You almost have to admire the chutzpah of Andrew Ross Sorkin. In his Dealbook column today, Sorkin mounts a spirited defence of paying the AIG bonuses. Given all the bloodlust and outraged deathwishes over the AIG bonuses, we hope Sorkin has hidden himself in an undisclosed location today.
Our admiration only goes so far, however. Sorkin argues that the sanctity of contracts and the importance of retaining particular AIG employees weighs heavily in favour of paying the bonuses. We’ve heard both of Sorkin’s arguments before and we’re unimpressed. Let’s take them one at a time.
- The sanctity of contracts. Sorkin argues that the economic mess could be made worse if the government introduced further uncertainty by “abrogating contracts left and right.”
Indeed, there would be costs to a government policy tearing up old contracts, with actors on both sides of any deal having to worry about latter policy interference. I worked as a corporate lawyer for half of this decade, and my practice was largely devoted to writing and negotiating contracts of various sorts (mostly merger agreements, loan agreements, security agreement and bond prospectuses but also a few employment contracts). I know how difficult it is to negotiate a contract under business uncertainties, and can appreciate concern over the cost of introducing political uncertainty as well.
Still, I don’t see anything about voiding the contracts on the grounds of public policy as violating the sanctity of contracts. The key to understanding the AIG bonus issue is that AIG would be bankrupt and in the process of a court supervised liquidation but for the extraordinary government action that has kept the company afloat. If not for the government bailout, the contracts would be worthless because the employees would be unsecured creditors in a company worth less than zero.
To put it differently, the abrogation of the contracts is just a normal form of counter-party risk run by anyone entering into a contract. All contracts are at risk that the other party will go broke before they can perform. You take a job from your employer, perform work and expect to get paid. But if your employer goes broke before you are paid, you have to line up with the other creditors and hope there’s enough left over to pay you.
Nothing about the introduction of a government bailout should be seen as changing the situation of the AIG Financial Products employees. There’s simply no reason that a bailout meant to support the company because of systemic risk from failure must also mean that other aspects of AIG’s operations cannot be treated as if the company actually were broke. We’re in undiscovered territory here, it’s true. But I don’t see a reason why the situation of AIG employees should be improved simply because they got a bailout.
Actually, there’s a high cost in paying the bonuses. Essentially, the employees receiving bonuses are being treated as super-creditors, immune to the counter-party risks that most employees in the market assume. It rewards, essentially, working for a company that is likely to be bailed out rather than one that will not.
This turns on its head the usual argument for paying bonuses at bailed out companies. Instead of worrying about allowing them to retain “the best and the brightest” we should be worried about the perverse incentives we create by guaranteeing the income of employees at bankrupt firms posing systemic risk. Do we really want to encourage the creation of systemic risk in this way?
- AIG’s contracts are so complicated that we need these employees. Sorkin also argues that we need to pay the AIG bonuses because if the employees leave, they might simply turn around and trade against A.I.G.’s book. This could be a huge disaster, in his view.
Frankly, I don’t get this point at all. If there is easy money to be made by betting against AIG’s positions, that is a social benefit. Why should talent be trapped inside a money losing company rather than freed to create wealth outside? If these guys and gals use insider information to make their trades, we can sue them for insider trading.
It seems likely to me that the costs of bailing out AIG’s bonus pool actually exceed the costs of abrogating the contracts. Just tear the damn things up.
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