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Should we let the AIG bonuses go?

I'm struggling with how we should proceed on the AIG bonus payouts. How much time, energy and money should go into stopping bonuses retroactively when the effort could be spent fixing the problem that allowed this to happen?

A lot of this bonus money has already been paid out. The President and the Treasury acknowledge the difficulty of getting it back. One of their solutions is to have AIG repay it as a condition of the company's fourth bailout -- $30 billion that AIG hasn't received yet. The New York Times points out the flaw in this thinking:

By seeking to link repayment of the bonus money to the coming $30 billion in assistance, the administration seemed to leave open the possibility that the company would effectively be repaying taxpayers with taxpayer money. A Treasury official disputed that taxpayers would be repaying themselves, but could not specify how else the company would give back the money.

Bloomberg commentator Roger Lowenstein has a better suggestion. Renegotiate the contracts:

Pay a very modest portion now and give the employees a chit for the rest to be redeemed later. Employees who are unhappy with such a compromise can take it to a judge. AIG then would have the option of filing for bankruptcy, rupturing the contracts, and putting an end to the derivatives business for good.

The risk of lawsuits could be worth it. The courts might consider the extenuating circumstances here, like the fact that these contracts would be worthless if the taxpayers hadn't bailed out AIG. Another solution - Congress is talking about imposing a 100% tax on the bonuses. This seems like a quick, easy remedy, but it might set a dangerous precedent.

Dealbook's Andrew Sorkin makes a case for just letting the bonuses go. For one thing, he says AIG may need these derivatives people to untangle the mess they created:

So as unpalatable as it seems, taxpayers need to keep some of these brainiacs in their seats, if only to prevent them from turning against the company. In the end, we may actually be better off if they can figure out how to unwind these tricky investments.

Maybe, but where are they going to go? Who's hiring derivatives "experts" right now?

If there's a way to resolve this without spending a ton of money in court or wasting time, I'm all for it. Otherwise, let's focus on preventing this from happening again. The Journal cites a new economic paper that suggests awarding bonuses in "dynamic incentive accounts:"

...top managers' compensation would be placed into escrow accounts that would be invested in company stock and cash. Each month the account would be rebalanced, so if it were 60% in stock, and the company's stock price fell, cash would be drawn down in the account to buy more stock. This would ensure that managers had skin in the company's stock price even after the firm's value fell. And it would take away the common problem of managers' stock options getting repriced lower after a decline, which in essence rewards them for failure.

The IMF just issued a report that says bonuses should be paid out over a longer time period: "An early priority should be to delink bonuses from annual results and short-term indicators."

These are good suggestions because if the President and the Treasury Secretary aren't careful, Wall Street's going to sneak an even worse pay structure by them. The Journal says Citigroup, Morgan Stanley and other financial companies are talking about increasing base pay to work around new bonus limits tied to TARP money. From the article:

Under the forthcoming rules, bonuses could come to no more than one-third of the total annual compensation paid to employees covered by the restrictions. Some compensation experts view the bonus limits as a mistake that turns the notion of pay for performance on its head, despite Wall Street's culpability for the recession and credit crisis.

Then again, it's possible that fat bonuses tied to revenue only encouraged Wall Streeters to take crazy risks. There has to be a way to incentivize healthy success instead of potentially destructive risk-taking.

There seems to be no rational explanation for AIG's derivatives people getting bonuses when the company lost $99 billion last year. But the system in place now allowed it to happen.

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Tax the bonuses! Just from the companies getting a bailout and just for this year, or perhaps next if need be. We need to "de-incentivize" incentive pay. Come up with some formula -- tax anything over 3% of the base salary at 100%, etc., that truly recovers the majority of these bonus payments, across the board, from people working for bailout firms.

Is this 100% fair? No. Certainly some "deserving" people working at the bailout firms will be penalized. But take a look at what's happening in the world -- all over the nation, in every sector, deserving, hard working employees are being laid off at worst, or at best, being asked to take unpaid furloughs or told that there will be no raises this year or next.

So that's the reality we live in, a reality brought about, largely, by the recklessness of AIG and all the other bailout firms. It's not as if these people don't already make a good living. Use our tax policy to help them share a little bit of the pain.

I keep hearing about how a large portion of the bonuses are being given to the people in the sector of AIG that is involved with the Credit Default Swaps that got them into this mess in the first place. Is AIG still producing and backing Credit Default Swaps at all? If they are, do they have a good reason why?

Bryan, AIG is still losing money on Credit Default Swaps, so yes, they're still in that business. They're not creating new derivatives - they're trying to unwind positions and undo very complex agreements. Until that work is done, AIG will continue to be a money-losing sink hole.

The people in AIG's financial unit may be the only folks on the planet that understand the junk they created. If the gov't wants to get this over with, it may need those people to stay on the job, which is why going after the bonus money already paid out is risky, not to mention costly. When this work is completed, the government can shut down the financial unit forever, break up the company and maybe AIG can go back to what it used to be -- a harmless insurance company.

If the AIG people had just one smidgen of class they would decline the bonuses. But high flying lifestyles require lots of money to maintain. Over the years Congress has gotten very good at creating special tax loopholes for very small groups. How about a reverse loophole? Since the payout is in 2009 they still have time to create a very narrowly defined tax such that only these guys would be affected. I'm not normally in favor of confiscatory tax rates but in this case I think 99% is appropriate. To make sure the money doesn't run away in the interim, the President should issue an executive order freezing the bank accounts where the bonuses are deposited.

Scott:

Forgive me if you've mentioned this in a previous blog, but for those interested I recommend the Washington Post three part series on the collapse of AIG by Robert O'Harrow and Brady Dennis, December 29, 2008.

It is fascinating and put names to the marriage of the insurance company with the stellar reputation to new financial partnership.

These risk takers all seem to want to hedge their bets so they can take predictable profits.

The rest of us are trying to avoid poverty in old age. After listening to this all week; I'm becoming hard pressed to figure out how much worse off we would be if we didn't bail them out. If they did go bankrupt who would suffer more? People have lost their homes to banks who will not renogiate. What have they have lost?

I wish that I had a job where I could get a generous bonus regardless of my performance. The idea suggested by a previous poster is a good one. Let the bonuses get paid and tax them at a high rate. Going forward, gains that are the result of complex and risky financial instruments should be taxed at a higher rate than less risky investments. Maybe that would discourage this kind of behavior. Since the government has an 80% stake in AIG, they should clean house and bring in new people. I'm sure there are many competent people looking for employment who will do a GOOD job without an obnoxious bonus.

I think we just have to accept that the bonuses are being given out. It's an outrage, but our hands are tied. Their contracts guarantee bonuses (is it common for people to have contracts guaranteeing a bonus irrespective of performance?) and the law does not prevent the bonuses being paid if the contracts were in effect before 2009.

Since the government has controlling shares of AIG, it should cancel the contracts of top executives, fire them with their golden parachute paid in AIG stocks (valued at the price they <i>would</i> be worth if the sub-prime mortgages had been sound investments), and dismiss the board of directors.

Then the government should elect a new board of directors to appoint new executive officers. The contracts will have bonuses linked to performance paid in stock that will be hold in trust for 10 years and no golden parachutes. (Either that or break up AIG into pieces that are not too large to fail and privatize those.)

Scott,

I work for an AIG subsidiary, they need to get all that money back. Why? Because its wrong. I've heard that there is a plan to pay out another round some say up to a total of $450M, others are saying it will by up to a total of $1.2B.

At the end of last year, the execs told the AIG workers that no one will be getting raise due to the state of AIG. The thinking was that any extra monies would be used to pay back the government.

Then they paid themselves all that money and most of them ran. Those that are left are running the company into the ground. This is a free for all. Meanwhile, the average worker at AIG is going around wondering when they will be laid off.

If the 100% tax bill doesn't pass, then there ought to be civil lawsuits to get it back.

There is no excuse.

This is not reckless, because reckless implies that it was not intentional. Let me tell you, then planned all of this out and they're planning more to come.

Betty, thanks for your viewpoint - it's good to hear from someone who has to work inside this mess. I hope things work out for you personally. The Treasury's current solution of having AIG pay back the bonuses from the funds it is about to receive is unacceptable, in my view. I'm all for taking this to court to extract the money from the people who were rewarded for failure, as a way of sending a message. I just hope we don't take our eye off the most important piece of this. And that is, what are we going to do about your parent company?

Scott, here's the update.

AIG is trying to separate out all of the insurance business by spinning off a separate company AIU (American Insurance Underwriters) with its own stock ticker and everything.

I hope it works out too.

BTW, I heard that in December they had already paid out $155M in bonuses. The $165M is the 2nd installment and there's another installment coming up.

It's sad.

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