Free Markets, Free People

The Phony Cacophony – Congress, The President and AIG

The other shoe concerning the AIG “bonuses” and the administration’s knowledge of them is beginning to drop. The Politico reports that all of the outrage from both Congressional and administrative officials is simply a front. All of them knew.

Watching the coverage the past 24 hours, it would seem AIG just made public its plans to give top employees big bonuses. Wrong.

AIG disclosed its retention-bonus program more than a year ago, including bonuses directed to those handling the exotic derivatives that got the company and the country into this mess.

The bonuses were essentially a nonissue when AIG got its initial bailout money, almost $150 billion under President Bush in the two months surrounding the presidential election. Joe Biden, then the vice presidential nominee, came out strongly against the bailout. Obama did not.

Timothy Geithner, then at the New York branch of the Federal Reserve, was a huge proponent and architect of the AIG bailout. So if Obama had strong private opposition to the idea it did not affect his pick for the person who would oversee all bailouts.

In fact, if you look at the first line in the letter AIG CEO Liddy wrote to Geithner, it is clear he at least knew about all of this before last Friday:

Thank you for the open and frank conversation on Wednesday regarding the compensation arrangements at AIG Financial Products and AIG generally. I admit that the conversation was a difficult one for me.

And there’s more:

You have also asked AIG to rethink our 2008 corporate bonus proposals. The proposals AIG originally submitted to you are part of a deliberate process, recommended by me and supported by the independent compensation committee of AIG’s board of directors.

So what you’re seeing out of the Obama administration is demagoguery at its worst. This was a plan being worked with the previous administration and the present administration, and when AIG payed those monies out last week Friday (they were required by law to do so prior to March 15), it was with the full knowledge and apparent acquiescence of the Obama administration, and, one assumes, key members of Congress.

As to the “why” of the situation, some reading of the AIGFP Employee Retention Plan – written last year – makes it clear that none of this was being hidden from anyone.  And it makes for some very interesting reading – here, for instance, is the portion which details the impact of their failure to pay these “bonuses”:

Details Regarding Business Impact of Failure to Pay

AIGFP’s derivatives portfolio stands at about $1.6 trillion and remains a significant risk. Failure to pay the required retention payments therefore could have very significant business ramifications. For example, AIGFP is a party to derivative and structured transactions, guaranteed by AIG, that allow counterparties to terminate in the event of a “cross default” by AIGFP or AIG. A cross default in many of these transactions is defined as a failure by AIGFP to make one or more payments in an amount that exceeds a threshold of $25 million.

In the event a counterparty elects to terminate a transaction early, such transaction will be terminated at its replacement value, less any previously posted collateral. Due to current market conditions, it is not possible to reliably estimate the replacement cost of these transactions. However, the size of the portfolio with these types of provisions is in the several hundreds of billions of dollars and a cross-default in this portfolio could trigger other cross-defaults over the entire portfolio of AIGFP.

There are also substantial risks related to the hedging of AIGFP’s various books. Although we view the large-market risk books at AIGFP as generally well hedged, the hedging is dynamic – that is, it must be monitored and adjusted continuously. To the extent that AIGFP were to lose traders who currently oversee complicated though familiar positions and know how to hedge the book, gaps in hedging could result in significant losses. This is driven to some extent by the size of the portfolios. In the interest rate book, for example, a move in market interest rates of just one basis point – that is 0.01% or one-100th of one percent – could result in a change in value of $700 million dollars if the book were not hedged. It has virtually no impact on the hedged book. There are similar exposures in the foreign exchange, commodities and equity derivatives books.

AIGFP’s books also contain a significant number of complex – so-called bespoke – transactions that are difficult to understand and manage. This is one reason replacing key traders and risk managers would not be practical on a large scale. Personal knowledge of the trades and the unique systems at AIGFP will be critical to an effective unwind of AIGFP’s businesses and portfolios.

In this current environment, any perceived disruption in AIGFP’s ability to conduct business, such as one that would result from the departure of a number of key employees, could also cause parties to limit or cease trading with AIGFP. Obviously, this would adversely affect its ability to continue to cost-effectively hedge its positions.

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. 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. 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.

Essentially, as I pointed out this morning, the loss of key players could cost AIG and the taxpayer much, much more than the bonuses. Note the final paragraph where an example is used to point out the danger of seeing key players leave the firm while it continues to “unwind costs”. As pointed out the “personal” knowledge of the trades and transactions is critical. This isn’t necessarily about the “brightest and best”, but instead about those who know where the bodies are buried, how they got there and how to get them out of there and where they’re supposed to be. The possible downside of losing these key individuals is a potential cost of “tens of billions” to the tax payers.

Here’s something else which may interest you:

AIG has taken significant steps to limit overall compensation at AIGFP where it can and has committed to doing more. The 25 highest paid active contract employees have agreed to reduce their remaining 2009 salaries to $1. Salaries for this group ranged up to $500,000, and the average salary was in excess of $270,000. (There are apparently legal limits that may complicate the implementation of this and AIG will likely implement the lowest salary levels we can equitably put in place across the relevant jurisdictions.) The remaining 2009 salary of all other officers – anyone with a title of associate vice president or higher – is being reduced by 10% (subject to compliance with local law requirements).

In addition, other forms of non-cash compensation will be reduced or eliminated. We also believe that there will be considerably greater flexibility to reduce contractual payments in respect of 2009, and AIG intends to use its best efforts to do so. AIGFP intends to sell some of its books of business during the year. The employees related to these books will go with the sold businesses, and we intend to require the buyer to assume going-forward compensation payments.

It is also expected that, over the course of the year, employees will leave voluntarily or be terminated for cause and will therefore no longer be entitled to retention amounts from AIG. Because the plan was designed to provide security for employees, including protection against terminations without cause, AIG is required to pay the amounts owed to employees who are downsized. However, if a downsized employee finds new employment, retention amounts will be reduced by the earnings from the other employer. In addition, for employees in foreign jurisdictions who are not U.S. taxpayers, to whom the limits of Section 409A do not apply, AIG will have the ability to negotiate with employees who are downsized.

With all of these actions and other creative restructuring solutions, AIG hereby commits to use best efforts to reduce expected 2009 retention payments by at least 30%.

To review, the 25 highest paid contract employees are on a $1 a year salary for 2009. 10% salary reduction for all other officers. Non-cash compensation – reduced or eliminated. Selling some of it’s “books”. Downsizing. Retention payments for 2009 reduced by 30%.

As to the payouts themselves, this information is available:

Of the $220 million, about $165 million is required to be paid on or prior to March 15, 2009 and about $55 million was previously paid. In light of the large losses incurred last year, current and former employees will see their deferred compensation accounts reduced to the point where they will have negative balances. As a consequence there is no immediate prospect that employees will receive any payout of the at-risk piece for 2008 (about $93 million) or the remaining approximately $582 million in at risk pay earned from prior years. A senior AIGFP manager therefore worked in 2008 for about 43% of his 2007 expected level.

Did you ever hear about any of that in the phony cacophony that has blown up around all of this? AIG apparently had a plan, one has to assume it wasn’t one done in the dark, and it appears they were literally in the middle of executing it ($55 million having been paid last year and some more millions to be paid after March 15). The plan outlines how AIG planned to cut its costs while fulfilling the remaining contractual obligations they had. You and I may not like the fact that the bonuses are going out there, but if you take the time to read the retention plan, you can understand that there is a legal and financial reason for doing so.

All of this faux outrage, then, is politically calculated theater designed, as usual, to shift blame on the designated bad guy. It’s the usual reversion to populism when caught doing something unpopular. If you think a single politician, up to and including the President, is going to stand up and take blame, well, you have this example to dispel that notion. Insteadof  leadership, we get demagoguery.


14 Responses to The Phony Cacophony – Congress, The President and AIG

  • This all very clearly exhibits an idea I first saw on Billy’s site,

    “Konrad Heiden, ‘Der Fuehrer: Hitler’s Rise To Power’, Boston, 1944, p. 139: ‘Propaganda is not ‘the art of instilling opinion in the masses. Actually, it is the art of receiving opinion from the masses.'”

    (Hannah Arendt — “Part Three of The Origins of Totalitarianism”, footnote 55 at p. 59)


  • If the Congress gets away with punishing people at AIG who have not been even ACCUSED of breaking the law (in effect, a bill of attainder) because those people are politically unpopular, what will stop them doing it again and again in the future?  Pharmaceutical corporate officers?  Union officers?  All could become fair game if enough phony outrage can be ginned up against them. 

    • You’re asking how to beat the devil at his own game.  There’s only on way to win it–refuse to play. In this case, that would mean going before a bankruptcy judge instead of selling-out.  Yes, that would have been tougher, but that’s what courage is for.

      • Titus Quinn,

        While I agree that the firms in trouble should have been allowed to go bankrupt rather than be (perhaps only temporarily) propped up with taxpayer dollars, the confiscation of bonuses by the thieves in Congress isn’t a question of “not playing the game”.  Congress is planning to pass what amounts to a bill of attainder: they are punishing a specific group of people even though those people have not committed any crimes.

        If Trashcan Chuckie, Countrywide Dodd, and Hari-kari Grassley can do this to one group of Americans, they can do it to ANY group of Americans.  All that is needed is a ginned-up sense of “outrage”.

        • That Congress would pass a de facto bill of attainder is nothing new, and thus to be expected. In case you haven’t noticed, the US Gov is now effectively at war with its own people.

  • BTW, I see that Trashcan Chuckie (spit) is among those leading the charge to steal the money back from the AIG employees.  He’s the same c**ksucker who told us during the rush to pass Porkulus that taxpayers don’t really care about a few hundred million bucks.  It’s chump change, as it were.  NOW we’re not only supposed to care about that much money, we’re supposed to be in a near-homicidal rage.

  • Let’s shoot the lawyers before the pure dumbass politicians.

  • The Socialist Coup d’état is in full bloom…

  • I’ve read and re-read this, Bruce. It is excellent. Please accept my compliments.

    My earlier (and a little overly prickly) argument was based, frankly, on an instinctive mistrust of anything the Democrats offer up. That mistrust was proven correct, here. Any time you see the left working that hard to maintain a narrative, you know something isn’t as it seems.  The outrage seemed just a little too focused on the gallery, frankly.

    It’s as I’ve been saying;  Nobody’s keen on the idea of this money having been spent that way, but that is something that the Democrats should have thought of before they voted on a bill they didn’t read. The blame for that is squarely in their lap. Allow them to place any blame for any of this on AIG, and the Democrats control and extened that ‘evil capitalism’ narrative in the court of public opinion. And that’s precisely what all this smoke and flame from them is about. Diverting blame from the cause of the problem.

    Now the question becomes, will the Democrats get called on the carpet for their actions or will this, next week, just be background noise underneath the more recent outrage?

  • Politico has done an “analysis” piece today in which they offer this tidbit:

    A new White House timeline released Tuesday night shows that Geithner learned of the payments last Tuesday and called Liddy at 6 p.m. last Wednesday to tell him the payments are unacceptable and need to be renegotiated. By Friday, Liddy and Geithner had agreed to cut the bonuses in half and stretch executive bonuses out over time. President Barack Obama asked his team on Sunday to find a way to get the bonus money back. [emphasis mine – dj505]

    Um… The White House now claims that the Tax Cheat in Chief only found out last Tuesday?  Isn’t that flatly contradicted by other reporting, including Politco’s own reporting cited by McQ above?  Unless we stipulate the Geithner didn’t bother to read the plan when he helped draft it, that is.  That’s actually a good possibility: Geithner is apparently too stupid to do his taxes, so how could he be expected to understand the executive compensation portion of a bailout plan?

    The wheels on the bus go ’round and ’round
    ‘Round and ’round
    ‘Round and ’round…