be a
    contributing factor to not lending. We will have an all-day
    hearing on Friday, February 5th, with borrowers and regulators
    and lenders, and we want to get into this question about why
    more loans aren't being made. It is a bipartisan concern. And I
    do think it is legitimate to inquire to the extent to which
    other opportunities to make a lot of money displace lending,
    either directly or indirectly. Let me just now--
        Mr. Bachus. And I do think one answer is to look at whether
    they are lending, and if they are not lending, the government,
    if they are going to make money available it ought to be to
    those institutions that are lending and lending on Main Street,
    and put some competition out there .
        The Chairman. Yes. And that will be our February 5th
    hearing. The last questions will be from the gentleman from
    Florida, Mr. Grayson.
        Mr. Grayson. Thank you, Mr. Chairman. In capitalism,
    winners have to win and losers have to lose. People are
    normally rewarded for success and they are punished for
    failure. Now, we went through an experience where, between the
    middle of 2007 and the end of 2008, that 18-month period, we
    lost $12 trillion in our country's net worth. According to the
    Federal Reserve figures, the net worth of America dropped from
    $62 trillion to $50 trillion, by 20 percent in the last 18
    months of the Bush Administration.
        Is there any sign since these bailouts began that the
    institutions and the individuals on Wall Street and in major
    banks who were responsible for the decisions that led to that
    loss of $12 trillion actually were held accountable for it? Any
    sign at all?
        Professor Stiglitz?
        Mr. Stiglitz. No.
        Mr. Grayson. Ms. Minow?
        Ms. Minow. No.
        Mr. Grayson. Professor Bebchuk?
        Mr. Bebchuk. I think some of them lost their positions.
    Some of them lost money, but by and large they have not been
    held sufficiently accountable. And the most important thing is
    we don't yet have incentives going forward that would make
    people do the right thing in terms of risk-taking.
        Mr. Grayson. Well, you raise an interesting point. I
    actually asked the head of AIG, who actually were the people
    responsible for their losses that led to the government bailout
    and he wouldn't even tell me their names. Isn't it possible
    that the people who actually led to this financial disaster,
    not only in America, but around the world, are still doing the
    same jobs, very often down the block from where they were
    before?
        Mr. Bebchuk. I think some of the key people did lose their
    positions. So some of the top people at AIG are no longer
    there. But I think that I agree with your sentiment that
    probably they have not been held sufficiently accountable. And
    most importantly, many of them have been able to pocket and
    still keep large amounts of money that were based on results
    that they had in 2006 and 2007, which were disastrously
    reversed in 2008.
        Mr. Grayson. What does it mean for a capitalist country
    like the United States if over a long period of time, failure
    is rewarded and capital destruction is rewarded? What does that
    mean in the long run?
        Ms. Minow?
        Ms. Minow. Bankruptcy.
        Mr. Grayson. For the country?
        Ms. Minow. For the country.
        Mr. Grayson. Professor Stiglitz?
        Mr. Stiglitz. It obviously has a very adverse effect on the
    efficiency of our economy. I have called it an ersatz
    capitalism, where you socialize the losses and you privatize
    the gains. That leads to distorted behavior, which is why a lot
    of what we are talking about is about going forward, not just
    dealing with the past. Unless we correct these incentive
    problems at the organizational and individual level, we are
    likely to have exactly the same kind of problem again.
        Mr. Grayson. And Mr. Bebchuk?
        Mr. Bebchuk. I really agree. The difference between what
    Professor Stiglitz called ersatz capitalism and real capitalism
    is very substantial and costly for the country's well-being.
        Mr. Grayson. Now, on Wall Street the gearing, the ratio
    between assets and equity is often 10 to one or more, right?
    Professor Stiglitz.
        Mr. Stiglitz. If it were only 10 to one, we would think of
    that as very conservative. It has been up to 30 or 40 to one.
    That is an example of excessive risk-taking with very little
    social benefit that you can associate with that high level of
    risk-taking.
        Mr. Grayson. Well, let's say it was only 10 to one. Isn't
    it true that every dollar that is paid on executive
    compensation means $10 less in loan ability for these
    institutions, the ability to lend out money to the rest of
    America? Professor?
        Mr. Stiglitz. Yes. We were talking about that at the
    beginning of the hearing, that money that goes out in bonuses
    is money that is not available in, you might say, the net worth
    of the bank and therefore not available as the basis of the
    leverage that the bank can lend out.
        Mr. Grayson. Now, do the managers of these institutions on
    Wall Street and the big banks around the country have any
    incentive all in an economy that is based on incentives like
    America's, any incentive at all to economize on their own
    compensation?
        Ms. Minow?
        Ms. Minow. No, I think it is the sky's the limit.
        Mr. Grayson. Professor Stiglitz?
        Mr. Stiglitz. The incentives are distorted. We have been
    talking about what would happen if they had long run
    incentives. If they had more effective long run incentives,
    then of course they would say if they keep the net worth of the
    company larger, it will make larger profits in the long run.
    Therefore, in the long run the company is doing better, and
    they will get an appropriate return. But that is not the way
    the current incentive structures are designed.
        Mr. Grayson. Mr. Bebchuk?
        Mr. Bebchuk. They don't have the right incentives.
    Privately they would be better off paying, having larger
    compensation even at some cost to the shareholders. We have
    seen this in firms that were making decisions whether to return
    TARP funding, and it seems that some executives were eager to
    return TARP funding, even when that was costly to their
    shareholders, as evidenced by market reactions, in order to get
    out of the restrictions the TARP funding had on the
    compensation.
        Mr. Grayson. Thank you, Mr. Chairman.
        The Chairman. I thank the witnesses. We will take further
    testimony, particularly on the question of how you deal with
    short-termers and some of these things that are ongoing and
    also on what I think I will title the ``so what'' part of this,
    which is, oh, if you don't let us make all this money, we will
    go off and do other things. We know they are not going to
    England. In fact, one of our major bank CEOs--we don't need to
    mention him here--complained to the Chancellor of the Exchequer
    that they were driving away his potential investment in Canary
    Wharf because of their compensation restrictions. So they
    really are trying to play us off against each other. I will be
    in Davos next week, and one of the things I will most focus on
    is reinforcing this agreement, both with compensation and
    regulation, that we are not going to be played off, and I think
    in fact America will wind up being a little bit more lax than
    many of the others. So then the question is, okay, we will go
    off and engage in other lines of work, and maybe if we got some
    more family physicians and less people doing mathematical
    models, it wouldn't be such a bad thing.
        Thank you all.
        [Whereupon, at 12:19 p.m., the hearing was adjourned.]

                                A P P E N D I X

                                January 22, 2010

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