The AiG Bonuses, Part 5:
Can Congress undo the destructive incentives in H.R. 1586?
26 Mar 2009 in Regulatory Economics, Regulatory Policy
We have provided several analyses of the AIG bonus controversy, most recently on the political risk that now may poison private sector participation in the Treasury Department's new Pulic-Private Investment Partnership Investment Program, which includes the Legacy Loans Program and Legacy Assets Program. The effectiveness of this program hinges on aggressive private sector participation. However, recent actions by the House of Representatives to impose a 90% tax on bonus payments (H.R. 1586), and repeated statements of opprobrium from President Obama and the actions of New York Attorney General Andrew Cuomo and others, signal to investors that the government will not be a reliable partner.
In particular, prudent investors should expect that if they make "too much" money -- where "too much" is defined after the fact, based on political criteria -- the government will act to confiscate these profits. H.R. 1586 indicates that the government is willing to confiscate profits indiscriminately, for example by taxing away bonuses that AIG was contractually obligated to to pay to employees who had volunteered to work for the company to clean up financial messes create by others.
According to the Associated Press, Congress understands the destructive effects of the incentives it has now created, and it is trying to find a way out. It seems to have discovered such a path, but the path likely will fail because it does not involve admitting error.
The AP's Anne Flaherty reports:
Democrats are looking for a way to respond to the public's outrage over taxpayer money being used to bankroll big bonuses for financial executives without alienating an industry whose cooperation is crucial to the nation's economic recovery.
The House Financial Services Committee planned to endorse on Thursday a bill that would let Treasury Secretary Timothy Geithner and financial regulators decide whether an institution was spending too much money rewarding its employees.
The measure would exempt institutions that agree to participate in a government-sponsored program aimed at buying up $1 trillion of bad debt, or "toxic assets," sitting on the books of major banks. Geithner proposed the new investment program on Monday.
"We cannot solve this crisis without making it possible for investors to take risks," Geithner wrote in an editorial published in The Wall Street Journal.
Rep. Barney Frank, D-Mass., the panel's chairman, said Democrats decided to exempt firms willing to participate in the effort because "we do want to encourage wide participation."Democrats are walking a fine line. For Geithner's bank-rescue plan to work, private investors will have to trust that the government will keep up its end of the bargain. But as a recent flap over employee bonuses paid by American International Group Inc. has shown, Congress will intervene if it thinks the rules are unfair.
Last week, the House voted to tax away 90 percent of any bonuses agreed to in 2008 and paid this year by AIG or other recipients of bailout money.
"Private investors need certainty that Washington will not change the rules of the game while the game is being played," said Rep. Spencer Bachus of Alabama, the committee's top Republican, who opposes the latest committee proposal.
Congress appears to recognize that prospective investors have no confidence that Congress will be a reliable partner. Otherwise, it would not need to delegate to the Executive branch the authority to decide how much profit is "too much." Indeed, they would not need to worry at all that Congress might intervene after the fact.
For confidence in Geithner to be justified, however, prudent investors will insist that the Treasury Department regulations implementing such a bill give the Treasury Department and other regulators no discretion to make subjective judgments. An obvious reason to deny the government any discretion is that the Obama Administration's position has been highly inconsistent. President Obama, for example, has excoriated corporate executives for being "greedy" but also noted that their active participation is essential for his program to work. When investments in the new program are settled, which face of the Administration will investors encounter? The answer is unknown. Prudent investors should expect the worst.
And Congress could change the rules again, at any time. To provide minimal assurance that it probably won't, Congress may need to first admit that its previous interventions -- such as H.R. 1586 -- were wrong. Writing new legislation this week, in hopes of mitigating the damage caused by legislation it approved last week, aggravates uncertainty rather than reducing it.
From Terry on 26 March 2009, 17:45
With all these happenings in Congress, and the clawback potential, I was at first surprised to hear that PIMCO and Blackrock said they intended to participate. Then I heard that they own huge amounts of the bonds of the financial institutions which are likely to sell the "legacy securities' as part of the program. When these legacy securities are sold to the partnerships formed between PIMCO/Blackrock and the feds, the value of their bond holdings in the banks will skyrocket, and they will make millions. on day one With all the money they can make on their bondholdings, they can afford to significantly overpay for the legacy securities, which makes the banks, their stockholders and the bondholders (and the current administration) very happy - the taxpayers, on the other hand, are putting up 85% of the money necessary to buy this junk, through a non-recourse loan to beat, and the taxpayers are also putting up around 8% of the cash necessary to buy the junk. Blackrock and PIMCO only have about 6% of the money at risk, and they can collect servicing fees to boot. They manage the portfolios for a few years and write off generous amounts as the underlying mortgages are written off or renogiated. Low and behold, it turns out the legacy securities are not worth what they bid for them, and after collecting the servicing fees and the fees they collect for agreeing to modify the underlying loans, they put back the crap to the feds (the taxpayers), take their small haircuts on the money they had at risk, and do not risk any clawbacks (Timmy can say they lost their money, too, in addition to the taxpayers, so no need to penalize them) - they walk off with millions based on their bondholdings in the banks, while the taxpayers get screwed. The plan had to be written by PIMCO and Blackrock!