The Real AIG Scandal

by Francis Cianfrocca

The Real AIG Scandal

The flap over bonus payments to executives and traders at the American International Group continues in full force, and looks set to dominate at least another news cycle or perhaps more. The focus of mainstream press reporting on the story has shifted to “how much did Barack Obama and Tim Geithner know about the bonuses, and when did they know it?” But while journalists are obsessing over the reactions of the Administration and Congress, the real import of the story lies in how it vented a deep current of almost violent anger among the people, who have been seething over taxpayer bailouts since Bear Stearns collapsed a year ago.

That anger has opened the way for Congress and the Administration to take actions that will severely threaten the free exercise of contracts and agreements. Yet with all this, the actual impact of the AIG bonuses in financial terms is almost insignificant.

Every financial firm pays bonuses to its employees. In the former Wall Street investment banks, the annual bonuses (which are usually determined in November and paid out in January) can in fact comprise the majority of each individual’s compensation. This goes beyond the holiday bonuses or sales commissions that are common in other industries. For firms whose only real business is handling money, the bonus system is a way of inducing cutthroat competition among their own people.

When an investment banker or trader has his bonus review each November, he’s competing for as high a share of that year’s bonus pool as possible. This ties each individual’s performance not to some Dilbert-like abstract scale (”you did well in these areas, and in those areas you could improve”), but rather to how much he gets paid in relation to the other members of his “class” (meaning, all the people who were hired in the same year).

The bonus system means that much or most of what people earn is determined after they’ve done the work, not before. It’s far from uncommon for top performers to receive nine-tenths or more of their pay as a bonus. And it’s typical for the traders who have had the best years to receive bonuses that are several times higher than the total compensation given to their firm’s CEO (who himself has to compete for a bonus).

This is an aspect of Wall Street’s money culture that perhaps escapes people who don’t live in New York City, as I do. High bonuses are part of the DNA in the financial world. The annual bonus isn’t just a reward for good performance. It also gives people a yardstick to measure themselves against those they work with. And to what is certainly an unhealthy degree, it’s also the way many Wall Streeters measure their own worth as people, taking the place of morals, religion and even ethics. Someone could write one hell of a roman a clef (or a movie a clef) about this crazy age and the distorted human beings it has spawned.

In this light, the bonus situation at AIG is very small potatoes. For one thing, AIG is an insurance company, not an investment bank or a hedge fund. The vast majority of its more than 100,000 people have compensation arrangements that are quite like those that most people are familiar with. But there is a small unit, comprising a few hundred people mainly in London, that works with engineered financial products (mostly credit-default swaps). And they receive bonus-based compensation in the Wall Street style.

Now we’re talking about the bonus compensation being given out for performance during 2008, a year in which AIG lost the almost-mythic sum of $100 billion, borrowed most of that money from the Federal Reserve, and became 80% owned by the US Treasury. The reporting has focused on a $165 million payment that was due on March 15. Some back of the envelope arithmetic shows that we’re only talking about bonuses that range to a maximum of a few million dollars for the top people. Both the total pool and the maximum individual payouts are quite small by comparison with the Wall Street investment banks.

To be sure, none of this is to absolve AIG. If anyone deserves to have their bonuses rescinded, it would be the traders and managers on AIG’s Financial Products desk who made so much money selling credit-default swaps during the fat years that they got way too greedy. They are a special case of poor risk management bordering on malfeasance. If Lehman Brothers was the match that started the financial explosion last fall, AIG was the gunpowder.

But AIG isn’t the only firm that paid bonuses even as it was losing huge money and becoming assisted by taxpayers. I would argue that the case of Merrill Lynch is far more egregious, perhaps bordering on malfeasance. At the insistence of John Thain, Merrill moved its annual bonus review up a month, into October. Why? Because Thain knew that the regulators would force his firm to merge into another bank (Ken Lewis’s Bank of America, in the event) rather than collapse as Lehman did or be put to death as Bear Stearns was.

By making the bonus grants while still nominally independent, Thain thought he could avoid the glare of media and regulatory scrutiny, and in fact they managed to pay out a bonus pool that was only barely smaller than that of 2007. (Thain himself brazenly campaigned for a $10 million bonus but his board turned him down. It’s pretty unseemly to bonus the CEO when the company has lost billions of dollars and its independence.)

And in a preview of what Congress will do to AIG, New York State Attorney General Andrew Cuomo has been trying for months to force Merrill to cough up the names of everyone who received a high bonus. What they did was perfectly legal, perfectly in accord with their conditions of employment, and perfectly congruent with standard industry practice. But Cuomo will get a big political bonus for dragging these people’s names through the newspapers and making them unemployable.

That’s the correct interpretation of Barack Obama’s response to the AIG story. Obama has dispatched the foolish-looking Robert Gibbs to make the case that he and Tim Geithner simply didn’t know AIG would be paying bonuses to its employees. The only charitable way you could spin this is to say that Obama simply doesn’t know how Wall Street works. (He’s proved abundantly in the stimulus package and his budget that he doesn’t know how business works, so why not?)

I don’t see how you could say the same about Geithner. If he really wants us to think that he didn’t know until early this month that AIG pays bonuses, that leads us to ask quite reasonably if he was even paying attention while he was running the New York Fed and engineering the original AIG bailout in mid-September. Lame isn’t the word for how this makes him look, and now he’s facing considerable political pressure to lose his job.

For their part, Obama and his cat’s paw David Axelrod clearly saw a parade getting started and they rushed to jump out in front of it. The craven political opportunism here is breathtaking. We have a President of the United States who clearly understands (and revels in) the grandeur of his office, but has no appreciation whatsoever of its gravity. He’s picking political fights with named opponents (starting with Rush Limbaugh) in the manner of a bully from a Chicago schoolyard.

Obama tried to channel Claude Rains in Casablanca (”I’m outraged!”), and there’s only one word that can his describe his performance: coming from a President of the United States, it was disgusting.

The other side of Obama’s political calculation was compelling enough, though. The American people are showing a depth of anger over this issue that is astonishing. It violates everyone’s sense of fair play to pay people high bonuses for losing money, especially when those bonuses are being paid with taxpayer money. Obama therefore saw not only a political opportunity (in the same cheap and craven manner of Andrew Cuomo). He also saw a major danger to himself. Because the anger over AIG has to go someplace, and if Obama couldn’t channel it away from himself, it would end splattered all over him.

He may yet end up suffering that fate. In Congress, people are now talking about clawing back all of the bonus money paid out to AIG (and possibly to other financial companies that have received taxpayer assistance).

In all candor, I’d actually like to see something like this happen. America’s free society now faces a clear and present danger, as at few moments in our history. And for a change, the threat is not from a hostile nation, but from within. We have seen fit to elect a President and reinforced Congressional majorities that have forthrightly committed to take control of large chunks of our economy.

Let Congress step in and nakedly rewrite the private employment contracts of hundreds of people at AIG. (And suffer the financial hit of the ensuing litigation, which will cost far more than the bonuses would have.) Let Obama sign the legislation, with a grand flourish of the pen and soaring words from his teleprompter.

Then after the people have digested their pound of flesh, let them reflect that we will have set a precedent that permanently endangers every agreement and contract made by free people acting in their own interest. This ought to focus everyone’s mind on the seriousness of the project that our government has set for itself. Nothing could be more critical to America’s future than for every one of us to prevent our government from becoming emboldened to grab ever more power over our lives in the future.

The sanctity of private contracts is at the root of our free society, but it’s now under attack. Congress and Obama have freedom in their sights. Your freedom.