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Tuesday, March 24, 2009

Part 1 - AIG Bonuses Are Immoral, But That Is a Good Thing

Anger can be therapeutic, so can drama. Therapy, however, does not always diagnose accurately. Especially when the therapist is a politician, we should all know better. The mad drama surrounding the AIG bonuses is such that one is hard pressed to separate reality from truth.

I juxtapose truth and reality because, in reality, there is every reason to demonize AIG and Wall Street. After all, the financial sector did bring down our economy. In truth, however, these are bankers and executives who were merely doing their jobs. To punish them is to punish guilt by association, while the real culprits of the financial crisis lie safely elsewhere.

Do not forget that there was nothing illegal about the practices that brought our economy to its knees. For the sake of keeping our eyes on the ball (forthcoming in Part 2), I will defend AIG insofar as reality permits and truth allows.

In Truth
Bonuses are standard practice on Wall Street, be they performance- or retention-based. Even when financial firms suffer big losses, big bonuses are still doled out to executives in the name of retaining their services and clientele. However reasonable they may be, retention bonuses alone seem unconscionably huge to the common man.

But the truth is, these exorbitant sums accurately reflect the importance of finance to the post-industrial American economy. Simply put, Wall Street salaries and bonuses are set in proportion to its real economic worth, not by losses in a single fiscal year. $165 million does not sound unreasonable in today's context.

I have argued in another post that, even today, our economy needs Wall Street more than Wall Street needs us. Certainly the massive and grudging bailouts of Wall Street and AIG affirms this point. Without Wall Street, the most desirable aspects of the American lifestyle that each one of us covets (admit it) would not be possible.

Until our reliance on Wall Street changes--and it will--AIG deserves its bonuses as much as they ever did, plain and simple.

The truth is, why should it make a difference whether their bonuses are comprised of tax money from their fellow citizens or deposits from far off Asian savers? Their bonuses are deserved because Wall Street gave us our lifestyle, albeit one that eventually drove us into the ground. But what's that got to do with them? Nothing. After all, they're just mere bankers and executives merely doing their jobs.

In Reality
Despite all truth, rewarding executives--no matter how deserving or innocent--whose company is on life support is seen by most people as outrageous at best and criminal at worst. The specific indictments are superfluous to name here. No matter how you look at it, AIG executives who helped themselves to the taxpayer's dime while the economy burns are morally indefensible.

But in reality, does Wall Street or AIG operate on an ethic of morality? If they did, then:
  • AIG would preemptively volunteer to forfeit their contracted bonuses;
  • AIG would graciously allow us to tax back their bonuses;
  • AIG would not have doled out bonuses at all;
  • AIG would not reward failure, not on the taxpayer's dime;
  • AIG would never have run a quasi-hedge fund that gambled our money away on bad bets;
  • Wall Street might not have destroyed itself and our economy along with it.
It is as if we expect our bankers and executives to do the moral thing, and getting really mad that they are not. The trouble is, there was never anything moral about this business in the first place. And we know it.

Wall Street plays the market, an institution that knows no moral bounds. Business ethics ring hollow because a free market economy is held to work on efficiency and not morality. More often than not, voluntary "moral" actions contradict market rules and drive the moralizing entrepreneur out of the game.

Can you recall any large shoe-making companies that refused to offshore its manufacturing to Chinese sweatshops? Probably not, since those companies would have disappeared long ago for their morals. Market competition is such that executives cannot submit to their moral discomfort, if such even exists.

As I have asserted elsewhere, this is an economic reality that Americans must own up to: moral detachment, and the productive exploitation of greed, is what drives a capitalist economy to its optimal output.

Immorality, as it were, is a good thing.

The Conclusion
In truth, bonuses are price tagged by the market, not individual intent. In reality, immorality is often rewarded by the market, not rebuked.

As such, moral truths and expectations have no basis in the capitalist reality which Americans subscribe to. To scream about the immorality of AIG bonuses, let alone expecting executives to forfeit them, basically amounts to a moral repudiation of free market principles.

Are Americans really prepared to take this stance? I'm not; not yet, anyway, until all is ruinous. We are not quite there yet, though our economy "stands on the edge of a knife. Stray but a little and it will fail, to the ruin of all. Yet hope remains while all in the Company is true." (from Tolkien)

When things are good, we love Wall Street. When things sour, we do not stay true to the very institutions that brought us riches with the world's envy. Instead we turn against them as if they were filth to begin with.

There is something profoundly misguided about populist anger at the immorality of AIG bonuses, to which an even stronger objection might be raised, namely that the populist anger is itself immoral.

If the AIG bonuses debacle, and the financial crisis at large, can help Americans reflect on our moral contradictions, the cost might well be worth it.


Drew said...

You seem to be making several points, which I'm not sure proceed logically to your final conclusion.

First, you point out that morality has no place in a competitive market. This is certainly true. The only modification I would suggest is to say that morality has no place in the decision making of the market actors, but is essential in the decision making of those who create the market rules. Those who create the rules by which the market operates must do so such that an amoral actor will have incentives to act in a socially beneficial manner. This is true simply because we cannot depend upon people to behave morally. Basically, legislators and regulators must design a system which brings about a moral result when operated by amoral actors. What we call the "free market" is actually a highly artificial legal construct designed to bring about specific outcomes efficiently. So yes: morality not only has no place in the market, it has no place in critiques of market actors -- to the point that speaking of "morality" in this milleu is nearly meaningless. Based on this, you assert that the individual actors in the "AIG bonus scandal" shouldn't be blamed for their actions. I wholeheartedly agree.

Secondly, you argue that America needs Wall Street in order to continue its lifestyle, and thus Wall Street compensation is based on Wall Street's real economic worth to American society. I am not very convinced by this argument. Executive pay is set by the board of directors, which is responsible to shareholders. Thus, executive pay is set in relation to its value to these shareholders -- not to American society as a whole. To say that there is some debate regarding the degree to which AIG's shareholders represent the interests of the Common Man would be putting it mildly. Americans certainly want easy credit, and this bolstered banks' balance sheets for many years. However, as you have pointed out in other posts, this was an unsustainable economic model. Saying that retention bonuses made economic sense to semi-active shareholders in 2006 is much, much different than saying that retention bonuses yield a net positive impact to the average American's pocketbook over the long term. Thus, I take issue with your claim that Wall Street salaries were paid in relation to their workers' value to American society, rather than in relation to their short-term value to shareholders. Recent events make out a very convincing case for market failure regarding financial industry compensation.

Third, you state that AIG executives "deserve" their bonuses. This is a very bizzare choice of words, as you have previously stated that morality has no place in the analysis of individual market actors. The concept of desert is a moral one. I believe you are conflating the issue of whether AIG executives are morally to blame for their actions, with the issue of whether our financial system functions such that it doles out compensation in a morally correct, or even a merely efficient, manner. Your argument states that, since the executives are not morally culpable for their individual actions within the current system, the system must be morally sound. I believe that this is a logically flawed argument.

Although you are certainly correct in stating that blaming idividual actors for a market failure is absurd, stating that the failed market is efficient because it behaved consistently with its flawed internal structure is incorrect.

Drew said...

Ah, I think that I misinterpreted your post, and possibly misrepresented myself as a result.

It now seems to me that your core argument is that the American People have no business getting angry at AIG and Wall Street because we enabled their business model to begin with, and turned a blind eye to its folly because of our own short-term rewards. Yes, I heartily agree with this.

Looking backward, it is silly to say that AIG employees should give back their bonuses (although I recognize that outrage is a politically necessary position for those in government). If I'm not mistaken, this was your point in your original post. Looking forward, however, it is important to examine the structure of the market system itself to prevent similar occurrences (if it is indeed efficient or even possible to prevent them at all). This was my point in the above comment, but the accompanying criticism of your post was unwarranted, as it didn't really have much to do with my assertion.

atanas entchev said...

Well written, Sir! The knee-jerk reaction to the AIG bonuses was yet another manifestation of the bumper-sticker mentality of a vast segment of the American public. Sadly, this segment will not read your excellent post, what with all the words and no pictures.

And therein lies the problem of the ADHD society.

miles said...

Thanks for commenting Drew. Any confusion reading my stuff is understandable.. I'll get better! That said, I'm a bit confused over your comments too, so I'll go point by point and let you connect the dots.

I agree that free markets need to be guided toward the moral good. Your comment here pretty much echos my very first post, wherein I observed that the market is an amoral entitity that punishes indiscriminatedly. It is very well that you might be punished for making moral decisions that go against market rules.

It all boils down to this: either we bridle the market or the market bridles us. The latter is, of course, exactly what caused the financial crisis. The former is what you advocate, which will necessarily be our roadmap for some time to come. Success will depend on smart regulation (see my comment in my very first post) as well as capable geopolitics to ward off global adversaries. After all this is a global crisis and we are in a weakened position.

I get your point about how executive pay is set. I'm not privy to such details, but it is enough for me to simply see the massive amounts of money Wall Street toys around with. No other industry wields such wealth, which says to me that Wall Street is the mule which pulls the American economy.

So it's not so much that Wall Street executives are overpaid, but that our economy depends too much on Wall Street's fortune (which is precisely why they are overpaid). Ironically, the fact that they can lose money in the magnitude of trillions only reflects just how important Wall Street is. This fact alone justifies all the bailout money we've thrown their way so far, and by extension vindicates why their bonuses are big and even "deserved" today.

For the record: I believe that the recent AIG bonuses are NOT right, but that does NOT make it wrong.

I'd like to point out that political outrage is necessary only because the people demand it. The electorate, of course, determines how our representatives behave. Sadly, too often do the representatives end up running the electorate, as I believe was the case in the AIG debacle. I'll be writing a post about this shortly,.

I don't buy it for a second when Obama says he's as angry as anyone else about the AIG bonuses. He's too smart for that, but he was politically checkmated and had to go along with the stupid populist narrative. He was also naive to think that the GOP won't try anything to get mud on him.

Finally, I'd like to say that I had planned to write several posts about possible futures for American capitalism. They would have directly addressed your concern of how we can prevent similar crisises in the future. Of course I never got round to them... uuuugh one day!!!!!