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Mar 18 2009

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AIG – Torches & Pitchforks

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Amid the evaporation of life savings in the stock market, tight credit, business failures and rising unemployment, the temper of the American public is on a hair trigger.  And nothing gets the populist juices of the public more fired up than corporate types who get millions while the companies they managed run into the ditch.

And that very American sense of outrage reaches gargantuan proportions when citizens consider AIG and the announcement that some executives will be paid $165 million in pre-approved bonuses. The very idea is antithetical to the American sense of fair play, particularly in these trying times.

And after all, we own it, me and you; at least 80% of it anyway.  Is there nothing the US government can do? The President can order up $1.1 trillion in government spending in 50 days but can’t stop bonus payments for a corporation that played a singular role in triggering the recession?

There answer appears to be no.

But those frothing with populist fury should take a step back anyway.

No one wants to reward corporate bad behavior, and certainly those who have committed offenses should be prosecuted to the fullest extent of the law.

But as a nation, we need to set aside our justifiable emotional outrage over people making fortunes while presiding over disaster, from a more basic and central requirement that as a society we will enforce legitimate contracts. On that basis, there are solid reasons to proceed with the AIG payments, as distasteful as they may seem at first blush.

In the case of AIG, public fury is actually directed at compensation agreements that were signed and sealed eight months before the financial crisis began. And critically, these were not “performance” based bonuses; based on results – as we commonly understand bonuses, but rather “retention” bonuses, meant to keep skilled and talented workers onboard through agreement on future payments.

That point is critical.

AIG management at the time envisioned this $165 million as a vehicle to keep the most capable people with unique knowledge of the company on-board .  The risk that AIG took in crafting those agreements in January is the same as any of us take as we look to the future and consider our needs; when it’s the price of a dish washer, a car or a house? Will prices increase or decrease?  Where will the market be and when will be the right time.

AIG bet on a competitive market where they would need to depend on skilled and talented professionals to manage their global portfolio. The irony is that although events did not work out the way AIG management may have envisioned, as taxpayers and therefore owners of AIG, we could not need these people more right now.

When the subprime crisis blew open, the complex network of derivatives trading and credit default swaps that linked AIG and global institutions, fell apart. Amid the global collapse, it is now only these AIG personnel in the Financial Products Group, beneficiaries of the retention bonuses, who can untangle the transactions that are effectively Sanskrit to outsiders. If AIG loses those people with first-hand knowledge, there can be staggering real-world repercussions. Some estimate losses at $1.5 trillion or more.  Really, no one knows.

But $165 million seems like a reasonable price to pay to avoid a $1.5 trillion bill later. So there is ample  reason to keep these people on the job.

But the contract sanctity issue raised by AIG here is more fundamental. In the midst of economic hardship, contract sanctity is under siege on all fronts with government intervention intruding to denude it of its value.

Andrew Cuomo, Attorney General of NY (and aspiring gubernatorial candidate) wants to subpoena all the AIG bonus payments and publish them?

On what basis does he do that? And to what end?  To somehow show that these people are greedy because they expect what they were promised? Will they build stockades for public shunning at 30 Rock?

As much as you may individually take issue with AIG, would you want your name and bonus in the New York Times? What makes you think that this type of behavior, once sanctioned, will be limited to AIG or failed businesses? This kind of populist executive fiat has the potential for very damaging longer-term consequences.

Executive compensation has been an issue for decades.  Worth vs. performance.

The debate won’t be settled here, but it is clear that demonizing compensation will only complicate the efforts of our most promising companies to attract the best and contribute constructively to economic growth. And how seditious it really is for the government to intrude and create uncertainty if contracts cannot be executed based on arbitrary and capricious  dictate on what constitutes “enough.”

If you want to work where compensation is capped despite your ability,  go work for the government.

And what about the mortgage industry?

A mortgage is a contract. Yet Democrats in the Congress want to give judges the ability to arbitrarily reduce principle and interest and forgive debt, to keep people in their houses.

On what basis economic basis does a judge do that?

Yes, the foreclosure crisis is an element in our economic downturn, but who is to say who is a legitimate mortgage payer fallen on hard times versus someone who bought with no intention to pay? What of the underlying financial institution that has to grapple not only with dire payment performance issues, but the potential intervention of the government to nullify contract law to achieve a desired social end?

A very wise lawyer once told me that a contract, reduced to its most basic, was simply a set of expectations.  But the power we invest in the concept of contract sanctity is central to our economy, indeed to our social contract with the government.

If you start making exceptions based on arbitrary criteria, or worse, invest the government with the authority to unilaterally intervene and rewrite contracts,  you risk fraying our understanding of social order.

The psychology of recession is the absence of confidence.

The foundation of economic recovery will be written in the contracts for goods, for services, for employment and for homes. If we are no longer certain that those commitments are real and binding, we undermine the economy as a hole.

 

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