AIG Bonuses

I am scared. I have lost my job because of the economic/financial crisis and I am concerned about my future, but this is not the reason why I am scared. I am scared that the federal government is once again attempting to destroy the very principle that has made this country great and that will ensure its recovery and continued greatness: the rule of law. Congress, and even the President in this case, seem to be driven by political populism and sound bites, rather than a sober assessment of the facts and the law.

Personally, I find the AIG bonuses extremely distasteful, especially since the majority of the money went to the Financial Products division that created this mess. Then again, a lot of individuals who were part of creating this mess have received compensation for their poor judgement. More than anything else, though, the political and media furor over the compensation AIG paid to its employees has been driven by the fact that they are labelled "bonuses". Had these funds simply been paid out as "base salary", I highly doubt anyone would be crying bloody murder. This is the very reason why the government should get out of the business of regulating executive or any other kind of compensation; companies will always find a way to attract and retain individuals they deem necessary. In any case, these are private contracts and the government has no business placing limitations on them. Certainly, with the entities that have received federal support, the government has the same rights as any creditor, guarantor, or shareholder, to attach contingencies to its support or to force changes through the company's board, but changing contracts ex post facto is simply unjust. The government should, instead, focus on oversight of the companies it already owns (AIG, Freddie Mac, and Fannie Mae) and enforcing and enhancing shareholder protections and transparency laws. Let's get past this "bonus" is a dirty word nonsense and focus on the real issue.

With respect to AIG, I have major legal problems with the proposed bills to "tax" the bonuses in question. I am not a lawyer, but as an educated citizen who has read the Constitution, I am shocked that noted constitutional law scholar Laurence Tribe at Harvard has come to the conclusion that "taxing" AIG bonuses is legal. Far be it for little me to put my plain language reading of the Constitution and basic legal analysis against his years of scholarship, but I must try because I am scared.

The biggest issue with taxing AIG bonuses is the question of whether any such bill would be a considered a Bill of Attainder. In the case SBC Communications, Inc. v. FCC, Judge Jolly of the Fifth Circuit applied a two-pronged attainder test: (1) had the legislature acted with specificity and (2) had the legislature imposed punishment. While the court did not address the question of specificity, in my opinion even targeting all employees of firms receiving bailout money is clearly targeting punishment of a specific class of individuals. Regarding the punishment question, Judge Jolly laid out a three-pronged test: “(1) whether the challenged statute falls within the historical meaning of legislative punishment, (2) whether the statute, ‘viewed in terms of the type and severity of the burdens imposed, reasonably can be said to further nonpunitive legislative purposes’; and (3) whether the legislative record ‘evinces a congressional intent to punish.’” First, I argue that a special 90%+ "tax" is actually a fine enforced using the tax code, and a fine does fall within the historical meaning of legislative punishment. Congress will argue it is in fact imposing a tax, but this is not like any tax that I have heard of: only applying to specific, identifiable individuals and only applying to income received in a single circumstance. The government can call it a tax, but common sense tells us it is fine. Second, this law doesn't serve any purpose except to punish AIG employees; if there is a legitimate purpose stemming from AIG having received federal money, then that opens the door for the Congress to fine all employees of any company receiving any federal money or, in fact, employees of any federal agency on any portion of income or wealth whenever it chooses and to whatever extent it chooses. To be clear, the bonuses in question will already be subject to the normal income tax liabilities of the recipients, so the "taxation" of any amount above that is, in fact, a levy on wealth. As the majority owner of AIG, the federal government has broad powers over that company, but its employees committed no wrong in this case and should not be fined. Third, there is a definite record of Congressional intent to punish; suggestions that employees commit suicide are evidence enough.

As a taxpayer, I don’t want my money going to pay for the AIG bonuses, but I am much more fearful of the government abrogating private contracts and passing bills of attainder. The damage to liberty and economic freedom in this country would doom it. In any case, AIG’s employees are legally blameless in their receipt of bonuses. They negotiated contracts, which their ultimate employer, the federal government, approved of, if not directly, then at least tacitly. Like any other acquirer, the government could have renegotiated the contracts upon its purchase of 80% of AIG. Because it did not, it assumed those bonus payments as liabilities when it took over. I know this is distasteful to many people, including myself, but again, having the government breaking private contracts and punitively punishing individuals is even more distasteful. The government cannot play by different rules; if rule of law breaks down in this country, we are no better than Russia or China.

From a broader perspective, I think the government has been completely inept in managing these bailouts. We already have three major government-owned zombie-like entities - AIG, Freddie Mac, and Fannie Mae, and we are on the verge of creating another one, Citigroup. The government should spend its time and political capital to come up with a clear resolution process to wind down these firms: (1) put all the toxic assets into a sufficiently capitalized subsidiary that will restructure the assets and sell them off when the markets recover, (2) sell off all separable pieces of the company to private buyers to raise cash, and (3) either sell whatever viable entity remains back to the public market or liquidate the business and dividend the remaining cash to payback taxpayers as much as possible. Instead, the government seems to be happy owning 80% of these entities yet not taking an active role in their day-to-day management, so much so that Treasury claims to not even have known about the AIG bonuses until they were paid. The truth is, the government, or at least the Federal Reserve, did know about the bonuses, but they still allowed them to be paid because they know they are in the wrong, legally, and if they did not allow the payments, AIG's employees would have sued AIG in court, and would have likely won.

I am still confident that the legal system in this country will strike down any potential Congressional excess, and I hope that President Obama is smart enough to not let any bill of attainder "taxing" AIG bonuses to even reach his desk. If somehow the "taxation" of AIG bonuses goes ahead, don't be surprised if the federal government "taxes" your bank account at 90% because you are part of a broad class of individuals, that only includes the employees that work at your company, by claiming a "legislative purpose" of needing to raise money for its next "fiscal stimulus" program. After all, it's your fault that your company got into trouble because you worked there and you should [commit suicide] [be punished] be taxed. Yes, I am scared, and you should be scared too.

Job Repatriation

Today I had the opportunity to talk with the CFO of a relatively small (less than $1.5 billion of sales) American light industrial company. This company is at the forefront of one of the challenges of our generation - clean water. We talked about business in the slowing economies of North America and Europe, and while there are certainly short term challenges, this is a great business that I have no doubt will do well in years to come (it a low cost producer, has leading market share in its products, and serves what will be a growing market for foreseeable future).

What struck me most in our conversation, though, is that this company is planning to bring back manufacturing jobs from China to the United States. Talk about a paradigm shift! For all we hear about outsourcing jobs overseas and China taking jobs from America this company is talking about the exact opposite. Why are they doing this? The answers are surprisingly simply: the strength of the RMB, labor cost inflation in China, and taxes in China. Without any government intervention, this company is making an economic decision to bring manufacturing jobs back the America. Further, this CFO cited a labor walk out and eminent domain problems in China.

So this is a new paradigm and could be the start of a new trend. As developing economies turn into developed countries they are encountering the same issues that faced the workers of the Industrial Revolution in the West over a hundred years ago. This also got me thinking that if corporate taxes were eliminated or vastly reduced in the United States, it would (contrary to standard liberal talking points) actually create jobs right here at home by attracting our own companies to repatriate manufacturing. It would also attract foreign companies to set up businesses to take advantage of our productive workforce, legal system, and relatively low inflation. We have already seen the latter from the transplant auto plants of the Japanese auto manufacturers and BMW, but this is the first time I have heard of repatriation of manufacturing by an American company that had gone overseas. We can accelerate this shift if we eliminate or lower corporate taxes.

This company is still planning on growing in China, but it will use its expertise to manufacture in China to serve the domestic Chinese market and not to export back to the United States. Another company I talked to is already doing this, and it is in fact exporting key components manufactured in the United States for final assembly in China to be sold in China. I think we will see this shift take place at an even greater rate over the next 10 years as the American consumer slows its credit-fueled shopping binge for soft goods and electronics and as China demands more technologically advanced hard infrastructure and industrial products from the West.

Welcome to a New Contract

The 21st Century will be shaped by Generation Y. We came of age at the end of the 20th Century and will be the largest most influential demographic aggregation since the Baby Boomers. The world we will come to lead faces a new set of challenges and the way we choose to lead it will shape the next 100 years.

We must break free from the politics and economics of the past to forge a New Contract for our generation. We are the first generation that has not been heavily influenced by the major 20th Century conflicts of World War II, Vietnam, and the Cold War. We have grown up in relative luxury and the Information Age is inseparable from our lives. Some say we are irresponsible and selfish.

While the social, ideological, and military, conflicts of the past bear little influence on us, we must be aware that past is prologue and not forget the lessons of the history. Nonetheless, our New Contract must be forward looking and not focus on the crisis "du jour". The world is changing rapidly and the paradigms of the past can be broken before we have even fully come to grips with them.

So, what is the New Contract? Even in my own mind it is still evolving, but it must contain principles addressing four E's close to our collective hearts: Education, Energy, Environment, and Economy. This will be a wide ranging blog about politics, policy, history, economics, business, and culture. It is my hope that by sharing my experiences and thoughts, we will togther draft the New Contract - a contract for our future.