Two Cents on AIG

I had to run some errands this afternoon, and was in a bit of a hurry. Otherwise I think I would have stayed in the car and called in to NPR’s Talk of the Nation to disagree vigorously with Charles Calomiris, an economist at Columbia University, who argued that public anger with AIG bonuses is an unnecessary distraction and that there isn’t really a strong case for taking away the bonuses anyway.

Three basic things seemed wrong about Calomiris’ position on AIG.

1) Calomiris argued that the public, including himself, are too remote from the AIG situation to judge properly whether the bonuses are deserved or not, and as a result, it’s best to leave the matter in the hands of people within the company, as they know best. In particular, he pointed out, AIG’s current CEO wasn’t in charge when the company suffered its losses, and so his judgment isn’t tainted by that failure.

This is a bad and rather trite kind of defensive argument that can be used to defend virtually every kind of policy or action from public scrutiny. It’s true, of course. In the same way that if I was not present at the scene of a crime, or indeed, if I was not the criminal who did the deed, I don’t truly understand what happened. In fact, many of us don’t even understand our own actions, let alone the actions of others. If Calomiris means to be veering off into the kind of solipsism that makes one unable to judge anything at all, I guess he’s welcome to do so, but there’s no reason to talk about AIG as anything special if that’s the case. But if human beings are capable of making reasoned judgments from a distance, then the AIG case also doesn’t seem special. I think the public knows enough to know that the managers of the London unit deserve no bonuses. Surely some members of the U.S. government should know enough at this point, given that it now owns the company.

2) It’s not too surprising to find out that Calomiris is a fellow at the American Enterprise Institute. But I will be surprised if the day comes when he or anyone else at AEI adjust their general line to accomodate the implications of his remarks on AIG.

Calomiris argued that traders have small base compensation which is topped off by bonuses in order to incentivize them to make more money. Fine. He seemed to have a hard time closing the circle: the flip side of that system is accepting that risk has its consequences. I have no problem with the proposition that AIG’s many accidental counterparties should be saved from risks that they never agreed to or were aware of. I have my retirement funds in a money market account and have for some time precisely because I valued safety over what seemed to me to be enormous risks in other kinds of funds. (Not to brag, but it turns out I had a point.) If AIG’s catastrophic risks had rebounded upon me and others like me, that would upend the entire idea that there is a reasonable way to manage your investment risks in this economy: the 21st Century equivalent of a large empire letting trade caravans be ambushed at will by bandits.

But AIG’s traders should expect to suffer personally for the risks they took. That’s the whole point of accepting a compensation package with a small base salary and a large bonus potential. The moment Calomiris concedes that this is intended as an incentive to perform, he must accept that it exposes those who accept it to risk. He doesn’t, of course. Risk exposure and consequences are for peons. There’s no way to take him or anyone like him seriously unless they announce that they’ve rethought this whole exposure-to-risk thing completely and they concede that it’s a lousy way to run a society or a company.

3) Another apostasy that Calomiris should be confessing to, given his remarks, is a reconsideration of whether labor markets can be left on their own to judge the value or worth of individuals. He argued that you’ve got to leave AIG alone and pay the bonuses because there people there in the London unit who are just too valuable and if they’re denied their bonuses, they’ll probably walk. (Now who’s micromanaging?) Where’s the hard-nosed thinking about labor markets that capitalists are supposed to be so good at?

Let’s say you’re in the London unit of AIG, and you were one of the professionals who oversaw the credit-default swaps that killed your own company. I grant you have a valuable special expertise when it comes to unravelling your own failures, but what’s your market value in general? Let’s go over a few of the relevant points to consider before you quit in a huff and put your resume up on 1) your entire industry is in the toilet and you’ll be competing with thousands and thousands of other job-seekers and 2) your most recent and relevant professional experience is the destruction of your own company in a line of business that is now likely to be treated by global governments roughly the way that Rome treated Carthage. If you’ve got a long history in the business before you were working on credit-default swaps, you’re probably an expensive hire and your old experience is likely not too valuable in a rapidly changing world. If you’ve got a short history, you’ve got nothing else to show an employer that’s worth the trouble of hiring someone whose career now smells like a six-day old whale corpse in the summertime.

So you really want to quit when they don’t give you your bonus? Right now I’d say your only strong value is to the company you screwed up, so if I were you, I’d take whatever they’re offering and suck it up. I shouldn’t have to walk someone with Calomiris’ alleged expertise through this pretty basic bit of economic realpolitik.

Sure, pissing about AIG’s bonuses is populist grandstanding on some level. Beneath the momentary gratification of looking for villains, however, there are some more serious principles at stake. If you’re the kind of person who argued that folks who take economic risks should accept the consequences and that labor markets dictate the value of skilled employees, you should be the first person throwing rotten tomatoes at bonus payments to any managers at any of the bailed-out companies. The companies themselves are the front lines where risk and markets are being tested. But people like Calomiris are in a great rush to punish the innocent bystanders who took few or incidental risks instead, all in the name of “making tough decisions”.

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9 Responses to Two Cents on AIG

  1. fridaykr says:

    I didn’t hear Calomiris, and even if I had, I wouldn’t have considered his argument very compelling. The better arguments I have read for honoring the bonuses–and mind you, I don’t necessarily find these that compelling–are threefold. One, there is a contractural obligation to honor bonuses. Two, the bonuses are needed to retain those responsible for constructing the toxic credit default swaps, if merely because these “experts” are now needed to unwind the house of cards they constructed. (Your points about the likelyhood of AIG employees leaving are well taken.) Three, if these purveyors of credit default swaps leave AIG, they may be able to use their priviledged knowledge of AIG’s swaps to bet against the company, to the wider detriment of the market.

    At face value, these seem like better arguments that than the ones Calomiris was espousing, if only because they attempt to speak to our own interests, not just those of Wall St. or AIG. Unfortunately, I lack the financial background to assess the merits of the above arguments. For example, I would really like to know the extent to which the over $50 trillion in credit default swaps worldwide (obviously not all AIG’s) can only be “unwound” by a select few. I find this hard to believe, frankly. I also need to be shown how, in this market environment, inside knowledge of credit default positions confers a trading advantage that could harm others. Maybe this is true, but someone needs to explain it to me.

  2. AndrewSshi says:

    I’d say that the only real reason for paying the AIG bonuses is the whole contract issue. As annoying as it is, it’s part of a larger Rule of Law thing–the contracts guaranteeing bonuses to the people who ruined the livelihoods of millions are repellent, but then, so is seeing rapists, child molesters, and terrorists get a right to a fair trial. We do it, though, because of the larger principle.

  3. Timothy Burke says:

    I’m a bit curious about the contract argument simply because I wonder why on earth they’d continue to refer to them as bonuses if they were contractually obligatory compensation. I would really like to hear a bit more about the contractual language that is supposedly so binding, if only to confirm much of what I think about the company’s mismanagement. If they (and other firms) have contractual language that obligates them to pay “bonuses” in an absolutely inescapable way, then it’s simply one more bit of evidence that they were all run in a totally boneheaded way.

    Calomiris did make fridaykr’s second argument, that you’ve got to have these specific employees because they’re the only ones who know the full measure of the credit default swaps and thus are invaluable in untangling them. That’s fine, but my point about their marketability specifically holds against that. I hadn’t thought that there would be any mileage in using that knowledge to bet against the company simply because I think credit default swaps of this kind are almost certainly going to be the first major target of new regulation.

  4. Doug says:

    Time to update our Voltaire: “Dans ce pay-ci, il est bon de tuer de temps en temps un financier pour encourager les autres.” More encouragement, please.

  5. AndrewSshi says:

    Oh, there’s no argument that signing a contract to grant ridiculous bonuses is not exactly the soundest of business practices. But this is why the U.S. government, as the majority shareholder in AIG, should use its position to fire the worst offenders, not a reason to void already signed contracts.

    I’m not a fan of the whole “circumstances are changed, so this contract can be voided” argument under any circumstances. Because if it can be used against people who are clearly malefactors, it can also be used against people who aren’t.

    For example, at a certain research university, a few years back the university had agreed to increase the minimum stipend for graduate students over the course of three years as part of a settlement with the TA union. Well, when the university ran into financial difficulty because their stock portfolio (like everyone else’s) had tanked, they said that the promised pay raise had only been a promise to try and raise the minimum stipend if it were possible. At which point the TA union said, “Oh no you don’t,” went to the labor board, and the university very quickly backed down. Now then, the reason that the union was able to do that was because they had a binding guarantee, so that when the university said, “reality has intervened,” the union was able to throw a bullsh*t flag. The happy ending was that we did get our pay raise.

    Now then, I hate to sound like a high school civics teacher on this one, but if you can void the contract for a collection of malfeasant executives at will, then the contract for a collection of graduate students isn’t any safer. I for one do not want to start down that road. And yes, I know I sound like a high school government teacher lecturing on the Bill of Rights. But there’s a reason we have high school government teachers.

  6. Timothy Burke says:

    IANAL, but it does seem to me that there are some real oddities about contracts as they exist in our current experience. For example, I have “contractual” relationships to a wide variety of service providers, and often have to assent to those contracts at the start of service via a EULA or TOS. But the terms of these contracts can be unilaterally altered, leaving the service recipient only two choices: agree to the new contract or cancel the service. (Third unofficial option, as demonstrated with Facebook recently: make enough noise that the provider backs off.)

    Aside from the legal issues, though, it seems to me that our popular moral understandings of contract are as messy and contradictory as moral mapping of debt is. I wonder if anybody has done a good ethnographic study of contract as an idea and practice in the U.S., in fact. For example, there was a recent story about a University of Florida professor who was trying to fight a demand by the administration that she teach an additional class when she was hired to teach a 1/1 load with administrative responsibilities as well. Not surprisingly, the online brickbats started flying, occasioned largely by the idea that her workload was too cushy. Only a few people pointed out that this was a contractual relationship and that it was moral for her to enforce it. But most of the people complaining about the professor in this instance would likely argue that a lot of other contractual obligations in our society are and should remain sacrosanct, not so much as a matter of law but as a matter of moral obligation. Beyond a likely consensus that you can’t contractually be bound to perform illegal actions, I suspect there’s a really messy popular landscape around what contracts are and should be in moral and social terms.

  7. fridaykr says:

    Contracts often exist where there are asymmetries of power, say between an employer and employee or between a provider and customer. Some may assume that a contract is used to protect the weaker of two parties and that the value of a contract lies in the consequences that ensue when a contract is violated or abrogated.

    However, it seems like in many cases the asymmetries of power have grown so large, and the ability to delivery meaningful consequences has diminished to such a degree, that many contracts have ceased to function in a meaningful way. To take your example of contracts with service providers, I have often felt like such contracts are meaningless; if a provider doesn’t honor its contract, what recourse do ordinary citizens really have? Even in cases where failures to honor contracts are probably illegal, the resouces needed to obtain recourse are prohibitive for many individuals.

    AIG should use this logic. If contracts by definition favor one part over another, AIG could decide not to honor its contracts with its employees who received bonuses, and let such employees decide whether it is worth their while to go public and sue.

  8. marc_london says:

    I agree with the comments above regarding the importance of honouring contracts out of respect for the rule of law but i seem to recall that Obama specifically said that these bonus will be clawed back through any LEGAL means possible.

  9. Timothy Burke says:

    Legal realpolitik as practiced by corporations certainly follows fridaykr’s observations in many many other circumstances. Companies frequently bring lawsuits on intellectual property concerns knowing that the party they are suing cannot afford to contest the issue. Companies take actions of all kinds that are at least legally contestable when they judge that the other party doesn’t dare pursue legal redress.

    I don’t approve of that conduct, but what’s fascinating is that people like Calomiris who otherwise would condone doing business in that way are suddenly stricken by it.

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