Sunday, March 15, 2009

Learning from Those Big AIG Bonuses

Ok! I get it. I get it. The Obama administration is trying to preserve the American financial system by NOT fully nationalizing AIG, Citigroup, and other zombie institutions.

The problem from the Obama point of view is that most financial institutions were invested in the mortgage-backed securities and credit default swaps of companies like AIG. Why not? They were all under pressure to produce big profits and all this stuff looked like easy money. So, they all got in. Now, Goldman Sachs and I would think all kinds of hedge funds, pension funds, and mutual funds would go down the bankruptcy toilet if the government nationalized AIG and Citigroup and then sold their financial assets.

And that would wreak even more havoc on the whole global economic system.

Like I said I get it.

But there's been a big price to pay.

The $165 million, $450 million, or $1.2 billion that AIG is paying out mostly to people in the Financial Products Division that lost perhaps hundreds of billions of dollars illustrates one of the fundamental weaknesses of the Obama approach.

It leaves the toxic business culture of American financial institutions in place.

The 10, 50, and 100 million dollar bonuses available to financial services executives are a significant factor in the current crisis. With huge bonuses out there for the taking, executives at companies like Bear Stearns had a juicy incentive to make the kinds of speculative, high yield investments that could lock in the big profits for the company and get a nice bonus slice for the account executive. As the housing bubble inflated, the men and women who got in and got in big got all the bonuses and all the promotions while the guys who were cautious got fired.

The Darwinism of Speculation--I imagine that's how people like Alan Schwartz of Bear Stearns and John Thain of Merrill Lynch and million dollar redecorations got to the top.

What the big AIG bonuses show is that these kinds of people are still dominating office culture at AIG and are probably still dominant at other companies as well.

If the Obama administration had fully nationalized, most of the people and most of the business culture of the financial industry would have been flushed down the toilet in the wave of bankruptcies.

The collateral damage to the economy might have been too much, but caution and prudence would have ruled the day.

Now that it looks like many of the financial industry people and a lot of the speculative business culture are going to survive, it seems likely that the pressure toward big-time speculation is going to start re-building as executives look for ways to start earning big piles of bonus cash again.

The best thing the Obama administration can do now is double down on financial industry regulation as the most effective way to impose caution and prudence.

Obama can start by writing legislation to outlaw the kinds of mandated bonuses that are written into AIG contracts. If AIG contracts require millions of dollars in bonuses for certain levels of sales, they are encouraging toxic levels of speculation and putting the whole economy at risk for crashing.

Those kinds of contracts should be banned.

The pervasive abuses of the federal government bailout by the financial industry are certainly outrageous and the AIG bonuses should be cancelled.

But the abuses should also be seen as a learning opportunity for the Obama administration as it figures out the best way to regulate the financial industry in the future.

One place to start would be executive bonuses.

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