On the topic of the AIG bonuses, I understand and sympathize with the outrage but am very much on the side of respecting the sanctity of contracts and our system's (rather flimsily remaining, it seems at present) rules against bills of attainder(fn1) and the like. These are the kinds of things that our very civilization depends on and should not be trifled with no matter how vehement the popular outrage.
That said, the whole episode throws into stark relief an interesting problem with the way high-finance's compensation system is currently set up.
This piece in the NY Times presents the best (and, perhaps, only possible) defense of paying out the bonuses. In addition to sharing my respect for contracts, he points out that the problems these people are unwinding are tremendously complicated and since these folk built them, they know the details better than anyone and are in the best position to fix them. So you want to keep them around and thus will pay to do so.
Also, there is the possibility of other companies poaching these folk away precisely because of their familiarity with AIG's positions. Yes, they constructed the financial bomb that almost destroyed the financial world, but now there is good money to be made if you know which companies are counterparties to the mess. Basically, you could bet against the folk exposed to the bomb you built.
Can we see the problem here? If you are one of these geniuses of finance, every incentive you have is to make big, risky potential bombs. The bigger, the better. The riskier, the better. If everything goes well and it pays off, you become unfathomably rich. If everything goes wrong, then so long as it's big enough and complicated enough, you'll be paid handsomely to try to defuse it, because you were the one who built it. And if anyone should refuse to pay you to try to save them from the disaster you created, you can go and make a killing betting on it's blowing up.
Financial innovation can be a wonderful thing but so long as the entire system of rewards is set up so that those with the most skill and knowledge of complex finance can best maximize their earnings by creating massive potential financial catastrophes, we are going to continue to have massive financial catastrophes.(fn2)
I'm not sure what the solution is. Perhaps going back to something more like the old-school partner model might be beneficial, as then the folk responsible are not just playing with other people's money, but with their own and with their own name.
fn1: It occurs to me that folk might not be familiar with the term "bill of attainder". A bill of attainder is when you pass a law that directly targets an individual. Traditionally, they were used to punish or sentence to death without a trial. They are expressly forbidden in the US Constitution. My recollection is that they were only very rarely used even by the time of our split from England but still our founders felt it an important enough point to include in the constitution. Though with a "living constitution", perhaps our understanding of their prohibition has grown to include allowing them when we really, really want to get somebody without all the usual legal rigmarole.
fn2: Note that we will certainly have massive financial catastrophes either way, but without the poor incentive structure we will hopefully have fewer and, at the very least, can take consolation in that we weren't basically paying people to create them on purpose.
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7 comments:
I don't know what the law says, but I don't think the "sanctity of contract" argument holds much water from a moral point of view, certainly not as the "basis of our society." If AIG had gone bankrupt, those contracts could be broken. And AIG is essentially bankrupt, but for a special action by the government. Althogh the government has decided to pay off many of AIG's contracts for the good of society, I don't think it necessarily follows they must pay all of them. Why should Congress have less discretion than a bankruptcy judge? Again I am not a lawyer, so I don't know if that argument would stand up in court, but I certainly don't think the government has any societal obligation to pay. It is also an outrage to our societal values to see wealthy people ruthlessly game a system they have long been claiming has rewarded them for their merit. I think its a bigger outrage.
Perhaps I'll try to spell out why the sanctity of contracts is so important to our civilization in another post sometime.
For now, let me just say that if the government had wanted to put features such as you hint at (limiting of pay, even where pre-existing contracts exist) into the bailout bills, that would not have triggered the problems they have now vis-a-vis ex-post-facto bill-of-attainder type stuff. It may or may not have been a good idea from a policy stand-point, but it would not have constituted a civilization-imperiling mistake such as we are seeing now.
But in fact, rather than think through their actions and put in whatever restrictions seemed reasonable, they explicitly included language to allow contracts such as these and are now going to try and punish the people who obeyed the laws that this very congress wrote and passed not 2 months ago.
This is the problem and, contrary to your opinion, it is immoral for Congress to go about retroactively grabbing at things they suddenly decide are unfair.
Today's WSJ Editorial on the matter lays out some of the problems far better than I can:
http://online.wsj.com/article/SB123776465612908965.html
Per your point about Congress having as much power as a bankruptcy judge, again they should have made these decisions a part of the agreement. It is changing the agreement after the fact to target a small group that has angered them that is inimical to the stable functioning of our civilization.
Aside from the fact that bankruptcy proceedings have centuries of precedent and tradition that heavily lean towards removing punitive and political measures from their proceedings, the proper comparison to what Congress is doing here would be if a bankruptcy judge completed a bankruptcy and then a couple of weeks later decided that he didn't like the way it turned out so he re-opened it and started making changes to who got what.
The actions of the judge in such a case may or may not seem fair given the specifics of the situation, but the very act of revoking existing agreements merely because you have the power and you feel entitled to would pretty much destroy the value of the institution of bankruptcy. Once it became clear that bankruptcy proceedings could be re-ordered on a whim to suit the political needs of the judge or those close to him, no one would ever trust them again. Everyone would just keep lobbying the judge and the orderly wind-downs that are the hallmark of our stable bankruptcy system would be a thing of the past.
I would submit that no matter how grievously unfair the wrong the bankruptcy judge felt he was rectifying with his action was, the damage he would have dealt to the system would far outweigh it.
Bailouts of AIG and other financial institutions were emergency measures taken under great pressure to prevent their failures from endangering the economy at large. I think if the government needs a little leeway to adjust the terms, it is entitled to it.
If AIG didn't want to tangle in politics, they shouldn't have taken bets that risked prompting a government intervention. To do that and then stand by and insist like some self-absorbed first year law student on the sanctity of private contracts is a little bit rich.
But your main problem is that you keep insisting its a "political" problem. That no one at AIG actually did anything wrong other than maybe fluster some Congressmen -- But No. They actually almost caused the collapse of the economy and might still. That's a serious problem, which you don't seem to take very seriously.
You talk as if Congress abrogating some tiny contract is greatest threat this nation faces. It is not. That is the mess the financial services industry has made of the economy. So why are you so upset about Congress?
Why don't you turn some of your pseudo-legalese against the people who put us in the situation we currently find ourselves? There is plenty of wrongdoing and hypocrisy on Wall Street, look at how little power shareholders have to cast votes in corporate elections, or the fact that dozens of CEOs have been shown to game their contracts to pick attractive stock option dates after the fact, or all the lobbying dollars that were spent insisting that credit default swaps did not need to be regulated.
Where was your doctrinaire outrage then? Why are so upset about very slight injustices visited on the very rich and totally complacent about much more severe injustices visited on so many others?
Believe me, the people on Wall Street are not more scrupulous about following the letter of the law than Congress or anyone else. The fact that you are so upset about their rights being trampled says much more about you than it does about the civilization or the law or anything else.
Your comment is an almost perfect encapsulation of populist rage.
To summarize your argument with, perhaps, some of the ad hominem asides removed: these people have precipitated a crisis so anything we do to them is justified, besides that, this is an emergency, we can't be waylaid by niceties like the rule of law, we need to react! And anyways, the evil people who caused all this had no regard for laws so why should we?
Yes, by all means, let's throw out the underpinnings of civilized government in order to punish those we feel have wronged us or solve our immediate crisis. There's no way that'll ever bite us in the ass.
At any rate. I hope you can calm down enough at some point to think more clearly about the larger repercussions of the actions you are demanding from your elected leaders.
Thanks for reading!
http://online.wsj.com/article/SB123845605025971539.html
This is an interesting article. It's not relevant to AIG. But it makes the point that the bankruptcy of a major company takes about 9 months to sort out in the best of circumstances. AIG, which was mind-numbingly complex, could presumably take much longer.
But in deciding to bail out AIG the government didn't have nearly they much time, having to act before AIG collapsed.
So how can they be reasonably expected to have reviewed and approved all of AIG's contracts in such a short time?
The question is one of emphasis.
The government is already intervening in the private economy in ways it shouldn't have to, bailing out AIG, giving billions in loans to private institutions and effectively guaranteeing their debt. These moves – necessary or not -- are a much bigger perversion of our system than a law to limit compensation.
Signaling to the market that institutions like AIG, Citigroup or Goldman Sachs are "too big to fail" creates a moral hazard, allowing big banks to grow still more bloated and, more importantly, encouraging them to make still more bad bets. The precedent set by underwriting these firms already poses far more serious long-term risks to the economy and to our society than any precedent set by limiting last year’s compensation contracts at AIG possibly could.
So why does one strike you as a radical and dangerous move but not the other?
Your problem is that too often you take your cues from people in power who you think “understand” something their societal inferiors don’t. What Vikram Pandit and Edward Liddy really understand is their own self interest.
To take another example, just weeks ago these two, among others, were howling that limiting future compensation at Wall Street firms would ruin our economy by prompting executive departures. Those departures have started to happen, and some experts are saying – oh – on second thought, it could be a good thing.
(See “Crisis Altering Wall St. As Stars Begin to Scatter” – NYT)
Maybe, maybe not. But I am not convinced either way just because someone older in a suit told me so.
Like any number of privileged-at-birth young men who see themselves as conservative you seem to want desperately for people to think you are smart, but at the same time are afraid to take chances by challenging authority. The only thing you’ve proved you “understand” is how to parrot received wisdom.
As for whether it’s fair to make ad hominem attacks – what else is anonymously written blog for?
One more thing:
WSJ: Financial Firms Lobby to Cut Cost of TARP Exit
Here's a story that details how banks are lobbying the government to let them skip out of some of their contractual agreements regarding TARP. Seems like in the eyes of the financial services industry, some contracts are holier than others.
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