AIG Bonuses: The Tipping Point Toward Decisive Action?

By James Kwak

$165 million, of course, is less than one-tenth of one percent of the total amount of bailout money given to AIG in one form or another. Yet it may turn out to be the $165 million that broke the camel’s back.

The AIG bonus saga neatly encapsulates many of the problems that we have identified with the financial system and with the bailout to date:

• The bonus contracts - which have still not been released to the public - reflect the instinct of Wall Street to favor its employees over any other stakeholders. In the companies I worked at, it was common practice that all bonus plans were contingent on overall company performance: if the company had no money, you didn’t get any, either. Even our commission plans for sales people included the caveat that the plan could be changed by the CEO at any time for any reason. The fact that AIG did not similarly protect itself shows the Wall Street habit of putting itself first, or a failure to recognize the possibility of a bad year, or, most likely, both.
• The failure of the Treasury Department and the Federal Reserve to review and renegotiate the bonus plans as a condition of federal assistance last fall - despite the fact that the plans had been public knowledge since May - reflects the rushed, ad hoc nature of the deals that were struck. Or it reflects the understanding in Washington that the ways of Wall Street had to be respected. Or, again, both. And the failure to even say anything about the bonus plans since the initial bailout - even just to get ahead of the obvious public relations fiasco - reflects an overall strategy that amounts to hoping that problems will go away.
• The seeming inability of the government to do anything but throw up its hands reflects the failed strategy of the bailouts so far: provide as much cash as needed, but do everything you can to minimize the impact on the companies being bailed out. The fact that this is happening at AIG - the one the government has owned 80% of since September - shows that any “nationalization” so far has been a red herring. In a bankruptcy, or a government conservatorship, employees and other creditors would not have a legal right to all of their money. In the current situation, by contrast, AIG management can choose whom it wants to make whole, which is what makes self-dealing and other sweetheart deals possible. In this context, $165 million in employee bonuses pales against tens of billions of dollars of collateral provided to counterparties - beginning with Goldman Sachs. Yes, this was to cover open trading positions. But if AIG had gone bankrupt or had been taken over, it’s not clear that Goldman would have been first in line.
• The testaments to “the best and the brightest” - here, referring to the people of AIG Financial Products - reflect, I don’t know, either absolute, brazen obscenity, or a world-historical example of making the mistake of believing your own hype. The fact that people on Wall Street believe that they are the best among us is bad enough. The fact that people in Washington are willing to accept it is worse.

However, this scandal may yet serve a purpose. One characteristic of both administrations’ responses to the crisis has been to devise subsidies for the financial sector that are too complicated for even conscientious readers to make out, such as the asset guarantees for Citigroup and Bank of America, or the preferred-to-common conversion for Citigroup. Employee bonuses, by contrast, are strikingly easy to understand.

The key issues throughout this crisis have been political as much as economic. In this case, the Obama administration has been taking a difficult political position - propping up financial institutions in their current form and insisting everything will be OK - when it would have been easier to play the populist card.

This was by no means an inescapable choice; according to news reports in February, David Axelrod and Rahm Emmanuel were in favor of being tougher on the banks. Perhaps the AIG bonus scandal will force the administration’s hand toward the decisive action that we need.

Comments

[elcopone:]

Nice article and great points. I would add that this bonus scandal illustrates why the government should have stayed out of the system and let capitalism run it's course in Chapter 11.

Also, what does it say about our government when AIG execs are more scared of lawyers opinions and their own executive's potential lawsuits than they are about the governments wrath?

This "too large to fail" argument is getting really old. The cost of inaction must certainly be rivaling the cost of action (bailouts) at this point. And the real cost of the bailouts and whether they even worked is still a mystery. If companies got too large to fail then there needs to be better anti-trust laws so that company gets "too big too fail"

Mar 18 08:09 AM

[pacman1947:]

Elcopone raises a good argument. The anti-trust laws were broken when banks, insurance, and brokerages were allowed to combine.

Putting aside my disgust at rewarding these criminals with millions of taxpayers dollars, a cold look at contract law allows an unbiased view. If the contracts were written to reward illegal anti-trust activity, they are invalid.

No bonuses, baby. How 'bout some jail time instead?

Mar 18 08:30 AM

[Chris B:]

1) Where were the private shareholders? These bonuses had been paid for years without significant shareholder activism, but when the shareholders put on their taxpayer hats, the same corrupt self-dealing suddenly becomes a problem. Within a few months of the government taking a major stake, everybody is acting like corrupt excessive compensation is a new phenomenon. Experience has shown that excessive compensation does nothing to improve performance and may have the opposite effect by creating a "take the money and run" short-timer attitude. One of Bear Stearns' last acts was to make sure everybody got their bonus check. Same with Lehman. Citigroup, BAC, JPM, Home Depot - all failures for investors, with CEO's earning tens of millions.

2) The uproar over AIG's bonuses will not motivate decisive action, it will motivate inaction. The public will increasingly take a "let our banks fail, and damn the consequences" attitude. The administration will increasingly see bailouts as political landmines. Perhaps another Lehman-type failure is in our future.

3) The actual impact to taxpayers from the bonuses is actually hard to quantify. A careful analysis might have revealed that if these derivitive traders had quit and left the place in shambles, the losses and expenses to AIG might have been even higher than the cost of the bonues. After all, $165M is won or lost every day in the derivitives business. If that was the case, was it right or wrong to pay the bonuses? For better or worse, when the government has a choice between doing something morally outrageous and doing something in its own best interest, it usually choses the later.

Mar 18 08:54 AM

[Larrysyr:]

There appears to be no legal basis for AIG to pay another dime to anyone. They wrote policies they couldn't cover. Their liabilities exceed their assets. They are broke.

Mar 18 09:39 AM

[joan t:]

One should be deeply ashamed to work for AIG. One should be even more ashamed to support AIG by allowing these thugs to supply insurance for your company.

Mar 18 10:23 AM

[John Lounsbury:]

This discussion is just one aspect of a broader compensation plan problem. It is high time that owners (the share holders) demand that large compensation rewards be deferred in time to assure that the apparent success of the past year, for which a bonus is paid, is real and not just manipulation. Compensation plans should not exist for executives and key employees of companies that are bankrupt (or severely compromised) within a few years. No one should be rewarded for current success without that success having sustainability. To compensate on any other basis encourages manipulation. Our current crisis is clearly the result of manipulation.

Mar 18 10:26 AM

[Crocodilian:]

On Mar 18 08:54 AM Chris B wrote:

> 1) Where were the private shareholders?

When the stock was going up, they were making money, and didn't care. And then AIGs troubles at first seemed to involve Greenburg and accounting issues, not bonuses-- that's what shareholders were looking at.

Remember: AIG was still perceived of as a AAA credit, the "world's largest insurance company" at the beginning of 2008.

The public shareholders were wiped out before they knew much about AIG Financial Products, much less could inquire or protest compensation there.

Mar 18 10:37 AM

[LariAnn:]

The whole idea of "too big to fail" needs a serious rework. It should be "too big", period. Companies should never be allowed to become so big that, if they fail, they topple the U.S. economy. Talk about a danger to national security! Where is the Department of Homeland Security when you need them? A company that is "too big to fail" is TOO BIG, period. Smash them to bits for the security of the nation!

Mar 18 10:44 AM

[Mr. Big:]

It used to be that bonuses were tied to performance. If the company was profitable, the employee gets to share in the profits. What ever happened to this maxim?

Mar 18 10:45 AM

[user guest:]

The Dodd Amendment that permitted bonuses to AIG that was slipped into the Stimulus Bill

" (IV) For any financial institution that received financial assistance provided under the TARP equal to $500,000,000 or more, the prohibition shall apply to the senior executive officers and at least the 20 next most highly-compensated employees, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

`(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary."

thomas.loc.gov/cgi-bin.../~c111k6VOfS:e1272661:

Mar 18 10:49 AM

[user guest:]

the above link was truncated by SA - I`ll try to post below using "brackets"

"(thomas.loc.gov/cgi-bin.../~c111k6VOfS:e1272661:)"

Mar 18 10:54 AM

[bobbobwhite:]

Always, always remember, the same people making financial and economic rules and law and enforcing both in Washington are the same people that are on on Wall Street but at different times, as both places have an accepted revolving door employment "arrangement" that works both ways. Thus, why would you ever expect any impartiality or arms-length treatment of WS offenders by Washington? It would be like punishing oneself, and you know how poor the selfish and greedy are at that.

"We have met the enemy and he is us."

Mar 18 10:55 AM

[Tesa:]

The Chapter 11 would have meant the complete collapse of western baking system. Talking the talk is rather easy after the the hurricane is tamed. Capitalism tends to create capitalists that lie about the detestation that it can cause when it is not regulated.

On Mar 18 08:09 AM elcopone wrote:

> and let capitalism run it's course in Chapter 11.

Mar 18 11:23 AM

[myth1889:]

While politicians are "outraged" over the AIG bonuses, one has to wonder if they really aren't thrilled to have a scapegoat to deflect from their incompetent oversight. Remember the stimilus package was passed without time to read it. Plus, when politicians clamor for the bonuses to be repaid, how many have returned contributions received from AIG and other TARP recipients?

Mar 18 11:48 AM

[hopschoko:]

When will we finally get rid of the Fed and all of the cronies associated with it? Who is Geithner working for?

The news that AIG will return the bonus money just shows how corrupt and incompetent the U.S. Treasury is. Unless the money is actually recovered from the employees, I don't see what difference this makes. The US taxpayer will receive $165 million and the value of its investment in AIG will decrease by $165.

The government should create a program where the employees that received bonus money can voluntarily return it to the US taxpayer. The names of all employees who decide to keep the bonus money will be made available to the public along with the amount that they received. I have a feeling that all $165 million would be back in our pockets by next week.

Why do I feel that the US taxpayer is getting screwed for additional day that Geithner remains in office? The plan is obvious to me. The Fed put in one of their own guys to represent the US taxpayer and try to squeeze out whatever is left. By the time Geithner is replaced, the damage will already have been done.

Mar 18 11:53 AM

[biomedlives:]

Amen - propping up institutions that are "too big to fail" needs to stop.


On Mar 18 08:09 AM elcopone wrote:

> Nice article and great points. I would add that this bonus scandal
> illustrates why the government should have stayed out of the system
> and let capitalism run it's course in Chapter 11.
>
> Also, what does it say about our government when AIG execs are more
> scared of lawyers opinions and their own executive's potential lawsuits
> than they are about the governments wrath?
>
> This "too large to fail" argument is getting really old. The cost
> of inaction must certainly be rivaling the cost of action (bailouts)
> at this point. And the real cost of the bailouts and whether they
> even worked is still a mystery. If companies got too large to fail
> then there needs to be better anti-trust laws so that company gets
> "too big too fail"

Mar 18 11:54 AM

[Duude:]

"The failure of the Treasury Department and the Federal Reserve to review and renegotiate the bonus plans as a condition of federal assistance last fall - despite the fact that the plans had been public knowledge since May - reflects the rushed, ad hoc nature of the deals that were struck."

I totally disagree. Senators Snow (R) and Wyden (D) had proposed an amendment to the stimulus bill to block just this type of bonus payout that AIG is doing. Senator Chris Dodd (D) and Chuck Schumer(D) together with the Obama administration's backing dropped it from the stimulus bill. This isn't due the stimulus bill being rushed. One can only speculate where the money trail ends. But Geithner, Obama, Schumer, Dodd and most of Congress knew about this bonus plan more than a month ago, yet AIG still received another disbursement of 30 billion in the last few weeks. What is really happening is that these politicians misunderstood the amount of anger that would ensue from the public. Their own anger is contrived and meaningless banter to cover their tracks.

Mar 18 12:10 PM

[Tesa:]

The street believes that it was an act of socialism and communism to cut these bonuses and refuses to accept responsibility and it refuses to pass any pain to executives for malpractice and that is why the regulations fail because they maneuver around it to help themselves.

This is street's business as usual where their players and executives pass the losses to employees and the public owning stocks that holds their bags. These bags keep getting bigger and bigger as the pockets of executives are getting bigger.

For example Macy sitting at a 15 year low would cut 7000 jobs and give its executives bonuses and it is not just about the companies that have been rescued. The morals of unregulated capitalism is pass high benefits to those that shield themselves from pain in high ranking jobs.

Mar 18 12:29 PM

[Tesa:]

hopschoko, Paulson was at the helm in fact. Why aren't you naming him. Its funny when his name doesn't come up. The street is protecting their man. That's why.


On Mar 18 11:53 AM hopschoko wrote:


> day that Geithner remains in office?

Mar 18 12:35 PM

[frosty:]

Dear elcopone - capitalism did run its course and in the end forced world governments to step in and save all our asses. Anyone who thinks the insolvency of most major banks, most major wall street firms, the major auto manufacturers and whatever else, all coming at the same time is delusional to believe that would be a superior result to what we are seeing, which is bad enough.

'Capitalism' will return, hopefully better managed and better regulated. But what you think this is and what it will be are probablly two different animals. First of all, capitalism in America hasn't existed for a long time. For beginners, there are tax policies. Towns, cities, states and the federal government all stimulate or choke commerce through tax policy. My town lured big box stores through property tax incentives, other towns impose punitive measures to discourage the same type of development. States have enterprise zones. The federal government gives tax breaks to big oil, ethanol, alternative energy or whatever else the polically powerful are able to connive. This works against the most basic premise of capitalism that all businesses have a fair and equal shot in the beginning. Agriculture is another example. Price supports, crop subsidies, payment for retired lands have turned agriculture into a game for large corporate farmers who angle for federal welfare payments. This trickles all the way up to your shopping cart through thousands of businesses between the farmer and your dinner table. And why in the hell do we still support the tobacco industry? They kill people with their products. And wouldn't it be great if we had capitalism in the drug industry (I assume a capitalist objects to the rigorous oversight of the FDA drug approval process). This and many other areas need rigorous control by the federal government to protect the nation's and individual's health and well being. The financial industry also needs this more rigorous control until they can prove that they can be trusted.

John Galt died a long time ago. Get over it.

Mar 18 03:55 PM

[henarl:]

The population has already lost confidence in the ability, honesty, transparency, and concern for the public of all of the giant financial corporations. Now they are losing confidence that any of those same qualities exist in their government. Look for an incumbent bloodbath in the next election if this keeps up.

Mar 18 04:53 PM

[rakehell:]

about 25 years from now, when the US is a 3rd rate power like France is today, we'll all look back on this debacle and think that free market capitalism really would have worked just fine--if only the government hadn't gotten involved at any point in the game. for now, we are doomed to repeat the socialist experiment and we all know how that turns out.

Mar 18 05:44 PM

[guiron:]

"for now, we are doomed to repeat the socialist experiment and we all know how that turns out."

How's the free market working? Oh, another crash, another bloodbath, millions of people losing their jobs, and we're stuck paying for the risk that others took on, who are complaining that we're not just giving them the cash outright with no questions asked. Well, that's the free market for you.

Mar 18 07:10 PM

[Mad Hedge F...:]

I’m glad that I’m not counting on an AIG bonus check to clear the bank. CNBC has turned into the AIG channel. I can only imagine how that annual review conversation went down. “The good news is that your bonus is $5 million. The bad news is that you will have to spend $25 million in legal fees defending it”. Thank goodness for small favors. What hath Obama wrought?

Mar 18 08:42 PM

[Blackeyebart:]

I don't agree that AIG should have been left to die. This would have caused a domino effect that would have taken out many companies that will now survive.

Nor do I approve of what was done - a government writing a blank cheque can expect to be robbed, and not just by the normally dishonest.

The real problem is that Government has failed to deal with the problem of regulating, or banning, the instruments that created this mess.

Until that is done there can be no rational basis for evaluation progress.

Mar 18 09:35 PM

[longtermstocks:]

why didn't congress read the bill?

Mar 18 10:32 PM

[jimhsu:]

Surely there's a better way to incentive employees to stay besides giving them CASH? Why not instead of a million $, give them 100K shares or so of AIG stock. Better yet, do what tech companies are good at and give them options; say 200000 out of the money calls at 5$, and 500000 at 20$?

Mar 18 11:41 PM

[VP of Commo...:]

If you believe Liddy:

The bonuses in question were agreed to to retain the employees until AIG's highly leveraged ($2.7 trillion) positions could be wound down (currently $1.8 trillion). That's all. These bonuses are not for performance or anything like it, which we can all agree was sorely lacking.

The only question in my mind was: was $165MM necessary? Would $25MM have cut it? Where exactly where were these people going to go? Otherwise I don't have much of a problem with the concept. They thought they needed them to stay, they promised them money to stay, and they stayed. How is that wrong?

What really happened here is the management at AIG failed to set the bar high enough.

Mar 18 11:56 PM

[William Cowie:]

Bush had his Iraq War. Obama now has AIG.

Let us count the similarities:
Expensive (has anybody compared the dollar cost of the two exercises?)
Politically unpopular (am I the master at understatement, or what?)
Led by the nose by so-called experts
Oblivious to unintended consequences
Over promised, under delivered
Establishing new benchmarks of Big Government's inability to pull anything off
No way to win the thing

Please feel free to add to the list...

Mar 19 12:07 AM

[VP of Commo...:]

Well, except for Bush also was responsible for most of AIG's bailout. Other than that you're on point.


On Mar 19 12:07 AM William Cowie wrote:

> Bush had his Iraq War. Obama now has AIG.
>
> Let us count the similarities:
> Expensive (has anybody compared the dollar cost of the two exercises?)
>
> Politically unpopular (am I the master at understatement, or what?)
>
> Led by the nose by so-called experts
> Oblivious to unintended consequences
> Over promised, under delivered
> Establishing new benchmarks of Big Government's inability to pull
> anything off
> No way to win the thing
>
> Please feel free to add to the list...

Mar 19 12:10 AM

[the_lazy_ob...:]

bonuses for the "best and brightest"? WTF?
the guys who lost 60 BILLION dollars in a single quarter deserve a whole set of adjectives different from "best and brightest", and deserve something a whole lot different than a $165 million bonus.

how come we don't see anybody going to jail due to this mess? these greedy guys who caused the collapse of AIG should be put to jail for the expense they incurred from the taxpayers.
if i spilled a barrel of oil on the coast, which then caused tens of thousands to clean up, do you think i will get the same nice treatment that was given these AIG execs? losing 60 BILLION dollars is the same as 10 exxon valdez spills -- but then again, exxon valdez execs mostly got away with that mess too.

thehatemongers.blogspo...

Mar 19 03:32 AM

[Educated Se...:]

Yea, that is a logical, constitutional response to this complex issue. Let's jail employees (not just from criminal groups within AIG, but all now-gov't assisted firms) that received compensation before a date outlined in the original terms of a ridiculously diluted stimulus plan.
All of these employees are obviously guilty and the public should burn them at the stake. It is really the junior banker's fault for working 100 hours a week and earning over $30m in fees in finding financing for health care services startups. He or she should be hung for this misappropriation of government funding, and denied the true upside potential of his or her career. This also really does protect current shareholder's positions. That banker will truly want to stay and work for a socialist firm rather than go work at a boutique startup...

People don't even realize that $.90 of each dollar earned by a secretary at Citi (i.g. $2,700 of $3,000 bonus) who has a successful spouse (e.g. total household income +$250k) is now taxed. He or she is truly evil and must be held accountable for America's obsession with leverage.

On Mar 18 08:30 AM pacman1947 wrote:

> Elcopone raises a good argument. The anti-trust laws were broken
> when banks, insurance, and brokerages were allowed to combine. <br/>
>
> Putting aside my disgust at rewarding these criminals with millions
> of taxpayers dollars, a cold look at contract law allows an unbiased
> view. If the contracts were written to reward illegal anti-trust
> activity, they are invalid.
>
> No bonuses, baby. How 'bout some jail time instead?

Mar 20 01:08 PM

[Educated Se...:]

Valid analogy... But I think it deserves the slight edit from "Obama's AIG" to "Obama's Economic Stimulus".

I think the one difference that can be drawn is that at least Bush's Iraq created enemies external to the U.S. (whether or not you agree it's true) and Obama's is creating enemies within (again, whether or not you agree it's warranted)...

On Mar 19 12:10 AM VP of Common Sense wrote:

> Well, except for Bush also was responsible for most of AIG's bailout.
> Other than that you're on point.

Mar 20 01:17 PM