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Edward Lazarus

The AIG Controversy: The Public's Anger Is Certainly Understandable, But Some Suggested Solutions Would Go Much Too Far


Thursday, March 26, 2009

It easy to understand the surging tide of anger towards AIG's payment of $165 million in bonuses to its employees. As much as any one company can, AIG might be said to embody all that went wrong inside the nation's financial behemoths – the reckless piling of risk upon risk, in order to create ephemeral paper profits and outsized pay packages for corporate executives.

And more than any one company, AIG has cost the American taxpayer a fortune in bailout money because the company had become (to use one of the saddest clichés of the moment) "too big to fail." It's easy to work up a lather at the thought of the very people who helped create the biggest financial meltdown in our lifetimes now getting paid large bonuses -- bonuses that are coming out of taxpayer bailout money.

Some have suggested that this rage is misplaced because the bonus money is such a small part of the overall picture, with the significance of a mere rounding error when compared to the trillions needed to resurrect our economy. There is some truth to this. In the grand scheme of things, the bonuses are a minor issue compared to the policy choices reflected, for example, in the just- unveiled bank bailout plan.

On the other hand, there is nothing intrinsically wrong or nonsensical with directing one's anger at a symbol. And the bonuses are a reasonable symbol for the excess and greed that sent us spiraling down this rat hole in the first place. Indeed, the bonuses are more than mere symbols of what went wrong – in some circumstances, they were causal agents as well. By rewarding short-term profitability, the Wall Street bonus system encouraged a whole generation of banking executives to inflate the enormous bubble that has now burst in all our faces.

But to say that the outrage over the bonuses is understandable, does not mean that this outrage is always accurately directed. Nor does the fact the some outrage is appropriate justify the deeply troubling manner in which some public officials seem to be trying to leverage the public outcry for their own political gain. Irresponsible bonus decisions are now begetting irresponsible governmental actions – actions that add a threat to civil liberties to the damage already done to our economy.

It's True that the Main Culprits' Windfalls Need to Be Addressed -- But What About Less Culpable Figures at AIG and Similarly-Situated Companies?

Let's set aside the charter members of the bonus-recipient hall of shame. In this category, I would put former financial industry executives who walked away with huge bonuses based on short-term paper profits from financial risk-taking that was never prudent and has now backfired. These executives benefited outrageously from an accident of timing – the fact that they could measure their performance and obtain performance bonuses based on intervals too short to factor in even the medium-term perspective on their financial acumen.

And I'd add to this pool current executives who had some hand in the misguided financial engineering of the last few years, rode the compensation elevator up, and now have their snouts at the public trough.
But at AIG and elsewhere, there are surely quite a few bonus recipients who don't fall into either of these categories. This may be especially true of those who received "retention bonuses" – the kind of bonuses that are at the heart of the AIG situation.

Here is what I imagine to be a not uncommon scenario: You're a senior executive at AIG, in a unit having no responsibility for credit default swaps or the other toxic assets crippling the company. Indeed, the unit you help oversee is now being counted upon to help AIG survive and ultimately repay some of the bailout money it's received. And you have some well-paying options available to you if you jump ship.

So AIG's management comes to you and pleads with you to stay with the company and use your expertise to help turn things around. Out of loyalty, or perhaps a sense of civic duty, or perhaps just inertia, you'd like to stay. But you have a family to look after and a future to consider and you don't want to be a complete fiscal idiot. So you negotiate a retention deal that probably doesn't pay you what you could make at a new job, but at least makes it reasonable for you to choose to stay rather than leave.

We don't know how many people fit this general description, though some definitely do, including the person in charge of AIG's financial products unit, whose resignation letter describing his situation was published in the New York Times this week.

What we do know, thanks to that letter and other anecdotal evidence, is that the people in this position are now being subject to brutal pressure by the Attorneys General of both New York and Connecticut. Give back your bonuses, they have been told, or you and your family will face the wrath of the people after we release your names to the public.

The Pressure from the State Attorneys General Is Far Out of Line – and Creates a Dynamic Similar to that of an Extortion Attempt

This is an abuse of power. The people described above may not be especially sympathetic and may have been over-compensated in the hierarchy of social utility, but they have committed no crimes. Indeed, they've done nothing wrong at all, other than to agree to stay on at a company that others ruined at a level of compensation largely set by the marketplace. What moral or legal right do prosecutors have to extort repayment from these people by threatening to expose them to a public "shaming" and the possibility of much, much worse if vigilantes decide to act?

In private practice, it is considered extortion for one party in civil litigation to seek to obtain a settlement by threatening to refer the other party to the authorities. Surely, it is no better for the authorities, armed with the awesome powers of the state, to obtain money from a person who is neither accused nor suspected of any wrongdoing, by threatening to ruin that person's reputation and subject them to public opprobrium the intensity and potential violence of which may be difficult to gauge or contain.

One of the paramount duties of public prosecutors is to resist pandering to the politics of the moment by going after unpopular but legally blameless individuals. And one of the greatest sins a public prosecutor can commit is to wield the power to ruin lives not to right legal wrongs, but to score political points. Both Andrew Cuomo of New York and Richard Blumenthal of Connecticut know this. But even good public servants can lose their bearings in a maelstrom of public passion – and they are at risk of doing so now.

The terrible black cloud that engulfs our economic life will surely have a number of silver linings. The crisis will likely move us towards a regime of more vigilant and thoughtful financial regulation, including an end to the bonus system that so vexes us now. It will redirect some of our best and brightest away from careers in finance and towards careers in science, engineering, and other highly productive endeavors. But these salutary developments will be significantly diminished if the price we have paid in treasure is compounded by an erosion in the integrity of governmental offices whose duty it is to seek to mediate between the zealous pursuit of justice and mere zealotry.

Edward Lazarus, a FindLaw columnist, writes about, practices, and teaches law in Los Angeles. A former federal prosecutor, he is the author of two books -- most recently, Closed Chambers: The Rise, Fall, and Future of the Modern Supreme Court.

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