The Law of Unintended Consequences is older than Murphy’s Law. The struggle to limit the severance and other pay of CEOs at publicly held companies is an example of this law at work.

In the early eighties, the U.S. economy experienced two recessions, one of them deep, which led to a large number of company mergers and takeovers. Several high profile executive severance packages prompted Congress to enact a change in the tax code, known as a “golden parachute”, that subjected excess payouts to additonal taxes. Executives who received more than three times their annual salary in severance were subject to a 20% tax on that excess income. Before the enactment of this law, most companies paid their executives one year’s salary as severance. After the law passed, companies began to use the “3 times rule” as a benchmark. A study of CEO severance pay in the mid-nineties found that the median payout was two times annual salary. This increase in severance pay was hardly what Congress intended.

In 1993, President Clinton led a populist campaign to limit executive salaries by limiting the deductibility of salaries greater than $1M. Executives at the companies responded by designing pay packages that included stock options. The total CEO pay package grew from 100 times the average worker’s salary in 1993 to 300 times the average worker’s salary in 2000. By 2007, total CEO pay was 344 times that of the average U.S. worker.

I have been involved in several shareholder campaigns to have a greater say in executive compensation. As stock dividend returns decreased and executive pay increased in the past decade or more, the amount paid to executives seemed to come directly out of the dividends paid to shareholders. Some companies have allowed non-binding shareholder resolutions on executive pay but it has been my experience that management traditionally offers little more than a polite acknowledgment to these types of resolutions.

However, Congress would do well to pay attention to history and not make any law or rule that directly limits executive pay. Corporate law is a state issue and I don’t think that Congress could enact any changes in corporate law that would allow shareholders to have a binding vote on executive pay. Perhaps the first move Congress could make is to change the relationship between the federal government and states on corporate law. Large publicly held corporations typically incorporate in whatever state affords them the greatest operating flexibility. Unfortunately, this flexibility allows management to disregard the wishes of a majority of the owners, the shareholders.

Lydia brought up some good questions about my Foreclosures blog:
What do we do (under any of the plans including yours) with second mortgages and home equity lines?

The other problem, of course, is that all of these loans have been sliced, diced and tranched to the point that it is difficult to know who actually has what.

Then, of course, there are the Alt-A’s that will be resetting shortly.

And — who will pay for the appraisals and other evaluations your proposal requires?

And finally, while your plan seems very logical and workable, the government must change the mark to market rules for the lenders.

I replied:

Under this program, second mortgage and HomeEq lines would not qualify. There is too much potential for abuse here. On a house previously valued at $400K, a homeowner could have taken out a $100K second mortgage to start a business. Business has slowed down and it would help the business’ cash flow if the homeowner could simply call it a $100K income gain and pay the taxes on it for five years. Or a homeowner could have taken a $40K loan and built a nice swimming pool in the back yard. Now they are having problems making payments on the $40K. Not everyone can be helped. Some people made poor decisions.

The problem with writing down principal is that it is a violation of the existing contracts that the lenders have with the bondholders, many of whom are from other countries. It would require the consent of the bondholders to change the contracts so that the lender could write off part of the principal. It’s a big problem.

The slicing and dicing means that there may be many several contracts involved in the write down on one house. When the idea was first proposed in the nineties, the computer would make it possible to keep track of the slices and dices. But, in practice, is it possible?

There is a lively debate on “mark to market”. It is not the gov that does “mark to market”. It’s GAAP accounting rules. Some suggest a model of “future revenue stream”, pricing in a percentage of impairment or default. For a simple example, if you have an MBS of $1000, with a 10 year life, and the anticipated revenue stream is $17 a month for 120 months, why not price in an impairment or default of 20%, for example, and mark the MBS at $800? As it is now, some of these are being priced as low as $200, if there is much of a market for it at all. After Enron, changes to the “mark to market” rule are viewed skeptically by economists/accountants. Asset pricing has to have some basis other than the figment of someone’s imagination. However, it is difficult for some of these long term complex products where there is no market.

As to who pays for the eval, that’s a good debate. Most homeowners who are defaulting don’t have the money so as a matter of practicality, either the lender or the gov needs to pick up the tab. It is too onerous for the gov to pay promptly for these evals, so it would probably be best if the lender picked up the initial cost for the eval, then submitted a voucher to the gov. That puts a cash flow hurt on the lender, but I think they would prefer that to the limbo many of them are in now. They can at least show that as a good accounts receivable. The cost of the eval would then be included in the homeowner’s “gain” that they would pay taxes on.

Almost every plan I have read has some fault, some legal or moral hazard stumbling block.

Matt Miller, author of “The Tyranny of Dead Ideas”, in an op-ed in WSJ on 1/12/09 spoke with several former Congressional Budget Office (CBO) directors.

“If you do nothing on the spending side, you’re going to raise taxes whether you’re a Republican, a Democrat, or a Martian,” said Douglas Holtz-Eakin, the Republican-appointed director of the CBO from 2003-05.

Miller noted that Federal revenue today is 18.8% of Gross Domestic Product (GDP) and federal spending (excluding Fannie, Freddie and TARP bailouts) is 20% of GDP.

Holtz-Eakin notes that “pressures” (probably economic and social) could push spending and taxes to 23-24% of GDP, as much as 27% if health costs remain out of control. GDP is around $14T.

Dan Crippen is another CBO chief and adviser to McCain who predicts taxes of 22% of GDP by 2020, 24-25% by 2030. David Walker is another Republican (turned independent) who was comptroller general of the US from 1998 – 2008. Walker estimates taxes growing to 20-25% in the next 20 years, depending on how “radical” we get about cutting spending.

Matt Miller asked Holtz-Eakin why Republicans continue to tout tax cutting despite knowing that taxes have to go up. “It’s the brand,” Holtz-Eakin said, “and you don’t dilute the brand.”