AIG and the Building Blocks of a Healthy Economy

Obama’s perpetual political campaign is now all about AIG and the heinous, egregious, unconscionable, unspeakable [fill in with additional adjectives here: _______] $165M in bonuses paid directly or indirectly out of government bailout money. It’s a dream issue for leftists everywhere, and since the only business-related expertise in the Obama administration is in the form of David Axelrod’s background in public relations, they must be salivating over the “kill the capitalist pig” PR spin the AIG episode seems to lend itself to. But they are making a huge mistake—they are counting on the ignorance of the masses to soak this up, react with envy and hatred, and hail the virtuous President and his government riding to the rescue. They may win a few news cycles, but people will eventually see through it.

The building blocks of history’s most dynamic economy are intuitively grasped by the American people. They are freedom, the rule of law, and respect for private property. When they are honored in principle and practice, we see the economy grow. When the economy is declining, and especially when it is declining at precipitous rates, you can be sure these building blocks have been confused and abused—primarily by politicians.

Freedom

The freedom to buy what you want from whom you want on terms you like is what enables the market to produce and deliver an ever-greater variety and quality of goods and services. The “market” is simply people, sometimes organized in groups called corporations, but still people competing to supply someone else’s need on terms which that someone else finds attractive enough to convince them to fill their need using you as the ‘best’ supplier. Most people can easily see this aspect of the importance of freedom.

But perhaps the most important aspect of freedom in the economy is the freedom to fail. Because freedom to fail, and failure, is what assures learning from failure. Learning from failure is what assures improvement in the quality of goods and services, and improvement in the quality of management of the enterprise delivering those goods and services (because they don’t want to fail again).

Take away the freedom to fail—which is what bailouts do—and you take away essential learning and improvement from the economy. The building block of freedom was interfered with by the US government when it decided to override the free market for mortgage loans and inject arbitrary social engineering goals into the mix. The government ordered one group of people (those running banks) to do what they would not do if allowed freedom—namely, offer mortgage loans to people who were not creditworthy—and enabled another group of people (those who were not creditworthy) to avoid the learning of personal responsibility that must take place under freedom. (This is not the morning news...see the December Brushfires essay on the economy, here ).

The building block of freedom was doubly hammered when the first government interference was followed by a second form of interference—which was to take away the freedom to fail. AIG, for example, should have been allowed to fail. That way all of those in the line of failure—which includes customers, vendors, employees and shareholders—would have learned to be wiser in their business methods and decisions.

The ‘too big to fail’ argument, in our view, is almost never valid. “Oh, dear, you just don’t understand how the whole system could have collapsed!!” is the standard formulation of this argument, but what exactly do we call the loss of $3 trillion in Americans’ retirement and savings accounts in six months—followed by a lifeless, declining economy devoid of capital and incentive and a sense of rules of the road? Seems to us the system has collapsed, and the bailouts have made everything worse by confusing the future rules of the road—i.e. leaving ill-defined what sort of economic behavior is in bounds vs. out-of-bounds; reasonable risk vs. too risky.

The Rule of Law

Rush Limbaugh is right to draw attention to the fact that the AIG bonuses were apparently paid pursuant to negotiated contracts (negotiation is itself another dimension of freedom). If AIG was too big to fail, and AIG was therefore required to continue in business—how would it be able to continue in business if it did not honor the contracts it had entered into with its employees? Some may think, “oh, come on, everyone at AIG should have been able to read the tea leaves and should have just voluntarily declined to take the pay they were owed.” Really? Let’s think this through.

If you have a contract with Company A that pays you $10 plus another $100 if you achieve X, Y and Z—and you faithfully achieve X, Y and Z, what will you do if you’re told by Company A, 'sorry, you only get $10’? For starters, you will not woprk to achieve X, Y and Z again. You also might sue Company A to get your extra $100. But even more important, if your ability to achieve X, Y and Z shows you have skills not everyone has, you will likely not want to continue working for Company A. You’ll take your skills elsewhere.

And what happens next? Company A has lost the services of someone who could achieve X, Y and Z. Also, word of Company A’s reputation for reneging on contracts will get out, and then intelligent and competent people who might be able to achieve X, Y and Z will not apply to work at Company A. When less qualified people fill the available slots, Company A’s products and services will inevitably decline in quality. Company A will sell fewer products and services, leading to more financial distress….and the cycle goes on and on.

When the rule of law—including the honoring of contracts—is thrown out in favor of some 3rd party (call it "government") deciding what the contracts should have said, or simply ignoring the contracts altogether, the result will be complete chaos and ultimate collapse.

AIG in fact failed, but was not allowed to fail, and therefore not allowed to learn from its mistakes; and now AIG is propped up by a government whose ideology is to throw out the rule of law—which assures that AIG will never recover. AIG will never be able to attract the caliber of people necessary to engineer a recovery because those people won’t have a basis to believe in the integrity of the company when it comes to honoring compensation contracts. AIG is finished; the only question is whether there will be enough of a shell left for private enterprise to eventually step in, take it completely out of the hands of the government, and restore it.

Respect for Private Property

It’s been reported that New York’s Attorney General Andrew Cuomo has leaped in for his 15 minutes of fame with demands for the names of AIG employees receiving contractual bonuses. What in the world is he thinking?

Back to Company A—if you had a contract with Company A, and you performed your end, and they performed theirs by paying you what they owed you—that’s your private property, and the government should be told to go to hell for the mere asking of your name!

Now we know that Cuomo can roll out suspicion about when the contracts were entered into—the old, ‘what did they know and when did they know it?’ routine in relation to the receipt of bailout funds—but if there is any basis for that kind of suspicion (and if there is, we haven’t seen it), he can investigate this quietly without making implied criminals out of people who were doing the jobs they were contracted to do, and receiving the money they were contractually owed.

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We know or at least would be confident in guessing that the vast majority of working people do not have written employment contracts. So there may a wave-of-the-hand tendency to dismiss all this as applying to some class of people that doesn’t include or affect you. But the same principles of freedom, the rule of law and respect for private property apply up and down the line, and when they are undermined—which is what socialism does—everyone loses.

That’s the evil of the socialist’s class warfare game. In a free market economy, there is upward mobility available at the enterprise level—greater profit to those who win in the battle of competition—and at the individual level—greater compensation to those who are productive and effective, no matter what their ‘class’. But when there’s no freedom to fail, there’s less incentive to compete—because even if you do everything better than your competitor and have earned success, you find out it doesn’t matter because the government is going to prop up your failing competitor and all your effort to achieve competitive success is proved worthless. So at the enterprise level, there’s no reason to build the better team and hire the better people—which is what provides the upward mobility at the individual level to those who have earned it.

And at the individual level, there is no incentive to move up if there’s no rule of law—no expectation that you’ll receive what you were promised if you do what you committed to do.

The hat trick of economic destruction comes when private property is not respected. Because if your company has no incentive to succeed (because the competition is not free to fail); there is no rule of law to assure that your company will pay you what it promised to pay; and on top of everything else, there is a government which can decide at any time that whatever you got paid is, in hindsight, inappropriate—then there is simply no reason to work at all. That’s when the economy stops dead in its tracks.

Nothing good will come from this abuse of the building blocks of the economy. But this is the path of Obama and his socialist cohorts. This is a colossal disaster in the making. This needs to be stopped. NOW.

Paul Gable

Posted March 16, 2009