BizAims

A $500,000 cap on CEO pay at banks that have taken billions in taxpayer money?

It's not enough.

"Off with their heads!" yelled Wonderland's Queen of Hearts. Why isn't there ever a bloodthirsty sociopath with dictatorial powers and no regard for legal niceties around when you need one?

And heads do need to roll. Not just to satisfy a widespread desire for revenge on the masters of the financial universe who got the world into this mess -- although that's certainly a plus. But because the greedy, shortsighted and, in some cases, downright crooked people must be punished this time. That includes everyone from middle-class speculators who lied to get mortgages they couldn't afford to CEOs who took extreme risks because they thought they'd be out the door before the pyramid collapsed.

    * Talk back: Who's at fault and what should be done?

And I mean punished by more than just a slap on the wrist. If they aren't, we're just asking for a replay of this mess in five to 10 years, and, worse, we're telling the investors of the world that they shouldn't trust the U.S. with their money. Those aren't good messages to send when you plan to borrow $1.5 trillion to $2.5 trillion this year alone, as the U.S. Treasury will do.

The emperor has no clothes

The Obama administration's plan to cap CEO compensation at $500,000 got its share of headlines. With the Treasury about to unveil Troubled Asset Relief Program II, a second $350 billion-plus (hundreds of billions of dollars in "plus," in my estimation) plan to bail out the financial system, the move is an attempt to build political support for a deeply unpopular effort. The White House and Congress are being buried under a mountain of protest at any further bailout.

(For the likely contents of Bailout II, see my Feb. 3 column, "On the way: A bigger, broader bailout.")

But the deeper I dug into the details, the more inadequate the cap seemed. By the time I'd finished, the plan was insulting, a paper cut delivered when Madame Defarge is demanding the guillotine. Here's why:

    * The cap won't apply retroactively. If your bank has already received its $45 billion in taxpayer money, there's no cap on pay.

    * The cap won't even apply to all banks that take taxpayer money in the future. A bank that takes billions in "normal" bailout money from TARP II could get around the cap by disclosing pay and by holding a nonbinding shareholder vote on the pay. (It's nonbinding, so why wouldn't a company that wanted to pay more hold the vote? Because they'd be too embarrassed to pay the higher salary if they lost the vote? These companies, embarrassed? Remember the Citigroup (C, news, msgs) $50 million jet?) Only if your bank took "exceptional" assistance from taxpayers in the future would the cap be mandatory. It's not clear how the proposal would separate "normal" from "exceptional" bailout billions, but however the term is defined, the cap clearly affects fewer companies than it seems.

    * The cap doesn't apply to all compensation -- just to salaries. Banks could still give CEOs huge bonuses, but the bonuses would have to be in the form of restricted stock that couldn't be sold until after the company had repaid taxpayers.

    * And finally, and this is perhaps the most troubling, the cap, if finally triggered, would apply only to the top 25 or so executives at any bank. In other words, some Wall Street rocket scientist in charge of slicing and dicing subprime mortgages could make $5 million as long as he or she was far enough down the corporate ladder. Makes a lot of sense, right?

But don't take my word for it. Consider that Wall Street breathed a sigh of relief after the Obama administration announced the plan: "It's not as bad as we thought," one banker told the Financial Times. "We were all fearing a comprehensive cap on all bonuses."

That's it? That's the punishment for the reckless risk taking that pumped up the housing bubble, turned a decline in home prices into a global financial crisis that could shake banks and governments to the core, set off a credit crunch that brought the global economy to a standstill and has necessitated a tidal wave of taxpayer bailouts that will saddle generations to come with a mountain of debt and lower economic growth?

Doesn't somebody in the new administration know that this crisis has severely damaged global confidence in U.S.  financial markets and that we have to take extraordinary steps to restore confidence in the system? (Certainly, no one in the previous administration acted as if they understood that.)

The view from outside

Think about how you feel after watching your retirement nest egg decimated by the stock market rout after investing in blue-chip names such as Lehman Bros. (LEHMQ, news, msgs), Washington Mutual (WAMUQ, news, msgs) and Wachovia, after watching your home value fall by double digits or after getting a note from your friendly credit card company cutting the limit on your card. Think of the disgust you've felt over the past week at Wall Street's celebratory rallies on every rumor of a taxpayer bailout. All of us are mad as hell, and many of us are saying it will be a cold day in hell before we trust Wall Street or buy stocks or corporate bonds again.

Remembering your anger and disgust with the system, put yourself in the shoes of an overseas investor. They were sold Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs) paper by the truckload because Wall Street said it came with a government guarantee, and no one in Washington raised a hand to say, "No, it doesn't." They were sold Lehman bonds and minibonds -- $2 billion were bought by investors in Hong Kong alone -- because Lehman was one of the lions of Wall Street and because the ratings on these bonds said they were supersafe. They were sold stakes in U.S banks, buyout funds and hedge funds on the sizzle of the U.S. financial markets.

And most of all they were sold U.S. Treasury bonds. Billions upon billions of Treasurys.

Once burned . . .

And now? These overseas investors are looking at massive losses in most of the paper that Wall Street's sales force sold. They're being asked to buy a big hunk of the $1.5 trillion to $2.5 trillion in additional debt that the Treasury will sell this year, and the debt that European nations will sell, and the debt and equity that U.S.  corporations will sell.

And they quite legitimately are asking: Why? Why should they be suckers again? What's changed in the U.S.  financial system in 2009 so that their money is safer than it was last time around? What reason is there to believe that the guarantees and promises this time won't turn out to be as empty as last time?

Certainly it's hard to point to much that's changed. Oh, sure a few big names -- Bear Stearns and Lehman, for example -- have bitten the dust. Merrill Lynch is no longer independent but an arm of Bank of America (BAC, news, msgs). American International Group (AIG, news, msgs) will probably have to sell off half or more of its Asian crown jewels.

Those who drove us into ditch still at the wheel

But by and large, the folks who were neck-deep in the previous round are still in charge. And the punishments handed out have to seem like window dressing. The bonus system that paid out billions for "profits" that later turned into losses is intact. There's still no meaningful regulation of derivatives or hedge funds or private equity funds.

I'm sure that somewhere deep in the bowels of the bureaucracies that run the Bank of Japan and the People's Bank in China there are howls of laughter at the idea that the way to fix the U.S. system is to put someone in charge of "systemic risk" and making that someone the Federal Reserve, as Rep. Barney Frank, D-Mass., has proposed. The world's central bankers understand, even if the congressman doesn't, that the Fed didn't use the powers that it had to head off the bubble and bust of 2000 or 2007.

Even if you give the U.S. financial and political system a TARP-sized benefit of the doubt and say these are hard problems to fix overnight, it's still hard to understand why no one has gone to jail. (And I don't mean Bernard Madoff for his decades-long Ponzi scheme.) It's pretty clear that there are legal grounds of prosecuting individuals in the financial industry for fraud, criminal negligence, misrepresentation, violation of fiduciary duty, insider trading, misappropriation of company funds and other crimes. But where are the "perp walks"? Where are the trials with lurid details of birthday parties in Morocco  and $15,000 shower curtains? Where the tearful spouses grieving the loss of $4 million second and third homes?

The message we are sending

If the U.S.  is indeed serious about fixing what's broken in its financial system, why aren't legal officials putting some people behind bars?

In the short term, I don't think that would get Japanese homemakers or Chinese banking officials to pour more money into U.S. debt instruments. The fear level is too high around the globe, and sitting on your money is the safest investment available, even if it pays nothing.

But this isn't a short-term crisis. The U.S. and the other developed economies and governments are going to need to attract capital year in and year out, as far as the eye can see. To do that, we've got to move now to assure investors, here and abroad, that they can believe in the fairness and honesty of the U.S.  financial markets.

The world is justifiably tired of being played for a sucker.

Developments on past columns

"5 stocks for even-gloomier times": The recession certainly isn't slowing down McDonald's (MCD, news, msgs), even if a strengthening dollar is hurting reported sales growth in the short run. On Feb. 9, the company reported that comparable sales at its restaurants open at least a year had climbed 7.1% in January, driven by strong growth in breakfast, chicken and value-menu items.

Excluding currency effects, same-store sales grew 7.1% in Europe, thanks to a strong performance in the United Kingdom, France and Russia.

For its Asia-Pacific, Middle East and Africa segment, comparable sales climbed 10.2%, excluding currency effects. The company said chicken and beef items tailored to local markets, convenient operating hours and promotions tied to the Chinese new year helped drive sales in that region.

Looking ahead, McDonald's estimated that a stronger U.S. dollar would knock about 4 percentage points off sales growth in February.

"Make money off China's nightmare": There's good news for iron miner Fortescue Metals Group (FSUMF, news, msgs) in its battle to win price concessions from dry-bulk shippers -- and to stay out of court. As rates for dry-bulk shipping have collapsed, the company has found itself faced with paying 10, 20 or 30 times current rates because of contracts signed when day rates were much higher.

Ship owners haven't greeted Fortescue's efforts to cancel or renegotiate those contracts with open arms. Angelicoussis Group, for example, sued Fortescue Metals for $130 million in December after the company canceled shipping contracts at a rate of $77,000 a day, at a time when spot prices had tumbled to $2,316 a day.

On Feb. 4, however, Fortescue reached an agreement with shipper Bocimar International that lets the strapped iron miner pay $22 million in stock to cancel high-priced contracts signed in February 2008 and then trades an additional $28 million in shares for new shipping contracts that lock in the prices for the charter of three 180,000- to 200,000-ton capesize ships at today's low rates for five to 10 years. Individually, this deal will dilute existing shareholders' stake in Fortescue by about 1%, but it gives the company a way out of pressing legal and financial difficulties.

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If Fortescue can find a way to settle its contract dispute with one shipper, it's likely to be able to sign similar deals with others. Perhaps best of all from the point of view of current investors, a shipper wouldn't be willing to sign a deal like this if it didn't believe that Fortescue stock is potentially worth much more than its recent price, near $1.80 a share. At least that's the conclusion the market seems to have reached: Fortescue shares rose 45% from Jan. 30 through Feb. 9.

When I last updated this stock in December, I wrote, "This stock remains what it has been since I added it to Jubak's Picks last November (2007) -- a highly risky bet with a very high potential return." That's still exactly true. The upside on this stock is still, I calculate, $5 a share by December 2009. The downside is $0. If the company runs out of money, it will still have significant physical assets in its mines and shipping infrastructure, but equity owners are unlikely to see much of anything if the company has to seek bankruptcy protection. You shouldn't have money invested here that will cause real hardship for you if you lose it all.

With that caveat, as of Feb. 10, I'm keeping my target price at $5 a share by December 2009. (Full disclosure: I own shares of Fortescue in my personal portfolio.)

Editor's note: Jim Jubak, the Web's most-read investing writer, posts a new Jubak's Journal every Tuesday and Friday. For the duration of the financial crisis, he will publish a third column whenever he gets really, really angry. Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. For suggestions on helping navigate the treacherous interest-rate environment, see Jubak's portfolio of Dividend Stocks for Income Investors. For picks with a truly long-term perspective, see the Jubak Picks' 50 Best portfolio, based on Jubak's new book, "The Jubak Picks." E-mail Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares of the following company mentioned in this column: Fortescue Metals. He did not hold short positions in any company mentioned.---articles.moneycentral.msn.com