Let them Eat Cake, and other Musings on the Financial Crisis

Now that public outrage du jour has turned towards AIG bonuses, I've been trying to make sense of what these recent events-- Bernie Madoff's guilty plea, Citibank's surprise report that it finally operated at a profit, and the widening of foreclosure problems into fixed rate mortgages--might tell us about the overall economy.

Are we at the bottom, or still sliding down towards it? Do we need to worry about imminent deflation or long-term hyperinflation? Will the economic stimulus turn out to be too little, too late or too much, too soon? And how do we get any kind of accountability back into our financial system?

Among all the contradictory indications of the past week, one piece of financial reporting stood out for me. Josh Bearman's story of how he started his own Ponzi scheme as a child gave the clearest narrative yet of how a Ponzi scheme works, but it also demonstrated the psychological dimensions of these schemes that keep both the perpetrators and the victims invested in believing in their own lies.

As a third-grader, Josh arrived at a new school where he had no “currency” to let him participate in the market of school lunch trading because his mom believed in “no sugar” lunches. So he started offering kids the promise of a “future security” in return for all the Cheetos, Rice Krispy treats, and other snacks he could get.

He even recorded their names in a book with the items they gave him and told them he would give them slices of a fabulous cake he said his mother baked for him at the end of every school year. As he himself put it, “[B]asically, I developed this sort of derivative lunchroom market for delicious cake futures," (“Sweet Memories Of A Snack Food Financial Scheme,” Planet Money/NPR, March 13, 2009).

Most of the kids bought into the scheme with enthusiasm until one skeptic figured out that there was no way to bake enough cakes to pay for all the food Josh had been enjoying. But Josh himself and the other kids were so invested in the idea of this glorious cake and so afraid of the prospect of admitting that they might have traded all their goodies for nothing that they poured scorn on the skeptic, forcing him to back down.

It was only when adult “regulatory” authorities intervened that Josh's scheme was exposed and Josh himself punished. Still, as Madoff's victims know all too well, there was no getting back their investments: as Josh concludes, “those Cheetos and Nutter Butters, they were never coming back."

A similar dynamic of uncovering explanations that don't add up has dominated reporting on the AIG bonuses. First the public was told that there was nothing federal regulators, or the Treasury Department, or even the new head of AIG could do about these bonuses because they were “contractual obligations.” That may be true, but whoever wrote these contracts was certainly setting up the recipients for a sweet deal.

In fact, the hand-wringing over these contracts rings increasingly hollow as more and more details emerge about the legislative bailout that authorized payments to AIG in the first place.

While the House version had specifically included language to exclude taxpayer payments for these bonuses, the language was reinserted in last minute revisions to the bill. Democratic Senator Christopher Dodd told CNN on March 18th that "he was responsible for language added to the federal stimulus bill to make sure that already-existing contracts for bonuses at companies receiving federal bailout money were honored."

According to Dodd, the request to reinsert the language came from officials at the Treasury Department whom he declined to identify. According to Dodd, they were "afraid the government would face numerous lawsuits without the new language," ("Dodd: Administration pushed for language protecting bonuses," CNNPolitics.com). Dodd himself has received more donations from AIG than any other member of Congress.

So it's not just AIG greed that is responsible for these excessive payouts, but it also appears the either political indebtedness or cowardice or incompetence in our own government has also allowed the greed to continue unabated and unchecked.

In addition to the "our hands our tied" defense, AIG executives also argued that they needed these bonuses for “retention” purposes. Really. The same financial wizards who created the credit default swamps that helped bring on our current economic Armageddon reaped huge rewards for their mischief. Then they allegedly needed these financial incentives in order to stay on because they were the only ones who understood the mess well enough to clean it up.

Apparently, one million dollars per person was not enough for eleven of them who took the money and left anyway.(See The Wall Street Journal, “AIG's Liddy Asks Employees to Give Back Bonuses, 3/18/09). These are the people who are supposedly irreplaceable “top” talent in a market where financial services firms have taken huge hits and let go thousands of highly-qualified professionals.

If you believe that, then I have a couple of slices of cake I'd like to sell you. Just hand over that package of Twinkies first.