Friday, March 20, 2009

When a 'bonus' is not a bonus

Misplaced anger at AIG

Or... why put the onus on the bonus?

Does AIG really stand for 'Almost In Government?'

Do not view this as a weaselly article in support over overpaid and undeserving AIG 'bonus-getters'. It may seem like that but it is not.

Define a bonus...
A bonus is a payment for a job well done or a payment to workers of a firm who did their jobs 'well' as the firm had a very prosperous year. Most of us think a bonus should not be paid if a firm has a very bad year and loses money- especially not if it is on the brink of bankruptcy and gets a federal bail-out to survive. Still, there is a question for a firm that is well diversified and for employees in some business units who do very well. But their contribution is swamped by losses elsewhere at the firm. That 'bonus' decision is more complicated.

Decision-making when it gets 'complicated'
A private or publicly traded firm without a cloud of a federal bailout over its head, might still pay bonuses in that situation to retain key players for the period ahead. A money-maker whose efforts are swamped by other business units and denied a bonus is sure to go elsewhere and might even command a 'signing bonus' like some baseball prospect out of college. This might even be true of a skilled pro who himself lost a lot money in the current year. But when public monies are bailing out the firm, such payments look much more inappropriate since doing this for the sake of 'the firm' and viewing the firm as a 'going concern' to be protected is a suspect action in and of itself. Moreover at time when so many on Wall Streeters are being let go it's hard to argue such workers could easily catch-on elsewhere. So why pay to retain them?

Rescinding 'undeserved' payouts
Passing a bill to claw back the bonus paid in this environment seems defensible, in this light. You take the step to remove the bonus that never should have been paid in the first place. But should it? Who has the real facts and who is the judge and jury here? Oh Congress? Does that make you feel better???

Bonuses? Were these bonuses?
I began this discussion talking about 'bonuses' and describing what they are. But what AIG 'seems' to have is a set of 'guaranteed payments'. They are not bonuses; they are NOT 'performance related'. Contracts agreed into should not be violated or abrogated in any way without proper due process involving the parties that entered into the agreement. If a firm can be shown to have entered into such a contract illegally that is one thing. But in the case of AIG what it did is more or less standard operating procedure on Wall Street (and I don't mean that in a bad or smarmy way- read on).

Standard operating procedure...
The complication is that on Wall Street, while firms seem to make money, a lot of it actually made by people and NOT by the structure of the firm. Change the people at a firm and you might find that huge blocks of business (and profits) go away. When stock salesmen leave one firm for another they often 'take their book,' their list of clients, and with that goes the business that those clients generate. Think of it as taking your cell phone number with you when you leave Verizon and go to AT&T or vice versa. When you do that, the business you do goes over to the new company. Sometimes they pay you (incentives for joining) for making that switch because they know you are bringing them business, revenue for the future.

So there is a question of where the value added comes from. Wall Street is not an auto assembly plant where you can take out any assembler and stick in another and expect the same result.

Keeping employees 'happy' and 'well paid' is part of the business model for good reason. You can envy them for that or not. But this is common in the world of sales even beyond Wall Street, where sales commissions are earned.

The downside of the downside
By now we know the downside of this 'model.' Employees share the profits, but when things go wrong the firm -and its shareholders- eat all the risk (loss). Granted, this is a 'minor bug' (!) that has to be worked out of the system. But this was the business model. Shareholders have put up with it. So have CEOs but then they profited greatly from it, too.

Another inconvenient truth
Still, the point is this: when a firm like AIG goes bad, its best earners (or "rainmakers") simply leave. Others on the street understand that good people have bad years. Okay really bad years...Okay 'Six-sigma' bad years... Still, when you are out leading a kayaking tour around the shore and a tsunami swamps all the boats and all those in your tour DIE does that make you a bad guide? Now we can debate the applicability of this example and the role of the Wall Street trader in the demise of AIG, but the only issue here is did these AIG employees get retention guarantees (not bonuses!!) or not? If so the idea was to keep them working on the Titanic as it sank to mitigate losses- not to refloat the boat- what is wrong with that? They were not retained under false hope. And hard to believe, the guys probably had other options- the top guys.

Hey, how many baseball players get a juicy contract after having a 'bad year' because someone thinks they still 'got it?' And how much do they make??

Blame the guilty!!
If there is an issue it is with the Treasury providing its funding without finding out if such contracts existed. There should be no sense of dishonor to employees at AIG that received such guarantees. Unless or until we know the particulars of their agreement, there is nothing out of sorts or even inappropriate about those payouts. The SIZE seems a bit excessive in these days. And that is a knock against the management that offered such large retention payments. Ironically, had these employees worked at the best of the best of the best firms on the Street, they would not have made such money this year. So who was it that signed off on such largess? Why didn't Treasury (or the Fed??) know about these contracts? As I said, the existence of these sorts of contracts is well known on the street in bad times. Shame on the regulators!

Bring a new guy who is a producer into a troubled firm at troubled times? You have to give that guy a guarantee. I worked at a large Japanese securities firm at one time as its Chief economist in NY. I never got a guarantee. But as that firm expanded into the equities business amid boom years, it had to pay huge guarantees to employees to get them to leave prosperous established Wall Street firms to go to a start up that had unproved abilities to generate earnings, profits and commissions.

What is wrong and WHO is outraged??
I do not defend Wall Street for what it has done or accept its ways of operating because they are there. There is in fact good logic behind what AIG did but here we have another example of how Size Matters. It's more the scale of the guarantees that seems so wrong for the times than their existence. It's also that Senator Dodd has been a prime recipient of campaign contributions from at least one of those slated to get a huge AIG 'payment'. Are you surprised? So WHO is really outraged here?

Don't sweat the 'small stuff'
This concern about bonuses is a concern about peanuts. There has been no outcry over the billions paid out to Goldman Sachs when the AIG bailout funds were dispersed and money were paid in full when mark-to-market prices would have strongly indicated otherwise... Goldman was paid in full! It had a very special relationship with both the US treasury and the NY Fed at the time. That seems far more smarmy than picking on guys who had guaranteed payments to spend extra time on the deck of the Titanic. Doesn't it?

It's the scale that is out of proportion
It is the scale of the payout at AIG that is at issue much more than the payout itself. So will Congress tax all the guarantees away and open the door of intervention into commerce in all sorts of unseemly ways? A bonus is not a bonus when it gets taxed away. It is not a bonus if it is a guaranteed payment. When you tax away a guaranteed payment that was bargained in good faith by both sides, you are asking for trouble. That is especially true if you were privy to the facts long ago as I suspect many (of the 'outraged') members of Congress really were. Some of these recipients were guys contributing to Senate and House campaign funds. That's what is really smarmy here. No air-freshener in the world will remove the stink that hangs over Washington from this affair.

Get outraged about that and about the BILLIONS AIG paid out to undeserving counterparties. Claw back some that. Okay, be envious of people getting guaranteed pay outs when you don't. Or of baseball players making millions to hit this spinning sphere better than you can or of basketball players with big biceps and strong leaping legs. Some people have a special physical skill, for others it is mental. We need to decide if we are going to be a nation that abides by the rule of law or not. It is up to Congress and the Fed to supervise the deal they entered into when they choose to bail out AIG. Save the sinking ship and you save the rats too.

When someone 'blows it', be sure to blame the right party.

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