Editore"s Note
Tilting at Windmills

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March 19, 2009
By: Hilzoy

And Another Thing ...

In the piece by Steven Davidoff about the AIG contract that I cited in my last post, he also writes:

"This was not a boilerplate contract. Rather, it was highly negotiated. And it was highly negotiated to pay retention fees at high levels without regard to performance. This is obviously shocking. But it makes me wonder: perhaps one area of direction here should be actually looking at who negotiated this and why?

It strikes me that the A.I.G. financial products division received an unbelievably sweet deal. Did its managers slip it under the radar? Did the managers act in good faith? And who at A.I.G. signed off on this and did they focus on the risks and rewards? Yet more avenues for possible litigation."

I hope the Obama administration is looking very hard at this question. The introduction to the contract says that one of its aims is to "recognize the uncertainty that the unrealized market-valuation losses in AIG-FP's super-senior credit derivative and originally-rated AAA cash CDO portfolios have created for AIG-FP's employees and consultants."

That certainly suggests that AIG-FP was aware that there might be significant losses, as does the fact that they got their compensation locked down in a way that made it independent of their profits or losses. (Unless their bonus pool exceeded the amount guaranteed in the contract -- then they got to keep more!) And hard as it is to imagine that AIG's general management had somehow overlooked the signs of trouble in the subprime market in early 2008, it's even harder to imagine that whatever whoever signed off on this would not have asked: why does AIG-FP want this? How bad do they think it's going to get?

I imagine it would be worth scrutinizing the public comments of AIG executives between the first quarter of 2008, when this contract was written, and September, when it collapsed. But that's only one point. I hope that every law enforcement agency with anything resembling jurisdiction goes over everything about AIG-FP with a fine-tooth comb. There are more than enough peculiar aspects to this story to warrant it.

There's nothing like legal liability and high-profile prosecutions and lawsuits to put the fear of God in people. And the Masters of the Universe badly need a little fear of God right now.

Hilzoy 2:06 AM Permalink | Trackbacks | Comments (14)

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Comments

Who does the negotiation for management contracts in any publicly traded company? Can someone who knows how this works explain? It seems like the whole public corporation system must be broken, since no shareholders would ever have agreed to these terms.

Posted by: Boronx on March 19, 2009 at 2:42 AM | PERMALINK

This bonus issue is the canary in the coal mine. Boatloads of taxpayer dollars are being given away without know what's going on. Congress should yank back all the bucks and immediately force ALL of AIG into bankruptcy. I don't know why this wasn't done in the first place, but my suspicion at this point is that "the bezzle" at AIG is HUGE.

Some predictions:
AIG-FI is not "unwinding" it's positions on CDS's - it just paying them out.
The rest of AIG (the supposedly normal insurance part) is also broke.
US taxpayers are paying out to hedgers betting this would happen (i.e. not a real transaction "hedge".)

We're in the "end game" of a huge scam. Wall St is just milking the US taxpayer for every last cent they can take. All Wall St companies "too big to fail" should go into bankruptcy like any other company so that scam can be stopped. Bankruptcy is designed to stop this type of scamming and we need to use it.

Posted by: Glen on March 19, 2009 at 3:16 AM | PERMALINK

Hilzoy: I hope the Obama administration is looking very hard at this question.

That is the last thing this administration wants to look at. Consider the revelation today by Sen. Chris Dodd that the Treasury Department demanded that he insert exemptions into the stimulus bill that allowed bailout recipients to receive bonuses.

Posted by: DevilDog on March 19, 2009 at 5:21 AM | PERMALINK

That certainly suggests that AIG-FP was aware that there might be significant losses

I'm guessing all the banner headlines about Bear Stearns in March '08 weren't the first clue. This might be one indication:

Two months later, on Feb. 11 [2008], AIG disclosed that its auditors had found the company "had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation of the AIGFP super-senior credit-default swap portfolio." On Feb. 28, AIG announced that its estimate of paper losses had spiraled to $11.5 billion. The company also acknowledged that its collateral postings had reached $5.3 billion.

Posted by: Danp on March 19, 2009 at 5:47 AM | PERMALINK

Too big to fail = so big it should be broken apart.

Posted by: bkmn on March 19, 2009 at 6:05 AM | PERMALINK

Dans ce pay-ci, il est bon de tuer de temps en temps un financier pour encourager les autres.

Voltaire amended.

Posted by: Doug on March 19, 2009 at 6:29 AM | PERMALINK

One word: RICO.

Posted by: bdop4 on March 19, 2009 at 7:34 AM | PERMALINK

Glen wrote:

"Some predictions:
AIG-FI is not "unwinding" it's positions on CDS's - it just paying them out.
The rest of AIG (the supposedly normal insurance part) is also broke.

Unwinding = paying them out in my experience. A contract can either be sold or settled. I seriously doubt anyone is buying AIG's CDS, so presumably they are being settled with the counterparties. There is a question of whether they should be, and if AIG had gone bankrupt, they might not be. But since they didn't go bankrupt (thanks to you, me, and every other taxpayer in America), we are legally obliged to unwind. It would be nice if they tried to renegotiate the CDS contracts, but since the same losers who negotiated them in the first place seem to largely still be there, that does not seem like a hopeful approach.

As for the rest of AIG--well the whole company is broke so they are broke too. But are you saying that the, say, car insurance part of AIG is operationally insolvent? I'm not saying you're wrong, but as speculation goes, that strikes me as pretty baseless...

Posted by: RWB on March 19, 2009 at 7:44 AM | PERMALINK

And what about the fiduciary duties of the officers and directors of AIG with respect to these contracts? Are they potentially liable to stakeholders?

Posted by: Shag from Brookline on March 19, 2009 at 7:50 AM | PERMALINK

As for the rest of AIG--well the whole company is broke so they are broke too. But are you saying that the, say, car insurance part of AIG is operationally insolvent? I'm not saying you're wrong, but as speculation goes, that strikes me as pretty baseless...

Reported by Newsweek:

The Next AIG Scandal?

The firm's problems may extend to its 'healthy' insurance side.

http://www.newsweek.com/id/189917

As for unwinding unfavorable CDS positions, you may be right, they have very little leeway at this point other than to pay. It would be nice if they could identify all the "gamblers" rather than actual counterparty hedges and ask for SEC assistance to bust those deals.

Posted by: Glen on March 19, 2009 at 8:30 AM | PERMALINK

Really the only equitable way to honor those AIG bonus contracts would have been to pay them in AIG stock with each share assigned a nominal value of it's highest historical price. It might have brought home to those putzes the magnitude of their achievement.

Posted by: Peter G on March 19, 2009 at 11:40 AM | PERMALINK

Let's consider the motivation for these bonus/retention contracts:

1. Executives want to guarantee each other very generous pay no matter what happens.

2. Ordinarily this could be done by paying high salaries. But the tax code does not allow companies to deduct salaries over $1M when determining corporate taxes. "Performance-related" pay, however, is OK and can be deducted.

3. So companies keep salaries at or below $1M and pay the difference in so-called "performance bonuses". The motivation is not to incentivize executives, but to keep their high pay fully deductable from corporate taxation.

4. When performances became so obviously terrible and difficult to explain, it was necessary to call the bonuses something else. "Retention contracts" sounded like a good name.

Posted by: jeri on March 19, 2009 at 12:30 PM | PERMALINK

What AIG really need is not "fear of God" but "fear of the marketplace", and the government is actively intervening to make sure that they have nothing to fear.

You could argue that those guys earned their bonuses by fooling the U.S. government into covering AIG losses. On that, they definitely were more competent than Congress, both the Bush and Obama administrations, and the Federal Reserve.

Posted by: MatthewRMarler on March 19, 2009 at 4:00 PM | PERMALINK

Glen: We're in the "end game" of a huge scam.

Probably not. Once the Feds start subsidizing, they keep on subsidizing, as with honey, sugar, ethanol, and just about anything else. They will want to increase their subsidies to AIG and others in order to avoid admitting that they were wrong in the first place. Treasury Secretary Geithner is never going to admit that New York Federal Reserve Bank President Geithner was gulled by the New York financial barons.

There is nothing in government nearly as effective at punishing bad management as the "creative destruction" of the market. Preventing themselves from being "creatively destroyed" is now the highest purpose of the financial barons and their friends (Republicans under Bush and Democrats under Obama)in the government.

I am a strong supporter of the free market, but sometimes the market leaders are both incompetent and corrupt, and this is one of those times. The only possible effective punishment is for the government to let the businesses fail and for the successful parts to be bought by the competition.

Posted by: MatthewRMarler on March 19, 2009 at 4:09 PM | PERMALINK




 

 

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