Government Could Have Easily Prevented AIG Bonuses

Wed, 18 Mar 2009 17:39:57 +0000 – By Ken Klukowski

The debacle over the AIG bonuses proves that opponents of the bailouts were on to something. There are at least three ways the federal government could have avoided this debacle, and now taxpayers are stuck with the bill.

Insurance giant AIG is paying $165 million in performance bonuses (a stunning thought, given the circumstances). AIG says that these are legally binding contracts, so it has no choice but to pay them. Since AIG is living off government money right now, these bonuses are really being paid directly by American taxpayers. The reaction from our leaders in D.C. has been to howl in protest, and then suggest this could not have been prevented.

Wrong.

First, if AIG had been forced into bankruptcy, this latest outrage would not have happened. When a company goes into Chapter 11, all of its financial obligations (such as these contracts) are put on the table, and bankruptcy courts have the power to modify or cancel these obligations.

Bankruptcy doesn't have to be the end of a company. The preferred outcome of corporate bankruptcy proceedings is for the company to continue operating and eventually recover in the marketplace. Indeed, that's what usually happens. If AIG has gone into a prepackaged, tightly-managed bankruptcy, these bonuses could have been eliminated.

Some say that AIG is such a global player that bankruptcy could have set off a row of dominoes, no matter how closely the process was supervised. They're basically saying that the headline "AIG Goes Bankrupt" would cause the same panic as screaming, "Shark!" would have on a crowded beach with hundreds of people in the water.

Even assuming that's true, government could still have prevented this scandal. First, Congress could have invoked its constitutional bankruptcy power in the bailout legislation, making the same changes to AIG's contracts that a bankruptcy court could make. Second, if even that would still cause a panic, then Congress could include provisions in the bailout bill that would have cancelled these bonuses.

Some pundits object that the Constitution doesn't allow government to change existing contracts. Wrong again.

First, the Article I Contracts Clause reads, "No state shall ... pass any ... law impairing the obligation of contracts." It only affects state governments. The federal government can do whatever it wants to contracts. Second, even states can still modify contracts, as long as the law is narrowly tailored to achieve an important state interest. Here, passing a law that narrowly targets a company's performance bonuses in exchange for receiving a massive infusion of taxpayer money to save it from bankruptcy and avoid a financial panic meets this test.

AIG protests that without paying these bonuses, it will lose the "best and the brightest" of its talent to other companies. Well, too bad. If there are such talented people at AIG, they're free to go wherever they want. Don't give taxpayer money to someone just to keep him at a basket-case corporation. If another company is willing to take someone from AIG, then so be it.

This whole situation shows the folly of government getting involved in bailing out companies or running the economy. Laws that are hurriedly passed invariably cause such exasperating results.

Once laws are passed, the consequences are difficult to undo. Legislative attempts to take away these bonuses with a 100% tax could possibly be struck down by the courts as unconstitutional bills of attainder. Seeking to have a court declare the contracts unenforceable because they are unconscionable is an equally bad idea, because it flies in the face of the legal rules governing unconscionability, and the last thing Americans should want right now is inviting judges to decide what kinds of employment bonuses should be discarded as unfair. And if the federal government stops these bonuses because it is now the majority shareholder of AIG, then we've finally moved to flat-out socialism. For any of these options, the cure may be worse than the disease.

Both the current and previous administration share the blame here, though ironically it was Tim Geithner at the heart of it under both presidents. This whole mess shows the perils of government trying to run corporations, or save companies from reaping what they sow.

And this isn't the end of such debacles. AIG is just the tip of the iceberg. Ken Klukowski is a policy consultant and legal analyst in Washington, D.C., and holds a business degree from the University of Notre Dame.