Money matters

By Megan McArdle

I'm watching the AIG hearings, and there is, unsurprisingly, a great deal of ranting about the bonuses.  I'm not exactly in favor of the bonuses, but I have to wonder:  what questions aren't being asked because of these bonuses?  The people who took them are at the very best foolishly arrogant--but the cash flows are trivial relative to the overall cash flows, and the company keeps coming back for more money.  Don't the congressmen have more important problems to pursue?

Barney Frank, however, uses the bonuses to make an important point:  the compensation structure at all of these firms is seriously screwed up.  Bonuses originally intended to encourage performance have morphed into deferred guaranteed compensation, for reasons that aren't clear.   That's not necessarily a huge issue--except now, when the time-shifting leads to moral outrage.  But the really pernicious problem is that the contracts are set up so that bonuses cannot be substantially cut if profits fall. 

It's not clear to me how contracts have come to be written that way--after all, they weren't always handing out taxpayer money, and the big bosses who wrote those contracts were also sizeable shareholders in their firms.  The result, however, is that all of the employees holding these sorts of contracts have vastly excessive incentives for risk taking.  Perhaps some of them were taking big risks on the moral hazard of having Congress bail them out--but as Lehman shows, that was never a slam dunk.  And I doubt a handful of these traders and money managers thought they were betting the firm.  Most of them thought they were gambling on their own careers--just not very much of a gamble.

Frankly, Congress shouldn't need to intervene in these contracts; they're inexplicably stupid.  Shareholders, having been alerted to the problem, ought to be demanding a fix.  Of course, look who's managing a lot of that shareholder money.  Honor among thieves?

This article available online at:

http://www.theatlantic.com/business/archive/2009/03/money-matters/1621/