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The · Psychohistorian


Wasting millions, or wasting billions?

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I see bonuses at financial services companies are in the news again. I was going to comment on bank bonuses last time around, but procrastinated too long, so I'll take the opportunity now.

To understand the issue regarding banking bonuses, one has to understand how banks operate. At banks, most people get part of their compensation in the form of bonuses rather than salary. This allows banks to ride out interest rate variations, which have a big effect on their income, by reducing bonuses rather than laying people off. That applies not only to the people we normally think of as "corporate officers", like the president and treasurer near the top of the company, but also to working level employees making five figures rather than six or seven. Yeah, in banking parlance, that lady you talk to for a car loan is an "officer", and gets a significant amount of her pay in the form of a bonus.

So when the wags in Washington start criticizing Wall Street "bonuses", banks start keeping a low profile by cutting everyone's bonuses - including that of my wife, who works in the IT department. Not exactly the best way to avoid deepening the recession!

This makes me take the news regarding AIG with a grain of salt. Unlike most of the banks, AIG was definitely mismanaged, but the top people who were most responsible for the mismanagement are already gone. It sounds like the government might just be trying to redirect anger at the bailout away from themselves and towards folks who might well have been managing the parts of AIG that were doing perfectly fine. That's not exactly the best way for a stockholder to behave.

In addition, it seems like some of those bonuses, or perhaps all of them, were already contractually obligated. Asking to cut them is like asking GM to take back last year's overtime pay from their assembly line workers because the cars they made didn't sell well. They had a contract, they did the work according to the contract, so they should get paid according to the contract. If the contract is bad, see if you can renegotiate it, but don't try to violate the 7th amendment takings clause.

Finally, it's to be noted that the total amount of the AIG bonuses in question is only about 1/1000th the amount that the government is spending on bailing out AIG (165 million vs 171 Billion - 171,000 million - which itself is small compared to recent federal bailout spending). If these bonuses are profligate, the government is being 1000 times as profligate by doing the bailout in the first place.

If anyone needs to commit seppuku, maybe it's Sen. Grassley, Barney Frank, and the rest of the "bailout congress".
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On March 18th, 2009 11:16 am (UTC), greyautumnrain commented:
All the talk of ripping up contracts and grabbing the bonuses back in the form or special excise taxes put me in mind of Zimbabwe. It was a hugely popular move when they decided to just take land away from the wealthy white land owners and give it to the poor... Now they've gone from being a food exporter to a country with a food crisis, not to mention their huge economic crisis. There's a reason why we don't just rip up unpopular contracts and take things away from people we think don't deserve them.
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On March 18th, 2009 02:14 pm (UTC), psychohist replied:
Yes. I don't remember if you overlapped with Vittorio Pareto at Devonrue, but he said that Brazil used to be pretty much a first world nation like the U.S. when he was a kid (and in fact that's the way they're portrayed in some older movies). We're used to underdeveloped nations working their way up to developed status, with the Pacific rim providing lots of examples, but it's definitely possible to fall back as well.

Zimbabwe isn't actually giving that land to the poor, though ... they're giving it to the President's cronies, and more recently, the cronies have taken to just seizing it for themselves. In the case of the bonuses, I guess it would go towards financing pork barrel projects like the recent "stimulus" bill.
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On March 18th, 2009 01:02 pm (UTC), twe commented:
I heard on the radio this morning that apparently some of those people agreed to take a salary of $1 for the year in exchange for a guaranteed bonus.
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On March 18th, 2009 03:29 pm (UTC), jdbakermn replied:
How exactly is a guaranteed bonus a bonus? Isn't that just deferred salary at that point? One of the arguments that Psychohist noted for banks giving bonuses is that the banks can reduce the bonuses to ride out interest rate fluctuations.

Or is it just that these 72 (73?) million dollar plus bonuses were the "floor" of the bonus portion of those compensation packages?

Edited at 2009-03-18 03:30 pm (UTC)
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On March 18th, 2009 04:06 pm (UTC), psychohist replied:
That shouldn't be a plural "bonuses" there; the 72 million is a total (for the top 90 or 100 people, I think), as is the 165 million figure (which probably covers a lot more people). No individual at AIG got that amount of money; it's everyone put together.

I'd also note that what I said about banks doesn't necessarily apply directly to AIG, which is more of an insurance company; as I mentioned, the post was originally thought up as a response to the situation a month or two ago where congressmen and the administration were saying similar things about banking bonuses.

I would guess that what twe heard about AIG "bonuses" resulted from a deal where people gave up their salaries in return for a "bonus" at the end of the year of a similar amount. They might have wanted to do that because the bonus pool was already allocated, so bonuses wouldn't negatively affect the company financial statements, while the salaries would have continued to show up as an expense. That's just a guess, though - except the part about the bonus pools already being allocated, which has been reported elsewhere. For all I know, the bonuses might be essentially sales commissions or something.

The bottom line is still pretty much the same: we're talking about taking people's normal paycheck away.
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On March 20th, 2009 12:57 am (UTC), countertorque replied:
I'm not really disagreeing with you, but $72M divided by 100 people is still a pretty nice chunk of change, at least for 1 of them. Maybe 1 guy gets $72M and the other guys all get $5.
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On March 20th, 2009 04:31 am (UTC), psychohist replied:
Well, it can't be $5 because then the other $90 million would have to be split among more than 18 million people, and even AIG doesn't employ that many people.

Still, if they're giving up their salaries as Kate mentions in another comment, an average of $720k for the top 100 people in the biggest insurance conglomerate in the world is actually considerably less than I would have expected. Maybe people at insurance companies don't make as much as at brokerage houses and banks.

I'd also point out that even the burger flipper at Macdonald's makes enough to seem equally exorbitant to most of the people in the world. Tearing down people who make more than you is ultimately counterproductive, and it's disturbing how popular it has become recently.


Edited at 2009-03-20 08:39 pm (UTC)
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On March 18th, 2009 10:35 pm (UTC), twe replied:
"at least 100% of 2007 bonus" was the guarantee in some cases
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On March 18th, 2009 02:23 pm (UTC), llennhoff commented:
This is the problem with doing things in an ad-hoc improvisational way. We're not even really bailing out AIG, we're bailing out its counterparties. If the company had been permitted to go bankrupt, the claims of the workers to the bonuses would have been fairly far down the list of claims against the worth of the company in dissolution. If the government would have nationalized it in lieu of bankruptcy and declared the terms up front I could see announcing that as part of the takeover all contracts would be renegotiated. But this constant free form improvising of 'let's give them money without conditions, and then after they've taken the money try to attach conditions' can't possibly work well.
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On March 18th, 2009 03:53 pm (UTC), psychohist replied:
The second pound of flesh
Agreed about bankruptcy. It's a system designed to handle exactly this sort of situation, that has been proven to work for decades.

I would say the government did pretty much nationalize AIG; they demanded and got 79% ownership in return for extending the credit lines. The government also got their pound of flesh: the resignation of the then CEO of the company. Now it seems they want to go back for another pound.

That illustrates another problem with the political branches - the executive and legislative - handling this sort of thing. They're often more interested in headlines than in actually handling things in a way that actually works. That's another advantage of bankruptcy law: it's handled in the courts, which are the branch of our government least subject to shifting political gusts.
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On March 19th, 2009 08:54 pm (UTC), psychohist commented:
Here's an article with additional details. Basically these are the guys who are trying to keep AIG from losing the Billions the government is lending them:

http://www.washingtonpost.com/wp-dyn/content/article/2009/03/18/AR2009031804104.html?hpid=topnews&sid=ST2009031801503

Looks like a lot of them may be leaving now because of the witch hunt, and the net result may be that AIG fails to pay back Billions of those taxpayer loans.
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On March 26th, 2009 02:36 pm (UTC), psychohist commented:
One more follow up: two French AIG managers have quit over the request to return bonuses, potentially putting AIG on the hook for $234 billion - $234,000 million:

http://online.wsj.com/article/SB123802506167942421.html

Basically the managers resigned after agreeing to return their bonuses. If AIG finds someone to replace them, things are okay - but that might not be trivial for a company which now has a reputation for not paying their people. If they don't, the French government may appoint a manager. That constitutes a change in control under the credit default agreements, putting AIG on the hook for $234 Billion - $234,000 million - of swaps.
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