Salem on the Potomac

The America of the past and the America of the future were on display Wednesday as the House Financial Services Committee held a hearing to look into the most recent uproar over AIG, this time regarding bonus payments.

On one side, was Edward Liddy; former CEO of AllState, CFO of G.D. Searle, a long-time employee of Ford, and lifetime Trustee of the Boys & Girls Club of America.1 A respected businessman with a track record of success and credibility, Liddy came to AIG after its’ collapse in September at the request of former Treasury Secretary Hank Paulson. He was motivated by nothing more than a now seemingly quaint notion of national service in time of crisis.

Liddy is a dollar-a-year man whose only stake in AIG is his considerable reputation, which he has put on the line. He represents an august past in America business, one of accomplishment, accountability, principle and virtue.

Across the table from him was America’s future. Members of Congress who lined up for eight hours to express their outrage at bonus payments made to AIG employees after $173 billion in federal funds had been used to bailout the crippled insurance giant last September.

The Members spittled, hurled insults, mangled angry metaphors and epitaphs and, ominously, promised punitive retribution. I don’t know what was worse; the camera-ready populist outrage or the colossal hypocrisy of Members in both the House and Senate who were part and parcel to this financial tragedy as they all but ran from their own culpability.

Our times call for gritty and determined leadership. Congress showed Wednesday that it is little more than a modern version of the “Know Nothing” movement; empowered by popular fears instead of facts, intent on placing blame and creating distractions, joining the mob instead of cautioning and informing it.

Responsibility was a painful casualty in Wednesday’s proceedings.

To fully understand why, a little history.

AIG’s Financial Products Group – the villains here – expanded AIG’s core insurance business to include new and novel insurance products, including credit default swaps; essentially insurance on the Collateralized Debt Obligations (CDO) that were being packaged by the major banks and traded on Wall Street.  These CDOs included substantial subprime mortgages that were bundled from Freddie and Fannie as Mortgage Backed Securities (MBS).

When the bottom fell out on Fannie and Freddie between July and September 2008, the value of the securitized debt being traded on Wall Street was called into question. As the subprime crisis blossomed with foreclosures, no one knew the real underlying value of the CDOs.  AIG, which had insured the debt above the suddenly crashing values, faced cash calls well beyond its ability to pay, forcing the crisis which led to the US government investment in and takeover of AIG.2

As noted in Wednesday’s Duffy, AIG used retention bonuses – guaranteed future payments – as part of its’ compensation plan for the traders and professionals at the Financial Products Group to keep expert personnel on the job. Those bonuses were negotiated in January 2008, nine months before the meltdown.

The jobs of these experts perform became more, not less important after AIG’s collapse, as these were the only people who understood how the complex financial transactions had been structured. While the Washington Post has stated that the most dangerous transactions were dealt with before January 2009, Liddy said yesterday that there is as much as $1.6 trillion in outstanding transactions that need to be settled within the Financial Product Group, adding to the importance of retaining high quality and knowledgeable personnel.3

There is no doubt that the optics of the bonuses are distasteful at best given current economic conditions nationwide.  73 individual million dollar payments, as well as one person who got a retention bonus who doesn’t even work at AIG anymore.

At the very least, AIG or Treasury could have taken steps to announce a separate repayment schedule for the bonuses in advance to ease public anxiety over the issue. But what is uncontestable is that Congress and the Administration had multiple opportunities to condition bailout funds for AIG on renegotiation or abrogation of the retention payments and did not.

As a result, those AIG executives, legally entitled to payments, have become unfortunate targets due to a public uproar over what is a startling political failure and a demonstration of rank incompetence.

Let’s talk about Chris Dodd. Connecticut’s senior Senator took $165,000 from Fannie and Freddie where, from his perch on the Banking Committee he nurtured the policies that led to the subprime implosion.  He also took a mind boggling $281,000 from AIG.4

In the bailout of AIG it was Dodd who placed a provision guaranteeing the bonuses for AIG staff prior to January 2009.

Where is Dodd held accountable in all of this?

Go back further. What about Timmy Geithner?

As head of the NY Fed he essentially designed the AIG bailout last year, before becoming Treasury Secretary. How is it possible that he didn’t know about the bonuses until last week? AIG published a statement in January on the pending bonuses it would pay out that didn’t seem to capture the attention of decision makers.5 It seems preposterous under the circumstances that AIG was being honest and transparent while the government was asleep at the bailout switch, but what other conclusion is there?

Under these conditions, why are the employees of the Financial Services Group vilified and punished for something that Chris Dodd codified in the government bailout last year and Timmy Geithner apparently didn’t object to in shaping the bailout to begin with?

Clearly an angry citizenry, fueled by economic uncertainty and a fundamental sense of unfairness, triggered a circus atmosphere of insidious finger pointing and insufferable moral indignation Wednesday by Members of Congress who should have known better.

Anger substituted for policy while stunts substituted for a course of action.  All the while no one took responsibility.

Barney Frank recast himself as a modern day Elliot Ness, demanding the names of all the bonus recipients and threatening subpoenas if AIG didn’t comply. Frank ironically stoked memories of the House Un-American Activities Committee demanding names that he could publish and expose as….capitalists.

But who remembers that it was Frank who dismissed warnings about subprime lending and said that Fannie and Freddie were sound?  Who remembers that it was Frank who took $42,000 from Fannie and Freddie, as well as $1k from AIG?6

Pitchfork in hand, Senator Chuck Schumer took the floor and warned, “If they [AIG bonus recipients] don’t [give back the bonuses] we plan to tax virtually all of it.” Does anyone recognize the colossal chutzpah from a Senator who took $111,000 in campaign contributions from AIG now demonizing its employees? 7

Contemplate the chilling effect on the private sector when a Senator brags about confiscating profits arbitrarily.

Here we see the frightening “Schavio-ization” of tax policy; the entire US Congress voting to single out an event for special legislative action. But where Republicans came into session to try and save Terri Shavio’s life, Democrats are legislating unrelenting and arbitrary hostility toward wealth.

The House voted Thursday 328-93 to impose a 90% tax on the bonuses received by those AIG employees. This is simply unprecedented; the US government voting on legislation to punish employees for doing their jobs.  Where is the criminality?  Where is the malfeasance by AIG employees?  Do contracts mean nothing? In the case of the Dodd amendment last autumn, does law mean nothing?

It is said that success has many fathers and failure none.

But this economic calamity was not brought upon us simply by AIG.

It is the resistance of the willing co-conspirators in Congress and the Administration to own up to their role in the crisis that both distracts our attention, fuels suspicion and craters the government’s credibility in dealing with the larger financial crisis. And it is both alarming and chilling that this childish name calling and perverse pleasure in penalization without a crime extends all the way to the Oval Office.

As a Senator, Obama took $126,000 from Freddie and Fannie. He accepted another $110,000 from AIG. Obama was present and voting as the bailout legislation passed Congress last autumn. He’s owned the Oval for 58 days.  But judging from the President’s comments, you’d think that he’d only just realized there was a problem.8

And as has become the Obama habit, when in doubt, blame the Bush administration. But the fact is that Geithner and Obama’s fingerprints are all over this.  Instead of taking responsibility, Obama assesses blame. Taking an alarming populist tone in California on Wednesday, Obama railed against, “a culture where people made enormous sums for taking irresponsible risks have now put the whole economy at risk.”9

Does he realize that he’s talking about himself and Dodd, and Frank and Pelosi and Raines and the rest?

And for anyone looking to the future, Obama has chilling words. “But what’s just as important is that we make sure we don’t find ourselves in this situation again, where taxpayers are on the hook for losses in bad times and all the wealth generated in good times goes to the very top.”10

Hey you wealth creators out there…consider this an All Points Bulletin – POTUS is gunning for you.

It doesn’t matter that the top 20% of taxpayers pay 7% more today as a percentage of their income than they did in 1983. Or that the bottom 20% pay 53% less than they did 26 years ago (see chart below)

Tax Rates for High-Income Households Have Risen

Source: Rates from CBO’s Historical Effective Federal Tax Rates: 1979-2005, December 2007

What matters is a sense – a sense that AIG employees don’t deserve contractually agreed compensation, that the “rich” who keep paying don’t deserve their wealth and need, indeed must, pay more.

Amid the market failures of our private sector and the political failures of our elected leaders over these many months lies a little recognized but potent fact.

The drama and attention over the AIG bonuses is but a sideshow to the much larger and consequential issues facing our economy. And the lack of political courage and leadership demonstrated in this episode, matched with opportunism by both Obama and his acolytes, and his conservative opponents, is fraying the public consciousness for affirmative economic action.

There is a real danger here.

The American people, already scarred by recession and angered at monumental spending commitments have turned their fury at bailouts, hardening against any additional assistance for the private sector at a time when most economists agree that more will be necessary.

In laying out the most ambitious spending agenda since the New Deal before addressing the fundamentals of the economy, Obama may have lost the public where and when he needs it the most.

Recession is the psychology of uncertainty.

For America’s producers, the engines of economic activity and wealth creation, Bernanke’s Federal Reserve trillions won’t help uncork growth when Democratic rhetoric and punitive legislation shows a decisive hostility toward wealth.

Biding your time and holding your cash is a much surer strategy amid dubious government intentions.

Obama and Co., need to understand that words and actions matter as much as pie in the sky policy prescriptions.

Punitive action maybe personally satisfying, but when AIG needs a fresh bailout because the Financial Products Group rightly walked out the door, don’t say you weren’t warned. Americans held the wrong people responsible this time.  The perpetrators are still busy spending money your grandchildren haven’t made yet.