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Over at TNR, Simon Johnson talks about what might happen if Goldman Sachs is allowed to pay back the TARP bailout money it was given back in October.  The government money came with certain restrictions, including restrictions on executive compensation, and Johnson argues that removing these restraints would allow Goldman to go back to the swashbuckling business model that got us into our current mess in the first place.  Plus there’s this:

Another risk is the effects on other banks.  If Goldman can really attract all the talent, which is what they’re arguing, and really go back to an earlier business model, that’s going to take away profits and remove future profitability from other banks, and that could increase the pressure on them.

Hold on a second.  I thought high earners didn’t deserve their pay because it turns out they produced huge losses instead of huge gains?  So why would Goldman Sachs be so eager to hire them all back?  And even if they do, who cares?  The rest of the industry is better off without them.  Isn’t that the party line?

Not anymore, I guess.  Johnson is basically admitting here that if Goldman can use high pay to attract top talent, then they’ll be more profitable and competitors will suffer.  But if that’s the case, no direct cap on executive pay is ever going to stop firms from bidding top talent into the stratosphere.  They’ll always figure a way around any cap we put in place, and trying to keep up is a mug’s game.

Much better is to let them pay whatever they want, and focus instead on ways to shrink both the size and profitability of the industry as a whole.  A limit on bank size is one possibility.  Limits on leverage are another.  Stricter regulation of opaque credit derivatives and off-balance sheet accounting is yet another.  Or, if you want to focus on pay itself, do it indirectly by creating tax advantages for long-term restricted stock grants that motivate better investing behavior.  And needless to say, do this for everyone, not just banks that took TARP funds.  Do this, and deflation of the Wall Street pay bubble will follow naturally.

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