5 Lessons From the AIG and Merrill Bonuses

Score one for common sense.

American taxpayers may not have much of a say over which banks get bailout money or what a fair price for toxic derivatives may be, but basic logic is finally winning out when it comes to lavish bonuses.

At AIG, the leadership first said it had no choice but to award $165 million in “retention bonuses” to about 450 traders who oversaw billions in bad deals that basically wrecked the company. Contracts signed a year earlier locked in the bonuses, the company explained. But after an intense public outcry, the traders started to cough up the bonuses, suddenly voiding their own contracts.

[See what’s good and bad about the AIG bailout.]

Merrill Lynch awarded $3.6 billion in bonuses to hundreds of executives, for their work in a year in which the ailing investment bank lost nearly $28 billion. That seemed fishy to New York attorney general Andrew Cuomo, who asked Merrill for the names of 39,000 bonus recipients. Merrill refused, saying bonus details were a “trade secret,” even though it had never treated them that way before. A judge sided with Cuomo, ordering Merrill and parent firm Bank of America to turn over the names.

These bonus pools are peanuts compared to the $2 trillion or more the government will ultimately spend to fix the economy. But it’s a huge moral victory for taxpayers worn out by entitled Wall Streeters who think the rest of America is too dumb to understand their business or vote on how much money they should slurp from the public trough. There are some practical lessons, too. Such as:

Inbred assumptions are often wrong. Edward Liddy, AIG’s CEO, defended his firm’s bonuses in Congressional hearings with a variation on the familiar argument: The bonuses were needed to keep talented people in place to do an important job. This is the usual Wall Street Kool-Aid. “Talent” is regarded as irreplaceable, which justifies spending vast sums to keep it around.

[See the real harm caused by the AIG bonuses.]

The uproar over AIG made it clear that hardly anybody is buying that. So let’s see what happens next. If the “retention” bonuses were needed to retain the only people who know how to fix the problems at AIG, and those experts had to give the money back, then they’re free to quit AIG and work someplace else where they can earn more. Let them. If it turns out those risky derivatives contracts are so booby-trapped that AIG and the government – which now owns 80 percent of the firm – can’t find anybody on the outside able to fix them, then that tells us something else that’s important to know: Nobody should be writing such contracts in the first place. It amounts to wiring the financial systems with explosives, then extorting a ransom for disarming them. Maybe that should be a crime.

Principles matter. In a widely read article, Andrew Ross Sorkin of the New York Times argued that it might be a pragmatic move to let the AIG traders keep their bonuses and continue their work uninterrupted, no matter how odious it seems. The experts most familiar with the risky securities, he argued, would be able to unwind them the fastest, which would ultimately keep the cost to taxpayers as low as possible.

[See what’s so outrageous about the Merrill Lynch bonuses.]

Sensible, perhaps. But think for a minute about America’s longstanding policy toward hostage takers. The U. S. government has made clear over decades (with a few notable exceptions) that it will not pay a ransom to anybody who kidnaps Americans. Pay one ransom, the reasoning goes, and you’ll start a cottage kidnapping industry, with thugs worldwide trying to snatch Americans and make a quick buck. For the same reason, we should have a zero-tolerance policy toward anybody whose job is dependent on bailout money: You screw up, you pay. It might cost more now, but it will cost less later, by discouraging money-grubbers from exploiting government largesse.

Bonuses are bogus. On Wall Street they are, anyway. For most of us, a bonus is an extra payment you get if you do your job well. At some of the financial firms, as we’re learning, bonuses are a way to fatten your paycheck on the sly, with no real connection to performance. Expect this to change, as new regulations require a stronger connection between pay and the actual well-being of the company, over a longer period than just one quarter or one year. But until then, be suspicious about modest-sounding Wall Street “salaries:” They’re likely just a fraction of total pay, once those magical bonuses are factored in.

[See 5 Wall Street fallacies.]

Reckless individuals can’t hide. Nobody notices a few million here and there when there are billions in overall profits. That’s what’s been happening on Wall Street for years. But when the bottom line is suddenly a big bogey, and the feds have to step in, routine overindulgences take on outsized significance. It’s obvious that the Big Men of Merrill and AIG thought they’d enjoy their millions in anonymity, and never dreamed their names would surface in court filings and Congressional hearings. Whoops.

It sucks when the government gets involved in your business. Precisely! So in the future, Ye Masters of the Universe, please keep your companies solvent and refrain from asking for taxpayer help. We’ll all be grateful.