Bonfire of the A.I.G.

The Congressional hearing over the AIG bonuses today may have been the most circus-like experienced by the normally staid House Financial Services Committee.  But theatrics aside, what we find is a deeply nuanced situation, full of half-details suggesting shady subterfuge, and not a person to trust as far as the eye can see.

First, the $165 million in bonuses/retention fees paid to employees (and apparently, a handful of ex-employees) of AIG.  There is an enormous amount of public outrag at this incomprehensible rewarding of the very people who have contributed (and not in a small way) to the financial crisis (certainly, on a per head basis, are far more culpable that the irresponsible mortgage holder that those of other side of the political spectrum love to hate). 

But peel aside the outrage and this is the situation we are left with: if we assume that AIG has a contractual obligation to fulfill the terms of what can only be characterized as criminally generous compensation contracts (and you can read this op-ed, as well as this recent post by Pundit Mom, for some critical discussion about the legal grounds which AIG may have to not perform on their obligations), then (1) breaking that contract may in fact cost AIG more than simply paying out on the obligation and (2) the government has already tied its hands with respect to the degree of its involvement allowed.

On the one hand, government interference in contract law may unleash a whole pandora's box of unintended consequences that I'm not sure we're ready for.  If nothing else, the uncertainty that it would cause for any financial institution attempting to enter any contract at this point might destroy the public/private partnerships that Obama and Geither are hoping to rely upon to clean up the financial industry.  More importantly, this government has made a conscious decision not to interfere.  Despite owning 79.9% of AIG, it has apparently placed a series of measures in place to deny itself of the shareholder powers that come with being a majority owner.  Ironically, this may well have been done to dissipate the stink of nationalization, because we all know that nationalization is a dirty, dirty word (apparently, dirtier than... oh, grand theft larceny). 

Truth is, the most logical solution for these obscene compensation packages is for the recipients to voluntarily give them up.  Which is why, as despicable as they are, the threats against the employees read by AIG CEO Libby today may get us closer to "justice" than anything we see from the courts, or the politicians.  If the recipients of the AIG bonuses are revealed, I imagine they might pretty quickly be willing to part ways with their undeserved gains.  It is unfortunate, but in a shameless nation, we seem to require some measure of forced notoriety to get people to behave.

The more offensive, and far less discussed, AIG revelation this past weekend, was the list of some of the financial counterparties that benefited so far from the $160 billion government rescue (click on above chart for more details). 

The initial reaction of many has been of resigned rationalization: guaranteeing against counterparty failure had been the primary motivation behind the AIG bailout, wasn't it?  So we should hardly be surprised when the very problem we had to solve is being solved by paying off the counterparties. 

There are two flaws to this thinking:

The most important being - the way we have CDS payouts structured right now, we are effectively paying out fire insurance when the fire hasn't happened yet. 

What upsets some people is that the government paid the counterparties in full even though the underlying securities had not experienced widespread, or perhaps even any, defaults.

When the government bought the underlying securities to cancel the insurance, the taxpayer became the owner of these pools of debt issues. Because the government chose to pay par or 100 percent of the face value, the taxpayer has downside risk if the securities lose value but virtually no upside.

Even if the purchasing of underlying securities is some weird, too smart for me way of unraveling the CDS commitments of AIG without causing undue stress on the system, the complete and utter lack of any coordinated effort on the part of the Treasury and the Federal Reserve to address the structural flaws in our system that seems to make us so susceptible to systemic failure is appalling.

From William Black, an economics professor at the University of Missori and a former bank regulator:

This [AIG fiasco] is the consequence of six things on the Treasury end of things:

(1) the failure to use Chapter 11 bankruptcy/pass-through receivership to deal with deeply insolvent financial institutions

(2) the failure to expose, and to the extent possible, remedy through restatements the massive accounting fraud that AIG was/is engaged in that triggers the bonuses

(3) the failure to bring criminal charges against the control frauds

(4) the failure of Treasury as negotiators -- they had all the leverage when they bailed out AIG and could have conditioned the aid on at least the VP tier and above giving up their bonuses

(5) the weakness of Treasury's current lawyers who, if press reports are accurate, couldn't think of any way for the U.S. government to take effective action against what it reportedly views as a scandal, and

(6) why was Treasury blind-sided by this? It confirms that they did not conduct even the most obvious due diligence on AIG's assets and contingent liabilities

Given what we know about the lack of due diligence by AIG on underlying assets, particularly nonprime paper, this confirms exactly how dangerous Treasury is to the the nation. It is also consistent with the concern that it faces such a critical staff shortage, particularly in the relevant skills (which the folks it hires from Wall Street lack). I doubt that they have five senior officials that have ever reviewed loan files for a living or conducted meaningful due diligence (which requires cracking the loan files).

If the bonfire of the AIG reveals anything, it reveals how ineffectual the current administration has been at addressing the real issues.  It's time to stop d*cking around with the bonuses and the mark-to-market system and the buying up toxic assets at par value and the private-public deals that get us nowhere except with lighter wallets, and start doing what should have been done in the first place: fix the bankruptcy system.  Nationalize.  Due diligence.  Prosecute the Frauds.

Comments

[Account Deleted]

This was so well written and on target. Really outlined the problems and the "bottom line". Most of these bailouts are just criminal and it does not seem that we, as taxpayers, have a voice in these huge amounts going to these companies! It is like they are being rewarded for their bad business behavior. It isn't the claims payer or the underwriter who sits at a desk and works all day, that benefits, in fact they could still loose their job because of layoffs. It is all the fat cats at the top, hidden under layers of lies, that are benefiting.

[Rusell]

I was absolutely outraged that tax money was being given by the millions to AIG Execs but then I read this letter written by one of those workers. I dont know now.

http://www.iht.com/articles/2009/03/25/opinion/eddesantis.php