Really, Congress, Leave the Bonuses Alone

While the Federal Reserve is busily trying to save the world, Congress is just as busily trying to destroy it.

This week the Fed announced it would inject much-needed money into the economy, and lower mortgage interest rates at the same time, by buying $750 billion in mortgage-backed securities, and another $300 billion in Treasury bonds. Bold move — making the Fed's enormous balance sheet bigger than ever. Bravo, Ben Bernanke.

At the same time, the Congress has turned into a seething lynch mob aimed at AIG (AIG), the failed insurance giant that has been the recipient of over $100 billion in federal bailout money, and is paying $165 million in bonuses to some employees. At the moment, the state of play is that the House of Representatives has passed a law taxing at 90% bonuses paid to employees of firms that received more than $5 billion in bailout money.

For the stock market, this is a rally-killer. Or worse.

No one seems to want to determine whether the people getting this money deserve it or not. Maybe some of them don't — maybe some of them are even the bad people who got AIG into trouble in the first place. But maybe some of them do deserve it. Maybe there's one guy or gal who has just done some brilliant trade that has made taxpayers billions, at least offsetting some of the billions in losses. Should that trader not get a bonus?

No one seems to care that these bonuses were all contractually promised, and a contract is a contract. Sen. Christopher Dodd (D., Conn.), who wrote an obscure law hidden in the recent so-called stimulus bill to sharply limit bonuses to federally assisted banks, is outraged to discover that there is a provision in his own law that exempts employees with prior written employment contracts. First he claimed he didn't know the provision was there. Then he changed his story to claim the Obama administration insisted on it.

No one seems to care that the 90% tax will apply to all banks that have accepted federal money, not just to AIG. That includes banks like Wells Fargo, who told former Treasury Secretary Henry Paulson that they didn't even want the money when the Troubled Asset Relief Program (TARP) was enacted last October. Reluctantly, Wells took the money at Paulson's urging, as did other healthy banks such as JPMorgan (JPM). Now virtually every employee of every one of them faces a 90% tax on their bonuses.

No one seems to care that the Internal Revenue Code is designed to collect federal revenue, not to punish particular classes of people. If Congress wants to outlaw bonuses, it should just outlaw bonuses. Not allow the bonuses to be awarded, and then tax them away.

No one seems to care that you have to pay people to run these banks, even AIG. If you don't pay them, or if you don't pay them enough, or if their pay isn't structured to create incentives for them to work hard and work effectively, then everybody loses. These employees will simply leave. Or they will turn their brains off. Either way, the taxpayers whose money is at stake in these companies will be hurt — because these companies will crash and burn without people to run them well.

I've been writing here over the last several weeks that the big problem the stock market now faces is the extreme instability of the political environment. I rest my case. Now, unless this foaming mad-dog of a Congress can be subdued, the wonderful stock market rally of the last couple weeks can be declared over and done, and it's back to the bear market— with a vengeance.

And then the Fed can print all the money it wants, and buy all the mortgage-backed securities it wants. And all we'll get for it is a lot of inflation. If it's going to turn into growth, then Congress is going to have to stop changing the rules of the game constantly. Without stable rules, it's not even a game. It's nothing but a street fight.

A successful economy depends more than anything else on the rule of law. There has to be a stable set of rules governing the interactions between economic players, and between players and the government. Sometimes the rules need to be changed, but there need to be rules about how to change the rules.

Without rules, no one will take economic risk. No one will invest. No one will plan for the future. How can you plan for anything without knowing the rules of the game? And unless you can plan, how can you take the risk of investing?

It's even deeper than that. Without rules, how can you even know what you own? Without knowing that, you can't invest — because you can only invest what you own.

So the challenge facing the stock market is simply this: When everyone is learning the lesson that you shouldn't invest, stock prices simply will go lower and lower as, one by one, everyone in the market withdraws from investing.

We'll have a spectacular and sustainable stock market rally when someone in Washington, D.C. imposes a little adult supervision. It would have been great if that could have come from our popular new president. He could have used his prestige and popularity to call a halt to the lynch mob. But he's done exactly the opposite. He's just joined the mob.

Until President Obama shows a little leadership — instead of just following every mob instinct set in motion by Congress — the bear market will just keep on roaring. Even after the rally of the last two weeks, it's still worse, right here and right now, than the bear market of the Great Depression. If Washington doesn't stop taking stupid pills, pretty soon there will be nothing left.