Sympathy for the devils

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(Fortune Magazine) -- Is something very wrong with our financial system when the nation's biggest banks are talking about seven-figure bonuses while ever more Americans are losing their jobs? Millions of people seem to think so: If we could calculate an outrage index, it would be marching toward an all-time high. But before we institute public floggings for bankers, let's take a closer look at who or what is really to blame.

At the root of the public's anger is a timing issue: In recessions the stock market tends to anticipate the recovery by six to nine months. That means that business at Wall Street firms, including those that accepted TARP money, will pick up while most of the country is still suffering. So Wall Street employees who are paid in part through bonuses will see those bonuses rise from last year's deeply depressed levels.

At the same time, overall unemployment generally does not improve until the end of a recession or even later. So for many months to come, maybe a year or more, Americans will be jobless in growing numbers while Wall Street firms will be hiring and paying more - with taxpayers' dollars - and Washington will be caught in the middle.

That means we'll see many days when headlines carry bad news for workers and good news for bankers. It's happening already. In late April, as Chrysler and GM (GM, Fortune 500) were headed for bankruptcy, Citigroup (C, Fortune 500) chief Vikram Pandit was talking about paying big bonuses to high-performing employees who've never been near a mortgage-backed security or anything else associated with the bank's collapse. Before he could do so, though, Pandit had to go to Treasury Secretary Timothy Geithner to plead for permission. Meanwhile, a front-page New York Times analysis of first-quarter pay at several TARP recipients found, not too surprisingly, that pay was going up, igniting an outcry from vast swaths of pundits who were predictably outraged.

Why shouldn't Wall Street be punished? Because it would be bad for the country. Now that all of us taxpayers own a piece of the banks, thanks to the Bush and Obama administrations' bailouts, we need our investments to pay off. It's in the immediate interests of taxpayers, and in the longer-term interests of the economy, for Bank of America (BAC, Fortune 500), Citigroup, Goldman Sachs (GS, Fortune 500), and the rest to do well financially. The more money they make, the sooner they can pay back the Treasury and focus fully on their necessary roles in the economy.

Restoring profitability to the banks will require paying bonuses. The only way these firms succeed is with superior human capital, and the way they get it is by paying for it. Plenty of global financial firms did not take TARP funds, and they can pay what they like. Analyze the first-quarter results of Credit Suisse (CS), Deutsche Bank (DB), CIBC, and others that compete with TARP recipients, and you'll find that they, too, are paying their people more.

The results are just what you'd expect. "Citi is hemorrhaging people, and the government restrictions are making it worse," says Alan Johnson, a compensation consultant whose clients include many Wall Street firms. "I have clients who are not TARP recipients and who are giddy that they can now steal people like they never could before."

You're unlikely to hear anyone in the Obama administration defend bonuses. No politician will even think of trying to tell millions of the unemployed why it makes sense for a Wall Street firm that was given tax dollars to pay some employees more in a week than most Americans earn in a year. "The government has to step back and say, 'If we want to maximize the value of our investments, we've got to get the best people in place,'" says Spencer Stuart headhunter Peter Gonye.

One quick way the Obama administration could tame the outrage index would be to deal with Wall Street the way it is dealing with Chrysler. If Citi and Bank of America are actually insolvent, as some analysts claim, then let the government break them up and reorganize them. That would go a long way toward dispelling the notion that the Treasury is bailing out fat cats at the expense of working stiffs.