Freddie, Fannie and AIG – It’s Just Not So Simple

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expert perspective telescopeExpert Perspective by Grahall’s Garry Rogers

In an April 4, 2009 article in the New York Times, “Big Bonuses at Fannie and Freddie Draw Fire”, Times journalist Charles Duhigg reports that
“…the two troubled companies at the heart of the nation’s mortgage market, are set to pay [7,600] employees “retention bonuses” totaling $210 million, despite [criticism and] calls from [some] lawmakers to cancel the payments.’ Duhigg further states, “Similar bonuses paid by the American International Group, which was also bailed out by taxpayers, incited fiery attacks from the White House and legislators when they were revealed last month.” 

So are these situations, one with Freddie and Fannie and the other with AIG, the same or different?  Should we permit taxpayer dollars to be used for bonus payments for any of the “bailed out” companies?  Should government stay out of it, and leave the business decisions to business leaders? 

The answers may surprise you, so let’s start with the basics:

The role of bonus compensation, or any compensation for that matter, is to reward and retain key contributors whose efforts support the goals of the company and influence revenues and profitability.  Fannie Mae and Freddie Mac propose to pay “retention” bonuses to a broad range of employees, in fact nearly 70% of employees would receive some form of a bonus.  At AIG, the bonuses were fewer and larger, in fact much larger for some individuals. 
At Grahall, we believe the use of retention payments is appropriate under certain limited circumstances.  These payments are best applied to preserve management stability during a period of anticipated turmoil, which could lead to an increase in unwanted turnover.  So do AIG, Fannie Mae and Freddie Mac qualify?   The answer isn’t a simple one, or the same for each company.

AIG ANGST

AIG finds itself in the bizarre situation of paying bonuses to the same individuals who almost single-handedly created the current economic crisis and would have brought AIG to its knees had the government not intervened. These AIG employees had enormous influence over the company’s vast financial resources, and, although their complex plans and programs didn’t have a positive outcome for AIG or the world economy, the unfortunate fact still remains that those employees might be the best ones suited to favorably resolve the situation. Further, AIG’s compromised financial situation may make those employees more valuable to AIG’s continued survival now than ever before.  Adding to the issue is the possibility that if these same employees went to a competitor they could, with their deep understanding of AIG’s financial positions, effectively “trade against” AIG, potentially against individuals less familiar with these positions than they are.  Thus, retaining these employees is arguably crucial to AIG’s survival, and AIG’s survival is critical if the government and taxpayers ever want to see the bailout money returned.  So as far as AIG is concerned, it just might be in the company’s and the taxpayer’s best interests to permit appropriate retention bonuses., even though having to rely on these employees is a bit perverse, and definitely hard to stomach. But the reality of situation is this:  retaining key players enhances AIG’s chances of survival, while losing too many could lead to AIG fail.

FANNIE AND FREDDIE FUNK

Lets contrast that to Fannie Mae and Freddie Mac, and their proposed “retention” payouts to 70% of their employees.  Is it reasonable for us to believe that all 7,600 bonus eligible individuals at Fannie and Freddie significantly influence revenues and profitability?  Do all 7,600 perform jobs that increase the systemic risk those firms represent to the US economy?  Both these propositions seem highly improbable.  Unlike AIG’s “retention” payment recipients targeted to individuals trading in highly sophisticated financial instruments, the Fannie Mae and Freddie Mac employees slated to receive retention bonuses do not appear to be on the leading edge, or bleeding edge, if you prefer, of financial performance for the agency. And although, as Duhigg says, “Fannie Mae and Freddie Mac own or guarantee more than half of the nation’s mortgages, and are essentially the only firms currently lubricating the nation’s mortgage marketplace”, we don’t see how the employees who might leave those agencies would so definitely damage them or be eagerly scooped up by companies looking to gain a competitive advantage over Freddie Mac or Fannie Mae.  In fact, those companies’ insular natures might actually work to their advantage. So, why pay retention bonuses to non-key employees when it’s unlikely that these individuals can find another job?  Are these “retention bonuses” merely just a bonus packaged in the new 2009 post-bailout style wrapping paper? Sure these folks are working hard, perhaps harder than they did before, but is it likely that they would quit without another job?  Based on the facts we’re aware of, the answer is far from clear but it seems that, unlike AIG, retaining all these 7,600 employees at Fannie Mae and Freddie Mac may not be critical to those firms respective survival.

THE GOVERNMENT AS “INVESTOR and CHIEF”

There has been blanket criticism of the government from fiscal conservatives for “overstepping” its role in dealing with the bailout companies.  In our view, once the bailout money was transferred to Freddie, Fannie and AIG, the government and taxpayers – that’s all of us – became involuntary and significant investors in those companies, and we acquired the same rights as any other large shareholder to impact governance of those entities. This would certainly include applying pressure on the Board of Directors to make changes, though admittedly, that sway may actually stop short of actual hiring, firing and direct decision-making.  Alternatively, we could view the government’s role as similar to that of a private financier, who could certainly negotiate a change of key management as a condition for providing initial or additional funding to a crippled business.  In either case, the government can influence decisions around compensation and retention for bailed out companies.  If you are wondering how this might play out, just ask GM’s recently deposed CEO, Rick Wagoner. 

THE BOTTOM LINE

Designing compensation schemes that provide appropriate incentives that are consistent with a company’s business strategy and its stakeholder’s interests is much more complicated than the public, the lawmakers and the press seem to understand.   The law of unintended consequences is alive and well, and we are concerned that the “sound bite” approach taken by the media is not enough to make the average person (be they a legislator, a company executive or the public) informed, let alone educated, regarding the complexity surrounding these subjects. 

Changes forced onto private compensation structure by well-intentioned but inadequately informed legislators answerable to angry constituents could wreck havoc on compensation programs with the possible ill effects being felt much further than the corner offices of bailed out companies.  Poorly designed retention bonuses that do not focus on preserving management stability can be a waste of resources and send the wrong messages, further exacerbating an already terrible set of circumstances.    Companies and legislators should tread lightly and with deliberate speed and appropriate counsel, precisely because compensation structures are far more intricate than they seem to the uninitiated.

What should never be questioned is the value of incentives as a critical component of a sound, integrated compensation program that compliments both the company’s business strategy and stakeholder interests.  We are in this situation not simply because pay was variable and probably too high, but because the pay structure didn’t reflect a broad enough spectrum of those stakeholder interests. Email Garry Rogers at garry.rogers@grahall.com


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