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AIG weekly recap – history, bonuses, Congress and outrage

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I certainly hope that this will not turn into a weekly feature, but the amount of news, sound bites, and heated rhetoric pouring in from every direction resulted in Jim and myself electing to take a knee for the past 48 hours when it comes to posting AIG articles.

That said, we’re slowly putting our toes back into the water and I’ve put together a recap for you to absorb this weekend. That way, you can get all fired up about it again on Monday morning.

History
AIG Financial Products (AIGFP) is a small division of AIG born in the late 1980s. The idea was to use AIGs strong credit rating and get involved with derivative trading – usually the purview of financial institutions – and make profits that would be split between AIG-proper and AIGFP. Even though derivative trades normally took years to pay out, AIGFP received profits up-front, with AIG holding most of the risk.

In the late 1990s, AIGFP got involved with credit default swaps (CDSs) by insuring the corporate debt of financial institutions like JP Morgan. AIGFP was hedging, treating the CDS business as they do other insurance lines of business. They bet that very few customers – like JP Morgan – would default on their corporate debt.

After AIGFP got rolling, the Republican Congress enacted, and President Clinton signed, the Commodity Futures Modernization Act into law in 2000, attached t0 – get this – another one of those huge omnibus budget bills that nobody seems to read. Not designed to weaken regulation, the act made the system more complex and opened doors to other ways of trading derivatives like credit default swaps.1

Many of the credit default swaps AIGFP made deals on included collateralized debt obligations (CDOs) with a high percentage of sub-prime mortgages. Yes, those sub-prime mortgages.

In March of 2005, AIGFP employee count had grown to about 400, and the New York attorney general was investigating AIG-proper’s accounting practices. Hank Greenberg, who ran AIG since the late 1960s was out, and the credit rating of the corporate giant was downgraded.

With their credit rating lower, and lots of the CDOs tied up in sub-prime mortgages, AIGFP was about to get squeezed – really hard – from both sides.

In late 2005, AIGFP pretty much got out of the CDS business due to the risk, but they could not undo the billions of CDOs already on the books.

With their credit rating lowered and the mortgage crisis hitting hard in late 2007, AIGFP was getting phone calls from investment firms like Goldman Sachs demanding billions to cover losses from mortgage-backed securities the AIG CDSs had insured.

The dominoes started to fall, AIGs credit rating declined, more phone calls came. Even when the writing was on the wall, AIGFP CEO Joseph Cassano and AIG CEO Martin Sullivan put on a consolidated front – the investments were solid.

AIG continued to loose billions. Cassano was gone by April 2008 and Sullivan by late June. A new CEO – Robert Willumstad formerly CEO at Allstate – was hired in June, but was gone by September and replaced by Edward Liddy when the government injected $85 billion in cash – with billions more to follow – to help save AIG while taking 80 percent ownership of the company.

passicco-aig1It’s important to note that Liddy was called out of retirement by the new owners – the federal government – to guide AIG out of the mess it was in. His salary is one dollar per year.

In October, Gerry Pasciucco was brought in to lead AIGFP and try to figure out the tangled mess of derivatives with the remaining employees. I include his photo (right) just so readers can wonder about the Che T-shirt.

Retention bonuses
In early December, members of Congress knew about AIGs retention bonus program that seems to have been effective on Sept. 22, just after Liddy came in as CEO. The SEC knew about the retention bonus program by late September, within days – if not just before – the first $85 billion bailout.

The following is from a letter (PDF, 2KB) written on Dec. 1 from Rep. Elijah Cummings (D-Md.), the full PDF is courtesy Salon.com and an article by Glenn Greenwald on March 19. It indicates that the day after Liddy came to AIG, the retention bonus program was put into place.

There is no way Liddy put this program into place in eight business hours, it was planned by former CEO Sullivan or Willumstad.

cummings-liddy-1Why pay retention bonuses and who are the employees getting them? There is much confusion about who is getting the retention bonus cash, but my speculation is employees who were managing AIGFP into the crisis are gone, and employees who were brought in to extract AIG from almost $2.7 trillion in exposure were asked to stay and offered retention bonuses.

From Hinderaker at Power Line, with my emphasis…

  • All of these payments, as to AIG’s troubled financial products division, are retention bonuses, not performance bonuses.
  • The money is not going to anyone responsible for the implosion of AIG–those people, who were in the credit default swap area, are gone.
  • These retention bonuses were promised to AIG employees who are responsible for winding down the company’s financial products division. At the beginning, this division had a potential exposure of $2.7 trillion. Winding down AIG’s book of business in this area was a dead-end job, and there was a great likelihood that the people responsible for the work, who knew the most about the products involved, would take jobs elsewhere.
  • In late 2007 or early 2008, AIG made a deal with these employees: if they would stay at AIG until specified conditions were met, i.e., either certain business was wound down or a given period of time had elapsed, they would receive a specified retention bonus.
  • As to all of the employees involved, they satisfied the terms of the bonus by wrapping up a portfolio for which they were responsible and/or staying on the job until now. As a result of the efforts of this group, AIG’s financial products exposure is down from $2.7 trillion to $1.6 trillion.

If you were one of the 400 employees in a dead-end job trying to untangle a $2.7 trillion dollar problem would you stick around? Those employees – with knowledge – could possibly take off without the retention bonus program. My interpretation was if they stayed for specified periods of time they would get a certain retention bonus. The longer they stayed, the greater the bonus. Yes, some may have stay only for a certain period of time, but they stayed long enough – per contract – to get a retention bonus that was paid last week.

Now, if you were still at AIG and trying to work out the remaining $1.6 trillion problem, would you stick around as AIG corporate security advises you how to protect yourself? Maybe you’d feel OK about a United States senator suggesting you commit suicide? Screw the $1.6 trillion, I might walk.

But Edward Liddy isn’t walking. During the theatrical presentation on the Hill the past couple of days, Liddy was crucified by some members of Congress who refuse to acknowledge that Liddy was brought in to clean up the mess after the fact. Liddy is a man who knew what was coming, walked in and took it like a professional. I’m not sure if he will succeed in leading AIG out of this mess, but for darn sure he knows that Congress doesn’t care one whit about him.

What happens to that $1.6 trillion if – let’s say – half of the employees quit? Just wondering…

The theatrics of outrage
Outrage this week comes from every American and politician froma coast to coast, but Senator Chris Dodd (D-Conn. & Iowa) is getting the brunt of it. I actually feel bad for the guy since he’s so disliked everywhere. But I want Connecticut to have a glimmering shade of red in the future so I want him gone from office too.

Wyndeward recently commented…

Chris Dodd would appear to be being cast in the Lou Costello role — the hapless peanut-vendor who just doesn’t seem to “get” it, while Barack Obama, among others, takes the Bud Abbot role — the slick, smooth-talking manager who leads his hapless counter-part around the infield legislation, manipulating the senior senator from Connecticut to their own ends.

First Dodd said he knew nothing about the clause that protected the retention bonus program – big mistake – then he said he knew about it but it was not his idea and did not know why it was there. Then he said it was the Executive Branch and we finally learn that it was Treasury Secretary Timothy Geitner who demanded the change.

Now Dodd has suggested – and Congress is already working on – a bill to selectively tax the AIG employees who received retention bonuses.

The big picture
Goodness, we’re talking about $165 million in bonuses paid out to employees and AIG has gotten $170 billion from the federal government since September. We’re talking about less than one-tenth of one percent here for the retention bonuses. This group of employees seem to have successfully negotiated AIG out of $1.1 trillion in exposure in the past seven or eight months.

Is this a Congressional diversion to take the eye of the people – and the media – off the real problem?

When we started bailout-palooza we went in for a few billion, and we’re now in for a few trillion.

Resources

1700-plus words… I don’t think I spelled anything wrong…

Appendix

1 The act would again permit single stock futures contracts, allowing investors to treat stocks like commodities and resolving the disputes between the Commodities Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) as to which regulating body would regulate the market.

As a side note, the act included language excluding energy commodity trading from regulation by the CFTC or the SEC. This allowed Enron to launch EnronOnline, their Web based commodity trading application that was the companies downfall. Sen. Phil Gramm (R-Texas) worked with Enron lobbyists to include the language in the omnibus bill.

Oh what a tangled web we weave …

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First make a law … then implement it … then express outrage when it is … mix it up and you get …

The $165 million AIG bonus flap that has caused outrage around the nation has its roots in a provision of Connecticut labor law that political leaders say needs to be changed.

The embattled insurance giant, which has received about $170 billion in federal bailout money, has said it is legally bound to pay the bonuses because of a provision in the Connecticut Wage Act. Many of those receiving the bonuses work for AIG’s financial products unit in Wilton.

If AIG failed to pay the bonuses, under state law the company could be forced to pay a double penalty, legislators said.

“The state of Connecticut should not be used as the scapegoat or the excuse for AIG to pay these outrageous” bonuses, said House Republican leader Lawrence Cafero of Norwalk.

Read the whole story to hear the outrage from all of the lawmakers … ummm … who wrote and passed the law.

Dodd Under Fire For Allowing Bonuses-Video-Update: Dodd Responds

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The NY Times is reporting (paragraph 16) that Chris Dodd included an exemption for bonuses like the ones given AIG in the February stimulus bill …

I thought about adding this to Steve’s post on the Democrats going after Rob Simmons but this story is becoming bigger by the minute.

The administration official said the Treasury Department did its own legal analysis and concluded that those contracts could not be broken. The official noted that even a provision recently pushed through Congress by Senator Christopher J. Dodd, a Connecticut Democrat, had an exemption for such bonus agreements already in place.

Note, that’s the Obama administration throwing Dodd under the bus. This is not going to help Dodd’s sinking poll numbers which, as even the Wall Street Journal now notes, has made Dodd as target …

Already, a growing anti-industry backlash presages a tough re-election fight for Mr. Dodd next year — a remarkable development given his popularity in a solidly Democratic state. Former Rep. Rob Simmons (R., Conn.) on Monday said he would challenge the senator in 2010, proclaiming in an interview that “it’s time for a change.”

With polls showing the men almost tied, there are signs Mr. Dodd may be staking out a newly populist stance, pushing for limits on executive pay over the objections of the White House and rattling markets by musing about nationalizing banks.

Interesting stance on Dodd’s part, populism, given his willingness to veto restrictions on Fannie Mae in 2005, his noted bonus exemption provision in the stimulus bill,  and then there’s this ..

But the Countrywide controversy has come at a bad time. It emerged in June that Mr. Dodd, who received two mortgages from the firm, was in a special program for “friends” of Chief Executive Angelo Mozilo. Mr. Dodd said he didn’t seek, nor was he aware of, receiving any special rates or terms.

Mr. Dodd has always had good relations with financial firms — and that could be a liability in the current climate. In the past six years, he has raised $1.5 million from the securities industry, third most among senators. The industry also gave $2.7 million to his presidential campaign.

Then there’s the LA Times chiming in … and it ain’t good.

Now, of course, he finds himself in the red-hot center of the country’s banking collapse. He may be able to take credit if Congress passes new, tougher banking regulations, but, asNaftali Bendavid of the Wall Street Journal reports, the public mood toward bankers and their buddies is sour: “He also is a longtime friend of Wall Street, making him a convenient scapegoat if voters sour on the government’s handling of the economic crisis.”

Even Fox Business has jumped on the story.

httpv://www.youtube.com/watch?v=8G3-CSVSToQ

Update: Here’s an excerpt from their story over at Fox Business:

While the Senate was constructing the $787 billion stimulus last month, Dodd added an executive-compensation restriction to the bill. The provision, now called “the Dodd Amendment” by the Obama Administration provides an “exception for contractually obligated bonuses agreed on before Feb. 11, 2009” — which exempts the very AIG bonuses Dodd and others are now seeking to tax.

Dodd’s explanation:

“Senator Dodd’s original executive compensation amendment adopted by the Senate did not include an exemption for existing contracts that provided for these types of bonuses,” wrote Dodd Spokesperson Kate Szostak in a response to FOX Business. “Because of negotiations with the Treasury Department and the bill Conferees, several modifications were made,” she said, without suggesting who made the change.

The provision excluding those bonus payments made it into the final version of the bill, and is law

Read the whole thing. And make sure you read Steve’s post …. Dodd’s got some big problems and George Bush won’t get him out of this one.

AIG Bonuses are justified and necessary, an alternate view

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Like everyone else I was initially outraged over these supposed AIG bonuses. But I have changed my mind on this and they need to pay these compensation contracts.

First of all these can not be performance bonuses, maybe they are attendance bonuses or bonuses that reward poor stock performance. Either way it seems that these bonuses were designed to be compensation for these bankers. It would be interesting to review these contracts. If these are performance bonuses and they performed then you can not destroy this culture of compensation for performance. Maybe we should pay our congress people this way (omg could you imagine the corruption?).

Secondly, you may think that these guys are a bunch of crooks; after all they drove this bus into a wall. So why should we allow these crooks to continue driving the bus after this major accident? Well the answer to this is that they knew exactly what they were doing. They understood the risk and they did it anyway because they were greedy. This does not necessarily mean that they are incompetent when it comes to performing the core of their job. They have a great deal of insight into how this thing is wrapped up and we need them to un-wrap the mess. So you may ask “why are we rewarding them for their greed and irresponsible actions?” Well inside of any group of people (AIG included) there are group relations and groups of people always revert to their lowest denominator. Group empathy is a powerful force and allows a group or a crowd to do things that the individual is not capable of. Hence the phrase “one bad apple spoils the bushel.” We need to find the bad apples and eliminate them, keep the institutional knowledge and right the ship. You need to properly compensate the rest of the bushel.

My next point on this issue is that it is in your best interest to allow this company to run itself. This is absolutely not a democratically run institution and nor should it be. I will grant you the fact that because of this infusion of capital we are all investors, this investment is not by choice, and given this past year’s performance you would not invest under these circumstances. This does not give the mob the right or ability to make management decision. It is in your best interest to allow a management team run this company. I feel that as an 80% owner the government should have the voting rights to install whatever management team that they see fit and to properly compensate those individuals. Once in place investors need to allow the management team to run the business on a day to day basis and give them the freedom to make compensation decisions.

This point is a real sticky wicket because the government is the largest investor and the only possible investor. At the same time the government has no business whatsoever dictating employee compensation. So how does one straddle the line between government and investor? I am not sure but I know that the common ownership, control over the means of production (day to day operations), and the common specification of compensation, defines communism. All of you bail out complainers are doing your level best to promote communism. Congratulations!!

My last point is about Connecticut senator Chris Dodd. Dodd is considering a proposal of a bill that will tax these bonuses such that the government can reclaim 98% of this money. Well I have to say that I appreciate his creativity, though I heard this same idea on the Sound Off Connecticut show today, and I am not sure he can take the credit.  This idea is fun to think about but it is really bad and sets a precedent for government targeting a tiny set of individuals for unfair taxation. When you are the next target you’re not going to like it so much.