Don’t blame AIG for the bonus payouts

I don’t understand why so many people who should know better are demanding that AIG stop paying out $165 million in bonuses.  In particular, I am rather disapointed that President Obama chose to speak out more like a grand-standing politician than view the issue with the perspective of the lawyer that he is (or was).

Sure, I can understand that taxpayers are outraged because they would rather have the bailout money go to shoring up AIG’s capital base rather than rewarding employees.  They would rather have AIG start a witch-hunt among its employees to find out who got AIG, and the taxpayers, into this mess.  I can understand the taxpayer sentiments, even though I know they are misguided.

But sentiments don’t come into the picture here – AIG has already said it is paying these bonuses because it has a contractual obligation.

In response, people want AIG to tear up the contracts.  This, they think, would solve everything.

I hope they really don’t mean to say that.  Think about it.  If AIG has Presidential approval to tear up some contracts, why shouldn’t it tear up other contracts too, while it’s at it?  You know, contracts where it might have to settle with other firms, and so on?  And why only AIG?  Why cannot every other company tear up their contracts too?  Why do we need contracts anyway?

You can see where this is going.  If no contracts are enforceable, eventually we can all look forward to living in caves and growing our own food.  We shouldn’t even be able to barter, for even that’s really a contract.

Okay, then let’s not tear up contracts.  But fire those employees, they say.  Then we don’t have to pay them those bonuses.  Surely, we can get cheaper labor in the market?

Of course we can, but given how complex all those transactions were in the first place, you will need someone who knows about them to untangle them.   If you hire new people, you risk a months-long or even a year-long period where they try to understand all the complexities of the various deals and grapple with them.  It is not time we can afford to lose if we want these companies up on their feet – wasn’t that the whole point of the bailout?

Let’s face it – no Wall Street firm, or any other firm for that matter, would like to compensate rank and file employees attractively (CEOs are another matter), unless they have actually contributed significantly to the company’s profitability and are so talented the company cannot afford to shortchange them.   Otherwise, don’t worry, they will find ways to shortchange you, however hard you work.

The New York Times’ dealbook seems to be the only sane voice in this wilderness, pointing out these obvious facts.

But even the dealbook doesn’t talk about the next question on people’s minds – if we were bailing out AIG only to have them use some of the money to pay bonuses, should we have bailed out AIG at all?

Of course we should have, because if AIG went bankrupt, half of the financial industry (AIG’s counterparts) would have gone under too..and we’d all be in a deep Depression right now.

But when the government was bailing out AIG and others, did it make any specifications on how the bailout money could be used?  Given the recent controversy about asking AIG how it spent the money and so on, I am guessing the government never asked any of the bailout recipients to submit (weekly? monthly? quarterly?) reports about how the bailout money was being used.

In fact, the Washington Post reported in end-January that the Government Accountability Office (GAO) found that bailout oversight was restricted to an inadequate monthly survey of bailout recipients to see how they were using the money.

The $165 million dollar question is – why didn’t the government specify how the money should be used?

Well, because it’s not the government’s business to tell corporations how to handle their day to day affairs.   Besides,  money is fungible and I am not sure how much the government could have prevented AIG from paying out bonuses from existing revenue if it found a way.

Having said that, perhaps if the government had put in a stipulation saying that AIG cannot use the bailout money to, say, pay bonuses exceeding $500,000 (or some such amount)  things could have been different.   AIG may have had to defer  the bonuses, or pay them in instalments over a few years, or whatever – basically, it would have found a way to renegotiate the contracts with the employees.  I am sure most of the employees would have agreed to a renegotiated bonus too, especially in this economic environment.

But since AIG had a carte blanche from the government to use the bailout money as it chose, it really had no incentive to renegotiate its contracts.

So really, I don’t see that AIG is to blame for this mess.   If the taxpayers/ government had a list of “approved uses” or better still, a list  of  “prohibited uses” in their mind, they should have specified them.  That’s what contracts are for – you can stuff them with as many conditions as you like.

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33 thoughts on “Don’t blame AIG for the bonus payouts

    • I am glad you like to hear both sides. The other side has all the support of the public, and so you won’t see a lot of people trying to understand both sides of the story 🙂

  1. I agree that violating contracts is no way to go but you can always re-negotiate a contract. Given the reputation of the executives who landed AIG in this mess, do you think they would not re-negotiate the bonus elements of their contracts as long as they get to keep their jobs? If you say we are being held hostage by the people who landed us in this mess and we need them around to help untangle this mess, something doesn’t feel right. To paraphrase, there is the letter of the contract and the intent of the contract and AIG is shrugging its shoulders and pointing to the former while missing the big picture of accountability.

    For the future, what would you suggest? Do we restrict companies getting as big and involved as AIG has so that we can let them fail without bailing them out and avoid (or at least mitigate) ripple effects caused by their failure? But of course, you wouldn’t want the government to dictate the size and reach of companies so how do we solve the moral hazard problems from the actions of such companies?

    • I agree that AIG should have tried to renegotiate those contracts. But AIG’s responsibility is to its stakeholders, not to taxpayers. So if they can get away with trying to retain their star performers at taxpayer expense, they will. I don’t expect AIG to look out for taxpayers, it is the government which should have done that.
      As to government dictating the size of companies, it already does that in some cases – e.g. there is a law that no bank can have more than 10% of deposits nationally, and if they exceed that (by a takeover, say) they have t submit a plan as to how they would reduce to below 10%.. so your point on restricting company size is certainly something to think about..

      • But AIG’s responsibility is to its stakeholders, not to taxpayers. Aren’t these stakeholders same as taxpayers who own 80% of the company? Shouldn’t AIG be accountable to its new owners.

        The contracts have to be renegotiated, I agree. I don’t want to see contracts broken willy-nilly. Personally, this could mean my bank could decide to break its contract with me and increase my mortgage rate. And, that would be BAD. But, one can easily make a case for these AIG employment contracts to be thrown out. The company that made those contracts with these horribly incompetent employees doesn’t exist anymore. It has new owners. I’d say the representatives of the new owners, i.e. Paulson, Geithner etc., are at fault for not renegotiating these contracts or putting conditions on honoring these contracts when the new owners took over.

    • As a lawyer, Mr O would know that renegotiating contracts when one side might disagree vehemently may be tantamount to summary dismissal, which could give rise to further lawsuits. :-/

      You live by contracts, you die by lawsuits (no pun but hey what an opportunity!).

  2. Lekhni, I second Nikhil. Yours is a very well-written, clearly argued, rationally presented case. A welcome relief from much of the shrill stuff going around.

  3. Hi, I agree that contracts should be respected but I was under the impression that most employment contracts tie up bonuses to your own performance and company performance both of which are questionable in this case.
    But I guess they insert that clause only at my level and so I didn’t get a bonus this year even though my company has not had to be bailed out.

    • I am not sure why the individuals’ performance is questionable. Let’s remember that the vast majority of insurance professionals were not dealing in mortgage securities. If AIG thinks those employees performed well, I believe they must have done so.

  4. Maureen Dowd says it best:

    “Geithner, who comes from the cozy Wall Street club, and Liddy believe it’s best to stabilize the company and keep on board the same people who invented the risky financial tactics so they can unwind their own rotten spool.

    Isn’t that like giving bonuses to the arsonists who started a fire because they alone know what kind of accelerants they used to start it? “

  5. Lekhni, there seems to be somewhat of an apologist tone to your posts on this issue. 🙂

    I mean, no post criticizing the obscene and extravagant partying by a firm right after it received the first bail-out, no post asking these AIG execs to voluntarily decline these hefty bonuses when unemployment is on the rise, but posts to defend Wall St. and justify handouts. 😉

    Are you by any chance, like bureaucrats, looking after your own interests/people/industry? 😉

    These are extraordinary times, and contracts can – and should be renegotiated. And it’s not that difficult to draw a distinction between employee contracts that promise them bonuses, and contracts between firms related to their work.

    There was plenty of criticism of Bush-Paulson-Bernanke when they came out with a one-page proposal for handing out taxpayer money with no details on how to track it. The assumption was that the banking firms would act somewhat responsibly given a second chance, and that they would spend the money in an ethical manner that shows they are serious about accountability and making this work, instead of continuing to act like spoilt brats. If they need any guidance, here’s some inspiration for those selfish idiots who run the financial sector: http://www.boston.com/news/local/massachusetts/articles/2009/03/12/a_head_with_a_heart/

    Since these financial whiz-kids are the ones who are chiefly responsible for the mess, it’s not unreasonable to ask them to sacrifice a bit by letting go of their bonuses – there will be plenty of bonuses once the economy is back on track in a year or two. And yes, criminal investigations are definitely in order for these financial firms. Why not?

    • Why would I be an apologist? An apologist for whom, and what? I was certainly not defending anyone in my post..

      And no, I don’t see why anyone would want to return their bonuses just because others were unemployed. The unemployment rate in India is even higher, there is much more poverty, so should every one in India return their bonuses? 🙂

      As I keep saying, I am all for renegotiating contracts (and bonuses). What I am NOT for is unilaterally tearing up contracts, or imposing arbitrary taxes ex-post facto.

  6. Lekhni

    A lawyer who becomes a lawmaker/ politician is a dangerous entity. Of course, we all remember Mr ‘Depends on what ‘is’ is” Clinton.

    Most recently the Labour party deputy leader, Harriet Harman, also a lawyer, said on TV that Fred Goodwin’s pension pot would not stand in the ‘court of public opinion’. The same court of public opinion also wants MPs’ expenses to NOT be beyond the Freedom of Information Act. It also wanted elections when Gordon Brown instead clung to power.

    We are also in the UK big on incitement to violence but only when Muslims are expected to be victims. No mention of the nation’s two leading newspapers recently inviting people to pelt stones at Fred Goodwin (who by the way has had to take his kids out of school for their safety).

    There is much foolishness going around of course and I disagree with Amit that your posts are an apologist’s point of view. Nobody’s morality is absolutely the right model to apply to any situation.

    • That’s fascinating stuff on British politics.. I see that following British politics should be my default entertainment option 😉

      I am not arguing morality here, and yes, that would be completely subjective. I am only talking about contracts and incentives..

      • My last line was referring to Amit’s comment, not your argument.

        If you want true entertainment though, you need to follow India’s politics right now. British politicians are learners at the game.

      • Oh OK, got it now (on the morality point).
        I agree that Indian politicians are far more entertaining, but unfortunately Indian politicians are actually capable of causing large-scale violence and rioting and so on. I am assuming British politicians haven’t yet developed such capabilities..

  7. Me thinks that since the government owns nearly 80% of AIG, as a majority stakeholder, it has the right to dictate terms to the company. That said, any contractual obligations cannot be neglected because the government is the majority holder.

    I believe that taxing the bonus at more than regular levels is unfair. Re-negotiating the contracts is the right way to go. Otherwise, who knows, tomorrow the government may not like me and demand all my salary as taxes!

    • I agree completely. The way the new higher tax rate has been applied seems patently unfair. And of course, the government had every right to put in whatever conditions it wanted when it was handing out the money. It cannot come up with stipulations on use after the money has been used 🙂

  8. #

    hi, it is nice to go through ur blog…and it is well informative too…by the way why don’t you start a blog in your own mother tongue…? as i know it is not a big task….

    recently i was searching for the user friendly Indian language typing tool and found .. ” quillpad”. heard that it is much more superior than the Google’s indic transliteration…!? It gives you the option of Rich Text as well as 9 Indian languages…whereas Google is providing only 5 languages and no Rich text option…

    It is indeed a pleasure as well as proud moment to express our views in our own mother tongue…and it is our duty too….. so, save,protect,popularize and communicate in our own mother tongue….

    try this, http://www.quillpad.in

    Jai…. Ho….
    Reply

    • Thanks for telling me about quillpad – but I see that you have spammed multiple blogs with the same comment. Are you affiliated with quillpad then?

  9. lekhni,
    A sound logical analysis (except for the following part)
    >> Let’s face it – no Wall Street firm, or any other firm for that matter, would like to compensate rank and file employees attractively , unless they have actually contributed significantly to the company’s profitability and are so talented the company cannot afford to shortchange them.

    With accounting firms and the financial industry there’s always the case that at Point in Time n the profitability may have been cooked up by the said employee who was supposed to have contributed to the group. It’s kind of like retaining the bad-coder only because there are higher chances that he/she would know all the bugs their code had in the first place.

    I still would like to read some sound what-ifs (even who can sue who, what next and other analytical financial content and it’s so hard to come by on the web!)

  10. Time to enact and enforce sticrt regulation of Wall Street.Also a transaction tax would help finance the government’s bailout, say .02 percent on the purchase or sale of a future contract and 0.25 percent on the purchase or sale of a share of stock.

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