A Cautionary Note on AIG Bonus Clawback: Is the United States Turning into Argentina?

March 25, 2009

A friend who works in Wall Street was livid upon learning about the U.S. House of Representatives’ move to tax the controversial AIG bonuses at 90 percent. My friend—who is from Latin America and does not work at AIG—said that it looks like the United States is turning into Argentina. He was referring to last year when, in the midst of the commodity boom, the Argentine government attempted to raise the tax rate on the additional profits to around 90 percent and to increase its access to resources it nationalized the private pension plans.

I asked my friend: Why didn’t cuts in the pay and benefits of the members of the United Auto Workers generate a similar sense of betrayal? His response: in the case of the auto workers the new terms were negotiated while the tax on AIG bonuses is imposed by the state. For people like him, it boils down to a breach of contract.

For me, as an economist who has worked much of my career on inequality and poverty issues, taxing largely undeserved and tax-payer funded bonuses does not seem outrageous at all. Still, my friend has a point, a lesson, if you will, from the developing world.

The political uproar in Washington is spooking the financial sector and, most likely, the business community more broadly. Is the United States heading to some form of “class warfare” that could undermine the prospects of an economic recovery because investors will be afraid to invest in such an atmosphere? Or will today’s indignant forget their grievances and start investing again as soon as the signs of a turnaround become apparent? My guess is the latter. However, I may be wrong.

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1. Yakima Says:
   March 27th, 2009 at 6:25 pm

   Yeah, there are a lot of people on Wall Street who still seem to think that they ought to be immune from the effects of their own industry’s “correction” (a term I prefer to “collapse” because it actually implies that mistakes were made). Funny that your friend should mention, “breach of contract,” as this is precisely the method by which Rep. Barney Frank, Massachusetts (D), stated would be the actual means by which the government, as now 80% stakeholder in AIG, would sue the bonus recipients for recovery if they did not return the money voluntarily. He was basically admitting that the 90% tax was a publicity stunt that no-one seriously thought would ever make it through the Senate and to the President’s desk.

   Another aspect of your friend’s reaction was echoed when the AIG CEO testified before Congress recently, where he seemed to be trying to protect the interests of his shareholders against an intrusive State, without seeming to have processed the fact that the elected representatives are in fact holding the proxies of 80% of AIG stock. I know that Wall Street is not used to thinking of the US Government as an investor or creditor as well as the traditional regulator, but that is the situation likely to persist for some time, and they really ought to adapt.

   Smarter companies are doing something very different to “retain” employees, they are re-valuing employee stock options in line with the crash in many company stock prices and realigned predictions of short to medium term share price performance. This not only improves overall employee compensation, it also stimulates short term capital inflows when options are exercised (though long term obligations are of course increased, that should have been accounted for in the re-valuation process).

2. Per Kurowski Says:
   March 27th, 2009 at 9:13 pm

   Yes forget about the AIG executives, the real question to be made is whether a country that has to hit the markets to the tune of a couple of trillions in public debt can afford to be tinkering with such dangerous-to-confidence issues like retroactive taxes.

   The 165 million in cost of the bonuses could pale in comparison to the additional margins the markets could charge the US in risk premiums in order to compensate for such unsettling behaviour.

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