Bonusgate: Politics, Economics, Outrage and Media

By James Kwak

Warning: This is a post about economics and politics; it is a reader response post; but (here’s the warning), it’s also one of those annoying self-referential posts you only see on the Internet discussing a debate among the commentariat.

Last week went something like this:

1. We learned about the $165 million in retention bonuses at AIG Financial Products.
2. A lot of people, up to and including President Obama, got mad.
3. Various commentators, including Ian Bremmer (on Planet Money, around the 14-minute mark) and Joe Nocera, said, in Nocera’s words, “Can we all just calm down a little?”

Their argument is basically that $165 million is small change, the government should be working on bigger issues, and the demonization of AIG is making it harder to solve the real problems.

Andrzej Kuhl, a former colleague of mine, put it well in an email to me after reading our New York Times op-ed:

I feel that the timing of the piece is harmful and its final conclusion is too limited.

Don’t take me wrong, I am a strong believer in compensation plans being tied to performance. And not just a short term - one year - window, but a performance measured over a multi-year period. Ideally, compensation enhancements should have multiple parts, ranging from evaluation of the performance of an individual, to that of a larger unit within which the individual performs. I also believe that all individuals are replaceable and should be moved aside if their performance has been sub-par (and bringing a company to the brink of bankruptcy is definitely below par).

Having said that, I strongly believe that the current brouhaha over bonuses at AIG, and other TARP recipients, has reached the level of a national hysteria. What should be an effort for some lower level functionaries, has been occupying front pages of newspapers, tying up valuable time of top government officials (including the president), as well as encouraging members of the congress to pontificate in circus-like hearings and propose retroactive tax legislation of dubious legality. In effect, our leaders are following, or being forced to follow, the angry crowds. But history also teaches us that such crowd-pleasing games, just like feeding a few Christians to lions, only obscure current problems and defer their resolution.

Ironically, those same historical facts described in your article could have been used to present a much broader set of recommendations. Rather than adding fuel to the fire (focusing on the lack of justification for retention bonuses), you could have called for a radical restructuring of the financial services industry and its compensation practices.

After all, even if we claw back the $165M (or even the $218M reported by Reuters today), the economy will still be in shambles and the mind set among the leaders of financial services establishments will not be much changed. On the other hand, if we can muster as much bi-partisanship into congressional work on budget, economy rescue plans, financial services regulations, etc. as we witnessed on the “bonus tax” proposal, we could be a step closer to the real solution.

I think there are two separate issues. On the first issue, I agree completely with Andrzej, and in large part with Bremmer and Nocera. I began my first post on this topic with these words: “$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.” I agree that the bonuses have an insignificant direct economic impact. I also agree that the furor that erupted over the bonuses has made it harder to solve our big problems. Not only have the president, his economic team, and Congress been distracted by Bonusgate, but the public backlash will make it much harder for the administration to get money from Congress when they do need it - not only as the economy deteriorates, but even when it comes time for things like health care and education.

At the same time, let’s not forget that Bonusgate has also had some positive effects. First, though small in itself, it strikingly illustrates a broader issue of tolerating business at usual in a failing financial sector. Scond, it has finally made the administration realize that there is a political cost to repeated generous bailouts of the financial sector.

The second issue is more complex. Bremmer and Nocera basically say, “calm down.” (Andrzej says something more subtle, which I will get to in a bit.) In Bremmer’s words, “if you are a subsistence worker, outrage is a luxury you cannot afford.” I’m not sure what this is supposed to mean. Outrage is an emotion, not a rational choice. Blaming outrage is like blaming greed: it’s an unavoidable part of the human condition. The question is whether we can do anything about it.

Bremmer, Nocera, and (to some extent) Andrzej blame our political leaders in Washington for indulging in populist bonus outrage instead of acting like responsible adults. But this raises an interesting question about the relationship between economic policy and democratic politics. I’m no expert on democracy, but I can make a couple of basic observations. We live under a democratic system. We want our elected officials to be sensitive to the concerns of their constituents. We don’t necessarily want them to do everything that a majority of people want - they are supposed, to some extent, to resist popular pressures and instead do what is in the public interest - but at the same time we get very upset when they seem to ignore popular opinion, or seem out of touch with popular opinion. When that happens, an administration can lose popular legitimacy, and without popular legitimacy, it will find it very difficult to get Congress to cooperate.

This is the risk the Obama administration now faces, as eloquently described by Frank Rich. Even if the administration officials believe that Bonusgate is a distracting sideshow - as they probably do - they cannot simply ignore, or belittle, the concerns of Main Street; if they do that, they lose whatever ability they have to solve our “real problems.” I think that the last administration was at fault for not dealing with the bonus issue back in September, and the new administration is at fault for not dealing it when it learned about it. But that’s water under the bridge, and Washington has to meet the public partway. And I think that is what Obama was trying to do.

This is not a country where technocrat-economists can design perfect policy solutions and implement them without regard for public opinion, nor would we want it to be. As I said in a recent post, I have made the mistake of thinking that an ideal solution could be imposed without taking proper consideration of the political difficulties involved. In the country we have, the ability of the government to implement the “right” policy solutions depends instead on its popular legitimacy, which means at a minimum feeling the public’s pain.

Now, Andrzej raised a slightly different issue: whether I (and, by extension, the many commentators who piled onto this issue) am at fault for helping to stoke bonus outrage. President Obama has to be sensitive to popular opinion; I don’t. In my case, Simon and I wrote an article trying to debunk one of the arguments for the AIG bonuses. We wrote it first because we believed what it said, and second because we thought its relevance went beyond AIG, since it dealt with the broader question of whether failed institutions can hold up reform by insisting that only they can fix the problems they created. So the question is whether we should have published it or not. (I agree with Andrzej that a better outcome of Bonusgate would be a systemic fix for flawed incentives in the financial industry. But publishing the article you most want to write, for reasons I won’t get into here, usually isn’t an option, unless you have your own column.)

Perhaps from a narrow utilitarian perspective one could argue that the article did more harm than good, because it contributed to the outrage that is making it harder for the administration to get real work done. From a broader perspective, however, one could argue that the value of the free exchange of ideas outweighs the short-term costs generated by the article. Of course, there is no way of quantifying and weighing these costs and benefits. And in any case they are probably relatively small either way; I don’t want to make the mistake of exaggerating my own importance.

In summary, I agree that Bonusgate has had some negative consequences (along with its positive ones), but I’m still comfortable with my small contribution to it. If we were much, much bigger, then perhaps I would pay closer attention to the potential consequences of what I write. But for now I’m willing to write pretty much anything I believe to be true.

Comments

[Mad Hedge Fund Trader]

No kidding. “Cash bonuses on Wall Street are going to become a dinosaur,” said Jon Corzine, governor of New Jersey, and former chairman of Goldman Sachs.

2009 Mar 23 06:09 PM

[market ace]

I think you badly underestimate the rage started by bonusgate. This is only the start. Remember the Boston Tea Party was one little act that changed the world and when the rage of the people reaches the proper level all hell will break loose in this country and hopefully change Washington forever.

Obviously the "its only a litte percentage" crowd misses the whole point that it is small like the tip of the iceberg, but will also expose the whole corrupt system below, that has married Wall Street and our incompetent gov't to screw main street and to take a position as our masters rather than as our servants and providers of financial services - The exact thing that our founding fathers and especially Jefferson warned about.

It is now exposing how congress - our representatives (LOL) constantly approve bailouts that the people are very much against and pampers and enriches failed financial institutions that pay them (aka campaign contributions) to act in their behalf against the will of the people. When all was going well no one cared, but people are waking up and caring deeply and congress and the President better wake up to that fact.

Those of us that have worked hard, paid our bills and tried to make a better life for our children and grand children are sick of this wasteful spending to save Wall Street from its reckless habits. We will not borrow money to live beyond our means and no American should be encouraged to do so again. Dicouraging savers, that are the true base of any real recovery, while again rewarding and encouraging reckles spending by example is a great shortcoming of this gov't.

Putting a Wall Strett insider in charge of the Treasury, especially one that is a liar and a cheat, instills no confidence in anyone and provides no creative thinking to solve economic problems. All Geithner is now doing is to use our hard earned tax dollars to entice and beg Wall Street to save us from Wall Street. I guess he was not content to just throw money at AIG without any controls so they could flaunt main street with insane bonuses. These are both ridiculous acts and will not work for the good of the country. This guy needs to go ASAP.

With the unconstitutional Fed directing our economy, like communist bosses, for their own personl gain, spending trillions of tax payer money with no say or oversight from congress, people besides Ron Paul are quickly figuring out that it is wrong and has to end. Bernanke getting so desperate to save his private bank owners that he is now creating money out of thin air like a banana republic dictator must be stopped.

Just as a small thing like Watergate exposed a corrupt whitehouse and brought down an admininistration hopefully bonusgate will bring down all of Washington and create a new era of prosperity for the US.

2009 Mar 23 10:33 PM

[John Lounsbury]

James - - -

You have given a thorough and balanced discussion. It is very logical.

The problem we have in the public arena today has more to do with emotion. You have discussed the emotional aspects, which you call "popular pressures" ("... they [the government] are supposed, to some extent, to resist popular pressures and instead do what is in the public interest - but at the same time we get very upset when they seem to ignore popular opinion, or seem out of touch with popular opinion."). These popular pressures are largely emotional. Most of our elections are decided on the basis of popular pressures, although sometimes 51% for one popular pressure defeats 49% of an opposing popular pressure. That is why (as you correctly point out) popular pressure may well decide how effectively this mess gets sorted out.

Main Street feels that they are composed of hard working folks who struggle to meet the costs of simple and moderate lives and live in dwellings of various functionality and comfort, but few live in extravagance.

Main Street views the bail-out beneficiaries as people who have made obscene amounts of money while , at the same time, destroying the vehicles they used to extract their personal wealth.

Using Bernanke's house fire metaphor, I feel that Main Street basically believes the fire in the Wall Street house should be extinguished before it spreads to the Main Street neighbors. What Main Street objects to is the (perceived) bailout of the residents of the Wall Street houses. Why should these wealthy individuals receive any "temporary relocation" support while their houses are being put in order? People on Main Street do not perceive that they are receiving any such support when their houses are threatened by the Wall Street fires.

Almost all of this Main Street/Wall Street discussion is emotional - not logical. Emotions fuel consuming needs. They must be addressed before logic can be heard.

That is why the arguments you quote from Andrzej Kuhl are so compelling to me:

1. <<<I am a strong believer in compensation plans being tied to performance. And not just a short term - one year - window, but a performance measured over a multi-year period. Ideally, compensation enhancements should have multiple parts, ranging from evaluation of the performance of an individual, to that of a larger unit within which the individual performs.>>>

2. <<<I also believe that all individuals are replaceable and should be moved aside if their performance has been sub-par (and bringing a company to the brink of bankruptcy is definitely below par).>>>

3. <<<...you (James) could have called for a radical restructuring of the financial services industry and its compensation practices.>>>

These issues (compensation plans and financial system restructuring, including eliminating the "too big to fail" structures that exist in our financial system) are logical items on the agenda of resolution of the crisis. However, they are also crucial to the emotional issues on Main Street. Deferring attention to these items until "higher priority" logical issues are addressed ignores the potential that emotions could undermine the entire process.

This is a very long discussion of your excellent article. I apologize for the length, but could not find a way to fully express my thoughts more succinctly.

2009 Mar 24 01:24 PM