The Upside of Anger

The $165 million in bonus payments sent out in mid-March to executives and traders at AIG's Financial Products subsidiary (also known as AIG FP, or the people who tried to bankrupt the world) is an "outrage," President Barack Obama has said. His top economic adviser, Larry Summers, called the AIG saga the "most outrageous" of the current financial crisis. "It's an outrageous situation," agreed Senate minority leader Mitch McConnell. His House counterpart, John Boehner, said the Obama Administration's handling of the AIG mess was "outrageous." Senate Banking Committee chairman Chris Dodd claimed to have warned Treasury Secretary Tim Geithner that the bonuses would be met "with an unprecedented level of outrage."

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It's heartening to see that at a time when so many things — credit, confidence, consumer demand — are in short supply, our political leaders are still able to muster such bounteous supplies of outrage. Outraged people often do dumb things, though, and my initial reaction to the many declarations of fury was to roll my eyes and mutter something about this being a trivial distraction from the Important Things we need to be dealing with. (I suspect that similar sentiments on the part of Geithner and Summers largely explain their politically tone-deaf handling of the bonus affair.) (See 25 people to blame for the financial crisis.)

Then I reconsidered. A Wells Fargo sales trip to Vegas — to name another recent, and recently canceled, source of Washington outrage — is a triviality. The AIG bonuses, on the other hand, are emblematic of the heads-I-win-tails-you-lose nature of Wall Street pay. This incentive structure was a major cause of our current crisis. It is an Important Thing, and the danger in the current Washington frenzy to do something is not that it will go too far but that it won't go far enough.

The AIG bonuses were retention payments promised early last year, when it was clear that London-based AIG FP was in trouble but not yet apparent that its parent company wouldn't survive without $170 billion (and counting) in taxpayer aid. Without that aid, AIG would have gone bankrupt in September and the bonus promises would have been torn up. AIG was not allowed to go bankrupt because Lehman Brothers had just failed and the people at the Treasury Department and the Federal Reserve worried (with reason) that another failure — in particular, the failure of a firm that wrote default insurance for banks around the world — might wipe out the global financial system and unleash an economic catastrophe far worse than what we're going through now. In short, the people at AIG FP, the very division that wrote the default-insurance contracts that dug AIG into such a hole, got their bonuses by holding the global economy hostage. (Read "How AIG Became Too Big to Fail.")

That is outrageous. But it's not any more outrageous than the even bigger bonuses paid out in past years to the masterminds of the AIG FP mess who no longer happen to work there. Slightly less so, in fact: the remaining AIG FP employees are being paid essentially to work themselves out of jobs by winding down all the unit's contracts. It's an awkward situation that means at least some of them probably would have gotten retention pay even in bankruptcy.

Members of Congress are talking up bills to levy a 90% or 100% tax on current bonuses at AIG and other financial-industry wards of the state. But if such selective tax increases are constitutional — and it appears that they can be — another approach would make far more sense (I am brazenly stealing it from financial blogger Steve Randy Waldman): impose a less punitive (50%?) but retroactive tax on the past four years of bonuses above a certain amount ($1 million?) paid out by any financial institution that receives a bailout. That is, spread the net wider to catch the real culprits, and use tax policy to change incentives in the financial industry forever.

The retroactive tax would hit people who had nothing to do with the bets that pulled their firms under — but that's not all bad, because in the future it would give executives reason to keep a close eye on risks being taken elsewhere in their companies. Yeah, there are complications — the main one being that lots of highly paid employees of AIG, Citigroup and the like are overseas and not subject to U.S. taxes. But it's worth a try. If nothing else, it would give the outraged American electorate the sense that the responsible parties are paying for something closer to their fair share of the financial bailout. Which would allow us all to get back to the Important Things that Larry Summers and Tim Geithner (and I) would rather focus on.

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