The right eloquence needs no bell to call the people together and no constable to keep them. ~ Emerson

Wednesday, March 18, 2009


I posted on Monday that while populist outrage over incidents like bailout recipient AIG paying $165 million in executive bonuses was understandable, it did little productive in dealing with the hard choices imposed by our current financial crisis.

New York Times columnist Thomas Friedman stuck a similar note yesterday. “It is dangerous for so many reasons but most of all because this real anger about AIG could overwhelm the still really difficult but critically important things we must do in the next few weeks to defuse this financial crisis.”

The Obama Administration has a bailout plan that “makes sense and, if done right, it might even make profits for U.S. taxpayers,” adds Friedman. “But in this climate of anger, it will take every bit of political capital in Obama’s piggy bank . . . to sell it to Congress and the public.”

More to the point, public sentiment may endanger Obama’s attempts to sell his plan to investors. The Washington Post reports this morning that Federal Reserve and Treasury Department officials are worried all the anger out there could discourage investors from joining government efforts to revive lending as well as a separate plan that relies on private money to buy toxic assets from banks.

“Am I afraid of the populist outrage? Yes,” said Lynn Tilton, CEO of Patriarch Capital, one such private-equity firm that has weighed making an investment.

AIG is not alone in earning wrath for paying bonuses. Government officials previously excoriated bailout recipient Morgan Stanley for the practice as well as Merrill Lynch, which paid bonuses to its executives while its sale to bailout recipient Bank of America Corp was pending. Even so, AIG is particularly subject to public ire as a series of revelations have proven it far weaker than anyone previously feared.

Rather than seeking to cool populist fury, Congress increasingly resembles a lynch mob itself. Several pending bills vow to tax the AIG bonuses out of existence if not revoked by the Obama Administration or voluntarily surrendered by AIG executives. Republican Senator Chuck Grassley of Iowa went so far as to suggest AIG management ought to be noble Romans and kill themselves, which is pretty strong stuff, even when just speaking rhetorically.

The hubbub was sufficient for AIG Chairman and CEO Edward Liddy to pen an editorial in today’s Washington Post defending himself and his company.

Of our own initiative, we suspended our federal lobbying activities and halted corporate political contributions. We also restricted executive compensation. In all, total 2008 compensation for the top forty-seven executives is fifty-six percent lower than their total 2007 compensation. My annual salary is $1.

To prevent undue risk exposure in the meantime, AIG has made a set of retention payments to employees [in the Financial Products unit] based on a compensation system that prior management put in place.

Taxpayers should also know that AIG has a plan to return money to the government and we are making progress.

Washington Post
columnist Ruth Marcus was eager to buy into these arguments. “Hammering the AIG employees to give back their bonuses risks costing the government more than honoring the contracts would . . . 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.”

Her colleague Harold Meyerson was quick to disagree, ruing, “[Treasury Secretary] Geithner's indulgence of bankers' indulgences is fast becoming the Obama Administration's Achilles' heel.”

Some in Congress, sensing a weakest link quality in Geithner, charge that he should have prevented the bonuses before their payment and suggest he ought to resign for failing to do so.

As it turns out, Geithner was more than aware of the pending bonuses and urged CEO Liddy to renegotiate the contracts requiring them. He backed off when AIG lawyers insisted the contracts existed prior to the bailouts, leaving the company and government open to lawsuits by disgruntled executives if revoked retroactively.

“He recognized that you can't just abrogate contracts willy-nilly,” Council of Economic Advisors chief Lawrence Summers told the Associated Press in an interview Tuesday.

The President continues to stand by Geithner but also ordered the Treasury Department to “pursue every single legal avenue” to recover the AIG bonus payments.

If the Obama Administration hopes to maintain the trust necessary to carry out its plans – and likely appropriate billions more from Congress in order to do so – then it must stifle the mob’s outcry for draconian vengeance by taking reasonable but forceful actions of its own. Bailouts will never be popular but restoration of public faith outweighs any potential damages from punishing AIG.

Lawrence Cunningham, a Professor at George Washington University Law School, writing yesterday in the New York Times, wisely notes, “Moral outrage and public rebuke do not provide legal grounds for backing out of a contract.” Yet he also notes that AIG attorneys “must do more than say nonpayment would expose AIG to damages or penalties. Nor is it enough to invoke the sanctity of contracts.”

The most obvious way to stop bonus payments under the contracts would be any finding of fraud against the employees involved or if AIG terminated or is likely to terminate any of its employees for cause. But Cunningham also sees “at least some chance, given AIG’s functional insolvency and the government takeover, that these agreements may be rescinded either on the basis of impracticability or by virtue of unforeseeable and uncontrollable circumstances.”

In other words, the bailouts are such large and extraordinary responses by government to such a large and extraordinary crisis that they cancel out preexisting contractual arrangements made in earlier, more ordinary times. There is existing precedent within the bailout itself for such reasoning.

Bankruptcy judges now have the power to force lenders to accept less on defaulted mortgages if the renegotiated principals allow overextended borrowers to keep their homes. The UAW was told it must concede several important previously won contractual concessions as part of securing bailout money for the auto industry.

Ruth Marcus had ready counterarguments to both of these examples. “[Auto] renegotiations mostly involve the future terms of employment . . . That's different from telling AIG employees they're not getting the amount on which they agreed for work they've already performed.”

However, both AIG specifically and the financial services industry in general have repeatedly argued the bonus payments are less rewards for previous (bad) services and more a retention program to ensure management is not lost for future (hopefully better) services. Judged from this standard, the Wall Street/Detroit analogy is very comparable and the stated purpose of the bonuses is a bust.

New York State Attorney General Andrew Cuomo charged after investigations that of the seventy-three AIG executives receiving $1 million plus bonuses, at least eleven have already left the company.

A former AIG senior executive told the Washington Post that the Financial Products unit was a shrinking division no longer seeking new business. “The guys who are getting paid all the big money are not really the ones who are important to the company,” he said. Even CEO Liddy admits that if he had been in charge at the time, “I would never have approved the retention contracts that were put in place more than a year ago.”

In the case of renegotiated mortgages, Marcus argues, “Bankruptcy is a legal mechanism designed precisely for the abrogation of contracts” that is not readily extendable to the AIG situation. She has a point here. A well-established process, which parallels bankruptcy, exists for liquidating troubled banks through the Federal Deposit Insurance Corporation. No such process exists for dealing with the collapse of other kinds of financial institution, such as AIG.

While Marcus is correct “It is intellectually consistent to support expanding the power of bankruptcy courts to rewrite mortgages,” it is important to remember that government would never have permitted the expansion of these powers without the current crisis. That which justified expansion of powers in one area may well justify them in others.

The public’s desire for retribution and punishment, no matter how keen, should not override the Rule of Law. At the same time, the best way to ensure minimum populist rebellion is for the public to see the Rule of Law as a straightforward path to justice as opposed to a series of loopholes to circumvent it. This will never happen if government permits the AIG bonuses to stand.

Rather like the French Revolution as imagined by Charles Dickens, taxpayers seem more callously villainous than sympathetically wronged when they sit without pity, like Madame Defarge over her knitting, counting aristocratic executive heads as they role.

Still, it is easy to understand their frustration when the guilty not only avoid punishment, due to the exigencies of the crisis, but receive rewards for their malfeasance as well. In this version of the story, not only does noble Charles Darnay escape prison and return to his beloved Lucie but his uncle, the wicked Marquis St. Evrémonde, receives bailout money to repair his damaged coach.

The restraint counseled by Geithner toward Wall Street has its logic. The more difficult the times, the more wiggle room firms may need to escape them. Kicking a person while they are down is more likely to keep them down than incent them to rise.

In this case, it seems a swift kick may be necessary to remind those down that they got in this position by their own actions. Furthermore, government is not imposing this bailout upon them; Wall Street came begging for the money of their own volition. The power of free markets to fix all ills went the way of the dodo last fall.

Taxpayers will doubtless have to fund these bailouts through future tax increases or, at an absolute minimum, far fewer tax cuts than that for which Republicans are constantly calling. Even so, our children and we will face red ink in the federal government’s ledger for many more decades to come. This is our sacrifice to ensure the global economy’s continued stability.

Foregoing promised bonuses is the sacrifice for executives at AIG and other bailout corporations. The Obama Administration should enforce such sacrifices when not made voluntarily.

Government must not allow its sovereignty pushed aside by an angry mob but it must do something constructive to address the mob’s collective howl of pain and outrage.

1 comment:

Thomas Paine said...

The big concern is not really with the amount of the bail-out money that goes to these bonuses -- it is a lot of money but relatively insignificant in the big picture -- but the real issue is that the anger over this seriously undermines any support for the future bail-outs that likely will be needed.