Kevin Drum

Friday Cat Blogging - 20 March 2009

| Fri Mar. 20, 2009 12:15 PM PDT
On the left, Inkblot is worried that Congress will consider him a fat cat and tax his evening dinner bonus away.  I told him it actually counts as straight salary in his case, so no worries.  On the right, we have a rare shot of Domino actually walking somewhere.  It's not that she never does this, just that it's hard to take a picture of it since she instantly makes a beeline for the camera if she sees it pointed in her direction.  This time I caught her just in time.

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Debt, Debt, Debt

| Fri Mar. 20, 2009 11:54 AM PDT
The Congressional Budget Office released some new numbers today and the White House had this to say:

Responding to today’s new, more pessimistic CBO scoring of the president’s budget in light of the deteriorating economic situation, Peter Orszag was at pains to emphasize that deficit projections are highly sensitive to relatively small changes in assumptions. For example, suppose that first you project revenues of $100 and spending of $103 for a $3 deficit. Then you get some bad news about the economy so projected revenue drops by five percent. Well, suddenly you’re looking at a deficit of $8. The alarming way to put this is that the deficit has nearly tripled. The calm way is that revenue has fallen by 5 percent.

Well, yes, deficit projections are highly sensitive to small changes in assumptions, which is why presidents traditionally tweak their assumptions to produce rosy economic projections.  It doesn't take much.  Obama and Orszag actually did this less than most administrations in their initial budget proposal, I think, but they still did it.  And now it's coming back to bite them since, in fact, the alarming way of looking at this is also the correct one.

Now, given the current state of the economy, a larger deficit might be a feature, not a bug.  But if the deficit stays above 4% of GDP for an entire decade, as the CBO suggests, then we have a problem.  We can't keep that up forever any more than Wall Street could keep the subprime bubble going forever.  Someday we're going to pay.

Happy New Year

| Fri Mar. 20, 2009 10:18 AM PDT
President Obama, showing his command of YouTube once again, wishes the Iranian people a happy Nowruz:

So in this season of new beginnings I would like to speak clearly to Iran's leaders.  We have serious differences that have grown over time.  My administration is now committed to diplomacy that addresses the full range of issues before us, and to pursuing constructive ties among the United States, Iran and the international community.  This process will not be advanced by threats.  We seek instead engagement that is honest and grounded in mutual respect.

You, too, have a choice.  The United States wants the Islamic Republic of Iran to take its rightful place in the community of nations.  You have that right — but it comes with real responsibilities, and that place cannot be reached through terror or arms, but rather through peaceful actions that demonstrate the true greatness of the Iranian people and civilization.  And the measure of that greatness is not the capacity to destroy, it is your demonstrated ability to build and create.

Unsurprisingly, the initial reaction from Iranian leaders wasn't very enthusiastic.  But it's still a constructive gesture.  Symbols matter, and they make the substance a little easier to address when the time comes to talk substance.  I just hope they got the Persian subtitles right.

Taxing the Bonuses

| Fri Mar. 20, 2009 9:55 AM PDT
This is a little embarrassing to admit, but by yesterday I'd gotten so tired of the AIG story that I barely even noticed the details of the House bill to claw back all the bonuses.  But it's a monster.  Taxing the million-dollar bonuses is one thing — I may be a little ambivalent about that, but overall I don't think it's all that problematic — but the bill that passed last night taxes away bonuses from anyone with a household income over $250,000.  That's a couple of mid-level analysts.  This is likely to hit tens of thousands of fairly ordinary workers who had nothing to do with AIG's troubles and who simply don't deserve this kind of treatment.

A friend of mine who describes herself as "Marxist at heart" but has nonetheless been trying to convince me all along that the tax clawback idea is a horrific idea, points me to this article in the Post today about how AIG employees are reacting to the death threats and armed security guards in the parking lots:

A sense of fear hung in the room -- the palpable, unsettling kind that flashes across people's eyes. But there was anger, too. No one would express it publicly, of course. Who wants to hear a wealthy financier complain? And yet, within those walls off Danbury Road lies a deep sense of betrayal — first by their former colleagues, now by their elected leaders.

The handful of souls who championed the firm's now-infamous credit-default swaps are, by nearly every account, long since departed. Those left behind to clean up the mess, the majority of whom never lost a dime for AIG, now feel they have been sold out by their Congress and their president.

"They've chosen to throw us under the bus," said a Financial Products executive, one of several who spoke on condition of anonymity, fearing reprisals. "They have vilified us."

They say what is missing from this week's hysteria is perspective. The very handsome retention payments they received over the past week were set in motion early last year when the firm's former president, Joe Cassano, was on his way out the door. Financial Products was already running into trouble on its risky credit bets, and the year ahead looked grim. People were weighing offers from other firms, and AIG executives feared that too many departures could lead to disaster.

So AIG stepped in with an offer to employees of Financial Products. Work through all of 2008, and you'd get a lump payment in March 2009. Stick around through 2009, and you'll get paid through 2010. Almost all other forms of compensation — bonuses, deferred payments and the like -- have vanished.

"People are trying to do the right thing," the same Financial Products executive said. "Guys have worked their [tails] off to try to get value for the taxpayer. This isn't money that's being advanced to us. People have performed the work and done it exactly as we asked them to do."

I don't know what the Senate will do with the House language, but they simply can't leave it the way it is.  A high marginal rate on million-dollar bonuses at bankrupt companies is one thing, but putting huge swathes of their professional staff in the same boat is another.  If this is where populist outrage is taking us, it's time for a timeout.

Unleash the Fed?

| Fri Mar. 20, 2009 9:18 AM PDT
Over at our main site, James Ridgeway remarks that "the Federal Reserve seems to be catching remarkably little blame for the current economic crisis."  This doesn't surprise me.  After all, in a lot of ways the Fed seems to be practically the only institution in Washington actually capable of taking dramatic action these days.  And something is better than nothing.

More interestingly, James points to a Nation piece by William Greider, a longtime Fed watcher, in which he climbs down slightly from some of his previous criticisms.  It's not that he suddenly thinks the Fed is doing a good job, but drawing on the work of progressive economist Jane D'Arista he suggests that part of the problem is that the Fed now has too little authority:

When deregulation began nearly thirty years ago, some leading Fed governors, including [Paul] Volcker, were aware that it would weaken the Fed's hand, and they grumbled privately. The 1980 repeal of interest-rate limits meant the central bank would have to apply the brakes longer and harder to get any response from credit markets. "The only restraining influence you have left is interest rates," one influential governor complained to me, "restraint that works ultimately by bankrupting the customer."

....The central bank was undermined more gravely by further deregulation, which encouraged the migration of lending functions from traditional bank loans to market securities, like the bundled mortgage securities that are now rotten assets....In 1977 commercial banks held 56 percent of all financial assets. By 2007 the banking share had fallen to 24 percent.

The shrinkage meant the Fed was trying to control credit through a much smaller base of lending institutions. It failed utterly.

The problem, D'Arista argues, is that the Fed's control of short-term interest rates has less and less effect on long-term interest rates as the money supply moves outside the traditional banking system.  And fixed capital adequacy requirements, which require banks to slam the brakes on lending during bad times, make things even worse.

Read the whole thing.  I don't have the chops to fully evaluate what she says, but it's an intriguing argument and I'd be interested in hearing reaction from other blogospheric economists.  It's something to think about once we've put out the immediate fire.

Indispensable?

| Thu Mar. 19, 2009 10:19 PM PDT
Is it really true that the traders who created AIG's CDS mess in the first place are also the only ones with the knowledge to unwind it successfully?  Do we really need to pay millions of dollars to keep them around?  Simon Johnson, who certainly has the experience to know, says no:

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, which certainly were complex. Or the Russian bankers in 1998 who were convinced that only they and their friends could possibly close the deals that they had taken on. 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.

Charles de Gaulle said it best: “The cemeteries of the world are full of indispensable men.”  If the current crew isn't willing to work for anything less than a million bucks a year, I doubt that AIG will have much trouble replacing them with someone who will.

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Bonus Babies

| Thu Mar. 19, 2009 10:13 AM PDT

Hilzoy comments on the terms of the bonus contract written last year for AIG's Financial Products division:

The introduction to the contract says that one of its aims is to "recognize the uncertainty that the unrealized market-valuation losses in AIG-FP's super-senior credit derivative and originally-rated AAA cash CDO portfolios have created for AIG-FP's employees and consultants." That certainly suggests that AIG-FP was aware that there might be significant losses, as does the fact that they got their compensation locked down in a way that made it independent of their profits or losses.

Of course they got their comp locked down when they saw the storm ahead of them.  This is what executives always do.  Back during the dotcom bubble, corporations handed out trainloads of cheap stock options even though the practice was heavily criticized.  Why?  Because the stock market was going up and it was a nearly guaranteed way to make lots of money.  After the bust, they suddenly took the criticisms to heart and largely stopped the practice.  Why?  Because the stock market was going down and it wasn't easy money anymore.

Likewise, in the financial industry, pay has long been heavily linked to performance.  Why?  Because the industry was going gangbusters and it guaranteed everyone a big payday.  Now, though, banks are all talking about increasing base pay and cutting back on bonuses.  Why?  If you think it's because they've finally taken public criticisms about short-term incentives to heart, I have a bridge right here in my backyard with your name on it.

What happened at AIGFP is standard practice throughout corporate America.  America's corporate titans like to talk endlessly about performance-based pay and how capitalism rewards risk, but in real life compensation packages are almost always constructed to avoid as much risk as possible.  If you work in a growing industry, your bonus depends on raw growth rates.  If you work in a declining industry, your bonus is linked to relative growth rates.  If the market is up, your bonus is paid in stock.  If it's not, suddenly deferred comp and increased pension contributions are the order of the day.  Heads you win, tails you win.

The AIG traders who got this sweetheart deal are nothing special.  Management probably didn't even think twice about it.  Of course you switch from performance bonuses to retention bonuses when the market looks stormy.  What else would you do?

I don't, frankly, care all that much about the AIG bonuses being slashed.  The only reason AIG isn't in Chapter 11 is technical (they're too big to fail!), so morally I don't see any reason not to treat them as if they were in Chapter 11 like any other failed company.  That means employees stand in line for their bonuses along with all the other creditors.  On the other hand, this whole thing really is small potatoes in the grand scheme of things, and Tim Geithner and the United States Congress have better things to worry about.

But the culture that brought this on?  That deserves to be dismantled brick by brick.  I may not care much about AIG, but if it's the spark that finally gets Americans to take the executive comensation racket seriously, then hallelujah.  If it's not, then it's just a carnival sideshow.

Hooray For Us!

| Thu Mar. 19, 2009 9:20 AM PDT
We don't have Academy Awards here in magazine-land, but we do have the National Magazine Awards.  Last Year MoJo won the award for general excellence in our circulation category (that's 100,000-250,000, if you're curious), and this year we've been nominated for three awards, the first time in our history we've gotten that many nominations.  One is for general excellence in print, one is for public service, and the third is for general excellence online, for which I take full credit, of course.

(Except, um, for the legion of other people who write, design, blog, administrate, and illustrate the 99% of it that has nothing to do with me.  But other than that, full marks, baby!)

The full list of nominations is here.  Congrats to everyone nominated, and special congratulations to Clara Jeffery and Monika Bauerlein, our co-editors here for the past three years.

Rough Justice

| Thu Mar. 19, 2009 8:50 AM PDT
The LA Times reports on an ad hoc bankruptcy proceeding in Israel:

First came the employees, shortchanged two months' pay and laid off by the supermarket called God's Blessing. They rifled through their shuttered workplace, helping themselves to crates full of groceries.

As word spread through the small town, the store's jilted creditors joined in. They dismantled the light fixtures, ripped out wiring and absconded with the cash registers, even as television cameras rolled.

Within hours the parking lot was jammed with ordinary shoppers. They left car engines running and brought their children to help pick the shelves clean. Finally even the shelves were hauled away, leaving latecomers to scrounge the floor for leftover fruit.

This is not what you'd call an orderly liquidation.  Is it a harbinger of things to come?

Quote of the Day - 3.19.09

| Thu Mar. 19, 2009 8:31 AM PDT
From Matt Yglesias, commenting on the fantastic amount of money we spend on the Pentagon:

It seems to me that if you told the man on the street that you had a plan to spend double on defense what China, Russia, North Korea, and Iran spend combined that said man would assume you were proposing to spend a healthy amount of funds on national defense. Such a standard would, however, imply very large cuts.

If you want to project power over thousands of miles, it costs a lot of money.  Most countries don't really want to do this.  We, on the other hand, are pretty seriously addicted to it.