Unintended Consequences
One of the more memorable topics in my Econ 101 class was the idea that trying to force the market's hand often lead to unforeseen results (you should never try to force the invisible). Classic examples include price ceilings for housing leading to a lower supply of houses and rising minimum wages leading to fewer jobs and increased prices of low-cost goods. Politicians love these approaches because they always come out looking magnanimous on the surface, and the failure of their policies can later be blamed on countless other intangibles.Today we have a new beast with which to wrangle, stimu-bailout monies being doled out at astronomical rates. I'm not sure if I am 100% against any and all bailouts (I see pros and cons to saving an institution whose failure could severely damage financial infrastructure), but our good friends at AIG sure showed us how quickly things get entangled when trying to mix government and private control.
It's hard to accuse Liddy of any selfish motives at his $1/year salary, but also hard to see the wisdom of retention bonuses without any commitment to stay with the company (11 executives who recieved bonuses of $1+ million are no longer with the company).
Do I think these executives are selfish jerks? Sure they are. I'm guessing that these bonuses weren't the first hefty chunks of change that they'd seen in their careers, so unless they invested with Madoff, they're probably still getting by. If I were in their shoes and made a contract over a year ago that included a huge bonus would I be happy about giving it back. Of course not. I would feel that $1 million is more than my share to contribute to the stimu-bailout bill. Then again I think I would realize that my company wouldn've been around to pay me my bonus had Uncle Sam not come along. So the final verdict remains "selfish jerks."
Yet I'd have to say that I'm more bothered by the fact that Sen. Dodd wrote the bonus option into the stimulus package at the behest of the Obama administration in the first place (and the fact that he denied it until cornered, but I guess that shouldn't surprise me any more than the fact that there are selfish executives on Wall Street).
We'll just say that the whole mess was unintended.
Comments
First, you have to read this:
http://www.nytimes.com/2009/03/25/opinion/25desantis.html?_r=1
and then this:
http://corner.nationalreview.com/post/?q=ZDY1NjdkYjkyNTk1YzkzZDEwNjRkZWY0YjE2ZTlhZWY=
and then this:
http://justoneminute.typepad.com/main/2009/03/the-22nd-book-the-book-of-the-dead.html
These executives aren’t selfish any more than anyone who wants to get what he has earned is selfish. Were these executives making a bunch of money? (including that AIG exec.) Sure. But what does that have to do with anything! Maybe they were worth it. Finance is hard. Try deciphering the financial posts at JustOneMinute for a good test of your understanding. In the process, you’ll also run across this quote from some liberal, which I love:
“...The second [issue with not paying the bonuses], which is much harder to accept, is that no one but the idiots who put these trades together understands them well enough to unwind them.”
So, I think there actually is something to this finance business that may justify high bonuses.
I also have a huge problem (and I’m surprised you do not have this same problem) with you essentially advocating that the government put the kibosh on a valid legal contract that AIG formed with its employees. These bonuses were paid according to a contract that the employees formed with AIG. AIG got exactly what it intended to get out of these retention bonus contracts: The employees stayed on board at the company, even though they knew the ship was sinking. But now that AIG has already reaped the benefit of the bonus contracts, the employees are greedy for wanting AIG to keep its part of the deal? Please! (Just because some bonus recipients are not with the company does not mean that they didn’t stay long enough to qualify for their bonus. I’m sure AIG would not pay out a big bonus if the terms of the bonus contract were not met.)
Also, all this chest thumping is really counterproductive. Our government is pumping billions of dollars into AIG, and at the same time, it’s running off the financial talent that could actually rescue the company.
Brett, this is a really strange post where you start with the correct premise (i.e., that government meddling in markets is bad), but somehow reason to the exact opposite conclusion you should logically reach (i.e., that the government should have meddled in the executive pay market). Yes, Dodd is a weasel. But this is something he got right. Should we really interfere with validly formed contracts or cap pay (including bonuses) for executives at these troubled companies? How is this behavior that you are implicitly advocating any different from rent control?
--rdh
I feel that I was consistent in my post to the point that government intervention in businesses is poor policy. To illustrate that point I discussed how the water gets muddied (a negative consequence) when a business has only partial autonomy. Your dissent seems to center around the opinion that the water is not muddy, that AIG should remain completely autonomous in the execution of their contracts.
Even if the retention bonuses were legally negotiated before the bottom fell out, I feel that having the company supported by tax-payer dollars is a game changer. For example, if developer X subcontracts with cabinet builder Y to supply the cabinets for a given development and includes a $50,000 bonus when all is finished satisfactorily. In the meantime the housing market collapses and developer X is going under, leaving the development unfinished and the bonus unpaid. If a 3rd party doesn’t step in, that is how things would remain. But say magnanimous philanthropist Z (not that the government is magnanimous, but maybe tax-payers are) has an interest in seeing the development finished and agrees to fund its completion. Should philanthropist Z have to pay the bonus to the cabinet maker who would’ve been out of work otherwise? Should the cabinet maker take it if his previous compensation was already adequate? Sure the cabinet maker has a valid claim on the bonus, but if someone other than developer X is effectively his new employer I don’t feel that the situation is as clear cut as otherwise (the non-clear cutness being a negative consequence of government meddling – a negative consequence consistent with my premise).
I haven’t got to all the articles you suggested yet, but the Op-ed by the AIG exec didn’t evoke much sympathy from me. He’s basically saying that he’s worked hard (“10,12,14 hour days”), wasn’t responsible for the large losses, and deserves his bonus. There are plenty of first year accountants working for the Big 4 who put in hours like that for $60,000 a year. Don’t they deserve $1,000,000 for sacrificing their family time? Maybe DeSantis should’ve put his family first to begin with. I’m not arguing that Wall Street execs are overpaid (if someone thinks you’re worth that much to their company then fine. Though you do mention that they are worth it because what they do is hard. There are a lot of brilliant people working on incredibly complex problems (eg quantum physicists) who earn a pittance compared to a Wall Street exec. It’s not the difficulty of the task, but simply how much money the company thinks the employee can bring in for them.), but when your paycheck is now coming from tax-payers (I still believe it’s a key point that without them you would have no paycheck), claiming that you deserve the money because you’ve worked so hard doesn’t go far with me.
I will admit a misunderstanding on the direction of time for a retention bonus. I see now that the bonus was to retain them until the time it was paid, not to convince them to stay after it was paid. So I’m ok with the fact that some of them left after receiving their bonuses, but still have issues with the decisions to pay (and accept) them.
Now to the substance.
I think you’ve missed what I was hoping you would get out of the AIG executive’s letter, probably because I wasn’t explicit about it. Let me clarify. While the AIG executive does try to play on sympathy, I don't feel any sympathy for him either. But what I do think is that he makes a strong case for why all this AIG persecution is really counter productive. What talented person in their right mind is going to start or continue working at AIG in this situation? The employees that forwent other jobs because they were induced by bonuses are now receiving death threats and are having those bonuses taken from them. I have a huge problem with AIG reaping the benefit of their bonus contracts, and then having the government nullifying the benefit because of popular outrage.
The AIG exec. also makes another completely valid point: Why are we punishing a bunch of executives who, likely worked in fields completely unrelated to credit default swaps? Just because one area of the business is dramatically hurting the company, does not mean there aren't some people who are doing a good job and deserve bonuses. Taking this guy's story at face value, he runs a department that made 100 million last year. Now he's leaving. If even 2 or 3 million of that 100 million follow him out the door, do you think the company is better or worse off for having failed to pay the bonus? Dou you think the taxpayer is better off if the government had paid the bonus and kept this guy at the company, or is it better off having him leave and getting the bonus money back? It seems to me the clear answer is AIG is much more likely to do well if it keeps valuable employees as this guy seems to be. The tax payer is also better off if AIG is not making its profitable divisions unprofitable.
I could have been clearer at what I was getting at when I said “finance is hard.” I realize that there are a lot of different jobs that are hard. My point was that, not only is finance hard, but it also serves a very valuable role in the economy. Thus, financial experts are paid very well. My point is simply this: 1) Finance guys make a lot of money because that is what they are worth. 2) They are not selfish for wanting to get paid what they are worth and what they bargained for.
You’re assuming that these executives wouldn’t be paid by AIG if there had been no bailout, but I don’t see how that is true. Even in bankruptcy, my understanding is that employees are at the top of the list of people who get paid, so I’m pretty sure they probably would have gotten their bonuses either way. If AIG had to sell off those profitable divisions to other companies, those new companies would be bound to the bonus contracts as well. This kind of Government intervention is the only scenario I see where these executives don’t get paid what they bargained for.
Consider this example: Suppose you are science teacher at a private school and head of the science department there. Because the English department failed to get accreditation last year, students are enrolling elsewhere, and the school may go under. The government decides to step in and take over the school. You get paid $100,000 a year because the school wanted to steel you away from a high paying research job that you we’re also considering taking. Many students that want to become scientist specifically enrolled in the school because you are teaching there. Furthermore, the students have tested well in science this year despite the problems over in English. Does it make sense that, because your paycheck is now coming from the government, you shouldn’t get paid for the summer months, which you’ve technically earned?
I understand your point, and even agree in the abstract, that sometimes market interventions necessitate further market interventions. But I don’t see any reason that the AIG bailout requires us to intervene in this particular executive pay market (or in your words, change the game). We didn’t have to bail out AIG, and if we didn’t want our money going to pay corporate executives, then we shouldn’t have. Furthermore, with the exception of this one transaction, I don’t see how making these executives return bonuses helps AIG, the government, or the taxpayer in the long run. In my opinion, all we are accomplishing is setting a bad precedent, unnecessarily interfering with this market, and running off the people we need to successfully run this troubled company.
--rdh
A large part of the popular reaction to the bonuses is simply based on the term "bonus," which implies that this money is some sort of award for performance. The public is outraged because the companies are not performing well, and so presumable neither are the executives receiving bonuses. The perception is the executives are being rewarded on the taxpayer's dime, despite their performance failures. Of course, as shown in previous posts, many of the people receiving bonuses have done well for AIG in spheres unrelated to AIG's problems.
The outraged people also assume that the taxpayer money is the money going to the bonuses. That's arguably true because the companies cannot continue to operate without the money. Money is, after all fungible. Let’s skip that issue for now.
The final assumption leading to outrage, which is also false, is that these bonuses are some kind of merit award. Instead, as I understand it, they are a type of deferred pay. This arrangement appears to be for the corporation's benefit, as employees would almost always prefer a dollar today as opposed to a dollar a month or year from today. Instead of getting higher monthly pay, they get the money at the end, probably with some increase for interest and inconvenience, etc, to incentivize them to stay with AIG. Thus, the bonuses actually are designed to benefit the company, and, without the bonuses, these employees likely would have received higher monthly salaries.
Your counter argument to all of this is that, now that the government is paying the tab, these employees don't get what they otherwise earned because. . . . now the money comes from the tax payer.
Which brings me to this hypothetical: an AIG secretary is paid $20,000 a year with a similar year-end retention bonus of $20,000 ($40,000 total). Do you think that she should return the bonus because it comes from taxpayer money?
If not, what is the principled distinction between the case of the secretary and the case of the 1 million dollar bonus?
It seem to me that implicit in your criticism is one of two arguments you are not making directly. Either, first, the executives just aren't worth the money they are getting paid, or second, you just think we should have a deep-pocket rule, where if you are getting a really big bonus, then you should donate it back to the government, but if you are a secretary getting a small bonus, then that is ok.
You're already rejected the first argument. The second argument to me seems inconsistent with your position that taxes shouldn't be raised on the rich (also a deep-pocket rule). But I don't see another justification for making the executive return his bonus, and letting the secretary keep hers.
Or maybe you just think that the secretary should return her bonus too? If that's the case, maybe we should retroactively tax every employee of AIG for their earning at the proposed AIG bonus recipient rate. The only difference I see between the executives bonuses and every other employee's pay for the past couple months is that the employees who were paid every month got their pay up front for their own benefit, whereas the employees that received bonuses deferred payment in a scheme that was designed to benefit AIG. Why should the employees that helped out AIG by deferring payment be the only ones that suffer?
-rdh
-Theresa
You should read that first article. One point it makes clear is that there are all sorts of financial products that are completely unrelated to credit default swaps, or what is ailing AIG. There are divisions of AIG that are still making a lot of money. Don't you think we should differentiate between those people that are responsible for the mess and those that are actually making AIG (and possibly the tax payers) money? Thus, the English teacher /science teacher analogy is right on point.
Sure a secretary is not responsible for AIG's failures. But there are a lot of finance guys at AIG that, again are not responsible for AIG's troubles either. Again, that was my point exactly. We shouldn't paint bonus recipients with such a broad brush. We're chasing off a bunch of talent that we actually need, and that is not responsible for AIG's downfall.
-rdh
I agree that much of the outrage was knee-jerk reactions to the word "bonus" without looking further into the details. Even many of the congressmen asked Liddy why any bonus would be rewarded to a manager of a failing company (implying that they were performance bonuses). Personally I knew that they were retention bonuses rather than performance bonuses, and as I mentioned I did have the functionality of the retention bonuses a little confused (which I imagine did add to my distaste of the whole ordeal).
Now to your teacher/secretary examples (I hope your hypothetical school situation will one day be a reality, not so that I make 6 figures, but because it would bring the competition much needed in schools, but that's a topic for another post). As a highly paid science teacher I think that I would be willing to take a pay cut in that situation if I really believed in the institution and wanted to do what I could to help it succeed (kind of like a professional athlete taking a pay cut to free up salary cap space to bring in better teammates). I would surely have my professional pride hurt by being lumped in with underperforming teachers in the public's opinion, but as long as I could still do my job effectively I think I'd get over it.
As for the secretary, you bring up a good point about just what this bonus pay represents. I don't know enough about the corporate world to have a good feel for how much of a retention bonus represents deferred payment and how much is just bonus (whatever that really means). Is receiving most of one's salary in the form of a bonus how most executives' pay works? I guess my emotional reaction to your example is "Well if the money is something they need to make ends meet, it's different than bonus (or play) money." Thus the secretary's bonus effectively serves a different purpose than the executives'. But defining that distinction is obviously riddled with ambiguity.
So I guess that I'm conceding that on principle the contracts needed to be honored. But I'll hold that 1. the parties involved were naive to think that there wouldn't be public outrage, and 2. that these execs should've "taken one for the team."
Nevertheless, I agree that many employees likely deserved the bonuses they recieved, it's mostly just the immense amounts of money given to those in charge of the company that bugs me. But it was right for AIG to pay the bonuses even if not everyone deserved it, because you have to honor your agreements. Whether to give it back would be a personal matter, depending on how you feel about the money coming from the government and your assessment of your job performance. I know I wouldn't keep a bonus that was paid for by a bailout, unless I was like the secretary, trying to make ends meet.
-Theresa
That AIG exec. writes the following in the article:
"I started at this company [AIG] in 1998 as an equity trader, became the head of equity and commodity trading and, a couple of years before A.I.G.’s meltdown last September, was named the head of business development for commodities. Over this period the equity and commodity units were consistently profitable — in most years generating net profits of well over $100 million."
I initially read that as meaning that commodities continue to make a consistent profit today. Now I'm not sure if that means that commodities continues to make a profit today, or that until September 08, they made a profit. (Or maybe they continue to make a profit, just not a consistent profit?)
In either case, it wasn't the commodities market that tanked AIG. This guy had control over commodities, and ostensibly did a good job. He also writes "I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. "
Of course, he could be lying (although this is a signed letter). But, based on the article, I can only conclude that, in fact, he probably isn't only blameless for AIG's problems, but has done very well for AIG.
It does appear to me that bonuses make up a much larger part of the financial industries pay structure. The exec. in the article I keep referring you to had a 1 dollar salary, although that is probably an exception, not the rule. You can also read the following post, where an AIG employee explains his salary hasn't changed for 15 years, and that his main form of compensation is bonus.
http://www.businessinsider.com/blogging-from-inside-aig-exec-says-everyone-else-is-lying-2009-3
But really, when you think about it, what's the difference between "retention bonus" "normal bonus" and regular salary (other than whether you're legally entitled to the pay, of course). They are all just different terms to label the compensation given a person. Ultimately the person needs to get the compensation he is worth, or he will go elsewhere. I'm not sure the form of the compensation maters much.
Brett and Teressa:
Brett- you write "Well if the money is something they need to make ends meet, it's different than bonus (or play) money."
And Teressa, you write, "it's mostly just the immense amounts of money given to those in charge of the company that bugs me."
I guess I don't understand this kind of thinking. These guys, like everyone else, work for money. I'm sure that they would do other things with their time if they knew they were not going to be adequately compensated for their services. What they actually need to get by is irrelevant. Price is not determined by costs, its determined by supply and demand, and that applies to the labor market, just like any other market. You may think that they are not worth what they are getting paid, but I have no reason to believe that the market has not determined the correct level of compensation for these people.
I don't know why the execs should take one for the team. What team? The U.S. Government? AIG? taxpayers? None of these teams are worth the sacrifice. If these employees are going to do charitable work it should be charitable work of their choosing. I'm sure most of them would not have chosen to toil away at AIG for their charity work.
Brett, I don't think that it is foreseeable that, of all the government waste, people would latch on to this one example, and get mad (And I don't even think that this is waste). You never know what's going to get people's attention. This reminds me a lot of that Dubai ports deal in the way it came out of the blue.
In summary--and correct me if I'm wrong--it seems to me like you guys do not believe in free markets or their ability to determine how much a person should be paid.
--rdh