19th March 2009

Prioritizing our Outrage (A.I.G and Jon Stewart)

There have been several reasonable articles pointing out that our anger about the A.I.G. bonuses, while probably justified, is probably not the best thing to be spending our attention on now. The A.I.G. bonus thing represents a mere $165 million amid trillion dollar outrages. As Planet Money (one of my favorite news sources lately) points out, shouldn’t the President and Treasury officials be focused on the bigger issues?

Besides others point out, these contracts, while probably inappropriate are contracts, and isn’t preserving the soundness of contracts more important than lashing out against these people?

Before I get to my main point, I’d like to go over a few pieces of this situation-

  • It seems like these contracts were created in the time right during the collapse of A.I.G. before the government really stepped in. One can assume that the people inside knew by that point that something was horribly wrong and that it was likely the government was going to step in to help. From what we know right now (including that the current CEO says that he had no wiggle room to adjust the results) the contracts seem unduly beneficial towards the employees. Fred Wilson wrote a bit about bonuses yesterday and it just seems unheard of to be creating contractual bonuses that don’t seem in any way related to actual performance, are short-term focused (in industries I’ve worked, retention compensation gets paid out over a period of you staying for 5 years), etc. The problem is due to the amazing lack of transparency, we don’t know the details of these contracts yet or how they got created or who they were given to or how those people performed, but presumably that is what Cuomo is trying to find out. But it seems suspiciously like a bunch of guys, all with one foot out the door gave each other binding sweetheart deals in the moment before the government stepped in.
  • I think it IS totally appropriate to shift some of the attention to how well these guys have performed rather than their personal payouts. The fact that they have been spending the bailout money to resolve the companies obligations with their trading partners is not a problem- in theory, that is what the bailout has been for. But the reports are (again, with little real data, amazing lack of transparency given the situation, etc, etc), they have been cutting the worst possible deals and basically just handing over huge sums of cash to the other folks in the industry. Many of these positions were insurance on various bond offerings, where if the bond offering failed, A.I.G. would cover the losses. But what I’ve read is that A.I.G. is paying out cash at 100% on the $ for these even in cases where the underlying bond is still fine. The analogy someone said was you buying fire insurance, and then the insurance company paying you off 100% even though the house didn’t burn down.
  • The above together look like a bunch of guys who are not working in the interest of the company that pays them, or the shareholders (the tax payers) but rather cut themselves a sweet deal and are now handing out wads of cash to the very folks that are likely to be offering these individuals their next jobs.

The $165 million in bonuses itself isn’t such a big deal, but for the recovery of the financial system to work, the people of the United States have to feel like we can actually trust the people fixing stuff to work on actually fixing it, not starting more fires.

Which leads to the biggest point and back to Jon Stewart vs. Cramer. I feel increasingly like a good chunk of the current world financial system is just a big scam. If you want to look at the “big picture”, ignore Madoff and his Ponzi scheme, and consider that it looks like a big chunk of the financial industry is fundamentally corrupt and using their ability to hide what really goes on to collectively scam the whole of society. Let me stop for a second to point out that there are tons of people in the financial industry that are hard working competent people who are just doing what they can to provide access to capital, create markets with fair price discovery, and provide safe places for people to invest their savings. But the Stewart / Cramer confrontation just highlights the overall big picture that just about all the big firms (Lehman, Goldman, Citi, A.I.G), and a big chunk of the financial media were all participating in this system that wasn’t about a well functioning market but was rather about coming up with some scheme to make .5% return on some obtuse derivative and then leverage it 60-1 into real money, and meanwhile go hype up some rumor on some stock (Cramer tries to blame the shorts, but there is just as much or more artificial boosting stocks for people who are long).

And all of this was fueled by two key elements- a system that was fundamentally non-transparent, and short term compensation. The industry worshiped the notion that a good hedge fund (or private trading desk at a big bank) would come up with some proprietary system and would then do their trades with tons of different counter-parties so that no one could catch on to the system. But this also meant that there was no way for people to judge risk, no way to judge market saturation to the point of illiquidity (assuming that the “system” didn’t rely on creating illiquidity in the first place to in effect corner the market on some obscure derivative which often backfired for example in the cast of LTCM).

And that brings us back to the $165 million in A.I.G. bonuses. $165 million is nothing compared to the $10+ trillion Ponzi scheme that we fear we are all wrapped up in. But the reason that it IS important is that it does represent that the heart of what has gone wrong all along is still happening- short term windfall compensation and financial dealings that are not looking out for the interests of the right parties. It represents the erosion of fundamental trust in the system. It represents the fear that we won’t be able to fix things without a major overhaul, that the core DNA of Wall Street, and many of the people that work there are fundamentally out of touch with what we need to maintain a stable, functional financial system that actually meets the needs of society.

As one last point, I’ll say that I am concerned that the reaction of government in trying to fix this is going to be the wrong one. There is too much of a temptation to just create a bunch of regulation saying that you can’t do this, you can’t do that, and those kind of regulations will never keep up with the market and will strangle legitimate dealings. Back in September I suggested radical transparency for the financial industry and the more this crisis has progressed, the more convinced I get that it would really represent the best solution (hey, even Wired jumped on my bandwagon). If the deepest current problem is a trust issue, this kind of switch to full transparency becomes the only cure. The financial firms that rely on some proprietary trading scheme aren’t going to like it, but those don’t actually add to society- they just leach off it with very real and painful external costs (bailouts when they fail).

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