Wall Street's Dangerous Refusal to Learn

By Steven Pearlstein
Wednesday, March 18, 2009

You have to wonder what else has to go wrong, how much more wealth will need to be destroyed, before the people on Wall Street get the message that it's no longer business as usual.

The latest outrage, of course, is over the $400 million in retention bonuses promised to those financial geniuses at AIG's Financial Products unit last year, months before the insurance giant was essentially taken over by the government in a bailout that already has required an injection of $170 billion in taxpayer money.

The legal argument for honoring these ill-considered contracts is that a deal is a deal and that trying to abrogate them will only wind up costing the government even more in legal fees and punitive damages. But that doesn't mean the government and its handpicked new management team at AIG were powerless to renegotiate those contracts long before last weekend's deadline.

After all, if the government hadn't stepped in, AIG would have gone bankrupt and those whiz-bang traders could have lined up with all the other unsecured creditors at the bankruptcy court to see how much money they might receive three or four years down the road. And the government could still put the company into bankruptcy anytime it chooses.

Moreover, the Justice Department would surely have been within its rights to launch an extensive civil and criminal investigation into whether those bonuses were granted as part of an ongoing conspiracy to defraud shareholders -- a conspiracy in which the traders were knowing participants. As part of that investigation, prosecutors could have also prepared a public report to the Treasury, the Federal Reserve and Congress listing the names and home addresses of all the traders who were slated to receive the bonuses, along with a detailed description of their role in creating the mess that brought down the company. There could even be a chart listing their salaries, bonuses and other perks over the past decade.

Call me a cockeyed optimist, but I suspect that when confronted with the prospect of a bankruptcy and a prolonged and public investigation, the sharpies in London and Connecticut might have been receptive to the idea of renegotiating those bonuses in favor of new contracts -- contracts that increased their base pay but tied their bonuses to success in reducing future taxpayer liabilities at AIG.

Unfortunately, none of this seems to have occurred to Eddie "Good Hands" Liddy, the former Allstate executive who was supposedly brought in to dismantle AIG and sell it off in pieces for the benefit of the taxpayers and creditors. So far, all Eddie seems to have served up is a litany of complaints about what a bad hand he was dealt.

A tougher and more creative executive, I suspect, could have found a way to quickly sell off the healthy insurance businesses and the valuable AIG franchise, even if it meant persuading the government to finance the deals or offer some risk-sharing arrangements.

A more hard-knuckled executive would have gone to the counterparties of those derivatives contracts and suggested that it would be a real shame if AIG were forced to file for bankruptcy, and offered some sort of workout.

If nothing else, he certainly could have been more upfront with his new owners -- the taxpayers -- about not only the bonuses but also the identity of the counterparties to those derivative contracts, who were the indirect beneficiaries of the government's bailout.

Instead, Eddie has not only left us wondering whose side he's really on, but also, because of the bonus backlash, he has managed to put the entire financial rescue effort in political jeopardy. That's harsh criticism, I realize, especially for a respected business executive who volunteered to leave a comfortable retirement to take a $1-a-year job at the request of his government. But at some point you have to ask whether we've hired Gary Cooper for a role better suited to Clint Eastwood.

Liddy is hardly the only one on Wall Street who can't quite grasp the idea that extraordinary times require a different way of doing things.

One of the reasons AIG gave for offering retention bonuses in the first place was that the employees who had negotiated the infamous derivatives contracts are the best people to help the company unwind those positions at the lowest cost. Indeed, over the weekend, it was reported that some of the employees were being recruited by other banks and hedge funds, which hope to use the inside information to inform their own trading strategies.

This is, of course, a time-honored tradition on Wall Street, whereby uncovering the trading strategies of counterparties can reap huge profits. But it surely speaks volumes that other Wall Street players still think it not just their right but their duty to their investors to try to take advantage of AIG's weakness, even if it is the taxpayers who will suffer.

Then there is Richard "Is This America?" Kovacevich, the chairman of Wells Fargo. Late last week, Kovacevich gave a talk at Stanford University, complaining about how unfair it is that the government forced his bank to take $25 billion in bailout money last year when it could have easily raised private capital -- and then compounded that outrage by changing the terms of the deal and forcing Wells to cut its dividend. Kovacevich said it was "asinine" for the Treasury to order his and other big banks to undergo a special "stress test," explaining that well-run banks like Wells were routinely doing their own stress tests.

Kovacevich apparently believes that because his bank is still relatively healthy, he and his shareholders shouldn't have to assume the same costs and burdens as banks that aren't, particularly when those costs and burdens are imposed by incompetent government officials. That's the way it works in America.

Except, of course, when it doesn't. The reality is that, if the government had not stepped in to take over Fannie, Freddie and AIG; had not recapitalized Citigroup and Bank of America; had not provided the guarantees to allow for the orderly sale of Merrill Lynch and Bear Stearns; had not become the buyer of last resort for commercial paper and home mortgages, then the entire financial system would have melted down by now and taken Well Fargo and its arrogant chairman with it. Rather than bellyaching about how un-American it all is, Kovacevich ought to be thanking the government and asking what more he could do to help.

Like it or not, we're all in this together now. It's cooperation and compromise, not the usual every-man-for-himself competition, that is going to get us out of this mess. And the sooner people on Wall Street embrace that reality, the better it will be for everyone.

Steven Pearlstein is moderator of a new Web site, On Leadership, at http://washingtonpost.com. He can be reached at pearlsteins@washpost.com.

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