Friday, March 20, 2009

Why the AIG bonuses are not so bad

I think the recent AIG kerfuffle has been an unserious distraction, with serious consequences. Members of Congress are falling all over themselves to prove their level of outrage. It doesn't seem contradictory to me, however, to find something offensive in the bonuses and still think it bad policy to try to recoup them.

1. the bonuses amount to less than 0.01% of total funds received by AIG.

2. the argument seems to be: "if you took our money, you play by our rules." But shouldn't, as a matter of prudence, the rule be: "if you took our money, you do whatever is necessary to make yourself healthy again?" So it behooves Congress to show the bonuses are bad policy, which is separate from showing they are distasteful.

3. Its not clear AIG ever "held its hands out," but rather their arms were twisted. The whole categorization of TARP recipients as greedy supplicants is incomplete at best. The original nine recipients agreed to the money after Paulsen strong-armed them in a private WH meeting. Goldman Sachs was vociferously opposed. AIG was seen as a TBTF institution and thus their quasi-nationalization was something of a forgone conclusion. Nevertheless, is someone any more beholden to you because they asked for money as opposed to took it because you saw they were in need? Maybe.

4. This is the bed the Fed made for itself. Capital infusions could have taken place by buying toxic assets, or putting companies through FDIC receivership, using a speed bankruptcy procedure or something similar. But somewhere along the line Paulsen decided taking equity stakes was the way to go. Many of us saw that something like this was bound to happen. Maybe not bonuses. But the politicization of corporate governance was inevitable. My guess was it was going to be a clause in some executive employment contract that guaranteed 45 days of vacation, but the point's the same.

5. What does this do to contracts? Unlike some, I'm not all that concerned about the "sanctity of contract" writ large. But I am concerned about the willingness of other companies to do business with TARP recipients. Who wants to enter M&A talks when everything is now subject to Congressional review and populist backlash? Isn't it indisputable that this adds another layer of uncertainty to companies already shorouded by fear?

6. It's possible, though I dont suppose to know, that many of the "bad people" at AIG were already cleared out in early 2008. Thus bonuses, which are often up to 90% of compensation packages on Wall Street, were a suitable incentive for appropriate talent who were understandably looking to jump ship. Also, even if these are some of the same people who "got us into this mess," should we reject paying them out of hand? Derivative contracts (especially credit-default swaps based on asset backed securities) are very complex and only a small handful of people really understand them. If AIG (and firms in similar situations) are to unwind their positions without taking down everyone else, we need the people who at least understand the problem, even if they are culpable for creating it. As my friend Garett Jones puts it, sometimes you have to bribe the bombmaker to defuse the bomb.


Rob said...

I appreciate your #5 because the debate really is more complicated than "contracts mean nothing" vs. "contracts are sacred."

There is a sense in which, once we've decided to do the bailout, it is a little bit disingenuous to turn around and get outraged about the bonuses. Our bailout dollars are probably going to a whole bunch of outrageous crap. That was sort of part of the deal.

Of course, this is an issue of the heart, not the head. And I am very concerned about the meta-issue of what Josh Marshall called "what appears to be the president's mortifying impotence in the face of bankers and financiers who created the problem."

That's more than just a political problem for the White House (though obviously it is a massive political problem for the White House). The financial system is still floundering, and one contributing factor among many has been the perception -- from Paulson and Bush to Geithner and Obama -- that political leaders don't have a plan, aren't in control, etc.

I don't really know how you reassert that control. I doubt you do it by taxing bonuses at 95 percent, or whatever was in that House bill last week. But at this point I don't think the financial system gets fixed without a public perception that government institutions are in some sense in control of things.

Saxdrop said...

You know a bankruptcy/receivership (or "nationalization" if you prefer) would have asserted government control right from the beginning and would have taken on much more certainty. But of course that ship has sailed (at least for the current crop of troubled institutions).

There does seem to me to be some conflation of what bailout funds were for. Unlike GM, the money was a "hold your nose" and rescue banks whether they were at fault or not, and not as leverage to reform them. The reform was supposed to come (or so I thought) through regulatory changes ex post that addresses why banks ended up where they are.

Also as far as Obama goes, since Geithner, Bernanke, and Obama himself have left open the possibility of future bailouts in a "we'll do whatever it takes" mantra, the outrage itself as well as joining in on it will only handcuff these efforts.

Saxdrop said...

also the other advantage of bankruptcy is that in bankruptcy court, judges re-write contracts all the time. In fact its quite common for bonus contracts to be written down or eliminated. The difference is when a judge does it, its usually much cleaner, with deference to the actual obligations of the company all taken together, and its also expected.