Let’s Hear It For Bankruptcy!

The big news of the day is the AIG bonuses. Barack Obama, obviously worried about getting on the wrong side of the bailout backlash, berated AIG and directed Tim Geithner to do what he can to block their payment. Republicans weighed in too; John Boehner called the bonuses “outrageous” and demanded an “exit strategy” from AIG. The company, meanwhile, says it is contractually obligated to pay the bonuses and has no choice.

It strikes me that this episode illustrates the inherent evils of a bailout. There really are no rules; the government pumped many billions into AIG, but the company and its new “owners,” the taxpayers, are making it up as they go along. AIG is likely right in saying it is obligated to pay the bonuses, but the public is also right in believing a bailout shouldn’t work this way. The problem is that we have no established rules to govern bailouts.

Which is one basic reason why bankruptcy is far preferable. Bankruptcy has reasonably clear rules that have been developed over many years. The bankrupt company is run for the benefit of its creditors, or, if appropriate, shut down. The creditors decide whether to keep existing management on. Executory contracts can be accepted or rejected; labor and supply agreements can be renegotiated. A judge presides so that disputes can be fairly resolved.

A bailout is an ill-defined procedure in which no one’s rights are clear, and political calculation counts for more than fairness or transparency. The flap over AIG bonuses is just one of many that we can expect to arise if we continue down the path of endless bailouts, rather than allowing insolvent companies and their creditors and investors to pay the price of that insolvency.

UPDATE: Andrew Samwick, a member of the Council of Economic Advisers early in the Bush administration, alerts me to this post that he wrote over the weekend:

Based on this latest story in The Washington Post about millions in bonuses being paid to AIG executives, there are any number of words whose meanings need to be revised:

1) Bonus: My understanding is that a bonus is related to performance. At a company that needed a federal bailout to remain afloat, what metric is being used to assert that the bonus payment is positive? If there is no metric, then why is it called a bonus at all?

2) Retention: The bonus payments are sometimes referred to in the context of retaining these employees. In what universe have the talents of those at AIG Financial Products just become more valuable? Are there other financial firms just lining up at the door of AIG FP, begging these folks to come wreck their companies like they wrecked AIG?

3) Ownership: The article notes that for its $170 billion, the government has an 80% ownership stake in the company. And the “owners” are being told by the CEO that they cannot determine compensation levels of the “workers?” This is yet another reason why the government should not “own” corporations.

Even more importantly, this is another example of why bailout in lieu of bankruptcy is a terrible idea. Do we now still think that we couldn’t have done better with our $170 billion by selectively supporting AIG’s creditors after AIG went into bankruptcy than by shoveling that money to AIG so that it could be siphoned off in any number of ways, including these bonuses?

You can follow Andrew and fellow economists Stan Collender and Pete Davis at Capital Gains and Games.

FURTHER UPDATE: The Washington Post has more details on the bonuses, and makes the best case for their reasonableness I’ve seen. Which, in my view, doesn’t change the bailout vs. bankruptcy evaluation at all.

FINAL UPDATE: My Facebook friend Patrick Yun comments:

A real life example of what we, as taxpayers, do for our government. It is for the most part, an incompetent, poorly and inefficiently run business, and taxpayers are essentially forced to bail it out with rising and never ending taxes. Then the members of congress increase their benefits and pay despite their poor performance.

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