Finance

By Sean West

Policymakers appear puzzled by massive Wall Street payouts. Why are the banks paying such large salaries and bonuses amid such political and public sensitivity to the issue?

There are a few possible explanations. They could be enjoying one last hurrah before a new regulatory regime changes their ability to earn blockbuster profits. Or they could be showing Congress and the administration, both of which demonized the industry earlier this year, that there's nothing either can do to stop them. Or perhaps it's much simpler: Pay is how bankers measure success, so firms will go to any length to retain top talent. Even if self-regulation could go a long way to currying political favor in Washington, don't expect it from Wall Street. But massive payouts after a year of taxpayer support at a time when unemployment is over 10 percent seems like a recipe for populist backlash. So how likely is another bout of populism in response to bankers' compensation? There will be plenty of opportunities to find out in coming months.

In recent months, anger at bank pay has subsided as the administration has tried to bureaucratize the issue by appointing a "Pay Czar" and Congress has remained focused on healthcare. In March, Congress lurched into action over bonuses at AIG. Only a handful of votes away from passing draconian bonus clawback legislation, Congress earned its highest approval rating this session: 37 percent. But few members have said much on the subject since then. The White House and Treasury have followed a similar path: cognizant of a perception that the administration was becoming too interventionist, they bureaucratized the issue by appointing Kenneth Feinberg to review pay packages at banks receiving exceptional aid in order to protect taxpayer investments. Part of the calculation is to create an environment for the banks to remain competitive, which includes retaining talent that demands market-rate compensation. It was no surprise that his first set of rulings, which applied to the top 25 highest-paid employees at each of the seven largest TARP-recipient banks, got big headlines but had a relatively limited real impact.

Even if the issue is downplayed in the near term by a light-touch Pay Czar, it will be a long time before bankers are out of the woods. For starters, bankers' pay may again become a political lightening rod as Congress focuses on financial regulation reform package through early next year. This is particularly true if Obama begins to feel threatened by rising unemployment or if he senses that he is losing his base and needs to deflect anger. In that case, look out for fireworks as an election year Congress turns its attention to financial regulation in the first quarter of 2010.

It's not just up to the Treasury Department or Congress though. Banking regulators like the Federal Reserve are trying to get in front of the issue to prove their competence and preserve their current powers -- and whatever Congress passes, it will be up to the regulators to interpret and implement. Plus, a whole new round of legislating may follow from the Financial Crisis Inquiry Commission, which will unveil its report on what caused the market turmoil at the end of 2010. While Feinberg may be more of a technocrat than a czar, significant risk remains for a populist-driven response to bankers' pay going forward.

Sean West is a U.S. policy analyst at Eurasia Group.

STAN HONDA/AFP/Getty Images

By Ian Bremmer

The most obvious long-term effect of the financial crisis is a shift in economic decision-making power from capitals of finance to capitals of politics. We see this trend in the United States, where decisions on how best to value assets and allocate capital are now made in Washington on a scale unthinkable until about this time last year. Outside the United States, nowhere is this development more obvious than in the United Arab Emirates, where power and wealth have shifted at startling speed from Dubai (until recently a financial powerhouse) to Abu Dhabi (the seat of political power). But the American trend is temporary; the UAE's might not be.

Remember when newspapers, magazines, and TV business reports produced feature after feature on lavish investment in Dubai's newest architectural marvel and the corporatist management style of its ruler, Sheikh Mohammed al Maktoum? As foreign investment stopped flowing into Dubai, large-scale infrastructure projects ground to a halt. Thousands of foreigners lost work permits in the construction sector. Thousands more saddled with loans they could no longer repay simply abandoned their property and left the country. By January 2009, local police complained that about 3000 cars had been abandoned at the airport. Dubai found itself buried beneath a mountain of IOUs, and for a few days in February 2009, the financial world lost faith. The emirate's credit rating tanked, and foreign investors began to plan for the once unimaginable risk that Dubai would default on its sovereign debt.

Faced with that, Dubai announced a $20 billion bond program to raise the needed cash. In February 2009, Abu Dhabi moved in with $10 billion bailout, underwritten by the UAE's central bank. So far, Dubai has yet to find the other $10 billion, and Abu Dhabi may have to step in again. But the bursting of Dubai's real estate bubble and the sudden collapse of its economy have already allowed Abu Dhabi's ruling al Nahayan family to buy a big share of the al Maktoum's assets.

On a recent visit, I saw the evidence for myself. Abu Dhabi is bustling as the city state prepares for its first Formula One championship this Sunday.  In Dubai, the traffic jams are gone, the hotels are struggling, and everyone's waiting for something to change. What a difference a year makes.

There's plenty of reason to fear that things won't get better soon. Real estate prices are now at about half their peak, but overbuilding on many projects continues because the state controls many of the emirate's largest construction companies. Many of Dubai's biggest construction projects are still underway, because the government wants to minimize further job losses. That's likely to continue through 2010, leaving the emirate with large amounts of unused commercial space.

In many cases, local firms haven't paid their employees in weeks, and there have been some moderately violent protests. The government appears aware of the seriousness of the problem and is working to improve healthcare and living facilities for the laborers. Dangerous levels of unrest are unlikely given that most guest workers can't afford to risk deportation.  

But there's another cloud on the horizon. If the United States moves to intensify sanctions on Iran next year (a good bet given the low likelihood that the current diplomatic optimism will last), Dubai will be vulnerable. Much of Iran's financial flows move through Dubai, and sanctions would hit the emirate especially hard.

Ian Bremmer is president of Eurasia Group.

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