Shock and Awe

My recent relative optimism took a pretty good body blow this week. Despite the Dow’s first back to back positive weeks since May, the brouhaha over the AIG bonuses threatened to impair much of the progress we have made in recent months.

There is no other way to color it. This was a painful spectacle to watch. Instead of carefully considered, thoughtful, sober approach—you know, the kind of thing that we were promised during the campaign, the outcome was policy born of rage. It was exactly what the Founding Fathers feared in a democracy—mob rule.

At issue is whether employees should be paid their 2008 bonuses, rightfully earned under the existing AIG compensation program. Unfortunately, some of these bonuses were rather large (by the standards of the current administration anyway) and many were to be paid to individuals that worked in the business unit that ran AIG aground. I fully understand the revulsion at using tax dollars that were used to bail out AIG to pay these executives. It was an unfortunate consequence of keeping AIG out of bankruptcy and is fundamentally unfair.

As AIG began collapsing last fall, the government had two bad choices available to it: permit AIG to go into bankruptcy or prop it up in some way. There were no other choices.

A bankruptcy in many ways would have been far simpler. The US Bankruptcy Code provides a scheme and a set of rules by which the bankrupt entity will settle up its claims, including executive bonuses and “stay” bonuses—amounts that can be paid to executives to induce them to stay at the bankrupt company and help it work out of its problems. Congress would not have to decide anything about these bonuses. That would have been left to the bankruptcy court.

The government chose not to permit AIG to enter bankruptcy. Because of the intricate interrelationships between AIG and other financial institutions, permitting AIG to go into bankruptcy risked dragging other financial institutions into a vortex which might have caused a total collapse of the financial system. It was like a string of mountain climbers all tethered together. If one went over a precipice, the whole string may go down. So while it would have made dealing with the bonuses easier, the cost may have been unimaginable.

In life, there are tradeoffs—we rarely get the full result we want. Here, the government could have let AIG fall into bankruptcy and let bankruptcy rules deal with the bonuses. Or it could have kept AIG out of bankruptcy with the unfortunate by-product of it remaining liable for the bonuses. Instead, the government decided it could have it both ways. In a grotesque exercise of raw government power, the government decided that it was going to TAKE the bonuses by imposing a retroactive 90% tax on them. This is one of the most egregious naked grabs for private property and intrusions into the contract rights in recent memory.

I find it ironic that President Obama, a law professor, has twice taken positions which effectively take freedom of contract out of the hands of private individuals and hands it to the government. Under the mortgage bailout plan, he has advocated giving bankruptcy judges the power to rewrite mortgages. And now, he advocates blowing up private contracts between a company and its employees.

The exercise of brute force by the government here is real shock and awe.