Bonuses to be Taxed at 90 Percent

by Manshu on March 20, 2009

in Opinion

The House has passed the Bonus Tax Bill after the AIG bonus furor.

WSJ reports:

“The House measure was approved on a 328-93 vote and would impose a 90% surtax on employees who earn more than $250,000 at companies that have received at least $5 billion from the government’s financial rescue program. The bonus tax, if approved by the Senate and signed into law, would be retroactive to Dec. 31, 2008.”

I am glad that the bill is passed and the real reason for that is — now the people at AIG Financial Product Division will surely quit.

I was watching Mr. Edward Liddy’s testimony and there is one piece that has been on my mind ever since. But before that, some interesting facts that I gathered from his testimony:

Last Friday, AIG awarded millions of dollars of bonuses to employees of the AIG Financial Products Division. This is the same unit that made massive losses and brought AIG to its knees. These bonuses were not “performance bonuses” but rather “retention bonuses”

In the beginning of 2008, AIG had made contracts with these employees, that promised them bonuses, if they stayed throughout 2008 and wound down the derivative contracts they wrote earlier.

The Financial Products unit itself is about 450 to 500 people, but the people who caused the real damage form a much smaller sub – unit of around 20 people or so.

Each financial contract is unique in itself and the person who wrote that contract is in a much better position to wind it down, rather than another person with similar ability but no knowledge of the contract.

In fact that is the main reason of paying the bonus. They didn’t want to lose the person who wrote the contract.

The second most important reason is that they had a contract which had to be respected.

Mr. Edward Liddy joined as CEO about six months back at the behest of the government and is just drawing a $1 per annum salary.

Obviously, any man who takes up this kind of job has nothing but the greatest good of the country in his mind (and maybe a little glory after wards). The main reason that Mr. Liddy has allowed the bonuses is because he felt the people getting the bonuses were irreplaceable.

In fact, all other banks and financial institutions have made the same case — that if they don’t give out the bonuses; they will not be able to retain their top talent, which implies that they can’t buy cheaper talent from the market.

And this is what has been on my mind ever since: Are these people really that talented?

Unfortunately, there is no way to find that out without firing these people. Fortunately, something quite close to that has happened.

These taxes mean that all these people have no incentive to work in the same company or even the same industry any longer and a lot of them will leave. If that happens, then according to the people who were in favor of the bonuses — the results will be catastrophic.

I think there won’t be any catastrophic results and these talents are largely mythical. Why do I feel that way? Because there are hundreds of people doing the same job. Some may be more familiar with a derivative contract than another, but, that doesn’t mean that they are irreplaceable.

And, when we find out that these people were replaceable that will hold a good lesson for future generations on:

How Not To Award Bonuses To People Who Screwed You In The First Place.

{ 9 comments… read them below or add one }

Kim Woodbridge March 20, 2009 at 6:48 am

Recently I’ve been wondering when earns a lot of money became equivalent to “best and brightest”. I don’t think it’s true. And I don’t think the company will be impacted in any way by these people leaving. I’m glad this bill was passed – it gets around the whole binding contract issue.

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A Friend of Urs March 20, 2009 at 7:41 am

The Whole Interview, a Massive Stage Play:

As I understand, AIG currently is almost a US Gov run entity after the bailout.It would be interesting to think about what would have happened if AIG board had consulted Gov on the decision of paying out the bonuses. Especially whether AIG could survive impacts of the Lawsuits that would be filed if the retention bonuses were not paid as agreed in 2008 and the collapse of the Financial products arm thereof. Given that US Gov has spent mammoth amounts in bailing out AIG, it would have to ensure AIG continues to function until such time that the interdependency of AIG to the Financial system and the economy is understood. I would presume, US Gov would have been in the same dilemma and would have probably gone along the same lines as what Ed Lilly did. Having said that, It is difficult to believe that a decision of this magnitude would have been taken without consulting the Gov. The only way out of this mess for AIG and the Gov was for AIG to payout the bonsues as a corporate decision…followed by an expected outrage from tax payers..followed by a grilling session where US Gov expresses public sentiments as well as offer Lilly to explain the rationale for the payouts and why that was important..concluded by Gov passing bills to assure the US taxpayer that such incidence would not be entertained in the future. What better way to do that then pass a 90% surcharge bill. In the end, neither AIG board nor the goverment nor the employees who received retention bonuses are held accountable and Everyone wins!!!

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Manshu March 20, 2009 at 9:05 am

@Kim, To a certain extent, there are links between your real worth and your nominal worth. But when a CEO of a company makes 400 times the person at the executive level, well, that’s just absurd.

@A Friend of Urs: Mr. Liddy did state in his testimony that Mr. Bernanke knew about the details of the bonus. They did seek legal opinion and the opinion that they got was if the employees sued them for payment of bonuses — they would surely win.

I don’t think this is such a big conspiracy. Rather, Mr. Liddy would have thought its just 0.1% of the whole bailout amount so its too small to raise any hue and cry. He might have under-estimated the kind of reaction that was generated.

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Kim Woodbridge March 20, 2009 at 10:05 am

Manshu – How so? I don’t see it. How about elementary school teachers?

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Manshu March 20, 2009 at 11:34 am

Kim,

I say that simply because of the skills required to carry out a job.

I am sure it is easier to replace elementary school teachers than it is to replace heart surgeons. It takes a lot more to become heart surgeon than it does to become an elementary school teacher and hence the difference in pay.

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Miss M March 20, 2009 at 2:54 pm

I certainly think there is a value in retaining your best and brightest people, but these people ran the company into the ground and subjected it to massive losses. Are they really the best and brightest cause I could easily accomplish the same thing for a fraction of the cost. Part of me doubts these people will really flee if they don’t get their huge bonus, are there that many financial jobs out there right now? I for one wouldn’t hire someone who ruined a company, who is going to take a chance on them. There are plenty of 2nd tier folks who will probably do a better, more ethical job and who have lower salaries.

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manshuv March 20, 2009 at 3:48 pm

@Miss M — Let’s see where these people end up going. I saw a story on Reuters today which said that these people will flee the banking industry and such. I think there will be attrition but not mass exodus…enough to prove the point though.

This is a great article by Simon Johnson and James Kwak which talks about why the bankers have a vested interest in claiming that only they possess the skills to unwind these contracts and how it has happened time and time again.

http://www.nytimes.com/2009/03/20/opinion/20johnson.html?_r=1

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Kim Woodbridge March 20, 2009 at 5:11 pm

Oh ok – I didn’t think about the medical professions. Thanks πŸ™‚

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A Friend of Urs March 20, 2009 at 9:59 pm

Monsoon,

AIG is totally aware how all actions of their are being closesly monitored. Lilly wud have known for sure, millions being paid as bonuses will definitely not go unnoticed for a corporate that has got maximum bail out especially after the Obama announcement and given that it was the very arm that got everyone in trouble. Totally agree that it was paid out in the best interest of the company. Point am trying to make is the whole grilling session was never going to be of any use. It is a sort of Gov grilling itself kind of act.

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