Grin and Bear the Bonuses

By Ruth Marcus
Wednesday, March 18, 2009

Could we put down the pitchforks for just a moment and have a reasonable discussion about the bonuses at American International Group?

No, I didn't think so. Here goes anyway.

I get the outrage. It's galling to pay $165 million to a bunch of wealthy traders to clean up a mess that they, or at least their company, made.

I get the political fix in which President Obama finds himself. The sums are staggering -- if not to Wall Street, then to everyone else who's ever worked for a living. The public is worked up, increasingly convinced that its money is being flung around recklessly, to a gang of extortionists at AIG and at European banks, without any hint that the fundamental problem is being fixed.

As a result, the administration's already dim prospects for obtaining another boatload of money for the bank bailout have gotten even dimmer. This presents a huge problem because of the likelihood that another enormous sum will be needed. The president's budget envisions $750 billion, and even that may not be enough.

So 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.

In the longer term, having the government void existing contracts, directly or indirectly, as with the suggestions of a punitive tax on such bonuses, will make enterprises less likely to enter into arrangements with the government -- even when that is in the national interest. This is similarly counterproductive.

Remember, the contracts were negotiated long before the government put a cent into AIG. "The plan was implemented because there was a significant risk of departures among employees at [the company]," AIG wrote in a paper explaining the plan, "and given the $2.7 trillion of derivative positions at [the company] at that time, retention incentives appeared to be in the best interest of all of AIG's stakeholders."

And federal legislation explicitly states that compensation limits for companies receiving bailout funds do not apply to preexisting contracts. Not to mention that the existence of the retention bonuses has been known for more than a year.

"That was then and this is now" is not a valid legal principle. "We are a country of law," Obama economic adviser Lawrence Summers said Sunday. "There are contracts. The government cannot just abrogate contracts." He was right.

But, you ask, what about autoworkers who are being squeezed to renegotiate their contracts? Those renegotiations mostly involve the future terms of employment, though, it is true, they also could affect retiree health benefits. If an autoworker doesn't want to show up on the assembly line under the terms of a new deal, he or she doesn't have to. That's different from telling AIG employees they're not getting the amount on which they agreed for work they've already performed.

So what about cram-down proposals to allow bankruptcy judges to change the terms of mortgages? This is more analogous, but bankruptcy is a legal mechanism designed precisely for the abrogation of contracts. It is intellectually consistent to support expanding the power of bankruptcy courts to rewrite mortgages on primary homes -- as they can with vacation property -- but balk at reneging on the AIG contracts.

The administration argues that anger over the bonuses, among the public and members of Congress, was at such a level that the president needed to say something to show that he understood the fury. Perhaps, but there is a countervailing risk in stoking this populist rage -- especially if the administration needs to come back to Congress for more money for the banks.

Once the pitchforks are out, it's awfully hard to convince the mob to put them down.

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