The AIG Hearings: Part 1, “Now that we’ve killed all the bomb-makers …”
“Now that we’ve killed all the bomb-makers, uh, who’s gonna defuse all these bombs?”
“Glad we killed all the guys who wired this together … oh, wait!”
What an idiotic week we have just seen in American politics, involving a hearing that was half circus and half show trial, culminating with probably the dumbest piece of tax legislation conceivable, all to appease ordinary taxpayers howling for blood, and since they cannot get the blood of those who made the mess, they will take it from those who are trying to clean up the mess.
“Burn them!”
I’ve previously posted about the mass drunkenness on risk-taking that consumed much of the world over the preceding decade, the belief that ’some other guy’ was doing the due diligence, the willingness to believe in a risk-mitigation perpetual motion machine, and the unlicensed insurance of Credit Default Swaps (CDSs). There’s plenty of guilt to go around, including us, the consumers, the people who were happy to see our stock holdings and 401(k)’s soar, and the pension fund managers who, starving for yield, took risks to which they were blind, or the possibility of international currency manipulation creating irresistible economic pressure.
Let’s take a look at the facts-be-damned quality of last week’s outrage:
A tidal wave of public outrage over bonus payments swamped American International Group yesterday. Hired guards stood watch outside the suburban
“It’s a mob effect,” one senior executive said. “It’s putting people’s lives in danger.”
“Yeah! We like putting people’s lives in danger!”
What’s really going on is this:
People are mad at Bernie Madoff.
I took you for $65 billion
They’re mad at Allen Stanford.
And I thought I was doing well at $8 billion
They’re mad at the pompous bank CEOs who waltzed into the sunset toting $20 million annual compensation, even while suppressing criticism and telling us how everything was fine.
“Everything’s fine, isn’t it?”
They’re secretly mad at Congress and the Administration for pushing through a $787 billion or so stimulus bill whose passage has preceded further stock market drops.
Since the mob cannot string up any of these people, they have chosen to string up the responsible executive, Ed Liddy, who is left trying to deal with the mess.
I swear I’m doing this to serve my country
To show how wrongheaded was last week’s hysteria, I’ve pulled this post together citing three sources, as follows:
Washington Post (indigo text)
The Business Insider, John Carney (red text)
The Business Insider (green text)
1. These aren’t the people who wrote the dangerous Credit Default Swaps (CDS’s)
“No one – is innocent.”
It would be one thing if those who played with financial nitroglyercine were also asking premium pay for their penance, but they’re not:
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.
Those who didn’t cause the trouble are the ones being not paid:
The payments represent only the most contentious of a larger group of bonuses being paid throughout AIG. The company’s top seven officials, including chief executive Edward M. Liddy, agreed in November to forgo bonuses through this year.
As Mr. Liddy wrote in his letter to Secretary Geithner:
I do not participate in any AIG bonus or retention program, have never attended a single AIG sales event or conference and, before September, did not have any relationship with AIG. I was asked to serve by your predecessor in connection with the acquisition by the government of almost 80% of AIG’s outstanding shares.
For, we might note, a dollar a year.
What Liddy’s being paid
My only goals are to have AIG repay, with interest, to the maximum extent possible, the assistance the American taxpayers have given it and to continue AIG’s main insurance companies as strong, thriving businesses and contributors to the economy. My only stake is my reputation.
That’s certainly the man we want to penalize, isn’t it?
2. Those being excoriated could leave tomorrow
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.
‘Greed’ is a word I’ve sought to banish from my vocabulary as completely subjective and thus meaningless; whoever says it means, more money for someone else than I personally think is equitable.
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.
“Have fun disarmin’ the instruments!”
“Think they’ll do it?”
“Not a chance.”
3. If they people go, the CDS’s could explode worse
This is the most insane part. We the taxpayer are sitting on a huge risk, and we’re threatening the lives of the people who can defuse these bombs? Washington Post:
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.
You want an example? Here’s just one, plucked largely at random from the AIGFP retention plan justification:
Departures also have regulatory ramifications. As an example, the resignation of the senior managers of AIGFP’s Banque AIG subsidiary would allow the Commission Bancaire, the French banking regulator, to appoint its own designee to step in and manage Banque AIG.
So we’d have French bureaucrats deciding how to settle contracts where the
Don’t you feel Sarkozy about now?
Don’t you feel all warm and cozy now?
For better or worse, we’re linked now
It gets better:
Such an appointment would constitute an event of default under Banque AIG’s derivative and structured transactions, including the regulatory capital CDS book ($234 billion notional amount as of December 31, 2008), and potentially cost tens of billions of dollars in unwind costs.
Default accelerates all sorts of other penalties, many likely to be adjudicated in foreign jurisdictions by judges friendly toward AIG’s claimant counterparty.
“We want blood!”
Although it is difficult to assess the likelihood of such regulatory action, at a minimum the disruption associated with significant departures related to a failure to honor contractual obligations would require intensive interactions with regulators and other constituents (rating agencies, counterparties, etc.) to assure them of the ongoing viability of AIGFP as well its commitment to honoring counterparty contracts and claims.
Smart people I know close to Wall Street have said that we made a huge mistake letting Lehman Brothers go under, because the disruptive costs were much greater than backstopping Lehman would have been … and we’re long since past the safety point on moral hazard.
4. The bombs are still live …
It would be one thing to tar and feather after the risks were all behind us, but they’re not.
“Tell us how to fix it it!”
From Mr. Liddy’s Wednesday Op Ed:
Although we have wound down more than $1 trillion in the portfolio of the AIG Financial Products unit that is at the root of the company’s troubles, there remains substantial risk in that portfolio. The financial downside for taxpayers is potentially very large, and that’s why we’re winding down this business.
It takes time to wind this down
There’s no need to repeat my previous astonished posts regarding the massive amount of unlicensed insurance that was written on CDS’s. The point is that, like the post-Soviet nuclear weapons, they don’t just disappear or atrophy. They have to be dismantled, in real time:
“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.”
5. … so we need the world’s best bomb-defusers
From Mr. Liddy’s Wednesday Op Ed:
To prevent undue risk exposure in the meantime, AIG has made a set of retention payments to employees based on a compensation system that prior management put in place. As has been reported, payments were made to employees in the Financial Products unit. Make no mistake, had I been chief executive at the time, I would never have approved the retention contracts that were put in place more than a year ago. It was distasteful to have to make these payments. But we concluded that the risks to the company, and therefore the financial system and the economy, were unacceptably high.
You’ve made a bad bet for $1,000, and you really, really want to prevent it from exploding in your face. So you decide that, since the original charlatans who talked you into it are long gone, you’ll offer a bounty of sixteen cents.
… would you pay this?
To save this …
That’s the arithmetic involved.
When I started this post, I expected it to be only a single part. But the spectacle was so surreal, and yet so dangerous, I have to continue it tomorrow.
“Sentence first! Then trial!”
[Continued tomorrow in Part 2.]
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