22 March 2009

AIG bonuses: capitalist greed or government intervention?

Federal money to incompetent bankers! I share the outrage about AIG bonuses but I am not sure about the logic of the accompanied analysis and the anti-capitalist conclusions. Everybody seems to blame “capitalist greed” (whatever that means). They are all wrong. The culprit for this unfairness is actually anti-capitalism.

Let’s first give the context: AIG, the gargantuan insurer that wanted (and failed) to become a hedge fund was designated as “too big to fail” by the government and received approximately $170 billion of federal money as a bailout. At the same time, it was revealed that AIG paid $165M (or $218M according to Bloomberg here) to 73 employees from the unit that actually made most of the losses.

The critical question that was not raised by anyone (or at least I did not see it raised) is whether the bonuses were actual contractual obligations of AIG. Let me explain: in the banking industry when a bank hires an employee from another bank, it is a common practice to offer minimum guaranteed bonus at the end of the year. The reasons for these bonuses are first to compensate the employee-to-be-hired for the loss of the expected bonus from his previous employer and second to pay a premium for the risk associated with the job change -especially when the new bank is considered “lower” brand in the market.
In the case that these bonuses were actually contractual obligations as it seems, I cannot see any way that AIG could have not paid. Since the government decided to bail out the company, AIG is not broke and it has to honor its obligations to its employees as it did with its obligations to other banks (Goldman, Deutsche et al. received billions from AIG after the bailout).

Now, imagine a world without government intervention in the markets. Well managed banks would indeed continue paying big (but fair) bonuses to successful employess, BUT at the same time the badly managed AIG would have gone bust and possibly(1) no bonuses would have been paid. Let’s then be clear. The reason that bonuses were paid was not any “capitalist greed” but government intervention in the market. In the USSA (United Socialist States of America) where the government decides to intervene in the markets and randomly save some banks, AIG with its third tier financial products unit is alive, kicking and paying ridiculous bonuses to the people that brought it down. These guys now have 200 million reasons to say out loud: “Long live government intervention!”

(1) Note that even if AIG had gone bust, the bonuses could be paid anyway, as employee compensation is usually considered “senior debt” i.e. first in line for payment after the liquidation of assets.

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