AIG and the cost of the bonuses

You have to admire the chutzpah of American International Group. It took nerve for AIG to spend nearly half a million dollars last year feting senior managers and salespeople at a swanky resort days after its initial $85-billion federal bailout. Since then, the company’s brazenness has grown along with the government’s aid, which now exceeds $170 billion. AIG was slated to pay $165 million in “retention” bonuses and other rewards by Sunday to 400 workers in its financial services unit. This blue-ribbon group sold a type of insurance on complex mortgage-backed securities, a bad bet that would have bankrupted the firm had it not been rescued by Washington.

The bonuses quickly became a political hot potato, which the administration handled as deftly as it has other elements of the financial crisis: It stumbled over the news and then spent a day trying to regain its footing. Officials claimed that Treasury Secretary Timothy F. Geithner had browbeaten AIG into trimming its awards to top executives, but said there was little they could do about the retention bonuses because the company was contractually bound to make the payments. As outrage built on Monday, President Obama declared that the administration was determined to block the bonuses, with aides pledging that the White House would seek reimbursement for excessive payments through a pending $30-billion loan to AIG.

There are at least two lessons in this episode for policymakers. First, when Washington saves a company from bankruptcy, it interrupts the painful but necessary process of restructuring a failing firm. Had Washington allowed AIG to slide into bankruptcy in September, a federal judge would have been empowered to cancel the bonuses regardless of contracts. We’re not prepared to argue that the feds should have let AIG fail, but we’re still waiting for the administration to clarify the circumstances under which a firm poses so much risk to the financial system that it cannot be allowed to fail.

And second, although it’s good for firms to pay employees based on their performance, AIG and many other financial industry players rewarded short-term successes with no regard for the long-term outcome. That heads-I-win, tails-I’ve-already-banked-my-bonus mentality is changing under pressure from shareholders and some enlightened boards of directors, which has led some Wall Street firms to eliminate the perverse incentives in their pay structures. We don’t like the idea of the federal government dictating how a private company pays its workers, but when tax dollars are keeping the company’s lights on, the least Washington can ask for is some humility in the payroll.