This crisis has brought a burst of creativity in the development of indicators of pain, from the subprime implode-o-meter to the downgrade-o-meter for structured securities. Perhaps it is time for the outrage-o-meter. Its needle would have jumped off the scale this week as America’s public, politicians and media huffed and puffed over the $165 million in bonuses paid to members of the financial-products division that brought down American International Group (AIG). Troubles in that unit have forced the government to bail out the giant insurer, so far to the tune of $173 billion.
AIG’s wayward eggheads are not the only ones squirming. The affair is a test of the Obama administration’s handling of financial excess-and so far it has been ham-fisted. After flip-flopping over whether it had the authority to meddle with employment contracts, the Treasury eventually seized on a clause in the recently passed stimulus bill that may allow it to retrieve payments deemed contrary to the public interest. Tim Geithner, the treasury secretary, promised to recoup the money by deducting some of it from the next $30 billion tranche of aid for the company.
This is unlikely to assuage critics. The employees get to keep the bonuses while AIG is deprived of funds that were supposedly essential to keeping it afloat. The government’s back and forth has also damaged the credibility of the Federal Reserve, which has lent heavily to AIG and was aware of the bonuses several weeks ago.
Mr. Geithner’s hand was forced by an increasingly hysterical Congress. Charles Grassley, a senior Republican, set the tone by suggesting that AIG executives apologise Japanese-style, first bowing and then perhaps committing suicide. The language was no less salty at a congressional hearing on AIG on March 18th, at which the firm’s chief executive, Edward Liddy, faced a rough ride despite being in the job only a few months and working for a salary of $1.
As the uproar grew, lawmakers began crafting bills that would impose taxes of up to 100 percent on the bonuses. Andrew Cuomo, New York’s hyperactive attorney-general, entered the fray, slapping subpoenas on the firm and muttering about possible fraud. His office stoked public ire by revealing that 73 employees had received over $1 million, and that $57 million of its “retention” payments were earmarked for staff it planned to lay off. At the hearing, Mr. Liddy said he had asked all those who received more than $100,000 to give back at least half, and that some-no doubt motivated by death threats and the unwelcome attention of paparazzi-had offered to return the full amount. But he also worried that they would leave AIG, making it harder to manage the toxic financial-products business.
Shocking though the bonuses have been, they pale in comparison with the $49.5 billion of payments that AIG has made to counterparties in its disastrous foray into credit-default swaps-many of them foreign banks (see chart). This was no accident: it was precisely bailing out these trading partners that the government viewed as necessary to avoid a systemic meltdown. Still, the transfers—including almost $13 billion to Goldman Sachs, making it, as one newspaper put it, a “charity case”—are likely to receive more scrutiny as the bonus storm subsides.
The furore over AIG is awkward for the new administration in several ways. First, it makes it harder to pin responsibility for botched financial rescues on the Bush team. The new lot could have nipped the bonus fiasco in the bud. It also leaves Mr. Obama walking a fine line between convincing the public that he shares their sense of outrage while also possibly pressing for more rescue funds. The government’s best guess is that another $750 billion could be needed. Insurers are clamouring for funds too. But bail-out fatigue is growing. The hearing’s chairman, Paul Kanjorski, suggested that the AIG mess could force Congress to reconsider any future largesse.
It does not help that Mr. Geithner’s star is falling. His failure to get ahead of the problems at AIG follows his botched unveiling of a bank-rescue plan. Regaining his credibility will depend on the success of two new schemes: one to boost consumer lending by reviving securitisation, and another to remove toxic assets from banks (details of which are expected any day). Here, too, the government faces a balancing act: it needs to make the terms attractive enough to bring in private buyers, but not so attractive that they invite more political fireworks.
Another risk is that restrictions placed on firms that receive public money backfire. Banks are responding to new executive-bonus limits by increasing salaries. This “flies in the face of making pay more performance-related,” says Pearl Meyer of Steven Hall & Partners, a consultancy. Chafing under restrictions on their activities, recipients of funds from the previous government’s Troubled Asset Relief Programme are scrambling to repay them early. This may cheer taxpayers, but the withdrawal of capital may also hurt lending.
No wonder Mr. Obama is keen to move the debate on. The focus now, he said on March 18th, should be on giving the government the tools to prevent a repeat: resolution authority over non-banks, similar to the power the Federal Deposit Insurance Corporation has to shake up sick banks. Mr. Liddy, meanwhile, will be urged to earn his dollar by disposing of AIG’s assets and cutting the group’s vast debt to the taxpayer. Such deals have so far proved elusive. This week’s brouhaha is unlikely to make the task easier.