Imagine, if only for a moment, that you decide that you want to modify your house. You've decided to give it an extra floor, so that it will increase in value, thereby increasing your personal wealth. You decide to get a contractor, and promise to pay him a bonus, regardless of whether he does a good job. In fact, you even decide to make it so you pay his bonus so long as he works for you on your house and other projects. Now imagine that the contractor has wrecked your house, and you have to spend even more money to put it back to something resembling sturdy. Would you still have to pay that bonus you promised?
As people are discovering much to their dismay, the answer is “yes.” AIG, that insurance behemoth that played such a large role in bringing about the current economic crisis, has recently been contractually obliged to pay out bonuses to their Financial Products Division. This part of the company can arguably be held responsible for all of the disasters that made a fundamentally strong company a beggar on the government dole. Losses of over $61 billion are nothing to sneeze at, especially when more losses are potentially present as the Financial Products Division struggles to unravel the complex toys they created.
Unfortunately, letting AIG fail is about as viable an option as expected. Part of the reason it cannot be allowed to go the way of extinction is because of how much the current financial system depended on AIG and its credit default swaps to protect themselves from their own investments. As a matter of policy, CDS were taken out as a sort of insurance policy should the securities created from pooling mortgages together fail. Obviously, with the same short-sightedness displayed by subprime lenders, AIG happily got into the swaps with the delusion that housing would never go through a business cycle again. Not only that, CDS are not regulated, so people who did not even own those securities could insure them: in essence credit default swaps are bets on whether or not something will fail, with the bet-maker paying an insurance premium while the house holds onto the bet. Should the bet not be paid off, the contract system falls apart, institutions have no reason to trust each other, and things become even worse than they are.
This is where the retention bonuses come in. After the market began to display the first stench of rot, the underwriters at FPG declined to stop their reckless insuring. AIG sensed that the end was near, as did many of its employees in the Financial Product Division. Aware that rats abandon sinking ships first, AIG realized it needed those same rats to unravel the mess they had created. It quickly offered them money; each one who stayed would get a bonus in 2009, and each one who stayed after that would get one in 2010. This internal deal was dutifully sealed in contracts, and the matter forgotten under the wave of defaults, trouble, and contraction that has been the economic upset.
Then, of course, the bonuses came due, right after a wave of government cash infusions that promptly went to pay off institutions such as Goldman Sachs, Deutsche Bank and Californian municipalities that took out credit default swaps. The government, of course, knew they were coming, as AIG had quietly informed the government and told them they had no legal way out. Treasury lawyers reviewed the same contracts and were forced to agree. The bonuses would have to be paid as they were for this year, but immediate work was done to curtail them for 2010.
The worst part, of course, is that the government, in its earlier haste to bailout the financial system, failed to put in language to prevent circumstances such as these in the earlier wave of bailouts. Much to its good fortune, however, public opinion turned on AIG rather than Congress. People are furious that a company that has received billions of dollars is paying out millions in bonuses. Firstly, to put things into better context for those who cannot perceive the difference, a billion is one thousand million. AIG has received $170,000 million, and is paying out $165 million in retention bonuses.
Nor does it help that the populist rage is being stoked by politicians and public figures alike. Obama in particular has been keen to play two-face. Faced with slipping poll numbers and diminishing public support, he has been the loudest in a pack of dogs baying for blood. The fact that bonuses were coming due was a well-known fact that was only brought to the forefront through Obama's well-timed efforts, even as he attempts to keep the private investors from jumping ship, leaving the government holding the bag. It is also a convenient distraction for the $9 trillion (9 million million) deficit his economic plans and budgets will inflict.
Comedians like Steven Colbert have gotten into the act, as well. The day after Colbert called for the mobs to sharpen their pitchforks, AIG issued a corporate memo that sounded more like a college campus advisory against rape, including such classics as not to wear AIG branded items (provocative clothing) and to travel in groups. Nor does it help AIG's case that its paperwork is showing a gap of $53 million between what it said it would pay and what it actually seems to have paid, along with the niggling detail that people who had left AIG in the time since the bonuses were agreed to were actually receiving them.
The populist rage is sufficient that AIG executives have rallies on their literal doorsteps, as activists protest outside their lush homes. Armed guards and heightened security measures have AIG employees fearful for their lives, senior executive down to office staff who do no more than supply paper and clean bathrooms. It has reached the point where some AIG employees are paying heed to their government-appointed chairman's request that they return their bonuses.
Fear is a powerful motivator, but as usual, the government has gone one step too far. In the closing days of the week, the House of Representatives passed a measure that would tax those who chose to keep their bonuses by an extraordinary 90 percent. This measure is, at best, illegal as well as a threat. Longtime readers will recall that I once advocated that all executives at bailed out firms return their bonuses, retroactive to September 2008, and may be wondering as to my seeming turnabout. As I explained through my analysis of the FOCA bill, the devil is in the details.
The measure that passed the House is flawed for a number of reasons. Firstly, it would not be a 90% tax. On top of federal taxes, money is subject to state and local taxes. That alone would boost the actual money paid to 102 percent. In effect, the people receiving the bonuses would be paying for the privilege of being taxed, a measure that most of the mob would heartily endorse but which is counterproductive at best. By applying this measure now, in the midst of the clean up, it encourages companies to pay back the bailout money immediately, dipping into funds they lack, causing themselves and the financial system greater instability. Lest we forget, the entire purpose of the bailout was to promote financial stability and prevent a systemic collapse.
Secondly, the law itself is unconstitutional. Congress is prevented by the Constitution from making taxes retroactive and targeting a specific, named group for higher taxation. By pushing ahead with this measure, not only are fundamental laws being violated, but a dangerous precedent created. If the measure actually succeeds, what is to stop future governments from taxing everyone at 90 percent? The slippery slope begins with a first step, and this one is more dangerous than most. Thirdly, the money would not go back to the company that arguably needs it, but straight into the maw of the hungry government budget, where any returns would be minimal, at best. Again, by creating this precedent, it becomes easier to justify excessive taxes on everyone to pay for more items no one needs or wants.
In contrast to my own measure, I will point out that while retroactive, it did not tax anyone. It was a measure designed to target those most responsible for the mess to give back their huge and ill-gotten gains to the companies they helped mismanage and virtually destroy. The difference between the government tax and my return measure is that the money would go straight back into the coffers of the ailing company, helping give it a little more cash to attempt to survive the strain in the financial system, it would not force anyone to pay more than they actually made, and it survives the litmus test of legality, while the House's tax is illegal, would go straight into paying Obama's massive deficits, and would help no one.
The public is outraged over the AIG bonus debacle, and their feelings are justified. However, in the midst of this populist fury, others such as Fannie Mae and Freddie Mac are also handing out bonuses, able to rest easier because the flak AIG is taking keeps the public from noticing them. Not only that but the outrage is being manipulated and used for political grandstanding in a non-constructive way, turned into the type of media circus that distracts people from more urgent, complex issues. Even as people protest and threaten AIG with death, metaphorical and literal, people continue to ignore the slow but definite recovery of the Dow before a dime of the government stimulus package is paid, as the government prints out $300 billion in cash, as inflation rises and what the common man makes becomes worth even less. The devil is in the boring, crucial details.
Sources
Gold futures rise more than 4% to above $920
Fannie Mae to Pay Bonuses of Up to $1M for Four Execs
The 102% Tax
How AIG Became Too Big to Fail
Obama budget could bring $9.3 trillion in deficits
AIG Offices patrolled by Armed Guards
Protesters visit AIG officials' lavish Conn. homes
Some Will Pay Back AIG Bonuses
Official: AIG bonus estimates grow $53 million
'Don't wear anything that says AIG on it': Under-fire insurer gives employees security tips as fury over bonuses grows
AIG’s Liddy Acknowledges ‘Distasteful’ Retention Pay
AIG names firms that got bailout cash
Obama Will Take "Every Legal Avenue" to Block AIG Bonuses
Congress played major role in AIG bonus mess
AIG has $61.7 billion loss, new U.S. aid may not be last
Jim Rogers: Let AIG Go Bankrupt, Not America
Subscribe to:
Post Comments (Atom)
"Aware that rats abandon sinking ships first..."
ReplyDeleteYou make some good points, but you obviously never worked at the top of a large corporation--otherwise you would know how critical RETENTION BONUSES are in times of distress--and how they differ from performance bonuses...
The first thing that Dodd and Co. should have asked is: "What does the paper say?" Anyone ever involved in contract law knows that public outrage, or a ranting congress with buyers remorse, cannot change the words in a legal contract. Insofar as confiscating the RETENTION bonuses with a ridiculous tax---as you point out, Article 1, Section 12, might well be successfully argued.
RETENTION BONUSES are paid to keep specific individuals from leaving for specified lengths of time. Experienced business people know what would happen if a company lost a significant number of it's senior management to competing jobs at a time when they presumably need them the most. Most businesses use targeted retention bonuses during times of major restructuring or business stress. If they don't, then they surely risk losing the wrong people as they are the first to perceive the writing on the wall---and the easiest to be lured away to "higher ground." Those that have no salable skills would not be at risk to leave voluntarily. So, it is the creme de la creme, not the rats, that would be at risk for the business to lose first---so they are offered retention bonuses to stay. The incompetent rats would be least likely to be lured away by competitive offers, and thus would not be offered retention bonuses. In fact, they are usually the first to receive furloughs.
However, CORPORATE PERFORMANCE bonuses based on total corporate performance should NOT have been earned nor paid to any AIG execs for 2008, of course. Nonetheless, it is also true that some INDIVIDUAL INCENTIVE bonuses may and should have been paid to deserving managers/Execs who met or exceeded their specific incentive goals.
Also, the outrage by the public is pathetic. Especially those people protesting about TAX dollars being used who are part of 50% of America that pay no income taxes! Looks like a simple case of CLASS ENVY and sickening MOB threats.
In capitalism, it is the owners, not the creditors, the government, nor angry public mobs who determine executive pay. And clearly not the lefty rabble-rousers in the media. Prospectively, as stockholders (if applicable) the government can like any other large stockholder impact bonuses, pay, strategy, policies and a lot more about the business. That's why this "bailout" is such a potential disaster. Dodd, Frank, Biden, Obama, Pelosi---the entire bunch has ZERO business experience.
More importantly, the left, including the media, and its class-envy sheep populist mobs are wasting time doting on and mis-characterizing these bonuses while Washington is burning up trillions of dollars on massive wealth transfer programs and earmarks that dwarf these payments. I dare say the State of California is paying more in benefits to illegal aliens that the entire dollar amount of these contracted retention bonuses.
Let's stay focused for God's sake! The villains are in Congress (esp Dodd and Frank), as well as Raines, Johnson, Gorelick, and the original creators of both the subprime mortgage pressure and the subsequent creators/purveyors of the disastrous and dishonest derivatives. Let's go after that ratpack. We need to remember it is an excess of BAD (risky) mortgages that is at the root of the problem. Mortgages of people who pay their debt on time, and whose mortgages wound up in these derivatives are not the cause of the problem.
Perversely, it has been argued that it was the very existence of the incredible increase in demand for housing enabled by subprime mortgages that fueled the housing price bubble. They both collapsed together. The same could happen to healthcare if the natural supply and demand balance is upended.
This could be the worst President ever and AT the worst time ever---he certainly has a start that portends an astounding naivety and lack of fundamental understanding or acumen in our capitalist system in general, or business in particular.
He and his team seem to have already demonstrated that they are not only dilettantes in foreign affairs, but a group of buffoons who are too dangerous and too inexperienced to handle our current economic mess. They are wildly throwing trillions of dollars at the wall and hoping that something sticks.
I do believe I made the distinction that the retention bonuses were specifically to retain the members of the Financial Products Group, which arguably, were rats, not creme de la creme, especially as they continued to underwrite CDS they could not pay once things began to go downhill.
ReplyDeleteHowever, I disagree with the necessity of those same retention bonuses, especially when they're more than claimed and being paid out to people who left the firm! I do, in fact, concur with the uselessness of the public outrage, the assignation of blame with the members of Congress who encouraged it, and the current intelligence and capability of the administration.
However, the fact remains that we're in this mess through human greed (living beyond their means, easy credit, etc) and the blindness of hope (Obama's election). I do, however, request that you provide an alternative to what is currently going on, as I believe I would be interested to hear whatever plan you believe would fix our problems effectively.