The AIG Mess

Outrage is all the rage in Washington this week. The only real question is whose outrage isn't faked. At the heart of the matter is around $450 million that AIG has paid or is contracted to pay to top executives in retention bonuses. $165 million of that went out last week.

According to the Washington Post, these bonuses were known about for months:

Attorneys working for the Fed had been examining the matter for months and determined that the retention payments couldn't be touched because AIG would face costly lawsuits and be subject to penalties from states and foreign governments. Administration officials said over the weekend that they agreed with that assessment.

These bonuses were announced nearly a year ago:

Beginning in the first quarter of 2008, AIG disclosed the plan to offer retention awards at Financial Products. The unit had already begun to hemorrhage money, a problem that would later grow exponentially. The unit's executives, fearing they might lose valuable employees in the tumultuous months to come, successfully negotiated more than $400 million for their workers, to be paid this month and again next year.

At the Federal Reserve Bank of New York, which has directly overseen AIG since its federal takeover in September, officials have studied the possibility of rescinding or delaying the bonuses. They even brought in outside lawyers for advice. The conclusion: If the bonuses weren't paid, the AIG staffers would be able to sue the company and probably would win, not just what they were owed but also punitive damages that would make the ultimate cost perhaps two to three times as high as the bonuses themselves.

Moreover, Fed officials also hope to keep current employees with the company. The senior executives whose decisions caused the company's collapse are long gone. Most of those left behind are trying to unwind complicated derivative contracts. Completing that process correctly is essential to preserving as much value as possible for taxpayers, officials at both the government and AIG have argued. If it is mishandled, it could expose taxpayers to billions of dollars in additional losses.

The article even goes on to speculate that the current government outrage was designed to pressure the execs into giving back their bonuses.

At any rate, it's pretty clear that these bonuses were known about well in advance and were deemed either critical to keeping key people in place, or at least more dangerous to attack than to leave in place. Had this all been explained up front to the American people I doubt we'd be having this big fuss.

But then we hit the big "teeter" (not quite a crash) of 2008. AIG received bailout money, along with quite a few banks. Only a few of those banks actually needed the money--the rest were pressured into taking it to help the needy banks maintain anonymity and prevent runs on those banks.

Then along comes the Stimulus Bill. Knowing about AIG's bonus program, and knowing there were many banks holding government money who didn't need it, lawmakers stepped in to remove an amendment from the bill that would have restricted bonuses to any company receiving bailout funds. It's claimed that Senator Chris Dodd inserted language that limited executive compensation, but exempted bonuses.

Dodd claims to know nothing about this "Dodd Amendment". In fact, no one seems to know how it got into the bill. The only thing we know for sure is that it wasn't the Republicans, as they were specifically kept from helping draft the bill. And we can't blame anyone who voted for the bill, because no one had time to read it.

The usual arguments over what Dodd knew and when he knew it are ensuing. And Dodd himself is trying to combat the provision he supposedly added--and undoubtedly hoping no one remembers the $103,100 campaign donations he received from AIG in 2008. This is the same Dodd who vigorously defended Fannie Mae and Freddie Mac when the Republicans tried to investigate alleged wrong-doings there, and one of the recipients of a sweet mortgage deal from Countrywide Mortgage.

Fannie Mae, by the way, is also giving its top execs retention bonuses of between $470,000 and $61,000 this year. Freddie Mac, not to be outdone, is planning similar bonuses. These companies received $15.2 billion and $13.8 billion in federal funds last year, and Freddie Mac has requested $31 billion more this year.

Meanwhile lawmakers are up in arms, and turning their ire on the Obama administration for being asleep at the wheel. The White House is expressing full confidence in secretary of Treasury Tim Geithner's oversight.

So let me explain...no, it will take too long. Let me sum up. Bonuses we knew were coming are being paid to AIG executives deemed necessary the company's recovery. These bonuses were protected by language placed in the Stimulus bill, though no one knows how it got there. But now that the money is being paid out everyone is suddenly surprised and angry and vowing to undo what they allowed to be done--while at the same time ignoring the exact same thing being done at two government-supported companies with an even more corrupt past. The result:

Hired guards stood watch outside the suburban Connecticut offices of AIG Financial Products, the division whose exotic derivatives brought the insurance giant to the brink of collapse last year. Inside, death threats and angry letters flooded e-mail inboxes. Irate callers lit up the phone lines. Senior managers submitted their resignations. Some employees didn't show up at all.

"It's a mob effect," one senior executive said. "It's putting people's lives in danger."

Politicians and the public spent yesterday demanding that AIG rescind payouts that they said rewarded recklessness and greed at a company being bailed out with $170 billion in taxpayer funds. But company officials contend that the uproar is scaring away the very employees who understand AIG Financial Products' complex trades and who are trying to dismantle the division before it further endangers the world's economy.

"It's going to blow up," said a senior Financial Products manager, who spoke on condition of anonymity because he was not authorized to speak for the company. "I have a horrible, horrible, horrible feeling that this is going to end badly."

I'm not sure what to be more concerned about, our tax dollars being spent to save the economy, or our tax dollars being spent to destroy it. At best we can hope the two cancel each other out without doing any lasting damage.

But then what can we expect when we put the party that hates big business and decries capitalism in charge of saving both. It's like asking Gen. Patton to perform life-saving surgery on Hitler. Why should we be surprised when the patient inexplicably dies on the operating table?

Oh, and now it's also coming out that AIG has send out over $100 billion--over half of what's been given them so far--to other institutions and city governments, including some foreign businesses. The Wall Street Journal has suggested the government is using AIG to launder foreign aid funding, and that Washington is making such a fuss over the AIG bonuses to draw attention away from its own inability to supervise AIG and other bailed-out companies.

Jim Rickards, quoted in the Washington Times, suggests there is a "straightforward economic reason" for the rerouting of funds, though it does present a huge political problem for the administration:

AIG, Rickards said in an e-mail, "had trades with counterparties (Goldman, Deutsche Bank and many others) which, over time, produced paper profits for the counterparties and paper losses for AIG as market prices moved against AIG. In that situation, it is customary (and contractually required) for the losing side (AIG) to pay the winning side (Goldman, others) the amount of the paper profits in cash."

"This protects the counterparty against the possibility that AIG might not be around to perform when the trade is finally closed out at maturity. The name for this is a 'margin call' with margin being the name for AIG's paper losses which have to be made good," Rickards said. "So, when the U.S. gave AIG money, the money went right out the door to meet margin calls."

"AIG was not much more that a conduit for government money which really went to the counterparties. So, in effect, the U.S. was not just bailing out AIG, it was bailing out the counterparties. Many were foreign banks which is part of the outrage," he said.

I think basically what we have is an administration that is deathly afraid of the public while being simultaneously condescending toward them. They don't think we're smart enough to understand business. I, for one, having read all the above articles feel the real problem is Washington's response, not AIG's activities--at least lately. There's no denying they did some very, very stupid--and perhaps greedy--things and got themselves into serious trouble. But they're not going to be able to get themselves out of trouble without doing some things that are not going to be immediately understood by the public.

Rather than try to explain it to us and risk taking the heat for supporting this, the administration prefers to keep things quiet unless they become public and then howl with rage and feign ignorance. In short, these people are afraid to make the tough call. They want to have their cake and eat it too. They want to make villains of big business while working quietly to try and save them. They claim that some companies are just too big to allow to fail, yet do everything they can to undermine the company's attempts to not fail.

Is $165 million a lot of money? Obviously. Is it money well spent if the people it was supposed to help retain really can salvage the company and stabilize the economy? I think so. If that's what it takes to make the right people willing to stick it out and put up with the crap they're having to wade through right now then it's a small price to pay.

Meanwhile, Congress has voted themselves a pay raise. Just what have they done to save the economy? They seem actively bent on destroying it with their selective amnesia and poll-fueled outrage.

Does anyone have the guts to stand up and say "Hey, we don't have to like it, but this is what it's going to take"? I can think of one senator that might have. In fact I voted for him for preseident. I'm becoming increasingly proud of that vote.

Too Many Strings Attached

Megan McArdle from The Atlantic:

Apparently, the restrictions that Congress is putting on bailout monies is pushing a number of institutions to give the money back.

What to think of this? One's first instinct is to say that this is an unalloyed good--the restrictions have made taking the funds costly enough that only truly troubled institutions will do so.

The problem is, that's precisely what the Fed was trying to avoid. Central bankers have long made a practice of keeping it a secret who borrows from them at the discount window, because publishing the names of those who need a temporary cash infusion could trigger a bank run. In order to get the money into the banks that needed it to stave off a liquidity crisis, Bernanke and Paulson very deliberately asked banks that were widely believed to be sound to take the money too. Otherwise, the government bailout funds might have touched off the very crisis we were trying to avert.

I guess the price of doing their "patriotic duty" was too high. It was bad enough for the banks taking the money they didn't need to be painted as a potentially failing bank. To accept the conditions that were pushed on them later at the risk of becomng a failed bank for real was just too much.

I wrote about this back in early February.

I think the idea of not paying the price for someone else's irresponsibility is gaining traction.

She goes on to make another good point:

It's also possible that some of the measures that express our collective rage at the bankers could tip the banks over the edge. It's satisfying to make AIG cut out junkets for independent insurance agents, but it also probably means that fewer AIG policies will be sold. Since we now own the company, we probably cost ourselves money in order to express our outrage. Similarly, watching the conga line of Merrill's top performers snaking up Wall Street to other firms, one can't help but wonder if B of A shareholders did themselves any favor by complaining about the bonus structure. The major assets of these institutions are client relations and human capital that tend to adhere to the individual, not the firm.

To reverse a popular phrase, "If you bought it, don't break it!" Like it or not, we're now stockholders in AIG and the like. If we want our money back some day we'd better support those businesses.

Bailout Banks, Not Hobble Them

The Chicago Tribune criticizes language in the Stun-ulus Bill to cap executive compensation:

But keep something in mind: Taxpayers are now deeply invested in the companies that receive a federal bailout. We want these companies to succeed.

Compensation caps would hurt the ability of these firms to attract and retain top talent. If salaries are higher at robust firms that aren't taking federal help, that's where talented people would go. Taxpayers are not going to be better off if the best business minds in the land avoid working at firms that receive federal help. The comp rules may also persuade execs at troubled firms to leave the federal assistance program before those firms are on sound footing.

I think that is right. If you're going to tinker in businesses, why not just insist that the boards fire the bad eggs, but don't hamper their ability to replace them with good ones. These banks are still struggling. They're going to need all the help they can get to survive. Just throwing money at the problem is not going to help. They need better management.

Patriotism Vs. Business

It's easy to be hard on companies who accept bailout money and still continue their lavish ways.

However, correct me if I'm wrong, but weren't there a bunch of other banks who were asked to accept bailout funds even though they didn't want them, just to help with a) protecting the anonimity of some of the other banks, and b) to stimulate the economy?

So if you're one of these banks that took money they didn't need, and now you're being told you have to abide by certain rules, including some that didn't exist when you accepted it, doesn't this actually interfere with their successful operation?

In other words, no good deed goes unpunished. This should make anyone else who wants to be helpful in the future think twice.

UPDATE: JPMorgan CEO Jamie Dimon criticizes the restrictions and makes a few good points:

“Pay got a little exuberant, and there were some legitimate complaints,” Dimon said. “But I don’t think the president of the United States should paint everyone with the same brush.”

New York-based JPMorgan, the second-largest U.S. bank, doesn’t have so-called golden parachutes or retirement packages, and all top executives must retain 75 percent of their stock- based compensation, Dimon said.

This is essentially government micromanaging businesses. Yes, there needs to be some concession from bailed-out institutions, but I don't think the Federal Government is a good candidate to determine how business should be run. After all, this is the group that has posted losses that make the banking sector look successful by comparison. And whose top officials don't feel obligated to pay taxes.