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Defending The AIG Bonuses

by @ 11:32 am on March 18, 2009. Filed under Credit Crisis, Economics, Politics

It is probably the most unpopular position to take right now, but there are some economists and pundits out there saying that the AIG retention bonuses currently causing outrage in Washington and across the punditsphere were actually a good thing.

Yesterday in The New York Times, for example, Andrew Sorkin notes that allowing the government to step in and take back these bonuses, either directly or indirectly, would set a very bad precedent:

If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

As much as we might want to void those A.I.G. pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is. Business agreements of other companies that have taken taxpayer money might fall into question. Even companies that have not turned to Washington might seize the opportunity to break inconvenient contracts.

If government officials were to break the contracts, they would be “breaking a bond,” Ms. Meyer says. “They are raising a whole new question about the trust and commitment organizations have to their employees.” (The auto industry unions are facing a similar issue — but the big difference is that there is a negotiation; no one is unilaterally tearing up contracts.)

Ruth Marcus, meanwhile, points out that paying bonuses to people who have stayed on makes business sense as well:

I understand Obama’s railing against the bonuses — but I think he may be making a mistake, both short-term and long-term.

“This is a corporation that finds itself in financial distress due to recklessness and greed,” the president said on Monday. “Under these circumstances, it’s hard to understand how derivative traders at AIG warranted any bonuses, much less $165 million in extra pay. I mean, how do they justify this outrage to the taxpayers who are keeping the company afloat?”

Well, because in the short run, hammering the AIG employees to give back their bonuses risks costing the government more than honoring the contracts would. The worst malefactors at AIG are gone. The new top management isn’t taking bonuses. Those in the bonus pool are making sums that for most of us would be astronomical but that are significantly less than what they used to make. Driving away the very people who understand how to fix this complicated mess may make everyone else feel better, but it isn’t particularly cost-effective.

And, finally, The Atlantic’s Jim Manzi points out that the consequence of voiding contracts far outweighs the relatively small amount of money in question:

There are all kinds of counts tossed around about what total bonuses are. The highest number I’ve seen credibly reported is $1.2 billion. Let’s assume this is correct. This would imply that AIG’s weight-average comp structure is about 80% base / 20% variable. I don’t know if this is optimal, but this doesn’t seem inherently crazy to me. Do you really want zero comp at risk for people operating this company in its current state?

Or is it that many people hate the fact that senior employees of AIG Financial Products (i.e., “the same people who almost destroyed the world financial system”) are being paid $100 million in retention bonuses to make sure they stay to unwind these positions? I don’t like this any more than anybody else. But as a taxpayer, which is to say, partial owner of AIG, I’m not looking for cosmic justice, I want my equity to retain some value. The aggregate size of AIGFP positions appears to be on the order of $100 billion dollars. $100 million is 0.1% of $100 billion. I don’t know if the incremental value that having these guys around to do the unwinding is worth more or less than that, but it’s not an inherently crazy idea either. I am confident that Barney Frank is no better a judge of this than I am, even if his incentives were aligned with mine, which they are not.

Sorkin, Marcus, and Manzi each have a point, but it’s a point that is being drowned-out in the hyperbolic outrage that is coming from all sides in the wake of the revelation of the AIG bonuses.

You can count me as one of those people who opposed the AIG bailout from the beginning, but that’s water under the bridge at this point. We bailed them out, and now it’s in the interests of the entire country that this company succeed so that we can get our money back. Like it or not, the best people to accomplish that are the people who received these bonuses. If they left, and if we sent the message that whatever contracts AIG made with it’s employees could be voided at the whim of the state, then who would be willing to come work for AIG  ? Whoever it might be, it wouldn’t be the people best equipped to do the job right, that’s for sure.

They may not be popular, but, in the end those AIG bonuses may well have been the right thing to do.

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One Response to “Defending The AIG Bonuses”

  1. tfr says:

    > If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

    And for that reason, I think it’s extremely likely gov’t WILL do it.

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