Tuesday, March 17, 2009

The lunatics are running the asylum

Let’s start with Josh Marshall. In writing about the AIG bonus story, he expresses his dismay thus:

Secretary Geithner found out about the bonuses. He told AIG CEO Edward Liddy it wouldn't fly. And Liddy, in a curiously imperial letter, tells Geithner that much as he is pained by the situation -- to blow it out his ass.

Why does Marshall interpret the letter as “imperial”? I have no idea. Marshall quotes from a Wall Street Journal article which he assumes everyone else will find as convincing as he does. But the WSJ article quotes Liddy as explaining the legal requirement that AIG pay the bonuses. I’m am at a loss as to how Marshall can transmute a desire to obey the law into “cavalier dictates about pay-outs and bonuses”.

Then there’s Hilzoy who writes:

[AIG] promised their employees all this money back in the spring of 2008. To which I can only say: what sort of idiot would commit a company to paying a bonus to an employee even if that employee took down the company?

It never seems to occur to her to stop and think about what she has just asked. Is it possible AIG had a reason for making this commitment? Is it possible there might be more to the story than what she got out of reading, yes, the very same WSJ article that Marshall read? It never seems to have occurred to Hilzoy to dig a little deeper. (Hint: She wouldn’t have had to dig very deep; the answer is in her very next paragraph.

Then there’s Glenn Greenwald proving once again that he doesn’t do his homework. He asks:

If Congress (with Obama's support) was willing to immunize lawbreaking telecoms from lawsuits brought by their illegally-spied-upon customers, shouldn't Congress be willing to immunize AIG from bonus-seeking lawsuits brought by their executives who helped spawn the financial crisis?

Had Greenwald bothered to read the AIGFP Employee Retention Plan, he would have found the following statement:

We have also been advised that AIGFP employees in foreign jurisdictions, including France, Japan, the United Kingdom and Hong Kong, could bring valid claims for unfair constructive dismissal in those jurisdictions.

Does Greenwald believe that the United States Congress can immunize AIG against lawsuits brought by employees in other countries? Or does he simply have no clue that the “I” in AIG stands for “International”?

Logic isn’t Greenwald’s strong suit, either. He begins his article by ranting and raving that although Summers is insisting on the sanctity of AIG’s retention contracts, the UAW made numerous contract concessions as part of the government’s auto bailouts. It appears to have escaped his notice that in the case of the auto bailout the government made the contract concessions a condition of the bailout. In the case of AIG the government would have to force the concessions after having already handed over the money.

Greenwald also insists that there must be some way to tag these contracts as invalid:

there are almost certainly viable claims to be asserted that the contracts were induced via fraud or that the bonus-demanding executives themselves violated their contracts. ... Many of these executives were, after all, the very ones responsible for the cataclysmic losses.

This is puzzling. Greenwald knows these are “retention” bonuses - he refers to them as such in the next paragraph. The only way to violate a retention contract is to refuse to be retained. As for fraud, exactly how does he think the holders of these contracts tricked AIG into offering them? They said they might resign but they didn’t really mean it?

Then there’s Robert Reich who was playing hooky the day God installed logic chips. Reich argues that AIG’s arguments that it is legally obligated to pay the contracted bonuses:

are absurd on their face. Had AIG gone into chapter 11 bankruptcy or been liquidated, as it would have without government aid, no bonuses would ever be paid; indeed, AIG's executives would have long ago been on the street.

And if my aunt had wheels she’d be a teacart. Bankruptcy does provide a vehicle for wiping out contracted obligations. AIG did not go bankrupt. Hence it’s contracted obligations still stand.

These bloggers - like their rabid counterparts on cable television - are maddening and to the extent that they are well-known they’re scary. But if they don’t quite have their facts in order or interpret every fact to reach the desired conclusion or can’t quite reason from A to B, well, so what? They’re rushing to get to print, appealing to specific audiences, and - most important - they don’t make policy.

Except it looks like they do. Everyone in the government from Obama down to Representatives you’ve never heard of is echoing their upset, their outrage, their demands that Something Be Done and to hell with whether doing it requires ignoring the law - or even the Constitution. This nonsense from our politicians is neither honest nor courageous. To see why, let’s take a look at the AIG timeline.

I’ve spent a fair amount of time piecing together the story behind the AIG bonuses mostly from reading the AIGFP Employee Retention Plan and Liddy’s letter to Geithner. Wikipedia filled in a few gaps. And thanks to a Patterico link provided by Baklava at neoneocon, I found the Tom Maguire post, “The 22nd Book: The Book Of The Dead”, a remarkably sane essay that helped with the logic behind the retention bonuses. Here’s what I see as the real story.

In the Spring of 2008, AIG realized it had gotten itself into some complicated and risky businesses and while they disposed of Joe Cassano, the man who apparently got them into the mess, AIG decided it needed to be sure it could hold onto the employees who could help get it out. As Maguire puts it:

In the spring of 2008 it was clear that the Cassano-led charge into credit derivatives was an impending disaster and Cassano was on the way out. Would it better for the AIG board to (a) sack Cassano and let his disgruntled rivals quit for jobs at other firms, or (b) sack Cassano and guarantee a bonus pool to those who agreed to stay on and attempt to pick up the pieces?

AIG opted for (b) and hence signed contracts that included the infamous retention bonuses. What are retention bonuses? Good question and one which it seems very, very few people fulminating about this issue have bothered to ask. Maguire speaks of a pool but I think of retention bonuses as sort of deferred salary. As I put it at neoneocon:

AIG hires John Smith to get a particular type of business up and running. AIG is willing to pay Smith $2M a year but they don’t want him to get the business half set up and then quit to go work for someone else. So Smith gets $1M the usual way - monthly pay checks - but only gets the other $1M if he’s still working for AIG at the end of the year.

So AIG antes up retention bonuses in the Spring in hopes of holding onto employees who could stave off disaster. Unfortunately, in the Fall of 2008, AIG’s credit rating was downgraded which resulted in a liquidity crisis. The United States government provided a “credit-liquidity facility” of up to $85 billion. As part of that effort, then-Treasury Secretary Paulson named Edward Liddy to run AIG. Everyone seems to have been confident that AIG could be wound down and largely sold off at a profit. Instead, additional bailouts in 2008 brought the total to $150 billion.

In December of 2008, AIG paid the first installment of the 2008 retention bonuses: $55 million goes to AIGFP employees.

In February of 2009, Congress passed and President Obama signed the Stimulus Bill which contained some very interesting language (emphasis mine):

SEC. 111. (b) (3)(D)(i) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, [snip]

(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

As you can see, the 246 Representatives and 60 Senators who voted “Yea” on this bill had no problem approving existing retention award contracts. (In fairness, I doubt they could have interfered with existing contracts without wandering into dangerous territory.) Neither did the President. And even the Senators and Representatives who voted against the Stimulus bill should have known about these provisions.

On March 1 of this year, the government made another $30 billion available to AIG.

On March 11, Liddy and Geithner discussed AIG’s second installment of the retention bonuses, amounting to $165 Million for AIGFP. Liddy wrote Geithner a letter about the topic on March 14.

At this point, we can see why virtually everyone in the government who is expressing a desire to Do Something about the AIG retention bonuses fails the honesty test. Retention bonuses are not an uncommon tool; AIG paid the first installment of the retention bonuses in December of 2008; the Stimulus plan specifically mentions “retention awards” as a type of executive compensation that must be limited; the Stimulus plan explicitly exempts preexisting contracts from the executive compensation limitation.

At a minimum every politician who was involved with the Stimulus bill - all of Congress, the President, the President's economic advisers - should have known that retention bonuses were an issue for some TARP recipients. Why else would the Stimulus bill have grandfathered them in? More specifically, the first installment was paid by AIG in December of 2008. If anyone was paying attention to AIG’s books that payment should have been noted. Yes, we have a different President now but many of the other players are the same: Geithner was involved with AIG when he was in New York; Bernanke is a carry-over from the former Administration; much of the current Congress - including those financial savants Barney Frank and Chris Dodd - were part of the former Congress. In other words, every politician who is now denouncing AIG is a politician who should have been paying attention and wasn’t.

It’s also possible that at least some of the people who should have known about the retention bonuses did know. Certainly Chris Dodd must have known something was up somewhere; he inserted the language that grandfathered in existing contracts for executive compensation. Whether Geithner, Summers, Bernanke, and Obama knew is open to question.

Bottom line: the people in government who are currently screaming loudly about AIG’s terrible behavior either should have known or did know that there were retention bonuses coming down the pike. Rather than own up to this and admit that they dropped the ball either by not knowing or by knowing and not telling, they’re distracting attention from their own mistakes by insisting that they’re “shocked, shocked to find that gambling is going on here.”

To understand why the reactions of people in government fail on grounds of courage, we need to look deeper. Why is the government working so hard to prop up AIG? Because AIG is involved one way or another in much of the derivative business that has become so dangerous to the world financial system:

[Liddy] said A.I.G. was acting as a sort of conduit to funnel money from the government to dozens of financial institutions around the world. A.I.G. had guaranteed about $300 billion in complex derivatives, many of which have gone sour, forcing it to raise capital.

The government feared that if A.I.G. became unable to pay claims, it would have sent shock waves throughout the financial world, causing many bank failures.

This is fear of the domino effect at work in the financial world. If AIG goes down, some - or possibly all - of its counterparties go down. If they go down, some of the companies that deal with them go down. And so on. Thus the government made the decision under Bush, Paulson, and Bernanke that AIG had to be propped up. Under Obama, Geithner, Summers, and Bernanke that decision has remained in place.

The only way we can stop propping up AIG is for it to unwind the deals that tie it so tightly to the rest of the financial universe. As AIG makes clear in its Retention Policy, it is doing just that:

The team that remains at AIGFP has made significant progress in bringing down the risks and winding down the portfolio. ... They have focused initially on reducing complex and difficult to manage positions...

I don’t know exactly what winding down a portfolio requires at AIGFP but I’ve seem linked deals that run into the hundreds of transactions. Getting those unwound is much easier if the people doing the unraveling were around when the web was woven. It is the desire to retain this type of expertise that prompted AIG to offer retention bonuses in the first place. If AIG loses the people who know the business best, it will take longer to straighten out the mess.

But, come the screams, these are the very people who got us into the mess. Well, if Maguire is right, not necessarily. The primary bad guy is gone; what’s left are the people who understand what he was doing and can put it right. And even if Maguire is wrong, the AIGFP people are still our best best for digging ourselves out: the ones who built the system are the ones most able to dismantle it.

So here’s the bottom line. The government believes we need AIG up and running in order to avoid pretty much total financial collapse. AIG believes it needs its AIGFP employees up and running in order to wind down its problematic deals as quickly and cleanly as possible. Furthermore, AIG believes it needs its retention bonuses paid now and next year in order to hold onto those employees.

Or to put it the other way around. If - to quote Liddy - the AIGFP employees “believe that their compensation is subject to continued and arbitrary adjustment by the U. S. Treasury”, they will quit. If they quit, it will be more difficult and take longer to unwind the deals that are holding the government hostage to AIG’s continued existence. It seems safe to assume that the longer AIG is in business with unwound toxic deals, the more funding it will need from the government.

And that’s the best case. A worse case is that key employees will leave and the ones who are left - or the new hire replacements - will not only have trouble unwinding the toxic deals, they will have trouble simply managing them. The AIGFP Employee Retention Plan points out the hedging problems this could cause which will result in increased costs requiring - again - more government help. Beyond that, the departure of key personnel can provide an excuse for regulatory agencies of foreign governments to step in. More costs.

And the worst case, of course, is that enough key employees leave to cause enough havoc to simply drive AIG out of business regardless of continued government support.

So the government needs to make a decision. Do they really and truly need AIG up and running to avoid financial disaster? If not, life is simple: shut down the credit lines. That should force AIG out of business almost immediately and then all we have to do is clean up the debris.

If, however, the government truly does need AIG up and running to keep the financial system stable, then they need to realize that AIG needs the employees it is trying to hold onto. And all those in Washington who are currently screaming we need to stop the bonuses - Obama, Summers, Geithner, Frank, Grassley, and everyone else who sees the chance to make some cheap populist points - need to suck it up and find the courage to tell us some unpalatable truths In other words, they need to stop acting like demagogues and start acting like leaders.

Leaders don’t give in to the overwrought arguments of people who don’t know what they’re talking about. Leaders don’t flirt with a financial meltdown because people are yelling at them. Leaders don’t let the lunatics run the asylum.

Instead, leaders use their authority and their credibility to explain the facts of a situation and, sometimes, to say, “Deal with it.” Especially those leaders who pride themselves on being “reality-based”. What Obama and all the rest of them need to say is something like this:

We’ve made the decision that keeping AIG running is essential to economic stability. We think Edward Liddy is the best man to accomplish that. Mr. Liddy has explained that he needs to hold onto the AIGFP employees in order to wind down the toxic part of the business. In order to do that, AIG needs to pay them the money they were promised a year ago. I understand you don’t like it. However, in our judgment this is the best course of action to take to keep things from collapsing completely.

Furthermore, this sort of issue has come up before and will come up again. There are some business practices - like retention bonuses, like awarding top sales people - that seem out of line in businesses that have received government - your - money and we certainly should be on the lookout for waste. However, it is to everyone’s benefit if the businesses that received government money become successful enough to pay that money back. No one in the Administration - no one in Congress - knows as much about running those businesses as the current executives. We’re all going to have to accept that some of the things that make us angry are essential to returning those firms to profitability. The more the government micromanages business decisions, the harder it will be for the companies to get back on their feet and pay us all the money they owe us.

Unfortunately, even in the unlikely event our leaders in Washington find their courage, it may already be too late. AIG employees know the government doesn’t want them to get their bonuses. They’ve got to figure that even if the government can’t block this round of bonuses there are a lot of politicians working overtime to figure out how to take the money back - and they’re willing to gut the Constitution to do it. Regardless of whether that succeeds the employees have to know the government will be working overtime to block the retention bonuses that are supposed to be paid at the end of 2009. And if all that is not enough to convince the employees to quit, maybe the death threats will do the job.

If I worked for AIG, I’d take whatever bonus money I got, cash the check, and move far, far away. We better all hope the AIG employees are a lot tougher than I am. Failing that, we’d better hope that either the government was wrong when it decided keeping AIG up and running was essential to avert disaster or that Liddy was wrong when he insisted he needed to hold onto his employees to get the job done. Otherwise, I sure hope all the politicians who drive the employees out of AIG know how to unwind derivative deals.

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