Unintended consequences, volume 2

Unless you've sworn off TV, newspapers, the Internet, and casual watercooler chats, you have witnessed the enormous backlash against the bonus payments destined for the AIG unit that led to the firm's collapse. Senator Chuck Grassley called for executives to commit suicide. And, if the executives aren't willing to do it themselves, others have written death threats against the bonus-receiving executives. Unions are protesting outside of financial firms' offices. Congress is considering passing a tax that would effectively recapture all of the bonuses. The President is opining on the subject.

This outrage (Mr. Grassley's suggestion and death threats excluded) is understandable and justified. These executives failed, and they are still getting paid. Whoever wrote their employment contract did a horrific job, and policymakers face a monumental challenge in ensuring that executive pay agreements are more appropriately structured in the future. But for all the outrage, the more relevant question is what to do now?

The government is right in asking these executives to voluntarily relinquish bonuses and to plan reforms to ensure that pay structures are better designed in the future. But much more is at stake than $165M dollars:

First, Ameircans should make sure that in their zeal to uphold their principles they do not encourage worst transgressions. There is simply no excuse to call for physical harm to any particpants in this ordeal. Yes, many mistakes were made by AIG executives and employees, but they were mistakes -- not capital crimes.

Second, the government has committed nearly $10 TRILLION dollars to the bailout by some counts. The AIG bonuses are 0.0017% of that total. The bonus issue has hindered Treasury Secretary Timothy Geithner's ability to get things done. Shouldn't we all worry about how he is using the other $9.999 trillion?

Third, consider how this hamstrings the government's ability to restart the economy. The government launched the Term Asset-Backed Lending Facility to help restart consumer lending and get the economy working again. But healthy financial institutions are hesitant to take advantage of the TALF, fearing that they too could get swept up into populist rage against the financial system.

This final point is particularly intresting: it is almost like reverse moral hazard. Companies that don't need taxpayer money might be willing to accept it in order to help get the economy moving again, but only if they won't face fallout or onerous terms in doing so. If they believe that they will catch the backlash even if they don't do anything wrong, they might just decide it isn't worth dealing with -- limiting the government's ability to get the economy moving again. Let's hope that Congress and the Administration can suspend their outrage long enough to realize that the AIG bonus situation makes for great political posturing but isn't getting the economy any closer to health.