"I Didn't See This Coming, Either"

In the past couple of months I've seen the documentary, Inside Job, a competent explanation of how the financial industry crisis arose, and of the ensuing collapse and bail-out. There are no big surprises for those who followed the crisis, but it's a good refresher course - and probably a good primer for those who are still wondering how the crisis occurred. I also saw the star-studded HBO dramatization of Andrew Ross Sorkin's novel, "I Love You, Hank Paulson" Too Big to Fail. That production offers a frenzied account of how the crisis was handled, but (in my opinion deliberately) omits mention of how the crisis arose or what has happened since Paulson "forced" the nation's biggest banks to accept billions of taxpayer dollars, no strings attached.

Two things struck me about the HBO production. First, if Sorkin's account is accurate, perhaps Henry Paulson's epitaph should be, "I didn't see this coming, either." Perhaps in order to maintain him as a sympathetic character, there's next to no mention of Paulson's background in Goldman Sachs, and what mention there is comes in the form of telling us how unfair it is that the government is viewed as being unduly influenced by the former Goldman Sachs employees who manage the treasury, or how hard Paulson worked to save Lehman Brothers (merely, we are told, the seventh largest investment banking firm in the country - why would Goldman Sachs care about such a minor player) and how it was that bank's intransigence and not Paulson's policy that resulted in its bankruptcy. There may be truth to that, but it's still very interesting how much effort Sorkin applies to salvaging Paulson's reputation as opposed to explaining how Paulson managed to avoid recognizing the perilous condition of the financial sector before we reached the crisis point. Seriously - thanks to Sorkin I now know Paulson's religion and that he has to be arm-twisted to take a sleeping pill (which he may or may not have actually taken), than I do about his history with Goldman Sachs.

The film ends with Paulson expressing a hopeful but concerned expectation that the banks would follow through on their implied promise to lend out the billions of "no strings attached" dollars to boost the economy, but unlike the rest of the film in which Sorkin's interpretations and conclusions are spoon-fed to the audience, you only "get" the ending if you already know that the banks did no such thing - but you're expected to believe that Paulson didn't see that coming. From Sorkin, you get no sense of any of the inside dealing and willful blindness that was behind the bubble or AIG's failure. This is stuff that just happened - a perfect storm, it would seem, of industry actions for for which nobody should be held accountable. You get no sense of regulatory capture - but as I've commented, Sorkin's coverage of the financial industry seems to me to be the journalistic equivalent of regulatory capture. The dramatization of his book reinforces that perception, and then some.

Some of the explanations for policy choices are left with the not-so-credible statements we've previously received. For example, we have no choice but to give the nation's biggest banks all those billions of dollars because if only the failing banks are given money everybody will know which banks are failing. The competing explanation, that it would not be fair to the non-failing banks if their incompetent competitors get that kind of boost and they do not, is omitted. But by the time of that cash infusion, everybody who was following the crisis knew or could easily determine which banks needed the money and which did not. The "we need to maintain a level playing field" argument would have been more credible; although I suppose that would have undermined Sorkin's explanation for why no strings could be attached to the money. You could achieve that level playing field by offering the money, strings attached, on equal terms to every bank. And not so much as a whisper about how your word is your bond in the financial and insurance sectors - maybe that's a rule only for insurance companies?

Timothy Geithner, on the other hand, gets no similar amount of love. When he's on screen the goal seems primarily to be to attribute to him some of the worst and least popular aspects of the bail-out - blank checks for the banks, "cash for trash".... That may be entirely fair. Whatever I can make of defenses of his intentions and integrity, I can't recall the last time I've heard a defense of his competence in relation to the management of this crisis. But really, given how a simple measure such as some form of bankruptcy cram-down for homeowners' first mortgages could have helped over the past two years, simplifying the process of getting people out of their upside-down homes without foreclosures or short sales, keeping struggling people in their homes, and in stabilizing housing prices, who could muster an energetic defense for a guy whose only concern was in shoveling as much taxpayer cash as possible, no strings attached, into the institutions most responsible for the nation's problems.

'...But a Rich Person Told Me..."

Some years ago a friend expressed her frustration with the Ann Arbor political left, which she perceived as talking a good game but ultimately deferring to people with wealth or power. As a matter of human nature, or even as a matter of U.S. culture, that's not particularly surprising. But she had higher hopes for well-educated, politically informed people who arguably should be able to distinguish wealth and merit, and to recognize that even when wealth comes from merit the politics it spawns can come from self-interest.

When I hear Andrew Ross Sorkin speak, I am reminded of that observation. For example, the other night on Real Time, Sorkin was describing that a business executive told him that he was creating many new jobs for educated people, but was creating them overseas. "Why?", Sorkin asked. "Because they're smarter," the executive replied, apparently under an express or implied agreement that he would not be named. Sorkin appeared to accept that argument at face value. In reality, though, the U.S. is dripping with talent. The real answer is that U.S. talent costs more. Yes, as international universities have improved, they produce graduates with a much higher skill set than in the past, and thus much more attractive to people like Sorkin's executive. But we're still talking money.

I'm of course also reminded of his credulity when presented with the arguments about the AIG bail-out and the "sanctity of contracts". I previously suggested that Sorkin didn't believe the nonsense he was producing on that argument, but perhaps the issue is that an anonymous insurance executive was whispering in his ear and... instant credulity.

Sorkin's recent column on tax rates reflects the same sort of credulity. Does Sorkin understand marginal tax rates? He probably does, argues Atrios, but "but it's also the case that people who writes about this stuff frequently fail to explain it to readers in a way which seems to be designed to deliberately mislead." Or maybe he's repeating what an anonymous wealthy person told him, and perceives no need to think it through because wealthy people are better than the rest of us. Sorkin categorized himself on Real Time as a "New York Times liberal". And I know he's more than sufficiently informed and educated that, if asked, he would recognize the absurdity of deferring to somebody's opinion merely because that person happened to be wealthy or earning huge bucks as an executive. But here there's not much difference between the author and the reader - like the Ann Arborites my friend criticized, many of whom are Times readers, Sorkin appears to be accepting the positions of his wealthy, powerful sources without reflection.

Andrew Ross Sorkin, Contrarian

Addressing the AIG bonuses, Andrew Ross Sorkin argues that the American taxpayer should bend over and... I'll leave out the middle part, but at least it ends with "get over it" as opposed to "pretend to like it." It's an essay apparently designed to provoke; unfortunately it doesn't do much to persuade. Quoting President Obama, Sorkin states,

“This isn’t just a matter of dollars and cents,” he said. “It’s about our fundamental values.”

On that last issue, lawyers, Wall Street types and compensation consultants agree with the president. But from their point of view, the “fundamental value” in question here is the sanctity of contracts.

The sanctity of contracts? I assume at this point that Sorkin's never had to negotiate with his insurance company over a claim or wrongful denial of benefits. It goes without saying that he's never gone to law school, let alone practiced contract law. I wonder if he takes a similar absolutist position on divorce - marriage is a contract, after all, yet here's the government letting people off the hook, all the time.

The world of AIG revolves around contracts - building contracts that are tightly binding on the other side, but loosely binding on AIG. They have platoons of lawyers that they can turn loose on their contracts to determine ways to deny claims, reinterpret provisions in their favor, revise contracts to take advantage of the latest changes in case law and statute, and otherwise to put the people on the other end of a transaction at contractual disadvantage. When there's a dispute over a contract, those lawyers don't hesitate to argue that the contract should be voided on any number of grounds, including fraud, mutual mistake, and violation of public policy. The only time they talk about the "sanctity of contracts" is when they're on the other side of the argument, and probably then only for the benefit of a jury - I can hardly imagine what a judge with any experience would make of an insurance company arguing that contracts are sacred and inviolable.

That may strike many people as a bit of convenient legalese, but maybe there is something to it. If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

You mean, like if the government offered things called "courts" where people could go and claim, "I'm in a contract dispute with this other person, and want you to vacate part or all of the contract," and had a person called a "judge" who had the power to in fact do that? Or a special type of court called a "bankruptcy court" where people could erase part or all of their financial obligations? Or where there was an elected "Congress" that would tell a company in financial trouble, "We'll help you - but only if you first tear up your contracts with your labor union"? The horror - thank goodness we don't live in a country like that.

Do you find yourself transported back in time to last November, when Sorkin felt quite differently about contracts?

Bankruptcy would give G.M. enormous leverage with its debt holders — and, perhaps more important, with the U.A.W., whose gold-plated benefits are one reason G.M. is no longer competitive. A bankruptcy filing would also give G.M. the cover to close plants, rid itself of unprofitable brands and shed dealerships.

Wow.... G.M. would need an industrial-strength shredder. And it gets better... Why should auto workers have their salaries slashed and lose their benefits, despite the "sanctity" of their contracts?

Part of the problem is summed up by comments like this one in The Detroit Free Press, made by Kandy O’Neill, 39, an assembler at G.M.’s plant in Lake Orion, Mich., where she builds the Chevy Malibu and Pontiac G6. “I think we’ve given enough,” she said about the cuts to her salary and pension plan.

“Everybody wants to come down hard on the workers,” she said. “Nobody knows what we do inside there but the people who work there. It’s hard. It is not an easy job.”

When you read a line like that you might sympathize with her, but then you realize that nothing can be accomplished without bankruptcy. Ms. O’Neill: your company is asking the taxpayers - many of whom don’t have health care coverage - to pay your salary and health insurance.

And Mr. Sorkin, you're asking the taxpayers, many of whom aren't getting $3 million bonuses this year, to... Oh, why am I still pretending that you intended your argument to do more than give you a lot of media attention for being contrarian. I can't believe you're so obtuse as to not see the contradiction, or have had a transformative experience that has caused you to abandon your earlier anti-contract stance. Do you believe a word you wrote in either article?

Seriously, here we have AIG that is bankrupt - it survives only through the injection of gargantuan amounts of taxpayer money and the implied (or is it express) promise that the U.S. Treasury continues to stand behind its obligations with a blank check. No, it hasn't gone through bankruptcy proceedings, but only because it's the unique and special recipient of an unprecedented bailout. It's perfectly reasonable, and perfectly consistent with contract law, to argue that the bonus contracts requiring a huge outlay of taxpayer money to reward AIG employees violates public policy.

But let's take a step back - Sorkin argued, "imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right." My response so far treated that remark seriously, whereas it's not a serious comment. It's a slippery slope argument - and he admits it ("As much as we might want to void those A.I.G. pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is.") I guess he hasn't studied logic.

My sarcasm should not be used to feed the slippery slope - although the government gives businesses and individuals both tools and opportunity to escape contracts, for the most part the government does seek to uphold contracts, and help others uphold them. Nobody in the business community would look at the AIG bailout, and the billions poured into upholding AIG's poorly considered contractual obligations, and conclude based upon the voiding of an oversized bonus contract, "The U.S. government can't be trusted to uphold contracts." Sorkin has to know that.

(The auto industry unions are facing a similar issue - but the big difference is that there is a negotiation; no one is unilaterally tearing up contracts.)

First, no, it wasn't a negotiation - it was a condition the government imposed as a prerequisite to issuing GM and Chrysler bailout money. The contract was entered through a negotiation, and is being abrogated because the government didn't want bailout money to support a compensation structure people like Sorkin argue is unjust to taxpayers. You know, because UAW members get health benefits. Second, Sorkin himself favored unilaterally tearing up their contracts through a Chapter 11 filing.

But what about the commitment to taxpayers? Here is the second, perhaps more sobering thought: A.I.G. built this bomb, and it may be the only outfit that really knows how to defuse it.

A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave - the buzz on Wall Street is that some have, and more are ready to - they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.

That's speculative, and although beneficial to AIG is not something I find particularly compelling. I suspect that, had it wished to do so, by now AIG could have brought people into the Financial Products division and got them up to speed, to the point that the people who created this mess could be given their walking papers. Sorkin's argument actually lends weight to the argument that the contracts should be declared void. If in fact their was an implicit threat, "Give us millions and millions of dollars, or we'll finish ruining the company and take down the world economy," it would be unconscionable to reward that behavior. The idea that they could walk away and trade on their inside information to the detriment of AIG and the country? Probably illegal, and certainly something AIG should have covered in its employment contracts.

And how does any of that explain why AIG gave these bonuses to employees outside of the Financial Products division, under the same exceptionally generous terms?

For better or worse — in this case, worse — someone at A.I.G. decided this company needed to sign bonus agreements last year to keep people before the full extent of its problems became clear.

And again the question arises, why? Why these unusual, "bulletproof", anti-employer contracts that guarantee extraordinary bonuses over a two-year period? The only compelling reason I can think of remains that AIG suspected that it would be taken over by the government and wanted to be sure that compensation would not be affected - regardless of performance, losses, or taxpayer subsidy. Liddy's comments support that thesis:

“We cannot attract and retain the best and brightest talent to lead and staff” the company “if employees believe that their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he said.

So this pay structure was created in anticipation that the U.S. Treasury would take over AIG?

Let them leave, you say. Where would they go, given the troubles in the financial industry? But the fact is, the real moneymakers in finance always have a place to go. You can bet that someone would scoop up the talent from A.I.G. and, quite possibly, put it to work - against taxpayers’ interests.

What's that supposed to mean? First, if people are able to be more productive outside of AIG, you create an economic efficiency by having them switch jobs. Second, how are the people at the heart of this disaster "real moneymakers"? You're going to gamble your company on their next scheme? Third, why are we assuming that they, and any other employer they join, would be working against taxpayer interests? Fourth, no small number of the employees getting these bonuses no longer work at AIG - how in the world does it benefit anybody to give them a retention bonus now?

“The word on the street is that A.I.G. employees are being heavily recruited,” Ms. Meyer says.

How does that justify the bonuses, even if we leave aside those paid to employees who have already quit? A retention bonus is only persuasive if it's higher than the next guy's signing bonus. If these guys could get the same or more elsewhere, the bonuses won't keep them at AIG. If they can't, but we're obligated to pay them more than their market value if we keep them on AIG's payroll, then AIG should be searching the job market for their replacements. In contract talk, that's called "increasing efficiency".