Entrapments of Our Own Making

The fuss and feigned fury over the bonus payouts to AIG traders is good political theater (I’m not sure whether it is comedy or tragedy) but it distracts us from more important work in resolving the current economic panic and recession.

On the one hand, that AIG’s Financial Services Division could expect bonus payouts at all after they ran the entire company in the ditch seems arrogant beyond measure to most Americans. That AIG executives hid behind ‘contractual obligation’ to make such payments in the current circumstances stretches credulity. That the Government let it happen is just plain dumb economics and even worse politics.

I suspect I was not alone in my reaction that AIG should ‘just say no’ and let the FSD folks sue them. The Government could have aided in this process by jawboning the FSD folks that unless they fore go any bonuses and help AIG unravel this mess they risk being investigated, indicted and tried in the search for scoundrels that would cost them much more than any bonus payments they might have received. Had this scenario played out all the parties would have looked like heroes instead of greedy or stupid villains.

I suppose we could just chalk this up to the inexperience of the Obama team that this spun out of control. That might be the kindest explanation and the most generous outcome from this experience. But I think the real lesson here is not found in the facts of what has happened about bonus payments, but rather the lesson of unintended consequences when the government gets in over its head and becomes entangled in entrapments of its own making.

As taxpayers, we have now spent more money on AIG than the company was actually worth before this crisis all began because AIG was perceived as being to big to fail. In truth, most of AIG involved in insurance is quite sound and could have been spun off sequestering the toxic assets in FSD with the Government absorbing them, holding them and working them out. I would be happy to pay bonuses to the FSD folks for each of these screwy deals they successfully unravel from any profits the Government makes over the long term process of cleaning up this mess.

Such a strategy would also do something else we need right now—build confidence that there is light at the end of this long tunnel. That is exactly what the Fed seems to be doing by its surprise announcement that it would buy back Treasuries and expand its purchase of “toxic assets” over the next several months. Some fear this will ignite inflation and weaken the dollar. But the real impact might be sufficient to reassure investors around the world that the US is taking assertive steps to right this ship. Maybe it is only coincidence that the Fed took these actions only a week after the Chinese worried aloud out the value of its US investments in Treasuries and other assets. I think not.

The Fed is imposing “ adult supervision” on the financial system and taking the steps that Secretary Paulson first recommended—get those toxic assets corralled where we can deal with them over time, and free the banks to get back to business.

Now THAT is really a change we can believe in!