AIG Outrage
Out of context: Reply #92
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- ukit0
Worth a read for an actual explanation of what happened...
http://www.fivethirtyeight.com/2…
The employees in AIG's Financial Products division (AIGFP) were compensated heavily -- perhaps almost exclusively -- via incentive-based compensation. That is, the employees got a profit share -- a rather generous 30 percent share -- of the earnings their division made by trading credit default options (CDOs) and related assets.
In the fourth quarter of 2007, the market for CDOs went completely to hell, an early casualty of the mortgage crisis. AIG, to that point, had already accumulated about $643 million in bad assets on its books. (Note AIG's use of the euphemism "other-than-temporary" to describe the writing off of these assets; that's a bit like calling Louie Anderson "other-than-skinny"). AIG must have anticipated that it was going to spend most of 2008, and perhaps most of 2009, merely climbing out of its hole rather than turning any sort of profit.
This must have posed something of a problem for the employees in the Financial Products division, since their compensation relied on these trades being profitable. So AIG struck a deal with these employees. It guaranteed them, for 2008 and 2009, the same level of incentive-based compensation that they received in 2007 (except for senior executives, who took a 25 percent haircut), regardless of how the division actually performed. The only requirements were that the employees couldn't quit and couldn't be fired for cause (a much stricter standard than the usual conditions of at-will employment.)
This turned out to be an other-than-good deal for AIG. But at the time, AIG must have believed that its hand was forced. At that point in early 2008, the market for the sorts of assets that AIGFP dealt in had crashed, but the broader asset markets hadn't yet. Many of these employees were highly skilled, and could plausibly find employment at another company that traded in other, relatively healthier types of commodities. But AIG evidently felt it needed them in order to minimize its losses and unwind its positions.
The thing about these "bonuses", however is that they're not really bonuses, which we usually think of as incentive-based compensation. On the contrary, they are something the opposite of bonuses: they took compensation that had been incentive-based and guaranteed it. It's precisely because that compensation was guaranteed -- not incentive-based -- that it is difficult to undo.
The fundamental issue here what I call asymmetrical agency bias. We as human beings tend to attribute our results to skill when we are performing well, but (bad) luck when we are performing poorly. Thus, AIG was willing to pay its Financial Products employees plenty when their trades were going well (assigning them agency for their profits), but was willing to make plenty of excuses for them ("the severe liquidity crisis", "the effects of rating agency downgrades") once things began to unravel. The employees, likewise, may have felt entitled to some large fraction of the incomes that they had "earned" before, and probably didn't regard themselves as culpable for the losses their trades had begun to take.
As someone who is alert to asymmetrical agency bias -- it is an extremely common phenomenon in both poker and baseball, two fields with which I am intimately acquainted -- I tend to be unusually sympathetic to the position that the individual traders at AIG were not especially responsible for the fact that their deals had begun to lose money. Even the most skilled and honest trader probably could not have done better than to limit his losses once the CDO market began to collapse in 2007. By the same token, however, I tend to be unusually unsympathetic in my assessment of how much alpha these traders were responsible for on the upside; any idiot could have made money trading credit default swaps in 2005 or 2006.