Aig-Ency Problems

Michael Giberson

At the Streetwise Professor, Craig Pirrong finds that the current political flap over AIG bonuses well illustrates the value of rules over discretion. His conclusion matches my view: “Several hundred million dollars is a lot of money.  But it pales in comparison to the amount that would be lost by undermining contracts and the rule of law.”

Pirrong also notes the problem created when companies are propped up for policy reasons and therefore become agents of government policy:

It is clear that the Treasury and Fed felt compelled to support AIG, rather than let it implode, in order to protect its counterparties, who happened to be large, systemically important financial institutions (e.g., Goldman).  But supporting these institutions indirectly, by funneling money through AIG, rather than in a more direct way, has created a huge agency problem.  AIG has become, in effect, the government’s agent in maintaining the solvency of other large financial institutions.  But AIG and its managers have their own agendas, and their interests and incentives are not well aligned with those of the other large financial institutions, or with the taxpayers who are ultimately on the hook in this arrangement.

As Tyler Cowen remarks at Marginal Revolution, “The real lesson is that this is another reason not to nationalize banks.  It means politicizing every decision which ends up in the newspaper.”

Or, as I learned it in graduate school, the problem with “discretion” instead of “rules” is that it becomes continuous rather than discrete.