Wednesday, March 18, 2009

Bailouts & Bonuses

It is widely recognized that bonuses are not a guaranteed supplement to a salary. They are typically given out of a company's profits, and when those profits are not there, bonuses are often withheld until the company is in a better position to award them. This is a function of a long-term plan that most companies operate under in a free market. However, when you institute a plethora of regulations, loopholes, and "free" taxpayer money, you have just warped this basic incentive towards long-term success. If I know that in spite of poor performance, I will receive large sums of money, am I likely to work harder and conserve that money towards promoting a stronger business model? Or am I more likely to spend that money now because I know that more will soon be on the way once the first round of funding runs out?

Instinctively, we react negatively when we hear about how our money is being given to AIG and doled out in large sums to executives. We are paying to run a company whose business model we disagree with! That is not fair! Of course, we blame the evil executives and call them greedy. But we forget that Congress and government intervention are fueling this greed. People are far more greedy when they are not spending their own money. We naturally agree with the free market, which gives us the incentive to forego short-term gain (and long-term losses) in favor of slow but steady long-term gains. The free market is just and fair, rewarding good decisions and punishing bad ones. The free market forces companies to make better decisions and spend wisely because otherwise they risk losing their incomes if they fail. Are the executives at AIG greedy? Sure! But we should not forget that it is the free market that reins in their greed and forces them to work for their bonuses, at least in the long-term. When we introduce government into the equation, we change the natural course of the market and give companies like AIG a free pass to do business with a short-term mentality rather than a long-term strategy. This is exactly what we are seeing now. AIG has not turned around in the last few months even with billions of dollars being handed over! What becomes the solution? If you ask Congress, they say that AIG just needs more money, or more conditions on how the next round of money should be spent.

What we seem to forget is that keeping the AIG name alive, does not mean that we are keeping AIG from failing. AIG has already failed. Any money that has been lost is already gone. We can either continue putting money into the bonfire in hopes of getting it back, or we can finally stop fueling the fire and let it slowly burn out.