The whole world is abuzz with the bonus given to a certain group of executives of the American International Group (AIG), the colossal insurance giant. People are aghast at the enormity of the event. When the country is passing through recession, it is unconscionable for anybody to accept huge sum of money by way of bonus, and it was stupid on the part of the management of the AIG not to be able to find a way to avoid such an embarrassing situation. It is all the more so, because the recipients of the bonus were the very same people who are said to have dealt in the derivatives trading which brought financial ruin on the company. Simplistically, they were rewarded for their incompetence. At least this is the view, which is popular in the media and public. Fuming with rage, the attorney-general of the New York, Mr Cuomo declared that he would “name and shame” the recipients of the bonus. Not to be left behind, his counterpart in Connecticut said, “……these people should have been shoved out the door, not showered with cash." In a fit of righteous anger, a senior Senator went to the extent of advising them to “resign or go, commit suicide.” In private conversations, people used much stronger language.
Yet, there is another side of the story. The bonus given to AIG executives was not a performance bonus. It was retention bonus and its value was not linked to the performance level of the individual recipients. It was a part of their total compensation package, and the company was obliged to pay it under a contract with them, regardless of how the company fared. Unlike the performance bonus, the retention bonus is not designed to be a percentage of the profit which they would be expected to add to their company. This modus of bonus is prevalent in many big corporations. In the popular mind, the concept of bonus is invariably associated with the idea of a reward which an employer gives to an employee for his exceptionally good work. In this case of AIG employees, it was an integral part of their pay packet.
Let us see the situation from another perspective. A surgeon cannot be denied his fee, even if an operation fails and the patient dies. A lawyer cannot be denied his fee even if his client loses the case. So why a banker who does his work with due diligence and sincerity be denied his contracted compensation, if he fails to add profit to his company due to circumstances beyond his control. Fact of the matter is that nobody in the world had foreseen the denouement of the story of subprime housing mortgages. One might argue, with some justification that the compensation paid to the top officials of the Bush administration should also be denied or heavily taxed because they failed to see the storm of recession coming well in time.
Jake DeSantis, the Executive Vice President of the AIG-Financial Products resigned on March 24, 2009. In his letter of resignation addressed to the CEO of AIG, he made a point that most of the employees of the finance product division who received the bonus had nothing to do with the large losses which occurred due to credit default swaps. He remarked, inter alia, that “None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.”
At this point of time it is purely academic to debate the ethicality or otherwise of the assailed AIG bonus. There are two seminal questions at this point which should be publicly debated.
Whether the law to tax such bonus retrospectively can stand legal scrutiny at the apex court; and
Whether taxing heavily AIG bonus will set a bad precedent and be detrimental to business climate in the USA.
The cardinal principle of Anglo-Saxon jurisprudence is that an ex post facto rule of law is astoundingly unfair and therefore invalid ab initio. Constitution of the United States is categorical on this issue. Section 9 of the Article 1 of the Constitution lays down, “No Bill of Attainder or ex post facto Law shall be passed.” It is, therefore, somewhat surprising that the House of Representatives passed a bill levying tax on certain categories of bonuses with retroactive effect. In all likelihood, this law shall be set aside by the apex court. If the matter goes before the courts, it is bound to create lot of interest not limited to the law-practicing community.
The retroactive law, if upheld by the Supreme Court, will set a bad precedent for the American business. The entire financial system is based on the trust. Treasury bonds worth billions of dollars are bought on the trust that the interest rates committed will not change. How many people, least of all the foreign governments, will be interested in investing in those bonds, if they are not sure that in some not foreseeable future the Congress might dilute the interest rates retroactively? Will it not make purchasing the American debt a risky affair for China and Japan?
Many banks have received assistance under Troubled Assets Relief Program (TARP). Since the law passed by the House relates only to those financial institutions who have been given massive financial assistance by the government, they may well tend to refuse such assistance as it would bind their hands in matters of deciding compensation to their executives. Financial institutions which fall in this category are the likes of Wells Fargo, Goldman Sachs, Morgan Stanley, Citigroup, Bank of America who may determine that the advantages of getting massive funds under TARP in exchange for their preference equity or general equity might not outweigh the advantages of their retaining operational freedom. This is all the more so when they are planning to sell their toxic assets to private equity funds and hedge funds. Accurate differential pricing of such assets will be crucial to the profitability of big banks and the whole exercise will need highly specialized skills and vast experience of their executives. Restricting their compensation package under an executive fiat or an oppressive tax regime is bound to encourage their prized employees to seek greener pastures elsewhere.
It is human nature to find a 'whipping boy' for their misfortunes. The monumental outpouring of public anger against the AIG bonus recipients stems from the people's belief that they were the villains of the piece, and that the recession would not have visited them but for them. The great hullabaloo on the AIG bonus issue has only resulted in distracting attention of the Obama administration from fixing the larger problem of rising unemployment and premature foreclosures on defaulted mortgages. Loss of 165 million dollars, assuming it is a dead loss and totally unjustified, is almost nothing in comparison to the federal budget of about 3,500 billion dollars, and less than almost nothing in comparison to the American economy of about 14,000 billion dollars.
We cannot afford to be million wise and billion foolish in our hour of supreme financial crisis.
