Why AIG Matters

by dday

I didn't think it was necessary to spell out why $165 million dollars in bonuses for individuals who tore down their companies is probably a bad thing. But there does appear to be a mild backlash against the over-the-top nature of the public anger, including from White House officials. And given that the numbers are a fraction of one percent compared to the bailout money AIG took from the government (that will never get paid back) or the Fed's huge program to buy up mortgage-backed securities, they may have a point. So, OK.

Obviously there's a political importance because the nation is following the issue so closely. But far more essential than that is how this is tied to income inequality and the stratifying gap between the rich and poor. Kevin Drum is absolutely correct to note that the standard practice in corporate boardrooms is to call bonuses a reward for performance right up until the moment that the performance tanks, at which point they become necessary for retaining talent.

Of course they got their comp locked down when they saw the storm ahead of them. This is what executives always do. Back during the dotcom bubble, corporations handed out trainloads of cheap stock options even though the practice was heavily criticized. Why? Because the stock market was going up and it was a nearly guaranteed way to make lots of money. After the bust, they suddenly took the criticisms to heart and largely stopped the practice. Why? Because the stock market was going down and it wasn't easy money anymore [...]

What happened at AIGFP is standard practice throughout corporate America. America's corporate titans like to talk endlessly about performance-based pay and how capitalism rewards risk, but in real life compensation packages are almost always constructed to avoid as much risk as possible. If you work in a growing industry, your bonus depends on raw growth rates. If you work in a declining industry, your bonus is linked to relative growth rates. If the market is up, your bonus is paid in stock. If it's not, suddenly deferred comp and increased pension contributions are the order of the day. Heads you win, tails you win.

The AIG traders who got this sweetheart deal are nothing special. Management probably didn't even think twice about it. Of course you switch from performance bonuses to retention bonuses when the market looks stormy. What else would you do?

The decoupling of risk and profit is the issue here. Corporate titans never rise and fall on the merit of their superior intellect, and there has been a great shift to mke sure profits, both personal and corporate, are kept in private hands, while the risk is socialized. When times are flush nobody really cares about or at least pays attention to this; when the same people who wrecked the economy feel entitled to their ungodly profits, people get understandably upset.

And the tone-deafness on this from the Administration, therefore, while striking, does not surprise. The Treasury Secretary is now admitting that he asked Chris Dodd to take out the executive pay caps from the stimulus. His rationale? "We wanted to make sure it was strong enough to survive legal challenge." Actually, they wanted to make sure Wall Street didn't pull the pin out of the grenade.

If they did walk out the door, who would volunteer to work at the Chernobyl of the financial world? And what would become of the mammoth portfolio that remains?

"It would become the biggest naked position on Wall Street," one longtime Financial Products executive said, "and everybody would exploit it." [...]

"Nobody is going to give (the bonus money) back and then stay," said one of the firm's employees. "If they give back the money, then they will walk. And they will walk into the arms of AIG's counterparties."

The sense of entitlement to a system that rewards them regardless and shovels massive amounts of money and power in their direction. Heck, we learned today that 13 bailed-out companies owe $220 million in back taxes and lied to Congress about it. OF COURSE they did. That's the system they've created - protections for their corporate bottom line, riches for them personally, crumbs for everyone else. Reaganomics basically set this in motion 30 years ago, and the system has been in place for so long that any alternative path is like the true forms on the outside of the cave instead of the shadows on the inside we think represent reality. But the public knows intuitively that they've been getting a raw deal for decades, and the bonuses are only a small part of the story.

James Galbraith has an amazing piece about the limitations of the Obama economic team to reinvent a new economic ideal, rewarding work instead of wealth, returning the business of finance to its narrow role of facilitating capital flows, etc.

The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. (Federal Reserve Chairman Ben Bernanke said it reflexively in a major speech in London in January: "The global economy will recover." He did not say how he knew.) [...]

Geithner’s banking plan would prolong the state of denial. It involves government guarantees of the bad assets, keeping current management in place and attempting to attract new private capital. (Conversion of preferred shares to equity, which may happen with Citigroup, conveys no powers that the government, as regulator, does not already have.) The idea is that one can fix the banks from the top down, by reestablishing markets for their bad securities. If the idea seems familiar, it is: Henry Paulson also pressed for this, to the point of winning congressional approval. But then he abandoned the idea. Why? He learned it could not work [...]

The government must take control of insolvent banks, however large, and get on with the business of reorganizing, re-regulating, decapitating, and recapitalizing them. Depositors should be insured fully to prevent runs, and private risk capital (common and preferred equity and subordinated debt) should take the first loss. Effective compensation limits should be enforced—it is a good thing that they will encourage those at the top to retire. As Senator Christopher Dodd of Connecticut correctly stated in the brouhaha following the discovery that Senate Democrats had put tough limits into the recovery bill, there are many competent replacements for those who leave.

Ultimately the big banks can be resold as smaller private institutions, run on a scale that permits prudent credit assessment and risk management by people close enough to their client communities to foster an effective revival, among other things, of household credit and of independent small business—another lost hallmark of the 1950s. No one should imagine that the swaggering, bank-driven world of high finance and credit bubbles should be made to reappear. Big banks should be run largely by men and women with the long-term perspective, outlook, and temperament of middle managers, and not by the transient, self-regarding plutocrats who run them now [...]

This cannot be made to happen over just three years, as we did in 1942–44. But we could manage it over, say, twenty years or a bit longer. What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers—and no alternative to taking the long view.

The AIG scandal represents a reminder of the way things WERE, when Masters of the Universe ruled the world and dared anyone to challenge them. There are raw economic benefits to getting executive compensation under control - the economic burst that would come from a steep reduction in the inequality gap, with a concurrent stronger middle class, reindustrialization, and the rise of labor unions. But there are even bigger implications. It means wresting control over our country away from the ones who ruined it, who are trying to threaten, cajole and intimidate their way into maintaining control. For two years a campaign captivated America with the promise that the people have power, that mass collective action can create change. But we don't. And the bonus babies have proved it. Now there's a choice, that policymakers will eventually have to make but which can be pressured from the bottom.

Who runs this country?