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Put Wall Street bonus money away for rainy day

  • Wall Street expected to pay big bonuses after year of reliance on government support
  • Fareed Zakaria says some of that money should go to reserve fund for future crises
  • He says Wall Street has had to rely on government help repeatedly
  • Zakaria: Reviving economy will be much tougher than bailing out finance industry

Editor's note: Fareed Zakaria is an author and foreign affairs analyst who hosts "Fareed Zakaria GPS" on CNN U.S. on Sundays at 1 and 5 p.m. ET and CNN International 2 p.m. and 10 p.m. CET / 5 p.m. Abu Dhabi / 9 p.m. HK

New York (CNN) -- A year after leading Wall Street firms teetered on the edge of collapse, they're expected to pay out robust bonuses to employees. But analyst Fareed Zakaria says he thinks there's a better use for a lot of that money: Sock it away in reserve funds as insurance for the next time the investment banks get into trouble.

Zakaria says that notion, proposed by former Reagan administration budget director David Stockman, is better than the special taxes on big bonuses imposed by Britain and France. He believes regulatory reform is needed to stop a cycle of recurring crises on Wall Street that has proven costly to the American taxpayer.

As public outrage grows over word of more big Wall Street bonuses, President Obama is proposing fees on the nation's biggest financial institutions to make up for losses from the Troubled Asset Relief Program.

Zakaria, author and host of CNN's "Fareed Zakaria: GPS" spoke to CNN Wednesday.

CNN: Wall Street investment banks are expected to start paying out big bonuses, after a year in which they relied on government to keep from failing. What do you expect the impact is going to be?

Fareed Zakaria: I think it's going to further create a sense of populist outrage. I'm not one who thinks that just because there's populist outrage, it's always justified. I do think there's a significant reality we have to keep in mind. The banks have been able to make these kinds of profits largely for reasons which have to do with government intervention which saved them in the first place, government intervention which eased up credit conditions, which provided effectively very, very low interest money to them and an implicit guarantee. All of those conditions provided the high profits of this year.

The second question is what should you really do. I don't like the idea of these super-taxes on bonuses that the British and the French are suggesting. I'm taken by one solution, one proposal that David Stockman has, the former budget director for Ronald Reagan, so he's a solid Republican, a solid free marketer.

He says the banks should be forced to sequester a good part of the profits this year that they are planning to give away as bonuses, sequester them onto their balance sheets as reserve capital and keep that reserve capital for several years as a kind of insurance against any further problems, insuring that if there is a further crisis, the banks will have their own capital they can rely on and not have to have a government bailout.

And that strikes me as a very sensible, simple proposal rather than getting into the business of having the government set people's compensation, which I think is a bad idea in a free market system. There has to be some understanding that these are profits created by government guarantees and government intervention rather than created by the normal risk-taking behavior of capitalist firms.

CNN: The banks would argue that they have adjusted their compensation plans for the most part by giving out more of the bonuses in stock and by enabling the firms to claw back the money if problems develop later on with the way the businesses were being run. Do you think those changes are helpful?

Zakaria: There's no question they're helpful. There's no question they're improvements on the old system. I don't know what the ideal compensation system is, and I think it's very difficult to regulate 1993, the government said the bankers are being paid too much money and their interests are not aligned with that of their firms, so they should be paid in the form of stock and options. So there was this huge shift of compensation toward stock and options.

So what happened was you had a big bull run and the stock options took off in value. And the result was that bankers were paid 10 times what they had been paid in the early 1990s. Trying to regulate something like this is like taking a sledge hammer to a very delicate thing. You're better off finding some other approach.

CNN: How important is the financial regulatory package that's now somewhat stalled on Capitol Hill?

Zakaria: It's crucial that we do it. This kind of crisis is likely to recur. If you look at the last 20 years, about every three years we've had some kind of financial crisis.

This is the largest one, but we had the S&L crisis, the Mexico crisis, the Long Term Capital crisis, the Latin American debt crisis -- all of them involving American financial institutions. So they are proving to be highly volatile and have proved to be in need of government intervention with a surprising degree of regularity.... It would be very useful to get some kind of nonpartisan panel or commission to really try to create the best regulatory structure that would maintain the innovative fire of American capitalism but make sure we don't have a system that keeps collapsing the way this one has over the last 25 years.

CNN: There was a story this week that the Federal Reserve Bank had a pretty good year. It earned about $50 billion in profit. If [Fed Chairman] Ben Bernanke were on Wall Street with that kind of bottom line, would he have walked away with tens of millions of dollars in pay?

Zakaria: Oh without any question. And by the way, last year the hedge fund manager who made the largest amount of money by far was actually the Mexican finance minister who had hedged his country's oil resources. In short he had ensured that no matter which way the oil price went, Mexico would reap tens of billions of dollars of benefits. It's important to remember that there are many people who do very well in the markets and don't demand multimillion bonuses.

Bernanke's record on the $52 billion or whatever the Fed has gotten is a sign of something we forget now, that the government intervention in the economy which took place in the last few months of 2008 and the first few months of 2009 has been remarkably effective at forestalling what could have been a serious replay of the 1930s.

CNN: While the financial rescue is generally considered very successful, the same isn't true of the economic recovery in the United States and other parts of the world. Where do you think the world economy is right now?

Zakaria: The economic rescue package has not been as successful because it is much more difficult to simply get an economy growing again. We're talking about a $14 trillion economy in which one very significant fact took place. The consumer stopped spending. That's 70 percent of the economy. And so it's very difficult to just wave a magic wand or spend a little government money to jumpstart that $14 trillion economy.

There's also a broader question of the fact that increasingly the fate of big companies in the American economy is not as closely aligned as it used to be with the fate of the average worker. So you can imagine a recovery in which GDP [Gross Domestic Product] numbers start looking good, companies post very good results, but there isn't a big uptick in employment. That's the kind of economy we've been faced with for the last two or three's a very difficult, complicated problem.

CNN: What's the solution?

Zakaria: I think this is the $1 trillion question, not just for the U.S. economy, but for western economies in general. What's happening is that the rise of technology, the knowledge economy and globalization are giving those who have capital enormous opportunities to invest, to find areas of growth where labor is cheap or productive.

The one word answer is education. The only way you can create better jobs for people is to have them highly trained, highly skilled. Unfortunately, it's the most difficult to implement, and we've done very poorly at it the last few decades.

CNN: Some people would argue that the pendulum may have swung too far in the direction of free trade and globalization, putting workers at a disadvantage.

Zakaria: I think it's a fair concern, but I don't think the solution is to have less globalization or less trade. First of all, it would be very difficult to do. How do you turn this machine off? Would it really help the American worker if we were to isolate ourselves and not take advantage of opportunities from the growth happening in India or China?

I would think the best thing to do would be to embrace this world with its competition and opportunities, but to prepare for it, to adapt to it, to raise our game, to strengthen our skills, to educate our workers, to engage in more technical training. That's going to be the long-term solution instead of trying to cut ourselves off.

The last five decades, there's a pretty clear lesson, that those countries that isolated themselves from the global economy did very badly for their people, and those that embraced it, participated in it did well. I just think that we need to do a much better job to prepare our people for this new world. Because it's a very different world, and it's moving much faster than anything we've seen before.

CNN: In the next week, we're going to be coming up on the first anniversary of Barack Obama taking office and the start of the federal stimulus plan. Do you think the stimulus plan has been effective, and has it been administered well?

Zakaria: I think history will give Obama very high marks for the stabilization of the American economy. Remember when he came into office, we were facing a financial industry in ruins, a housing industry that was in terrible shape, an auto industry staring at the abyss, and all of these things were dealt with systematically and pretty sensibly and pretty fast. And I think he deserves a lot more credit than he gets for that.

No question we needed a stimulus. Without the stimulus we would have had no growth, no recovery whatsoever.

Was it well conceived or well administered? No, it is very imperfect, messy and political. The Obama administration made a decision it was better to get it done and get it done fast rather than have something perfect, which would get mired and not get off the ground. That was a political judgment that they made.

As somebody looking from the outside, I certainly wish it had been better planned and better administered. This was a great opportunity to spend money on long neglected needs -- from infrastructure to education -- that could trigger genuine reform and growth.