Saturday, March 21, 2009

AIG bonus update

I now feel a bit more knowledgeable about the AIG bonus situation than the last time I posted about it, so here are some follow-up thoughts:

1) Words sure matter. If they hadn't called these things "bonuses," obviously no trouble. The underlying situation seems to have been as follows. These guys were getting what I'd call fake or misdirected incentive compensation. Fake in that, as we actually learned in the event, if the payoff from the incentive payments disappeared they would simply be compensated in some other way instead. So to a degree it was, as usual, "heads we win, tails you lose." Once there were no profits from their trading to share they simply got paid a flat fee instead. That said, I gather the salary cut they got was more than 50%, so there wasn't zero "incentive" element. But of course the incentive was misdirected even insofar as they actually faced variance, since the profits they shared in were akin to that from insuring 100% of New Orleans' hurricane risk before Katrina and hence taking home lots of money each year until it hit, whereupon the company got wiped out without actually being able to pay on its customers' insurance claims. Not a great incentive structure to induce people to pretend for a while the company is making money through these things.

2) Given the fixed pay they were receiving in lieu of "incentive" pay, there really was a retention element. Specifically, rather than getting paid more regularly they'd have to stay around for several months at a time in order to get their pay for the period only when it was over. So in that sense it wasn't really a bonus, so much as a plan to make them stay on instead of quitting sooner to get the salary they were otherwise earning (which wouldn't otherwise have been called a bonus, hence eliminating the entire political blowup).

3. Why pay these guys to stay? Who'd want them? What could be their opportunity cost of staying given (a) what they had done and (b) the down economy in financial services especially. I gather there actually is a decent answer to this question. While it's hard for me to judge how hard it would have been for someone else to unwind the AIG positions, these guys had economic value to other employers until the unwind was completed, for the simple reason that, having constructed the positions, they knew what the positions were. Someone who wanted to squeeze AIG (or rather the federal government) on the other side of the transactions could have made money off knowing just what the positions were. Or at least so I'm told. So by this light it was prudent to pay these guys something to stick around so they wouldn't quit and use their knowledge to help someone else cash in (along the lines of Long-Term Capital Management, which got hosed in the unwind some years back partly because counter-parties had figured out their positions and knew they had liquidity needs that would make them sell right away for whatever they could get in a thin market.

So there's underlying bad behavior at various levels here, but arguably the bonuses (a) weren't really that and (b) were worth paying from the government's position. Though I should stress that none of this interpretation is based on my own personal & direct knowledge - it comes rather from what I've read and heard, so in legal trial terms it's hearsay.

4. I gather that the blowup over the "bonuses" is already creating extreme reluctance by private parties to participate in ongoing and new government bailout programs that might subject them to similar firestorms in the future. Then again, given the extremely dim view that many have, for example, for Geithner's new bank bailout program (e.g., see Krugman here), maybe that's not as bad as it sounds. Suppose it forced the adoption of better-conceived bailout policies.

5. The 90% tax may conceivably face a serious constitutional challenge notwithstanding Larry Tribe's assurances to the contrary. Not a surprise, perhaps, as Tribe can be a bit political in his bottom line constitutional judgments. One source of possible trouble could be a NY state case from a few years back, Pataki v. Con Ed, in which a provision denying rate adjustments to the Con Ed shareholders for the blunders that had led to the Indian Point nuclear power plant problems was struck down as a bill of attainder. Obviously, the 90% tax is being drafted with an eye to avoiding the same fate, by causing it to apply more generally. But in the Con Ed case, the court cited legislative history showing that the legislators were specifically angry at Con Ed for its bad deeds and wanted to inflict punishment (hardly unreasonably, but that's not the point when the question of law is bill of attainder). Needless to say, the record of enactment for the 90% tax (if it goes through) is hardly lacking in evidence that the legislators were specifically interested in nailing AIG. Not to say that this is necessarily fatal, and it is presumably being drafted with a keen eye to the problem, but there's precedent for treating the clear intent as adverse evidence on the constitutionality question.

3 comments:

fish said...

A lot of folks in my circle are hemming and hawing about the constitutionality of retroactive application of the proposed 90% tax. My guess is that this is more a of political problem than a constitutional one. Your thoughts?

Daniel Shaviro said...

I tend to think the retroactivity is constitutionally okay. For example, Clinton's "retroactive" tax increase for 1993 (since it was enacted after Jan. 1 but applied for the whole year) was unproblematic. Any problems with this tax, compared to the 1993 story, strike me as more in the bill of attainder than the retroactivity area.

Bill Gentry said...

Dan --

Thanks for clarifying the language. I, too, had gotten caught up in interpreting "bonus" in terms of a profit share in an incentive contract. In this context, "bonus" seems to apply to the year-end payment even if the contingency is just staying with the firm. The rationale is much like vesting requirements in employment contracts. Would the public outrage be the same if the payments were labeled "delayed, vested salary"?

As anyone who has hired a contractor to work on a house (and as I learned from personal experience), it is always a good idea to make sure the last payment on the contract happens after the work has been completed. Thus, the back-ended compensation contract could make lots of sense in this area -- those who built the contracts need to stick around until completion.