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03.17.2009

Andrew Ross Sorkin Explains

Today's New York Times features a fascinating front-page article by Andrew Ross Sorkin, entitled "The Case for Paying Out Bonuses at A.I.G.". Sorkin argues that if we do not pay $165 million in performance bonuses to executives at the failed insurer, we risk chipping at the very foundations of the rule of law:

If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

As much as we might want to void those A.I.G. pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is. Business agreements of other companies that have taken taxpayer money might fall into question. Even companies that have not turned to Washington might seize the opportunity to break inconvenient contracts.

If government officials were to break the contracts, they would be “breaking a bond,” Ms. Meyer says. “They are raising a whole new question about the trust and commitment organizations have to their employees.”

It may be worth recalling why taxpayers now own 80% of American International Group. AIG's business model for the past few years was make expensive promises about the creditworthiness of third parties. In exchange for a fee, AIG would guarantee to pay you in the event someone else defaulted.

When those third parties began to run into trouble, AIG discovered that it actually couldn't meet its obligations. Without massive government assistance, the company announced, it would have to start abrogating contracts left and right.

This is nice work if you can get it. I personally would also like to offer insurance on the creditworthiness of large corporations, backed by the full faith and credit of the U.S. Treasury, and I bet I could do it at lower rates than even AIG. In fact, if readers will PayPal me the money, I will happily insure the creditworthiness of any listed or unlisted corporation for one penny per dollar per year.

As we computer programmers put it, if it doesn't have to work, I can make it run as fast as you want.

When a small company does what AIG did, it is called 'fraud' and people are sent to jail. However, since AIG had signed contracts with most of the biggest financial institutions in the world, it instead received a very large sum of money ($170 billion so far). This also makes sense. When a teenage kid breaks your storefront window, you chase him down and give him a pounding. But when the local mafia breaks your window, you sweep up the glass and make sure to increase the heft of your next monthly envelope.

Mr. Sorkin is now arguing that contracts AIG signed with the financial "brainiacs" who bankrupted the company also need to be honored, however distasteful it seems to us.

This makes it particularly instructive to read an article of Mr. Sorkin's from three months ago, discussing the future of General Motors, in which he advocates that the company be taken into bankruptcy so that its contracts with "gold-plated" employees can be renegotiated, or nullified:

G.M. currently employs about 8,000 people who actually don’t come to work. Those who do go to work are paid about $10 to $20 an hour more than people who do the same job building cars in the United States for foreign makers like Toyota. At G.M., as of 2007, the average worker was paid about $70 an hour, including health care and pension costs.

Those costs are already coming down slightly because of a renegotiated deal with U.A.W. last year, but not nearly enough
....
Part of the problem is summed up by comments like this one in The Detroit Free Press, made by Kandy O’Neill, 39, an assembler at G.M.’s plant in Lake Orion, Mich., where she builds the Chevy Malibu and Pontiac G6. “I think we’ve given enough,” she said about the cuts to her salary and pension plan.
“Everybody wants to come down hard on the workers,” she said. “Nobody knows what we do inside there but the people who work there. It’s hard. It is not an easy job.”

When you read a line like that you might sympathize with her, but then you realize that nothing can be accomplished without bankruptcy. Ms. O’Neill: your company is asking the taxpayers — many of whom don’t have health care coverage — to pay your salary and health insurance."

This second article is full of interest. It's worth explaining that Mr. Sorkin's figure of $70/hr is not actually the hourly wage of an auto worker - that is between $14 and $33/hr, based on the type of work performed. GM's figure comes from adding in such things as payroll taxes and health insurance. But breaking it down to an hourly figure serves the helpful propaganda purpose of making it sound like Kandy O'Neill and others like her are taking home half a grand a day in cold, hard cash, rather than living a modest middle-class life in Michigan.

The notion that a livable wage with basic health insurance (five free doctor visits a year) and some vacation and sick days represent "gold-plated benefits" says a lot about Mr. Sorkin and his view of the world.

But even using GM's cost figures, a single $3 million rentention bonus for one AIG "moneymaker" is enough to cover the cost of 1200 skilled union auto workers. Yet according to Sorkin, contracts with the former are bulletproof, while contracts with the latter need to be renegotiated posthaste from a position of strength, or broken if necessary through bankruptcy.

The simple idea that the egregious AIG bonuses could also be nullified through bankruptcy does not enter into the equation. And I cannot seem to find a quote from Pearl Meyer or other compensation professionals about the trust and committment companies need to show their blue-collar employees, though I will continue looking.

Sorkin's second argument for paying out the AIG bonuses is much stronger, and perfectly explains the difference between the two situations:

A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.

Future GM employees, if there are any, would do well to learn from this, and build self-destruct circuits into their vehicles. And Mr. Sorkin should stop avoiding simple words like "extortion" and "ransom" if he is so concerned about defending the rule of law.

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Read all about it on this Kickstarter page.

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