The week the US got mad

The outcry over the AIG bonus payments has turned into a full-blown witchhunt that now threatens the rescue of the banking system, says Stephen Foley

Hysteria: it's our only growth industry. So declared Stephen Colbert, the satirist, as he surveyed the furore over $165m paid in bonuses to executives at AIG. Then again, moments earlier he had pulled out a tool grinder and sharpened the prongs of a giant pitchfork. He has been promising all week to lead an angry mob to lynch executives at the failed insurance company.

While Colbert is being sarcastic, there are plenty of others who aren't. The executives and employees of Wall Street, once masters of the universe and the high-earning envy of their friends, had started acclimatising some time back to their new status as public whipping boys. But this is something new – and scary.

Now some of AIG's employees fear for their own safety and the safety of their families. There have been death threats. Bonus recipients who have been unmasked in the press appear close to tears as journalists descend on their homes. A union-sponsored group is going on a protest bus tour of their houses today, "to give folks who are losing their homes and their jobs and their health insurance an opportunity to see what kinds of lifestyle billions of dollars in credit default swaps can buy". The House of Representatives just passed an unprecedentedly punitive – and possibly unconstitutional – tax bill designed to seize 90 per cent of their bonuses. Across Wall Street, nervous executives are asking about getting some security protection.

How did it come to this?

AIG exists today only thanks to the largesse of the US taxpayer, who has forked out over $173bn so far to pay off what are essentially gambling debts, racked up in the opaque credit default swaps market. The company was too enmeshed in the financial system to be allowed to fail, the government decided last September. The men and women of AIG's "financial products group" where those bets were written are thus high on the list of people responsible for the company's need for a bailout, and for the resulting financial panic that pushed the world economy deep into recession. These are the people who are being handed $165m in retention payments, largely guaranteed by their long-standing contracts, and who are being kept on the payroll while their bets are wound down.

Politicians from President Barack Obama down have been calling Wall Street's payment of any bonuses "shameful" while companies are being propped up by taxpayer funds. Andrew Cuomo, the New York attorney general, has been pursuing a crusade against bonuses, and in particular against the $3.6bn paid to Merrill Lynch employees in the days before that fallen titan of investment banking was swallowed up by Bank of America.

The central role of AIG in last September's financial panic – and thus in the subsequent downward lurch by the US economy – makes its bonus payments seem even more egregious, and no politician or public figure could see a reason this past week to ratchet down the rhetoric.

It began with a few headlines a week ago, revealing that the Treasury had signed off on the bonuses, concluding that it had no legal alternative. Edward Liddy, AIG's chief executive, said it had to honour contracts, or face being left without the staff to sort out its problems.

On Sunday, a cadre of President Obama's economic advisers described the payments as "outrageous". The President himself followed a day later by ordering the Treasury to use every legal means to claw them back. By Tuesday, the language took a violent turn. Charles Grassley, a Senator, said he hoped executives would mimic the Japanese and "resign or go commit suicide" – a remark he later laughed off as "rhetoric".

And on Wednesday, when Mr Liddy went for a public flaying in front of the House financial services committee, he chided politicians for stoking public fury. He read out several of the threats which employees had received, including one which said staff and their families should be executed "with piano wire". Another read: "I'm looking for all the CEOs' names, kids, where they live, etc."

By Thursday, tabloid newspapers had unmasked a number of the recipients of AIG's biggest bonuses, including James Haas, a vice-president of marketing at the financial products group, who was pictured at his Connecticut home under the headline "Jackpot Jimmy".

The political furore, meanwhile, centred on which politicians, in Congress and at the Treasury, knew about the bonuses and when, and who removed language from the recent economic stimulus Bill which would have retrospectively cancelled them. Both Tim Geithner, Treasury Secretary, and Chris Dodd, chairman of the Senate banking committee, came under pressure to resign.

Few stopped to debate the potentially chilling effect of the witch-hunts on the financial system. This is a system, after all, which is only being propped up thanks to taxpayer money and loans into the credit markets by the Federal Reserve, the most widespread government intervention in markets in history. The consequences of making it insufferable to deal with the government have not been debated. The Fed's programme to inject life into the securitisation market attracted less interest than expected, in part because investors worried they could be caught up in a public relations firestorm if they turn a profit.

"This outcry might mean we are cutting off our nose to spite our face," says Claudia Allen, head of the corporate governance practice at the law firm Neal Gerber & Eisenberg. "The energy that has been focused on AIG this week misses the bigger issue of how best to get taxpayer money back. I think it will make it much harder to recruit the people needed to run financial companies and make them healthy again.

"You only have to look at AIG's Edward Liddy. He was brought out of retirement by the government to run the company for $1 salary. I think that job might be a difficult sell now."