The Big Picture and the Closeup

Bonus Baby Befuddlement

           As a number of commentators have pointed out, the $165 million in AIG retention bonuses that have so preoccupied us all in the last couple of weeks are a mere distraction.  Our economy has huge problems to solve, and the bonuses are neither at the heart of the problems nor, in relative financial terms, even a drop in the bucket.  But unlike many aspects of the crisis, the bonuses are something most of us think we can wrap our minds around, and surely for that reason the politicians, tabloids, and other deep thinkers have dragged the rest of us into obsessing about them.   

          Most of us don’t credit ourselves with fully understanding the bonuses yet.  There are too many facts we don’t know as of this writing, like the names of the bonus babies, and exactly what they did to secure promises of such golden recompense for their labors.  We also don’t have a good grasp as of this writing on who in government knew, and  when, about the fact and the significance of the bonuses.  But we feel that the situation is potentially understandable – particularly if we drop into our mental summaries a few “black boxes,” i.e. things that we don’t have to understand how they work but only how they affect everything else, “black boxes” with names like credit-default swap and derivative. 

          But there’s more reason for the furor than the fact that this is a relatively comprehensible part of the present economic chaos.  The bonus babies in some ways challenge, in others rely upon principles about which right-thinking people are deeply concerned.  Settling on outrage as our only reaction may be understandable, but it is a cheap and facile way out.  For seldom have we seen situations where policies we rightly care about are more sharply in conflict.  It may hurt one’s head to think about it, but if we must obsess, we should do so honestly. 

          So let’s take a stroll:

 •        Distributive Justice.  Most of us feel that society’s wealth should be distributed with some modicum of fairness.  Not that everyone should get the same, but that everyone should at least get enough.  It goes without saying that right now lots of us aren’t getting enough.  Meanwhile many of the bonus babies at AIG are receiving what for most of us are enormous sums.

 And we know that the Babies are just the latest manifestation of something that’s been going more and more profoundly wrong in our society for some time: the rich getting richer and the poor getting poorer.  Reaganomics, practiced for a generation now, promised “trickle down,” backdoor distributive justice, if you will.  But “trickle down” simply didn’t happen.  What happened was tax cuts for the rich, huge pay for senior corporate officials and financial professionals, golden parachutes and games with options.  In practice a diminishing share of the enormous wealth that our corporations produced ended up in the pockets of shareholders, governments, or workers.  And this malign effect applied in good times and in bad.  Owing to guarantees like the ones the bonus babies at AIG received, the big guys profited immoderately whatever the financial results they produced for their enterprises.  In a phrase so common I cannot determine now who first coined it, we privatized our gains and socialized our risks.

 Under this arrangement, all potential downside was reserved for the rest of us.  Labor unions were systematically destroyed to keep down wages, companies boosted bottom lines by firing workers or shipping their jobs overseas, and shareholders who relied upon the companies in which they invested for their retirements found that they were generally the last and least paid.  As a result of this scheme of redistributing society’s wealth upward, people have been tumbling out of our middle classes amid foreclosures and bankruptcies.  Unemployment benefits have run out on untold workers whose actual state of unemployment has not run out.

 The recent election was surely a referendum on Reaganomics.  We’re going in a different direction now.  And surely under the new scheme, there will be much more searching scrutiny before an employer can promise staggering and nearly unconditional rewards like the AIG bonuses.  BUT …

 •        Fairness at the Cusp is a problem.  In general we feel that it isn’t fair to change the rules of the game once the play has started.  The bonuses in question were promised in April 2008, before the great recession got under way, and before the election that began the change of the rules.  When the bonuses were promised, distributive justice was not the rule of the economic road.  However much we dislike it, promises were made.  In general, we believe in keeping our promises.  AND …

 •        Impairment of Contract is something we really don’t like.  We hate it so much we wrote  into our Constitution a very explicit prohibition against state impairment of contracts.  Almost everyone agrees that contracts should be lived up to.  Everyone EXCEPT …

 •        Management-side employment lawyers who frequently find Reasonable Excuses for Nonpayment.  Among the many things we don’t know are the extent to which the AIG Financial Products employees lived up to the job requirements they promised to abide by.  On the face of the Employee Retention Plan, which is posted at http://www.scribd.com/doc/13395005/AIGs-Employee-Retention-Plan, it would seem likely that if their job was underwriting other people’s bets that subprime mortgages would hold up, then, yes, they lived up to their contracts.  One could argue, of course, that if following orders meant driving their company over the cliff, this might somehow be unacceptable performance no matter what the agreements said.  Many (although not Larry Summers) would think so.  HOWEVER …

 •        Nonpayment might not be prudent.  We all strongly support Salvaging Taxpayers’ Equity.  It’s said that even if the bonus babies made the wrong calls at one point, we have to remember how few people foresaw the systemic collapse we have all experienced.  It may not prove the Babies are worthless, and it certainly may not prove they’re dispensable.  Claims have been made that we can’t afford to lose these Masters of the Universe, that if they leave AIG and take their financial expertise with them, AIG will become far more of a worthless shell than it already is, because only they know how to unwind the complex toxic assets positions they helped create.  This is a factual call which further evidence will probably elucidate.

 Such claims are inherently dubious.  The Babies may in reality have little more savvy than the bond-broker’s kind of expertise so memorably demolished by Tom Wolfe in Bonfire of the Vanities (1987): “Daddy doesn’t build roads or hospitals, and he doesn’t help build them, but he does handle the bonds for the people who raise the money…. Just imagine that a bond is a slice of cake, and you didn’t bake the cake, but every time you hand somebody a slice of the cake a tiny little bit comes off, like a little crumb, and you can keep that…. If you pass around enough slices of cake, then pretty soon you have enough crumbs to make a gigantic cake.”  But maybe AIG’s obligations really are more like the doomsday weapon assembled by a James Bond villain, crafted by financial workers with highly specialized and unique skills, and you have to incentivize the bad guys to disarm it, because there’s no one else who can.  If so, then it might be a good idea to pay the extortion.  ON THE OTHER HAND …

 •        There’s the Moral Hazard to think about.  It’s not just AIG, after all.  It’s Bear and Lehman and Bank of America and Citi, and most of the A-List financiers.  It’s the geniuses at the hedge funds.  Our Best and Brightest, the products of Wharton and Darden and the London School of Economics, have failed us.  As President Obama put it, they drove the economy into a ditch.  Even if you think that in general the principle of distributive justice must take a back seat to incentivizing the Best and Brightest so they produce wealth for the rest of us, what do you do when the Best and Brightest lay an egg?  If they don’t get whacked hard, what will motivate them to stop laying eggs?  So paying the bonuses might be even more imprudent than not paying them.  BUT YOU NEED TO CONSIDER…

 •        The argument that these guys may really be only Whipping Boys.  Reaganomics wasn’t only about redistribution; it was also about hobbling government oversight of almost anything in which there was money to be made.  Sure AIG may have insured terrible bets on bad mortgages.  But it was government that had allowed the monster to grow: wiping out the boundaries between banks and insurance companies and brokerages, encouraging the unregulated growth of Fannie Mae and Freddie Mac and their loose ways with underwriting, looking the other way as brokers at Countrywide juked the numbers to qualify financially ineligible people for home ownership, failing to regulate the hedge funds or the rating companies at all, allowing banks to pile up toxic assets without proper reserves – and allowing irresponsible borrowers to victimize the rest of us with loans they should have known they could not repay.  The men and women who pumped up the froth at AIG were only doing what government policy was bent on having them do.  Where’s the fairness in penalizing them?

 Thus, in sum, the correct course of action here is – uh, I forget. 

      My only proposal: Take comfort that it’s just a sideshow.  We need to start lending up again, cut the deficit, cut unemployment, reignite the housing market, and re-regulate the economy.  As for the bonus babies, however we treat them, it’s all political theater.   I’m with Rhett Butler.  Frankly, my dear, I don’t give a damn.

 Copyright © Jack L. B. Gohn.   All rights reserved.