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Wednesday, March 18, 2009

The AIG Bailout and Bonus Imbroglio

Given the incredibly low bar of insight and analytical thinking set for itself by members of Congress, it's hard to be surprised by Congressional hearings anymore. The March 18, 2009 appearance of AIG CEO Edward Liddy in front of a House subcommittee was no exception. If you just heard pieces of Liddy's statements and the indignant questions that prompted them, the transcript of the entire session could be succinctly condensed down to a single word.


The entire spectacle not only failed to enlighten Congress or America about the real nature of the problems at AIG and the larger financial system, but moved the spotlight from the areas that remain unaddressed by the government for any true stabilization effort, much less long term recovery.

Bailouts to Protect WHAT and WHOM?

Nearly an entire day was spent by the House Subcommittee on Finance on the topic of a mere $165 million in bonuses paid to over 73 employees at one firm that has already pulled in two bailouts of $85 billion and a second bailout for another $65 billion as part of a larger $700 billion bailout. Had Congress considered the original $700 billion TARP legislation with equal diligence, we'd be only 150 days into the 4242 days of debate on the bailout plan.

Is this an argument to have done nothing to try to stabilize the market in 2008? Of course not. It's yet another example of the substitution of talking points for progress -- the same substitution that produced the half-baked TARP program in the first place by focusing on "coming together" and "doing something" instead of addressing even ONE fundamental regulatory issue that contributed to the meltdown before flooding failed banks with taxpayer money or one material issue of the mechanics of the TARP plan itself.

Until the past week, AIG had refused to disclose the names of major counter-parties who stood to lose from a collapse of AIG and, consequently, stood to gain by its rescue. (#1) Two areas of concern arose when names were finally released. First, many of the parties are foreign banks. Of course, the immediate reaction from that involved the disgust that US taxpayer dollars were indirectly helping to bail out foreign banks. Of course, that emphasis would totally miss the more important point that such findings indicate all of the major banks in Europe are as close to the brink as US banks, meaning the resistance of the worldwide system to any shock is far less than anyone understood or at least publicly stated until now.

The second point about the disclosure of AIG counterparties is that by any accounting, Goldman Sachs was a major beneficiary of the TARP plan. Given the timing and magnitude of the overall crisis, that's not necessarily surprising. However, after considering the decision made by former Treasury Secretary Hank Paulson to #1) FORCE a rescue of Bear Stearns, #2) ALLOW Lehman Brothers to twist in the wind and die, then 3) LAVISH funds from TARP into AIG to help Goldman Sachs -- his former firm -- behind the scenes, one must conclude that is worthy of serious investigation.

Bonuses to Retain WHAT?

The Liddy appearance focused on bonus payments made to top executives in the division of AIG that concocted most of the highly leveraged schemes that tanked the company. Of course, there are two types of bonus payments offered in Corporate America. Performance based bonuses are intended to encourage employees to make business decisions that increase real profits and increase the real value of the company so stockholders make money. (PLEASE!!! Try to hold your snickering until the end of the point…) "Stay bonuses" are intended to stabilize the employee base during periods where the company's ongoing operations are vital to the survival of the company by encouraging key contributors to stay and avoid a disruption in the company's operation. Think of them as "combat pay" for staying in the foxhole and continuing to fire one's weapon as commanded during a corporate firefight for survival.

In the case of AIG, it really doesn't matter what terms were involved for the bonuses paid out -- they are unwarranted under any circumstance. Payment of any "performance bonus", even if routinely structured in financial firms as an end-of-year lump sum equaling even 50 to 100 percent of "base salary", are still supposedly based on actual profits and proper execution of the employee's fiduciary duties to the firm and its clients. These executives and their underlings failed both tests miserably. The firm's strategies failed to provide the financial protection claimed by the sophisticated products sold and produced catastrophic losses for its customers and the firm itself.

If the payments constitute "stay bonuses", exactly what talent is being kept? Few are actually arguing these key players need to be kept because they are geniuses who can return the company to profitability at some point. The argument is that the individuals who originated thousands of derivative contracts are needed to stick around to reverse engineer their own deals, figure out who all the counter-parties are, and help figure out how to dismantle the house of cards without triggering a collapse, thus "preserving" the American taxpayers' investment in AIG.

Uh huh.

Quite simply, there is NO WAY this will happen. The fact that the only person who can makes heads or tails of any particular contract struck by the company is the single employee who cut the deal is ipso facto evidence the employee did not meet his or her fiduciary duty to his client or to AIG and is not only NOT entitled to performance bonuses, they aren't even entitled to their base pay and are likely criminally culpable under racketeering charges. If you hired a lawyer to help you take your company public and after all the paperwork was signed and shares sold, you didn’t' know where your money was, your shareholders didn't get their shares, and only the one lawyer knows the dollar amounts and location of the paperwork, is that lawyer discharging their fiduciary duty properly?

Again, what's interesting about this situation is that NONE OF THE ABOVE is important in the larger scheme of things. What is important is the recognition of the fact that these derivative contracts of AIG very likely CANNOT be "unwound" AT ALL, much less in an orderly fashion with a predictable timeline in a manner that holds up to court scrutiny. If only ONE PERSON on the planet can reverse engineer a deal gone bad, courts would have to rely on ONE PERSON'S testimony who has overarching conflicts of interest that would render any verdict null and void. That literally means AIG -- and many other firms like it -- are in large part worthless mounds of indecipherable paperwork. What THAT really means is that Congress, the Federal Reserve and the larger financial system have not yet come to grips with the inevitable reality that a different approach is required to mitigate additional damage that WILL come forth as pieces of the system hit a stress point and collapse -- not just within AIG but within the entire system.

Implications for Geithner and Obama

Barack Obama's popularity remains quite high despite the turmoil over the bailout plans for AIG and other banks. The same cannot be said for Treasury Secretary Timothy Geithner. There are going to be many critical moments in the Obama Administration but one has already been reached this week and it really isn't clear if Obama "gets it" yet.

Geithner is in completely over his head. He may have been a competent, even brilliant central banking tactician for the New York Federal Reserve Bank. Unfortunately, we already have a Federal Reserve Chairman and don't need a second. The Treasury's outsized role as executor of huge financial institutions places it in a position where expertise beyond normal monetary policy and fiscal operations like Treasury Bill auctions is required. Expertise in contract law, personnel management and compensation, and criminal / civil law is required for the Treasury to more effectively work with the Justice Department and state Attorneys General to properly prioritize stabilization efforts, investigations and criminal / civil prosecutions. Geithner has failed to demonstrate ANY expertise in any of these areas either as Treasury Secretary or in his prior role at the New York Fed. Believe it or not, the current situation is NOT as bad as it can get. If this is Geithner's best game, he's completely unable to handle anything worse.

While these forces are at work and Congress gets distracted by one admittedly fascinating day of testimony, the press is covering green dye in the White House fountain for St. Patrick's Day and the President's Final Four basketball picks.

Psssssst. Barack!

Seriously. Get your head in the game. THE REAL GAME.



#1) http://money.cnn.com/2009/03/07/news/companies/aig.fortune/index.htm?postversion=2009030910