Terence Corcoran: AIG bonuses should be paid

This argument is so ridiculous that I almost thought it was satire. Here is the original. What follows is quoted in its entirety, with my systematic deconstruction of the various flawed arguments in-lined.

To use a current cliché, frequently deployed to humiliate bankers and CEOs: He doesn’t get it. Barack Obama, that is. He just doesn’t get it, and nor do millions of others who are following the U.S. President on his long destructive march against bankers and corporate executives for their alleged “recklessness and greed.” (I love when they use "alleged")

Those were the words Mr. Obama used Monday when he instructed his treasury secretary, Timothy Geithner, to “pursue every legal avenue” to block the payment of $165-million in bonuses to employees of AIG Financial Products. News of the payments sparked a demagogic explosion in Congress and the U.S. media, and the President seized the momentum and then got out in front of it. He loves a parade. (Excuse me, you're dripping condescension on my floor...)

There’s no need to repeat here the distorted content and hysterical tone of the AIG explosion. What is worth repeating, however, are some of the facts behind the AIG bonus payments. Much has been made of AIG CEO Edward Liddy’s letter to Mr. Geithner, explaining the reasons for the bonuses. For people who like facts with their hysteria, and can calm down enough to read it, the Liddy letter appears elsewhere on this page. (My, what a high horse you're riding on...)

Mr. Liddy had no involvement with establishing the original bonus plan, designed to “retain” AIG Financial Product specialists through 2008 and 2009. But he says he has “grave concerns about the long-term consequences of the actions we are taking” to reduce the contractual payments to AIG employees. He warns of AIG’s inability to retain the best talent. AIG, he says, will simply not be able to attract employees if they come to believe “that their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury.”

Finally, after three paragraphs of vitriol, we have an argument.

First, note that Mr. Liddy lays the blame at the feet of his predecessor. Why, though, was a "bonus" established before the employees in question had rendered their services? I was under the impression that bonuses were used to reward people for performance after-the-fact.

Second, perhaps AIG doesn't want the best talent. The second-best talent might not have screwed the pooch so badly.

Third, I'm sure that no one will have any problem awarding bonuses for people who deserve them based on their performance. No one wants to stop AIG (or any other company) from giving bonuses to successful people. But doesn't it pervert the incentive structure if we award bonuses regardless of failure?

Fourth, the auto-workers had to make contract concessions as a part of the bailout. Same basic thing happened with the Continental Airline workers. I don't see you defending them, but I imagine that you don't really care about those little people who actually produce things of value.

Now their compensation is about to undergo adjustment down to zero by the U.S. President. They say you can’t fight city hall. Then what can you do with the mighty U.S. government, which is going to throw the full legal force of the state against you? Even if the AIG employees are legally and rightly entitled to their bonus payments — which they almost certainly are — they are about to get steamrolled by a populist president riding an anti-corporate wave.

First, their compensation is not being adjusted to zero. They are still receiving their salary.

Second, without the US government, AIG would be bankrupt and those employees would have neither bonus nor salary.

Third, you do not know that they are legally entitled to their bonus payments. Have you read their contracts? Do you know for certain that they did not violate any provisions? Do you know for certain that the contract is enforceable?

Of course, if you believe that AIG and its Financial Products group —through greed, recklessness and malfeasance — were the cause of AIG’s failure and the adjacent global financial meltdown, then you have no problem with rolling back the bonuses.

But the attack on executive compensation, Wall Street bonuses and bankers is largely without merit, a trumped up attack on the private sector — on markets and capitalism — to overshadow the real causes of the global financial crisis. In recent weeks, reports from U.S. Fed Chairman Ben Bernanke, the International Monetary Fund and former Fed Chairman Alan Greenspan added to the already mountainous body of evidence that massive government failure created a monetary- and policy-driven house of cards.

Last I checked, capitalism rewards success and not failure. If you still feel that this is an attack on the private sector, you should research income inequality. It would also be illuminating to look at executive compensation relative to the average worker in the US, compared to outside the US. Ask yourself who is actually creating value - the CEO who rides a private jet to ask for bailout money, or the Joe Six Pack who is working in the factory assembling the cars.

Writing in The Wall Street Journal last week, Mr. Greenspan all but conceded that the Fed missed the signals and implications from the flood of foreign-owned dollars cascading into the U.S. market — dollars that his monetary policies had created. But he said his 1% interest rate regime through 2003 and 2004 was not to blame.

Absurd on its face. Greenspan wants us to think that it was the fixed-interest mortgages that are causing the problem, and that those mortgages aren't correlated with the fed funds rate.

However, those mortgages were never the problem. Adjustable rate mortgages, some of which were pegged to indexes that are in fact affected by the fed funds rate, were the source of the problem.

Further, consider that the 1% interest rate was giving the finger to everyone who wanted to save, because your savings account couldn't get you a decent return. Naturally, the "global savings glut" went looking for somewhere else to put all that money...

Then Mr. Bernanke, current Fed chairman, in a speech last Tuesday, said we were experiencing the worst financial crisis since the 1930s, but, “Its fundamental causes remain in dispute.” While corporate behaviour may have played a role, Mr. Bernanke ran through a list of government-based causes for the global crisis. Mr. Bernanke cited global savings imbalances, the buildup of U.S. dollar currency reserves in China and elsewhere and the build-up of oil dollars among petroleum exporting countries.

The build-up of systemic risk — the rising odds that the entire system might crash — took place beyond the ability or even the responsibility of any one private bank or insurance company. No bankers or AIG executives are responsible for systemic risk.

If it were not for AIG, the risk would be far less systemic! The branch in question whose bonuses are under threat specialized in credit default swaps, designed to provide insurance against risk. However, with a little bit of doublespeak, they can avoid the regulatory requirements normally associated with insurance - common-sense requirements that were put in place to prevent systemic risk from happening. They became responsible when they chose to bypass these requirements that were put in place for safety reasons because they wanted to make more money.

The leading government-created disaster behind the financial crisis is U.S. housing policy and the multi-trillion dollar securitized mortgage market created by the U.S.-government backed mortgage agencies known as Fannie Mae and Freddie Mac. In comments in 2007, Mr. Bernanke reported that the two agencies, with $5.2-trillion in mortgage obligations, posed a systemic risk. Such risk, he said, occurs when “disruptions occurring in one firm or financial market may spread to other parts of the financial system, with possibly serious implications for the performance of the broader economy.”

First, Fannie and Freddie had pretty strong underwriting requirements. 20% down payment, for instance. No jumbo mortgages, either. They largely avoided the subprime market up until about 2004, when Wall Street investment banks cut out the middle man and started heavily securitizing mortgages on their own. Certainly Fannie and Freddie abused their political connections to leverage themselves to the brink, but you might be surprised to know that a lot of European banks were as leveraged as Fannie and Freddie because AIGFP's credit default swaps allowed them to skirt regulatory requirements.

The greater share of the blame goes to Wall Street investment banks (like Bear Stearns) that would bribe small, unregulated brokers with attractive fees to provide them with more and more loans regardless of risk, and then they bribed credit ratings agencies with still more attractive fees to label the different tranches of this toxic waste as AAA using poor risk models. Then they sold this ticking time bomb to investors, justifying their intentional fraud because this was what a CDS was for...

When Fannie Mae and Freddie Mack failed, because of the mortgage bubble they helped create, the systemic meltdown spread around the globe. The private sector, bankers and insurance companies, were the victims of a failed global financial regulatory regime.

First, when Fannie and Freddie failed, they were taken into conservatorship by the US government. Only the shareholders lost money because all of Fannie and Freddie's obligations are now backed by the full faith and credit of the federal government.

Second, the bubble was mainly in California, Arizona, Nevada, and Florida. This is where most of the unregulated brokers were - you know, the unregulated brokers who weren't under any obligation by the Community Reinvestment Act (CRA) to loan to minorities. They made big mortgages (alt-A or jumbo) for the McMansions that are currently losing value the fastest.

That conclusion is essentially the one delivered by International Monetary Fund officials in early March. In a brief report, “Initial Lessons of the Crisis,” the IMF reviews the regulatory disaster. It tries to put the blame on “market failure” and financial institutions for failing to recognize the looming systemic problems. But it is the regulators — who are really charged with detecting and preventing systemic risks — who failed to see the train coming down the track.

Try telling that to Chris Cox, who reduced the capital requirements for Wall Street banks in 2004 at their request, allowing them to leverage themselves out of existence.

Botched regulations, distorting accounting rules, misguided monetary policy, over-stimulative government policy — the list of state policy failure behind the crisis is long and much more significant than any of the individual deals done by AIG Financial Products. They sold products that made sense under the monetary and regulatory regimes established by governments all over the world. Market players do that. Bankers are not responsible for systemic risk.

I still find it amusing that the people who are selling a product for managing systemic risk are not responsible for systemic risk. Doublespeak at its finest.

But now, apparently, bankers and financial market actors are supposed to personally pay for the government-created systemic risk and collapse. In its report, the IMF suggested that in future, financial market compensation packages should be designed so that individuals are only paid the money after the passage of time. “An early priority should be to delink bonuses from annual results and short-term indicators.” Instead, bonuses would be paid as “deferred disbursements and allowing for some claw back as risks are realized.”

Pay people a bonus after they have earned it? That's crazy talk!

Private market players, in other words, are to bear the burden of regulatory failure. They would only receive their compensation after they find out whether governments and regulators have done their jobs and protected against systemic risk. In AIG’s case, Mr. Obama is punishing AIG staff for massive, global government failure.

They ceased to be merely "private market players" when they began actively lobbying the government to change the regulatory structure in ways that permitted the systemic failure to occur.