The AIG Bonus Dilemma

In the days after 9/11, an almost unanimous Congress passed the Patriot Act. While most of the Act was indeed important and deserved to be passed – especially parts that improved border security, tracked foreign assets and allocated money to improve surveillance technology – debatable items like indefinite detentions without trial for suspected terrorists and the ability for the FBI to search personal records without a warrant have come under criticism by those who believe the Act violates the Fourth and Sixth Amendments. In its haste to respond to such an unbelievable act of terror, Congress may have rushed to judgment on some actions that should not have overlooked the Constitution.

Yesterday, the House fast-tracked a bill that would place impose a 90 percent tax on bonuses paid to any AIG employees and employees of other financial companies that accepted at least $5 billion from the TARP bailout. It was approved by a vote of 328 to 93. I am having déjà vu all over again.

I am in no way defending the boneheads at AIG who destroyed the world’s largest insurance company by their over reliance on collateralized debt obligations and mortgage-backed securities. And I’m sure Congressional phones are ringing off the hook with outraged constituents gathering torches and pitchforks. The pressure for the government to act, after they may have overlooked this payment, must be enormous.

But in the heated mode to act fast and ask questions later, serious mistakes can be made. I call this the “ready-fire-aim” plan of action that I try to avoid on a personal level. By changing an existing contract – unfair as that contract may be – the government is setting a dangerous precedent as an unreliable and capricious business partner; one that can quickly change any written contract based on popular opinion, as opposed to the rules of law and the Constitution itself. That occurred with part of the Patriot Act and I feel it happening again.

Unfortunately the government needs the insurance companies and hedge funds of the world to fix this problem, especially if it unveils some kind of public/private sector combination of buying troubled assets from banks. If I ran a hedge fund (and still had a job) this would show me that the government cannot be trusted if it has the right to change the plans and redo compensation and benefit laws at will. This is a dangerous precedent that I doubt would stand up in a court of law.

Andrew Ross Sorkin of the NY Times stated this very fact a few days ago, along with the possibility that the AIG people receiving these bonuses may be the only ones who know how to clean up their mess. I’m skeptical about the last part, and Sorkin has been raked over the coals for this. But he’s right about the contractual obligations and the knee-jerk response it has understandably and unfortunately set. In our rush to punish wrongdoers, we cannot overlook the law, even when it comes to detaining terrorists or suddenly taking bonuses away from people who have not deserved it.

UPDATE: Look who agrees with me -- Nate Silver, Henry Blodget and Paul Krugman. Holy crap!