Last month Britain was swept up in a maelstrom of rage after it was revealed that Fred Goodwin, the chief executive of the Royal Bank of Scotland, was due to receive a generous pension to the tune of a staggering £703,000 a year. The problem? The Royal Bank of Scotland is now 70% owned by the British taxpayer. Cue outrage from all sides: while the tabloids and broadsheets alike foamed at the mouth, government ministers went a bit mental and promised to suspend the rule of law. The controversy over Goodwin’s pension wasn’t just a matter of one man’s greed, however; it was a focal point for the public feeling of helplessness, disbelief and disgust brought on by the realisation that the mighty, all-knowing financial powers we entrusted with our money are actually just a load of out-of-their-depth greedy idiots who’ve gone and squandered the lot.
Well, now the United States is having their “Goodwin” moment – and who knows where the chips will fall?
The controversy centres around American International Group, the behemoth insurance giant who has so far been bailed out to the tune of $170 billion – $30 billion of that under Obama’s watch. It turns out that AIG intends to pay its employees $165 million in bonuses. Yes, you heard that right: AIG, one of the companies directly responsible for the financial meltdown, wants to reward its employees to the tune of one hundred and sixty five million dollars. Cue outrage across America: congressmen foaming at the mouths, TV pundits having aneurysms before our eyes, etc.
AIG Chief Executive Edward M Liddy (who is testifying before Congress today which should be, uh, interesting…), defended the bonuses by claiming they were necessary so that AIG could keep their “best and brightest talent”, though quite what the talent were doing while the economy went to hell in a handcart he neglected to explain. An arguably better defense of the bonuses has been made in the New York Times: essentially, they are necessary to stop the departures from AIG of the only people who know how to defuse the complex financial instruments that they helped put together. This is all very well, but perhaps we should first remind ourselves how AIG got into this mess, and then judge for ourselves whether we give a damn if there’s anyone left in their offices by the end of the month…
Basically, AIG dragged themselves into this hole – taking part of the economy with it – by engorging themselves on the devastatingly stupid credit default swap market. Say what now? Allow me to explain. A credit default swap is essentially an insurance contract, in that an insurance company – like AIG – says to a bank: I bet you that your subprime mortgages won’t fail. You pay me an annual premium, and, in the event of the subprimes being defaulted upon, I’ll pay you their value! Sounds alright, except for two things: the subprime mortgages turned out to be pretty rubbish. And by pretty rubbish I mean economy-ruining awful. Even more damning, AIG took on so many contracts that they didn’t have enough money to pay out in the event of all the subprimes defaulting. Which is obviously what happened – which in turn is partly the reason why you don’t have a job, the bailiff is taking your sofa and there’s an angry mob off to burn down the banks.
AIG, however, are not the only ones facing tough questions. Treasury secretary Tim Geithner, and his accomplice National Economic Council head Larry Summers, are under close scrutiny over their roles in this clusterf***. Specifically, why were strict rules on bonuses not ironed out when AIG was given a further $30 billion last month? Were Geithner and Sumners aware of the bonuses at that point? If not, why not? If so, then can we have your resignations, please? There is a growing feeling, as there has been ever since Geithner and Summers were appointed to their respective roles, that Obama’s economic gurus are, to repeat a cliche, more interested in protecting Wall Street than they are Main Street. Their original reaction to the news of the bonuses didn’t exactly squash this suspicion: Larry Summers basically said “they have ironclad contracts… there’s nothing we can do!” Nothing we can do, eh? I suppose that’s why Congress is right now planning to impose a 100% surtax charge on the bonuses, right?
If anything, this mess is another reminder that the Treasury seems to be trapped in what Paul Krugman has called the “Big Dither” when it comes to fixing the banks. Geithner is obviously reluctant to go down the path of bank nationalisation, even though – as increasing numbers of economists are pointing out – it’s the most efficient, tax-payer friendly way out of this mess. Indeed, as I pointed out a few weeks ago in my post “Nationalising Banks – In America?” a path to nationalisation was slipped into last month’s still-not-enacted Treasury plan. But Obama’s team seem unwilling to bite the bullet and take over the troubled banks. Instead, Geithner gets the worst of both worlds: no concrete action on the banks and a lack of confidence caused by the Treasury’s unwillingness to do anything. In this way, the AIG scandal only serves to highlight the perils of the current strategy: on the one hand using taxpayer money to bail out the banks but on the other hand not having any control over what happens to our cash. Given all this, it’s hard not to agree with Ex-Labour secretary Robert Reich’s conclusion:
Oh, and by the way, Mr. President. You may not want to hear this, but your Treasury Secretary is making things worse. His dithering on what to do about Wall Street, and his incapacity to speak clearly to the Street and to the public about what needs to be done, is spooking everyone. Why doesn’t he just put the irrevocably insolvent banks into receivership under the FDIC, sell off their assets, protect depositors, and reimburse taxpayers with whatever remains? Let the rest of the banks fend for themselves — working out their bad loans with their creditors. As to AIG, well, that’s a complete basketcase. Put it out of its suffering. Take it over, sell its assets, protect policy holders (you’ll need to create a big co-insurance plan with every other major insurer in the world), then get out.
I should add that had the government allowed AIG to go bankrupt then the problem would be solved: in bankruptcy proceedings bonuses would be right at the back of the queue behind dozens of more important creditors. This makes AIG protests all the more ridiculous. Of course, if the government owned them, then this wouldn’t be a problem: you don’t have to honour a contract if the other party doesn’t exist anymore. Given this, I think the argument for nationalisation of companies like AIG goes from “pretty rock solid” to “more unbreakable than diamond”.
Right now, Obama’s worst enemy is his Treasury department. The AIG mess and the unprecedented public rage that has followed it is not just another example that capitalism as we know it has failed – though it is that - but also an urgent warning to the President: If he doesn’t do something about the banks soon, then he can kiss the rest of his agenda goodbye. It really is that simple.
Update: Chris Bowers identifies the four main questions that need answering about Geithner and Summers’ involvement in the mess.
