Throughout much of the last week, the U.S. media has been obsessed with the bonuses that American International Group (AIG) was planning on paying its executives. Corporate bonuses are regularly scrutinized by the media as a way of the richer getting richer, but these carry with them special weight due to the fact that AIG has received over $170 billion in government bailout funds due to the financial crisis that began last September. With bonuses over $100 million set to be rewarded to executives who have been ridiculed for their incompetence during the crisis, the American people are outraged that some of their taxpayer dollars may go to filling the pockets of Wall Street executives as opposed to people who are without employment or who might lose their jobs in Detroit’s automotive plants.
The government response to the AIG debacle has been one of backtracking on initial promises and overreactions with hurried through Congressional legislation. Chances are that when the dust settles and smoke clears, much of the bonuses will not be paid out. Yet this incident has caused the American public to lose more trust in the ability of the federal government to resolve the financial crisis appropriately and has been a public embarrassment for the Obama administration.
Considering these ramifications, this brief will break down why AIG’s is in such bad financial shape, the response of Washington and the American people to the bonus payments, and what implications these bonuses will have for the American economic and political scene.
AIG Background
AIG was created in 1919 when its founder, Cornelius Starr, entered the Chinese market and was the first Western businessman to sell insurance to Chinese customers. When Communists overran China in 1949, AIG was relocated to the United States and has been headquartered in New York City ever since. AIG is the 18th largest publicly traded company in the world and its main market is in insurance sales. The company is the largest underwriter for commercial and industrial insurance (meaning that it evaluates the risks of people applying for insurance and they determine how much coverage people should receive) and also has a large stake in the global life insurance market.
What precipitated AIG’s fall was the credit crisis of September 2008, which caused its share price to fall by 95 percent. The credit crisis resulted in AIG’s credit rating falling below AA level and when it had to post collateral to sustain its operations with credit default swaps and collateralized debt obligations with its trading partners the company suddenly had a massive cash flow (liquidity) problem. This problem put the company on the brink of collapse and no private investor was willing to come to the company’s aid.
Faced with the prospect of what it would do the global and domestic insurance market, as well as the overall health of the economy, the federal government decided that AIG was a business that was too valuable to let go bankrupt. As a result, the Federal Reserve gave AIG an $85 billion packet in exchange for acquiring 79.9% equity in the company, with the power to not pay stock dividends to other investors.
By November of last year, the federal government was forced to increase its funds sent to AIG to $152 billion and currently the amount of money the federal government has given to the company is $170 billion, constituting the largest government bailout of a private company in American history.
Response to Bonuses
The recent outrage has stemmed from AIG’s decision to pay over $165 million in bonuses to executives of the company based on the company’s 2008 performance. At a time of economic distress, and when auto workers are being told that they need to make more concessions to keep their companies solvent, news of the AIG pay packages have provoked outrage and reignited a debate over executive pay. Extempers who read The Economist on a regular basis note the regularity that publication prints articles concerning the debates over executive pay packages and whether limiting executive pay will cripple the company’s long-term performance. The argument in favor of executive pay packages that are uncapped is that it allows a company to retain great executives and keep their companies running efficiently. Limiting pay packages, this argument goes, would discourage innovation and creativity in the business structure and decrease the incentives available for a high level of performance.
The American people have shown their disdain for the bonuses by calling congressional leaders and some have taken matters into their own hands by protesting at the homes of AIG executives in Connecticut. However, it would be wise to note to readers that the Associated Press (AP) said that the number of reporters who accompanied this protest outnumbers the protesters by a two-to-one margin. Activists are also planning future protests at AIG buildings across the United States.
Seeing these reactions, it is hardly a surprise that Congress has started to move forward in dealing with the AIG bonuses, despite the fact that they are to blame for this occurring in the first place (which will be explained in the implications section below). After hearing about the bonuses, Congress has tried to find a way to get them back, with the solution thus far being to tax the bonuses at a high level. The U.S. House of Representatives has already voted 328-93 to impose a 90% tax on the bonus payments, which still needs Senate and presidential approval. When congressional leaders have been asked what will happen to the other ten percent, they have said that states can get the leftover amounts.
The only problem with the tax strategy is that its constitutionality may be dubious because the U.S. Constitution forbids a bill of attainder, which is a punishment that is inflicted by a legislative body as opposed to a judicial body. For a court to uphold these taxes would be for it to ignore the precise wording and language of the U.S. Constitution and that would open a proverbial can of worms for future constitutional debates. As it stands right now, the anger over the bonuses seems to have cooled in the Senate following reports that $50 million of the bonus money will be repaid and Obama has told reporters that he does not believe such a tax measure is constitutional, bringing up the idea that he may not sign legislation that would impose the tax if it came to his desk.
Implications
The political fallout of the AIG bonuses will linger for some time and could be an explosive issue for Democrats in the 2010 midterms. The major reason this issue hurts Democrats is that they were at the forefront of the president’s new economic stimulus package, a package that they voted for en masse despite it containing a provision that allowed executive bonuses to be paid. This provision killed an attempt by Senator Ron Wyden of (D-Oregon) and Senator Olympia Snowe (R-Maine) that outlawed executive bonus payments from companies that were receiving federal bailout funds. Senate Banking Committee Chairman Christopher Dodd (D-Connecticut) has taken a lot of heat from the recent bonus scandal since he was the one who inserted the provision into the stimulus bill, although he has deflected responsibility back at the Obama administration, most notably at Treasury Secretary Tim Geitner.
Geitner has already taken heat over his failure to pay taxes, the first in a long list of Obama cabinet appointments who were faced with this charge, and does not have many allies on Capitol Hill. His judgment has been questioned and with this latest debacle, there will probably be more resistance on Capitol Hill to Geitner’s future plans for the financial system. Obama’s 2010 budget calls for $250 billion to be used for future bailouts, but with more suspicions surrounding Geitner’s moves in financial markets, there will probably be more opposition to future bailouts, which could impact the future health of the financial system should they become necessary.
Another reason this could reflect poorly on Democrats is that it gives the Republican Party, who opposed the economic stimulus bill, an easily understandable issue that all Americans can relate to. This economic crisis has been difficult for many Americans to understand with credit swaps and complicates securities instruments used by financial institutions. As a result, the Republicans can paint the Democrats as being inept on economic policy and blame them for allowing them to let corporate bigwigs get away with large bonus money in an economic stimulus bill that the party opposed at the outset. While the press ridiculed the party for opposing the stimulus bill, the Republicans may get the last laugh if further economic blunders continue by the Democratic Congress and members of the Obama administration.