Most American's are up in arms about the bonuses paid out to the very AIG traders that caused the company to fail. The company has been defending the bonuses saying that they need to retain the traders due to their exclusive knowledge of the financial products they are trying to wind down. This same argument was made during the Asian financial crisis of the late 90's, and the countries that didn't listen to it ended up much better off then the ones that did. For more on this, read the following post from Mark Thoma.
James Kwak and Simon Johnson say the arguments made to support paying bonuses at AIG - that the bonuses are needed to retain people with specialized knowledge - do not withstand closer scrutiny. Not only can the "discredited insiders" be replaced, it's best when they are:
Off With the Bankers, by Simon Johnson and James Kwak, Commentary, NY Times: A.I.G. can hardly claim that its generous bonuses attract the best and the brightest. So instead, it defends the payments by arguing they’re needed to retain employees who are crucial for winding down transactions that are “difficult to understand and manage.” ... There is no reason to believe this.
Similar arguments made during the 1997 Asian financial crisis ... turned out to be a smokescreen to protect the executives who were partly responsible for the mess. Recovery from that crisis required Indonesia, South Korea and Thailand to close or consolidate banks. In all three countries, bankers protested, claiming that their connections with borrowers were critical to recovery. ...
The leaders of Thailand and South Korea did not listen to such arguments, and thank goodness. Some of the leading Thai banks were taken over by the government. After the crisis, a civil servant in charge of one such bank noted that its bad loans were much bigger than had been indicated before the takeover, largely because of an internal coverup. Only when outsiders took over did the public discover the full scope of the losses. ...
But these reforms made all the difference. Banks became healthy and resumed lending within a few years after the crisis broke. ...
Indonesia did not respond to the crisis so wisely, and the costs were severe. ... The lesson of all this is that when insiders have broken a financial institution, the most direct remedy is to kick them out. Traders are hardly in short supply, and you don’t need to rely on the ones who made the toxic trades in the first place. Companies must always plan around the potential departure of even their star traders, or they are certain to fail. ...
If A.I.G. wants to argue that complex transactions, hedging positions and counterparty relationships require employees who are intimately familiar with those trades, it should at least provide evidence that the arguments for doing so are sounder than the ones made in Indonesia in 1997, when leading bank-owning conglomerates claimed that only they understood their financing arrangements... We heard variants of the same idea in Poland in 1990, Ukraine in 1994 (and in the Ukrainian crises subsequently), and Argentina in 2002.
Any grain of truth in these arguments must be weighed against the costs of allowing discredited insiders to manage institutions after they have blown them up. Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way. The argument that A.I.G.’s traders are the people that we must depend on to save the United States economy is ... weak and self-serving...
This post can also be viewed on economistsview.typepad.com.
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