Bonuses and the peril of Congressional hindsight
27 March
Which matters more to you?
- Anger at failed AIG executives who are receiving bonuses while their employer is being bailed out by the taxpayer.
- Fear of what this or a future Congress might do once they cross the line and start breaking contracts retroactively for people who are politically unpopular.
There are few more unsympathetic figures than a failed AIG official receiving a large bonus. You couldn’t design a more politically unpopular situation if you tried. Yet I am more afraid of what Congress will do, now and in the future, if it crosses the line into forcing retroactive changes to contracts between private parties. I know of no way that Congress can change the law to address their political problem that does not also do tremendous policy damage. I think they’re fundamentally irreconcilable goals, and policymakers have to choose.
As a policy matter, this is a no-brainer for me. Hindsight is not an appropriate basis for evaluating a contract, and Congress should not change the rules of the game retroactively. When two parties reach an agreement, they are bound by honor and the law to fulfill that agreement, no matter how unpleasant it may later seem, and no matter how conditions or circumstances change.
The House lost track of time. The AIG bonus payments were determined pre-bailout, and are being evaluated by elected officials post-bailout, when circumstances differ. If allowed to grow, this hindsight is perilous for all participants in our economy. Who knows if you will be Congress’ next target for retroactive legislation?
Our economy relies on millions of voluntary contracts made every day. We can borrow, lend, make future commitments, and buy and sell risk because we know that a deal is a deal. The government has an obligation to enforce those contracts without prejudice, not to apply their own judgment to those contracts after conditions have changed. Government’s job is to set the rules by which the rest of us operate, not to change the rules mid-stream so that their favored party can win. Full stop. Our system of contracts must protect everyone, including politically unpopular greedy failures.
The House’s behavior makes the U.S. a less attractive place to invest. In passing a bill to retroactively tax bonuses and even cash compensation for employees in firms receiving taxpayer funds, the House behaved like the Venezulean or Russian government. Replicating that bad behavior would sacrifice one of America’s core economic advantages: a stable and predictable system that respects the sanctity of contracts. A deal is a deal, especially when it later looks like a bad deal to one party. Congress needs to respect and enforce that, even when it’s politically unpopular. This is a pillar of our economic system that must not be damaged. Domestic and foreign investors have historically incorporated an extremely low political risk premium to investing in the United States. This kind of behavior increases that risk premium, making investment in America more costly and hurting American workers in the long run.
I believe that government should not set rules for compensation. That’s for you and your employer to work out. Compensation incentives, whether they’re commissions, bonuses, or merit pay, modify workers’ behavior. They reward and incent hard work, innovation, and greater productivity. Employers use them because they are effective at making their workers and firms more successful. They should be legally free to do so however they see fit to make their firms successful.
Finally, the House-passed bill fails to recognize that there are good, hard-working, and successful employees in failing and struggling firms. The management of these firms needs to be able to reward success on the individual level, even as the firm struggles to break even. I am not arguing that they should be prospectively rewarding employees who have failed in the past, but instead that they should have the right to offer incentive pay going forward to those who help the firm recover and succeed. The House bill paints all employees at firms receiving taxpayer aid with the same broad brush, inappropriately grouping them with the subset that caused the firm’s problems.
The House’s policy failure was broadly bipartisan. 243 of 249 voting House Democrats (98%) voted aye, while 85 of 172 House Republicans (49%) voted aye. I offer my compliments to the 6 House Democrats and 87 House Republicans who took the political risk and voted no.
The mob mentality appears to be subsiding. The House acted with passion and reckless abandon, using the tax code as a punitive political weapon against an unpopular foe. It appears the Senate may kill the bill through inaction. The Senate is good at that.
I fear, however, that further riotous behavior is just around the corner. There are other struggling financial firms and auto manufacturers receiving large taxpayer subsidies. It won’t be long before a demagogue finds another politically noxious example. The Congressional mob will then return, angrier than ever, and they will again try to act. I fear what Congress might do in such a scenario. I hope the Obama Administration is preparing for this scenario, substantively and legislatively.
I would also hope that managers would understand that employment contracts that reward failure, or appear to do so, cause tremendous political pain to elected officials. The AIG bonuses are one example. The CEO who “resigns” and garners a news story that he is “leaving with $___ million in deferred compensation and other benefits” puts those Members of Congress who embrace free market economics in an untenable position. Even if those benefits were legitimately earned long ago, the optics of receiving them after the failure are just horrible.
If the only possible cure to the frustrating situation of failed AIG executives receiving bonuses is for Congress in effect to rewrite past contracts, then the cure is worse than the disease.
President Obama meets with the CEOs of several major banking firms Friday. I was responsible for setting up many similar meetings with President Bush, and I’m certain that the White House staff have carefully planned the President’s public message coming out of that meeting.
If you had to write three talking sentences for the President to say to the TV cameras after meeting with the Banking CEOs Friday, what would they be?
Alternately, if you were one of those CEOs, what 3-4 sentences would you like to say to the President about this issue? Remember, you’re talking to the President of the United States, so please keep it professional and respectful.
I’ll post the 2-3 best answers I get to each question, including those from a different perspective than mine.
Related Posts
(best matches are listed first)- Understanding the GM bankruptcy
- Auto loans, part 3: the Bush approach
- Rose Garden Statement by President Bush on the Economy
- Auto loans, part 2: options for the President
- Auto loans, part 5: The press forgot to ask about the cost to the taxpayer
- Dr. Goolsbee gets it wrong on the auto loans
- Auto loans: a deadline looms
- Address by President Bush on financial markets
I enjoyed your posts on the auto industry situation, but I'm wondering if your view on the necessity of changing the terms of UAW contracts (including bargained-for retiree benefits) is not inconsistent with the views about the sanctity of contract expressed above.
Why is it okay to lean on blue collar auto workers making 70k a year building things, but not paper shufflers making 700k?
I'm not sure that its never appropriate to retroactively change employee contracts. Couldn't the US government have originally made it a condition of the bailout that all employees must give up their promised bonuses? AIG would have been free to decline the offer, but of course it would be the only option to stave off bankruptcy. A prospective buyer of a company is free to set such conditions, and the employees would have no room to argue since without the bailout AIG would have been bankrupt and the workers may not have been paid anything at all.
But I agree with you that Congress can't change things now, as the workers stayed on the job on the understanding that the bailout had not altered their promised bonuses. If they had known back then that they weren't going to receive bonuses, many would have quit.
Were compensation issues discussed at all back when AIG first got government money?
Your post implies that all AIG bonus recipients (and others covered by H.R. 1586) were culpable in the company's financial implosion. I've not seen any facts supporting this, and in his now-famous op-ed in the NYT, Jake DeSantis asserts otherwise. Oftentimes a company pays retention bonuses to keep its "best" people to clean up the mess made by others. This is an important question independent of economic, financial, constitutional, and ethical questions. It is extraordinarily counterproductive to direct populist anger at those who agreed to stay on to, in effect, save the taxpayers money. Like DeSantis, they may simply quit and leave less talented people behind (probably at the Treasury Department) to figure it out.
I have four blog posts on the AIG bonus issue, and its incentive effects, at http://neutralsource.org. I address the purposes served by bonuses and the statutory reason they are tax-favored; the text of H.R. 1586, and its implications; the awful tax implications of returning bonuses; and the incentive effects H.R. 1586 may have on the Treasury Department's new public-private investment partnership. In particular, H.R. 1586 signals to prospective investors that if they make "too much" money — a term to be defined after the fact — Congress may expropriate it.
I agree that when two parties reach an agreement, they are bound by honor and the law to fulfill that agreement. I don’t believe contracts should be retroactively rewritten, but how about the notion of suing for breach of contract as some have suggested. If there are no stipulations within these contracts regarding specific performance measures for these bonuses then shame on everyone. If there are, clearly those performance related provisions have not been met in most cases and could be called into question.
That's a fantastic question. I'm uncomfortable with the U.S. government negotiating with labor, or any other stakeholder in one of the firms, for that matter. We structured the auto loan negotiations as US Treasury <–> management of the firm. Then there were separate discussions like mgmt <–> labor, and mgmt <–> creditors. The loans that President Bush extended placed a requirement on management: make your firm viable or else repay the loan. We did not tell the firm HOW to make the firm viable. That's up to management, and so I think it's consistent with my contracts point.
We did lean somewhat, though, in that we set up "targets" for the mgmt <–> X negotiations. Management was not required to meet these targets, but would have to explain why they thought the firm would be viable without meeting the target. That lean is in tension with my contracts point, but I don't think it's an overwhelming conflict. Others might disagree. As I mention elsewhere, policymaking is messy.
Thanks for commenting.
It may have gotten messier today: the NYT reports that Obama showed Rick Wagoner the door.
You highlight the point that is the club that every member of Congress and Treasury should be hit over the head with. Somewhere along the way, and I suspect at more than one time, they could have told AIG, "no more dough until something is done about these bonuses." That Congress sat on its hands, and indeed dropped a provision addressing this issue, in the February stimulas package negotiations should be the outrage. We have nothing but spines of jelly and Milt Milquetoasts in Congress. All of them punted, hid behind the skirts of faux outrage, and allowed some seemingly responsible AIG employees–and their families–to be vilified and even threatened with physical harm. It's a disgrace.