House bill on AIG bonuses is understandable, but wrong

The House of Representatives' rush to tax the AIG bonuses at 90% expresses a true cry from the heart across the country against the bonuses. Fortunately for common sense and the rule of law, the Senate will probably dramatically cut back on the House's populist outrage. I may never say this again, but the Senate Republicans ultimately have it right. House Democrats may have gotten a catharsis, but they are ultimately wrong on changing confiscatory tax laws to tax income received before the tax law was changed.

Part of the PR problem here is that people don't understand, and neither AIG nor the Treasury Department has decently explained, what the bonuses are all about. Another part of the problem is that even the base salaries are so much larger than what most of us are used to that it doesn't seem possible that someone might be entitled to payment of a bonus on top of that -- particularly if the business is losing money. It's a little like the Washington Nationals -- Major League Baseball's worst team last year -- paying bonuses to its players. After all, bonuses are supposed to be rewards for excellent performance. But many Major League Baseball players have contracts that give them a bonus for simply playing in a certain number of games. If you get your bonus for playing in 150 games a year, it doesn't matter to the bonus that you couldn't hit your way out of a paper bag; you still get the bonus. Nationals fans may complain, but the contract is the contract. The player gets the bonus. The only thing that is different is that the Nationals players aren't being paid with tax dollars.

Like Major League Baseball players, many Wall Street financial professionals work on a system that has a base salary and a bonus. The base salary may be $250,000 a year, with a bonus calculated on any of a number of criteria -- perhaps revenues generated, perhaps simply sticking around. In some cases, those bonuses may be many times larger than the base salary. Such a system is not new, and it is not unique to companies being bailed out.

Like Major League Baseball players, many of these bonuses are retention bonuses. A MLB player may get a bonus just for still being on the MLB roster at the end of the season. On Wall Street, it is fairly common, when stock prices are falling and stock options have no value, for companies to tell their employees, "If you stick with us to the end of the year, we'll pay you a big bonus." That gives the employees an obvious incentive to not leave to go somewhere else. And AIG's stock was falling during the beginning of 2008. AIG's stock had traded at around $70 a share as late as October, 2007, when the Dow was over 14,000. Both AIG and the Dow fell about 20% by February, 2008 -- what seemed at the time like a general market correction. But the first indication that the outside world had of a potential problem at AIG was in February, when AIG dropped 15% in a matter of days, at a time when the Dow and most financial stocks were not falling. In May, June and July, 2008, AIG dropped another 30%, and was down about 70% from the October, 2007 highs. On June 15, 2008, the AIG president, Martin Sullivan, resigned. If you want to compare AIG's stock performance to that of the Dow and Bank of America, look at this stock chart. So if you were an AIG employee whose compensation package had usually included stock options (of value only when the price of the stock is generally rising), you might need some other sweetener to stay -- a retention bonus, perhaps, payable in a year.

The important point to make here is that the retention bonuses were agreed to a year earlier. They were NOT bonuses agreed to in March, 2009, to be paid to people in March, 2009, for agreeing to stay with the company after March, 2009. They were agreed to in 2008 to induce people to stay through some later date, like January, 2009. For example, Joe Bondtrader's contract with AIG, signed in January, 2008, might give him a large cash bonus payable in 2009 if he remained with AIG through December 31, 2008. Such bonuses were almost surely negotiated before AIG's peril was understood. There is plenty of reason for anger about the financial recklessness that led to the demise of AIG, but the bonuses were apparently negotiated in good faith by AIG at a time when AIG thought that it was solvent, and at a time when AIG thought that the people to whom the bonuses were to be paid were doing what AIG wanted them to be doing.

One frequent complaint we have heard this week is, "Why should these bozos get a bonus when they lost so much money?"

Believe it or not, it is not a violation of a contract to be bad at your job. Under most of these contracts, for a trader to lose money may be grounds for non-renewal of the contract, but unless the trader has covered up the losses or stolen money in the process, it is not grounds for termination before the end of the contract. There is no indication in any of this that any of the recipients could have been or should have been terminated for having violated company policy, or for having sexually harassed a secretary.

So when AIG decided to pay the retention bonuses, it was honoring a contract. It had no basis for NOT honoring the contract. The essence of AIG's bailout was to allow it to pay off its contractual obligations to Deutsche Bank and other counterparties; if we were giving AIG money to pay off billions owed to other banks, it would make little sense to deny AIG the power to pay off hundreds of thousands or millions owed to individuals.

It is also important to note that the typical Wall Street compensation agreement has a clause that says that if the employee is NOT paid the bonus on time, the company can be found responsible for treble damages. A $1 million bonus not paid when the contract provides would lead to a payout of $3 million, plus the attorney's fees necessary to enforce the agreement.

The only power that AIG would have had to refuse to pay to contractually obligated amounts would be if AIG went into bankruptcy; Bankruptcy Court would have the power to void or modify the contracts, under certain circumstances. And if AIG had filed for bankruptcy just to try to avoid paying its bonuses, it would be colossally messing up the company.

So who do we blame?

For starters, we can blame the Treasury Department going back into the Bush Administration (though including the Obama Administration) for not making sure that the Secretary of the Treasury and the President knew that these payments would have to be made. The Bush Treasury Department was aware during much of 2008 of the fact that AIG was hurting. The Federal Reserve and the Treasury Department were monitoring AIG fairly closely starting over the summer of 2008. On September 16, 2008, when the Fed essentially took over AIG in return for 79.9% of the company stock, Treasury and Fed officials were now on the inside. (It is worth noting that when we are talking about "the Fed," the lead oar was being pulled by the New York Federal Reserve Bank, whose President was Tim Geithner.)

And in September, AIG filed a document with the SEC -- a 10-K -- that outlined the retention bonus plan already in place. In November, Treasury and Fed officials restructured the AIG bailout, and there were specific negotiations over the terms under which A.I.G. could make the retention payments.

We know from various news reports that the executive bonuses were on the Treasury Department radar screen at least as early as December, 2008 -- CNN's Joe Johns reported on December 11 that although AIG's top 60 executives would forego their bonuses, there were still retention bonuses due to another 168 employees, totaling perhaps $150 million. http://www.cnn.com/2009/POLITICS/03/20/aig.bonuses/index.html?section=cn... Perhaps in response to this news, Democratic lawmakers asked in December to hold a hearing about the payments. It didn't happen, but the story did not go away. CNN's Mary Snow had a story in January, 2009, putting an estimate of $450 million on the retention bonuses. New York Attorney General Andrew Cuomo raised a stink about the AIG bonuses, and a New York Times story from January 30, 2009, says that he had extracted a promise from AIG officials that no future bonuses would be paid. (Is it important here that the AIG compensation agreements are controlled by Connecticut law, not New York law?) On at least a couple of occasions during February, the Fed and Treasury officials discussed the bonus plan.

And on March 3, when Tim Geithner was testifying before the House Ways and Means Committee, Representative Joseph Crowley (D-NY) asked Geithner directly, in an open hearing, what could be done to stop AIG from paying $165 million in bonuses to hundreds of employees in the very unit that had nearly destroyed the company.

Geithner responded with a general answer -- executive pay in the financial industry had gotten “out of whack” in recent years, and he pledged to crack down on exorbitant pay at companies like AIG that were receiving federal bailout money.

Geithner now claims that he did not know the magnitude of the bonus issue until March 10 -- one week after being asked a direct question that set forth the facts that he said he didn't know until a week later. (To be fair, Congressional questions are often so laden with dubious "facts" that no one should assume that the "facts" are correct; however, Crowley is not a crank, and someone should have at least wondered what he was talking about.)

So how about blaming Chris Dodd?

Dodd has been guilty primarily of playing trying to play politics with a hot-button issue. In January, he was trying to insert into the stimulus bill a provision that would have permitted what is sometimes called a "claw-back" of the bonuses. Simply put, the claw-back provision would have given the government the power to "claw back" the bonuses from the highly-paid employees of companies that received federal bail-out dollars. The consensus at the time was that there were few legal remedies; claw-back provisions really can't be used to interfere with amounts that are contractually due.

But the sober reality, compensation experts said, is that most if not all of the money that the banks have paid out is probably gone for good. The “legal means” Senator Dodd referred to are few. Unless actual wrongdoing is uncovered at the banks — and so far prosecutors have not disclosed any — the case for clawing back past pay is weak. “It’s not as easy as pounding the gavel on the table,” said Michael S. Melbinger, an executive compensation lawyer at Winston & Strawn in Chicago.

http://www.nytimes.com/2009/01/30/business/30pay.html The prevailing wisdom in January was that Dodd was arguing for it in part because he was feeling the heat for being too cozy with the financial industry. (He is now thought to be in a tough fight for re-election, being opposed by former Representative Rob Simmons; a Quinnipiac Poll conducted last week showed them essentially tied, 20 months before the 2010 election.)

The first version of the stimulus bill -- the version that passed the House -- had no limit on bonuses for bailed-out companies. The version that passed the Senate contained a provision that would have required that any bank receiving TARP funds had to pay back the government the same amount that they paid out in bonus money. (Note that this version did not prohibit paying bonuses -- it just made it expensive for a bank to pay them.) Because the House and Senate versions differed, the bill went to a Conference Committee.

Yet somehow, the version that was adopted by the Conference Committee was entirely different from the Senate version that had just passed the Senate. The Conference Committee Report, adopted on February 12, 2009, had been changed to substitute a whole different treatment for excessive compensation, golden parachute payments and bonuses. That provision barred golden parachutes and bonuses that met certain criteria, but included this caveat:

The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

http://thomas.loc.gov/cgi-bin/query/F?r111:1:./temp/~r111wYnFba:e1285275: That is the version that was passed by both houses on February 13, and signed into law on February 16. On February 15, the New York Times had a story in which Obama Press Secretary is quoted as saying that the Obama Administration wanted to have another law passed to amend this caveat, so that it prohibited fewer bonuses. http://www.nytimes.com/2009/02/16/us/politics/16shows.html?_r=1 Rep. Barney Frank (D-MA) and Senator Richard Shelby (R-AL) said, in essence, "No. Enforce the one we passed."

So the great mystery this week has been, "How did the Conference Report come to include an exemption for AIG's retention bonuses?"

Senator Chris Dodd has now 'fessed up, though he says that the request to change it came from "low-level Treasury officials" who were afraid that a provision like what had passed the Senate was too harsh.

Personally, I blame Geithner and the Treasury Department for the PR disaster. It has been noted frequently by David Brooks of the New York Times that Geithner has almost no middle management people in office. He can call a senior staff meeting in the bathroom, with the stall door closed. The usual crop of Assistant Secretaries and Deputy Undersecretaries aren't in place. If they had been present, we at least might not have been blind-sided.

But in the long run, the Dodd/Treasury amendment is, in my view, the only result that is consistent with the rule of law. We can be angry that we are shelling out $165 million at a time of economic crisis, but the principle that the government honors contracts is an important principle to adhere to. We don't have to be happy about the payments; we have to hold our noses and do what the law requires.

So how about taxing it all away? The current proposal, which passed the House by a wide margin in about a day, would tax that income at 90%. With state and local income taxes, that is effectively every penny of the bonuses. To me, this runs afoul of two other basic principles -- we don't tax people that we decide we don't like just because we don't like them, and we don't change the tax laws to suddenly tax at a confiscatory rate income that the taxpayer has already received.

The Senate Republicans have indicated yesterday that they don't expect that the 90% tax will move forward any time soon. And that is the right answer. Our economic system requires that we be able to rely on certain things -- a stable tax structure is one of them. We choose to take certain economic actions in reliance on the tax structure, and the tax consequences of those actions. For example, if I am thinking of installing solar panels on my roof, and I am counting on getting a tax break for doing so, I may make the calculation that I can afford the panels only if I get the tax break. If the government were to decide three months later that they would rescind the tax break, so that people who have already bought solar panels this year would not get that tax break after all, those taxpayers would have every right to be angry.

The Republicans in the Senate are right to emphasize the need for economic actors to be able to rely on the government to react legally, not cathartically.

And President Obama was right to emphasize (as he did on Jay Leno Thursday night) that we need to change the culture that values deregulation even when the deregulated industry is able to take down our entire credit market.

Why are they taxing them at all?

Why is everyone so against Bonuses? It's not like they didn't tell us they were going to give bonuses. The Dems and The Treasury stipulated and were fully aware that AIG could give out bonuses. It doesn't seem right when after YOU commit an action that YOU are allowed to use it to blame someone.

But also, bonuses aren't really that bad. You see, when the company is going into the shit hole, they need someone to manage it, and if no one wants to, what do you have to do? Make it worth their while.

You have to understand, these CEOs aren't morons, they're trained executives that screwed up because they didn't anticipate the problems with all the loans. There needs to be SOMEONE managing AIG. I don't see anyone that is clamoring 'bout these bonuses volunteering to manage AIG.

A Differing Point of View

Although this is a well written diary that makes a logical argument on the surface, I beg to differ with your opinion.

First let's start with the lack of senior level staff at Treasury. As a matter of fact, the Obama administration has filled more jobs at a faster pace than the Clinton or Bush administrations did at comparable points in their administrations. After several high profile appointments blew up in their faces, the Obama team had to slow down to the do the solid vetting task and that takes time. Unfortunately, we are in crisis mode. I don't know the answer to the dilemma, but I do know that picking the wrong people has consequences too.

As for your point about contracts being inviolable, please tell that to the employees of the country's major airlines, the workers in the auto industry, and the many thousands of other union employees who have, in fact, had their contracts voided in courts and have had to give back thousands of dollars in pay and watched their pension plans and health insurance decimated. Indeed, when the Big Three automakers asked Congress for a bailout, the very same Republican congressmen who are so opposed to violating the contracts of rich bankers were among the first to demand that automakers file for bankruptcy precisely so that union contracts could be voided.

Please keep in mind that those whose contracts are now being so vociferously defended actually caused the crisis by their bad behavior, risky investment strategies, and greed. The pilots, flight attendants, and auto workers were not responsible for their industries' failures. The CEOs of those industries also walked away with bonuses and golden parachutes while workers were left to bear the burden of corporate reorganization.

That's why there is so much populist rage. Contracts should be respected. But those whose performance leads to insolvency should not get performance bonuses. After all, you don't reward a bus driver who crashes his bus with a bonus for great driving.

That's not the greatest analogy

A better analogy would be

A Police Chief accidentally lets a murder go by having mistakenly had a search-warrant adressed for the neighbor's place by a typo. This officer has 15 years of service and is now thinking about leaving the force. However, the only available replacements would be freshmen officers with >3 years of service.

You would be forced to use money as a incentive to retain the officer.

Now I'm not saying that these CEO's deserve the money, but it makes the most sense for someone in the company's position.

Sorry, Bigvinu, but your analogy doesn't quite hit it either

I'm not sure these top level executives are the same as a police chief or a police officer who made one honest mistake. These are people who gamed the system to make short term profit at the expense of long term, sustained growth investments. They did this deliberately and without any concern for those who would be hurt by this, which is actually most of us.

No, they shouldn't be rewarded for it.

The thing I don't buy - and I think most of those who are angry about the bonuses also don't buy - is that those greedy executives are the only ones who could fix this. There are plenty of very good people who have already been thrown out of work through no fault of their own in the financial industry. Do you honestly want to tell me none of them would be qualified to fix this?

The truth is in crises situatations like this one it often takes a housecleaning where those who screwed up are booted out and the junior level gets promoted to fix the mess. Why are we protecting and rewarding those who created the problem and then using the lame argument that they are so valuable that we must retain them at all costs?

Common sense would actually argue that it's time to get rid of them and promote the bright, up and coming junior level executives and managers or to bring in new blood from outside to correct it.

Look, if I go to a new hairdresser who gives me a bad haircut, I won't go back to that person to correct it. I might go back to the same shop, but I'll ask for somebody else. Why would I trust the person who gave me the bad hairdo to do a better job the second time? Likewise, if a doctor or dentist screwed up badly, I'd go to somebody else to get a second opinion and correct the problem. I'm not talking about somebody who made a minor, easily corrected mistake, but somebody who botched it really badly.

I'd say those executives who are arguing that they deserve the bonuses botched it badly and are so unhinged from reality that they don't even see that. If they had any common sense or humility, they'd voluntarily be giving back the bonuses, cleaning up the mess they made, and rebuilding public trust. Then, once their companies were turned around, yes, they'd deserve bonuses. But not now. These were, after all, performance-based bonuses.

You and I and every other ordinary workers has had it drummed into us that we should be accountable and should only expect rewards at work when we do an outstanding job. And even then, it's only when that high performance is tied to our company's profitability. We don't expect to get rewards when our company has had a bad year and failed to turn a profit. That's another reason people are furious. We can see the double standard. Worse than a double standard, in fact.

There were years when companies were raking in large profits and rewarding their executives handsomely while their ordinary worker bees saw their own salaries stagnate. In its most profitable years, the wealth never trickled down to the rank and file employee. Yet, who is being asked to tighten their belts, go without raises, and even give back salary increases in the bad times? Not the executives who stubbornly insist they should continue to get handsome rewards even while they busted their companies.

Nope, you can't convince me there is any common sense reason for this, let alone any justice in it.

But you seem to be acting as if...

..That these people are just Satanic spawns out to destroy America. You can't use the attitude that these people are evil and deliberately tried to sabotage American markets. I'm not going to defend these peoples' morality. Heck I'm not even going to try to do that. These people are pretty scummy. (Then again Wall St. is exactly the most peaceful place on Earth). But something you've got to understand is that we can't change the rules to the game when the game makes us uncontrollably angry.

It's like those Crazy House Dems that are trying to tax the money 90%. You haven't exactly said the company's done anything wrong other than you don't like the morality of the company. What did you think these companies intended to do with the money we were going to give them?

No matter who you would've hired to manage these companies, they would've demanded a huge lump of cash. When you have a company going down, it's a hot-potato that no one wants to touch unless it's a potato with a price tag attached.

While I agree with you that this isn't the most ethical thing to do, we cant just change the rules because a news headline makes us angry. Our country was founded on something more that that.

Why?

We certainly changed the rules of the game for airline pilots, flight attendants, and auto workers. And it's not a matter of not liking somebody's morality or thinking they are Satanic spawn - that is ridiculous. And I'm not uncontrollably angry.

But I have spent four years chronicling the excesses of exactly these CEOs and top executives in their many companies. I've written about how, when their corporations were flying high and raking in profits, they grabbed huge bonuses while ordinary working people watched their wages stagnate and never grow. Now, when things are bad, I'm watching the same ordinary people devastated as their pension funds are slashed in half because of the malfeasance of the same executives who want to reward themselves with performance bonuses for businesses they ran into the ground. And while your pension and mine is sliced in half because of their bad investments, our tax money is going to give them these bonuses.

Sorry, Bigvinu, but you won't convince me. I'm willing to bet you won't convince the average American taxpayer either. That's because executive compensation is a longstanding problem. It's just hit the fan now and everybody can see it all for what it is.

I've chronicled the Second Gilded Age for years. It is time for it to end and for there to be a little bit of equity and fairness.

When you give these comapnies money...

... They
ll do what they've done. The fact that people expected to give them hundreds of billions of dollars and that they would shape up and become good hard-working Americans and everything would be great is unbelievably naive. They asked for money. We gave them money.

I was against the Bail-out from the start for this very reason. We'd give cash to banks and we would all became angry when they do what they always do. If we're gonna give these banks money to operate we might as well not completely tie their hands.

A lot of people have been using the argument "You use our money, you play by our rules", but I have to point out the obvious here.

The American people have been reliably oblivious to anything economic and political until they get riled up by a news headline and they have their anger turned into raw political capital by Democrats and Republicans in Washington. I'm not an economist, I'm willing to bet you're not an economist (I don't exactly know. I maybe wrong), and much of the American people aren't economists. If we're gonna give money for a bank bailout, we might as well not let the angry stupid masses be the ones to make sure the money is being spent right.

A few disagreements...

First, I agree that the Obama administration has been doing a good job of getting a lot of appointments in place, generally. Just not in the Treasury Department, for some reason. It may be that they are so busy putting fingers in dikes that they have no time to work on matters with a time horizon of more than a day. I don't know. But for whatever reason, there aren't a lot of deputy undersecretaries or whatever that have been appointed, and none that have been confirmed.

I don't maintain that contracts are inviolable. If you want to break a contract, there are two things that you do. Either you file for bankruptcy and get the Bankruptcy Court to do it -- which is how a lot of labor contracts get broken -- or you go to the other side and say, "we've got to work this out, or we -- you and I -- will all be in worse trouble." And when you go to the auto industry to renegotiate, you are asking to renegotiate the terms of payment for FUTURE work, not PAST work. You don't go to the auto industry and say, "You know that deferred compensation that is due to you for work already performed? Sorry. We're not paying it. We could, but we won't. Sue us for it." And you don't say, "You know that payment that we gave you last week? Well, now you have to give it back because it's really making me look like an idiot for paying you what your contract called for." That would be like going to auto workers and saying, "I know that you got paid $30 an hour for that overtime as your contract provided, but I've got shareholders who think that $20 an hour is plenty, and you really need to give me the extra $10 an hour back so they won't be so mad."

And the problem with the bonus contracts is that they were written to reward the wrong behavior. You mischaracterize them when you refer to them as "performance" bonuses. Most of them were retention bonuses, which reward simply sticking around. Some of them rewarded revenues rather than profits. That's why I use the analogy to the baseball player who gets paid for being on the roster for 150 games, even though he hits .187 for the season. He has "earned" the bonus according to the terms of the contract, but the real problem is that the contract rewarded something that had no relation to actual performance. To use your analogy, suppose the bus driver's contract provided that he gets a $500,000 bonus if he doesn't leave to go drive an 18-wheeler instead. If he got into four accidents but didn't quit, he may still be entitled to the retention bonus. He's not being rewarded for great driving; he is being rewarded for having complied with his contract. It is a perfectly reasonable question to ask whether retention is worth that kind of money, but if the bus company was stupid enough to sign a contract like that with him, why shouldn't he get paid for it?

I agree that the Republicans' attitude toward the auto workers in December was despicable; part of the problem with their attitude was their insistence on purveying such crap as the "auto workers make $70 an hour" lie, even after it was proven to have been wrong, trying to mobilize populist anger toward auto workers who are so greedy that they are running their companies into the ground with their outlandish wage demands. Unfortunately, what is consistent here is that the populist anger then, as now, was and is being driven in part by misunderstanding the facts.