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March 19, 2009

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Liddy dropped a number during his testimony. $1.6 trillion of derivatives they're trying to unwind. I'm thinking new rule: when you write contracts that exceed 10% of GDP they're automatically void, on the grounds of national security. And the perpetrators don't get bonuses, they get a trip to Gitmo as terrorists.

Hilzoy: I usually find your posts thoughtful, (maybe because I usually agree with them). I listened to Liddy's testimony yesterday. I was amazed at how frequently Liddy would answer a question -correcting some factual misstatement- and then throughout the course of the afternoon other Congressmen would ask questions including the same misinformation.
there was one point where Liddy corrected Frank. CNN's news clip was of the uncorrected Frank without context. To my mind it was as if they had no interest in truth or fairness (something like Fox quoting Biden from September to imply the opposite of what he actually was saying).

I think it would be good if you informed your opinion by actually listening to Liddy's testimony.

Yes, because the CEO of a company whose fraud helped crash the global economy has no reason to exaggerate or outright lie to Congress about the extent of the fraud, even if he did take over after the crimes.

Well, glad that's settled, onward and upward for the financial wizards!

Yes, because the CEO of a company whose fraud helped crash the global economy has no reason to exaggerate or outright lie to Congress about the extent of the fraud, even if he did take over after the crimes.

Why bother having them testify if you are automatically going to dismiss what they say?

I'm thinking new rule: when you write contracts that exceed 10% of GDP they're automatically void, on the grounds of national security.

So, all those life insurance policies with AIG are declared void? Or is your position that, if you write too many contracts, the government can pick and choose which ones are void?

Nate: Liddy is a retired executive who at the request of Bush administration took over AIG for $1.00 per year, no bonus. I assume you didn't watch him testify. He said the problems were credit default swaps entered into in 2005 and 2006. The bad management stopped doing that kind of business in 2006.
Greedy yes, big mistake yes, fraud no.
Seems to me Liddy is behaving just as a receiver would in winding up a business and selling off the assets for the benefit of the creditors.

I think you are very unfair in putting him in the same box as the bank executives and mortgage brokers.

Why bother having them testify if you are automatically going to dismiss what they say?

Why bother having any oversight if you are automatically going to accept every word that comes out of Liddy's mouth without question? Just declare him Financial Dictator and hand over the checkbook.

So, all those life insurance policies with AIG are declared void? Or is your position that, if you write too many contracts, the government can pick and choose which ones are void?

AIG has $1.6 trillion in liabilities in regular insurance? Doesn't look too good for them.

Pick and choose? No, realistically you'd just declare everything AIG did as contrary to national security (like shoe bombers, only more effective) and then cover the regular insurance buyers. Hell, the states do it for hurricane insurance.

Well, for one, if they testify and lie, we can bust them for perjury. And second, okay, so he's a "retired" insurance head, who's been on the board of a "global equity" group, and apparently involved with Goldman, too. (http://marketplace.publicradio.org/display/web/2008/10/22/corner_office_liddy_bio/) He was also part of Bush-Cheney '04's election team, and McCain's '08 team. And worked at G.D. Searle & Co, while Donald Rumsfeld was the CEO.
(http://en.wikipedia.org/wiki/Edward_M._Liddy) His pay is "As CEO of AIG, Liddy receives a salary of $1 and equity grants."

(http://www.usnews.com/articles/news/national/2009/03/18/10-things-you-didnt-know-about-aig-ceo-edward-liddy.html)

So he was one of Hank Paulson's buddies he asked to come in and take over AIG. Where he's in line for a "special bonus" in 2010, "depending on performance". And depending on the taxpayer dollars keeping the company afloat.

So, yeah, maybe he's not been directly involved in the probably fraud and racketeering at AIG, but he's certainly run in those circles for years. He can be judged on his performance, which hasn't been too stellar, or too transparent, so far.

I'm going to hold off on the "fraud no" conclusions, and the veracity of an executive brought in from the same class of people that broke the economy until such time as, say, AIG's books are gone over by auditors who weren't involved in the company or its probable fraud.

And it probably wouldn't hurt to have auditors go over the personal books and taxes of the people who were involved in betting more money than exists in the world, either.

Why bother having any oversight if you are automatically going to accept every word that comes out of Liddy's mouth without question? Just declare him Financial Dictator and hand over the checkbook.

When did anyone say that they accept every word out of his mouth? What I object to is the continuing insistence that people know exactly what happened, and who cares what anyone involved says.

AIG has $1.6 trillion in liabilities in regular insurance? Doesn't look too good for them.

AIG has liabilities. Some of them are derivatives. Some of them are life insurance policies. All of them are liabilities. You can't legally separate one from another.

Pick and choose? No, realistically you'd just declare everything AIG did as contrary to national security (like shoe bombers, only more effective) and then cover the regular insurance buyers. Hell, the states do it for hurricane insurance.

No, they don't. They may help pay off the policies, but they don't do so, and then tell other creditors that they get nothing. You can not make some creditors good, but do nothing for others.

Johnny C: I did listen to a couple of hours of Liddy's testimony, and read coverage of the rest. As I said in another thread, I did not take his responses to imply that no one who had any responsibility for AIG's meltdown was still there and getting bonuses; only that those most responsible were gone.

Hilzoy: which hours: before or after the break?

It strikes me that the A.I.G. financial products division received an unbelievably sweet deal. Did its managers slip it under the radar? Did the managers act in good faith?

Welcome to the real world, professor, where a minimum wage fry cook at McDonalds is more accountable than a million dollar financial executive. Kinda hurts to learn that, eh?

One huge thing I thing that is being overlooked by the Davidoff piece hilzoy quoted is "who negotiated this and why?"

Somebody -- or somebodies -- just didn't give AIG a blank check, as much as it seems that way.

Liddy mentioned that in everything that was outlined regarding money that was given to AIG was disussed with the Fed/Treasury.

Seems they should be up there testifying next.

Johnny C: about an hour and a half before the break. (That was when I stopped.)

I wrote you a comment on another thread, btw.

btfb: as I understand it, it was like this:

(a) the contract was negotiated well before AIG's collapse, and thus well before the government was involved.

(b) when AIG collapsed, the government put together a rescue plan very, very quickly. I think (I'll check if anyone wants) it was in a day. It seems to me completely comprehensible that this issue would not have arisen. To my mind, that just underscores one big lesson of all of this: we need to have procedures in place for this sort of thing, so that we aren't making things up on the fly.

(c) I don't know that the NY Fed had any involvement in the rescue plan -- AIG is not a bank. It did get involved later, but I think that was after Geithner had recused himself b/c he was being considered, or had been nominated, for Treasury. But certainly someone at the Fed knew, and probably so did people at Treasury (I'm still talking about Bush's Treasury here.) On the one hand, I find it completely bizarre that no one flagged this as a huge political issue that needed to be dealt with, if at all possible.

On the other, if Davidoff is right to say that the contract is very, very solid, then the obvious ways of dealing with it -- finding some reason to say that the AIG-FP people had not met its terms, for instance -- didn't exist. And I can easily believe that lawsuits over this could eat as much money as was in the bonuses (or thereabouts.) So if no one saw this as a huge political issue -- which, as I said, astonishes me -- then I can also see why people would have thought: oh well, it's a done deal. (The thought being: dealing with this in some way other than by finding a loophole in the contract, challenging it, etc., would have required a lot of work and attention, and that work and attention would have been forthcoming only if someone had thought: gee, people are going to be outraged by this, and brought it to the attention of whoever needed to be informed.)

I suggest Nate Silver's post on this over at fivethirtyeight. (Sorry for no link--I've not got an iota of html.) He has a good analysis of why the contracts were written that way, and he makes the point that the money at issue really is salary--no matter what it was called--since it was guaranteed.

Nate Silver on AIG

... I find it completely bizarre that no one flagged this as a huge political issue that needed to be dealt with, if at all possible.

My guess is that no one who wasn't stuck in the Wall Street mindset saw the provision, and those in the mindset didn't give it a second thought. The "bonuses" are really just like salary, so all it amounts to is some people getting paid millions whether they do a good job or not -- something that seems to be absolutely standard procedure among Wall Streeters and corporate executives. Why would it catch the eye of any of those people?

Thanks, ral.

hilzoy: OT -- But did you see President Obama's town hall meeting? I thought he was especially impressive and could see this developing as his version of FDR's fireside chats.

Also, to hilzoy or anyone who feels like responding:

Will all of the votes of confidence Obama is giving Geithner be a kind of reverse-whammy? (Of all the things Obama talked about yesterday, I thought he sounded least convincing on Geithner. But that's just me.)

Hilzoy: "about an hour and a half before the break. (That was when I stopped.)"

Perhaps my perspective was affected by listening to the same questions and misstatements of facts being made over and over. Incredibly repetitive. One incredibly obnoxious NY congressman late in proceedings.

I think Liddy was aware that the bonuses would be a political issue (but not to this extent). Fed Reserve reps had been involved throughout. I suspect Liddy incorrectly assumed Fed was communicating with Treasury. He testified something to the effect he had been instructed to communicate with the Fed.

Liddy would have no interest in stopping the bonuses apart from political backlash. He wants to do the job. Rich employees probably happier employees. When Fed signed off on the bonuses, he probably assumed issue over. It will be interesting to see how the communication links turn out.

Geithner either blindsided by Fed; or overloaded; or clueless or combination thereof.

My pleasure, jdkbrown.

"This was not a boilerplate contract. Rather, it was highly negotiated. And it was highly negotiated to pay retention fees at high levels without regard to performance. This is obviously shocking."

It's only shocking (in the surprising rather than moral sense) if you're unfamiliar with pay in financial services. Guaranteed bonuses are pretty widespread for high flyers. They're the banking equivalent of a wiseguy becoming a made man. In a banker's market, ie when firms are competing for "talent", guaranteed bonuses (and within that class large guaranteed bonuses) are one of the main perks used to attract executives.

Clearly it makes a mockery of the idea of performance related pay. That's not my point. My point is that it doesn't suggest that AIG FP expected significant losses when they signed the contracts. Every large financial institution was offering guaranteed bonuses to attract and keep senior people at the peak of the market. It was often a make or break thing for the person involved. If they didn't get the guarantee, they walked.

Ginger Yellow,

If Nate Silver is right (see link above), prior to 2008 the AIG FP employees did not have significant guaranteed bonuses and were instead compensated primarily through a profit sharing arrangement. The bonuses were only guaranteed after the fourth quarter of 2007, once the bottom fell out of the CDO market and the division was looking at losses rather than profits. So these don't seem to be the "standard" guaranteed bonuses you describe.

AIG has $1.6 trillion in liabilities in regular insurance

Uh...where'd that come from? Liddy said that the Financial Products division of AIG has $1.6 trillion in portfolio, which doesn't mean anything, by itself, in terms of solvency. What Liddy is up to, or at least what he says he's up to, is (apparently) divesting the FP division of all its portfolio assets and paying back the US government.

Some of that portfolio is undoubtedly risky investment that's going to show a loss. How much of it that is, I don't know, and I'm not sure that it's public knowledge.

It'd be interesting to know if Liddy was asked specifics on this point, and if so what his response was.

Slartibartfast: "It'd be interesting to know if Liddy was asked specifics on this point, and if so what his response was."

I understood him to testify that the AIG FP portfolio had already been reduced from $2.6 trillion to $1.6 trillion. That all of the credit default swaps had been cleared out, and that the remaining portfolio was mainly derivative instruments. He anticipated that a loss of $2 billion was likely and the process would take 2 to three years. He based this on the experience of Warren Buffet liquidating a portfolio - i think he said about 1/4 the size.

Independent of the liquidation of the AIG FP portfolio, and dependent upon there being buyers, Liddy plans to package healthy parts of AIG insurance businesses and sell them - if there are willing buyers with money. This the source of proceeds to repay Treasury and Federal Reserve.

He also kept repeating that the amount AIG is indebted to Tr and Fed was, if I remember correctly 79 Billion- not the 170 billion congressmen and media kept repeating.

I think over in the killed-virus thread we're seeing people conflate the $1.6t in remaining portfolio with net liability, which seems to not fit the testimony.

Slartibartfast Yes, I lacked the energy or ability to correct them.

jdkbrown: fair enough, it's not quite the same, but it still doesn't imply that they anticipated realised losses and were thus consciously stealing from shareholders. Indeed, the 10-K states that the reason for the scheme was that unrealised mark to market losses (which had wiped out the execs' bonuses) were not reflective of ultimate credit losses on most of the assets. Now that's probably not true, at least for the CDOs and subprime RMBS, but it certainly could have seemed plausible at the time, especially from within the bubble, as it were. No doubt the AIGFP people were telling their superiors that the assets would come good in the end, honest, so that they wouldn't be fired. By the way, I'm absolutely not defending the new contracts - it's one thing to have confidence that the assets will continue to perform in defiance of market values, it's another to reward the people who forced you to make that judgement exactly as if market values were still at their very peak.

It's worth remembering, however, that after the liquidity panic at the end of 2007, there was a rally in securitisation markets around the world, to an extent that bankers would kill to see now, and outside the housing market the real economy had yet to show serious signs of strain. Early 2008 was the peak time for "it's a liquidity crisis, not a credit crisis, except in subprime" sentiment.

Yes, I lacked the energy or ability to correct them.

I'd very much appreciate it if you would lay out your understanding of the assets vs liabilities position of AIG at this point. I am, frankly, having a hard time keeping track of the numbers and what they mean.

He also kept repeating that the amount AIG is indebted to Tr and Fed was, if I remember correctly 79 Billion- not the 170 billion congressmen and media kept repeating.

IIRC 79 billion is the amount of money used to purchase the Tr held equity stake in AIG, the rest is on the books at the Fed via their alphabet soup of lending facilities. If their collateral posted with the Fed turns out to be nearly worthless then most of that latter money will end up being a bailout in disguise, but at this point nobody knows how that story ends.

To put it in more human terms, there are to a very rough approximation 100 million households in the US. So let's divide the numbers being thrown around by 100 million to put it in more personal terms. If each one of us represents a single household, then we can understand the stake each one of us has in AIG via the following parable:

AIG aka "Thin Tony" (this is the stupid cousin of Fat Tony*) took your bank account and credit card numbers and went to the casino and placed about 30,000 dollars worth of bets at the sports book (he did this for all of us, under each one of our names). When we found out and went apesh*t, he said "Don't worry, I'll fix it for ya. But I need a really big favor. Right now I need you to fork over a check for 1,700 dollars so I have some cash to work with to make those bets go away - if you don't then thugs from the casino will break my legs and come burn down your house down. Hopefully I won't have to ask for more. Wish me luck."

So you reluctantly wrote out that check for 1700 clams, and Thin Tony went back to the casino to try settle those bets.

Later he came back and told you "I have some good news and some bad news".

"First the good news - half those bets are gone and I only lost about 30 bucks of your money making them go away, so the remainder is now down to only about 16k."

"Now the bad news - of the bets still on the books with the casino, it looks like you may lose out big time on about 4,000 dollars worth of them. We don't know yet, but it doesn't look good. Wish me luck."

Then he left to go back to the casino to try to work out those remaining bets.

After he left you found out that last fall, while you were writing out that 1700 dollar check, Thin Tony and his driver siphoned a gallon of gasoline out of your car, just to add insult to injury.

That's how much the AIG bonuses are out of your pocket (and mine, and everybody else's) - the price of a gallon of gas or a bit less. Meanwhile, we're still waiting to find out what happens to those bets that are still on the books under our names, and are worth (for each one of us) roughly the price of the car that he took the gas out of.

*Fat Tony is the street wise character in Taleb's Black Swan who knows what to expect on the hundredth toss when a "fair" coin comes up heads 99 tosses in a row. Tails it ain't.

ThatLeftTurnInABQ:Thank you for the human terms. One refinement- isn't it cash/ cheque for $790 and a promissory note for $910?

Two questions:1)isn't the loss to date $300, not 30?

2)Where did you get the $4000 in future losses? I thought Liddy said the rest of portfolio likely come off the books for $2billion ie $20.

3) promising to sell his wardrobe for $790 and will tear up the promissory note

To put it in more human terms,...

TLT, thanks for an entertaining story.

If what we're talking about here is negotiating with criminals, my advice is to cut them off at the knees, pronto.

In real life, when you cut a check for 1700 clams for Tony to take to the casino, Tony doesn't come back, and you never see your clams again.

And he doesn't siphon a tank of gas from your car, he takes the car, and you never see that again, either.

There's no upside in bargaining with 'Tony'. If we think there is one chance in ten that the folks we're dealing with are some form of 'Tony', it's time to cut them loose, cut our losses, and move on.

Just saying.

Geithner admits he screwed up.

And then there's this.

"The Treasury Department was concerned that legislation that would restrict contractual bonuses would not hold up to legal challenges, Geithner said in an interview with CNN's Ali Velshi."

As I understand it, Treasury was concerned about retroactive law, why they suggested the "loophole" that the law would apply only going forward from that date (which is pretty standard practice for legislation on grounds of fairness).

The big difference between the GM model and AIG is that GM has a surplus of workers and they will be out of a job unless they make concessions (and maybe even if they do). These people at AIGFP were already filthy rich, yes they would lose their job if AIG went bankrupt, but they would either be hired back by the receiver to work on the wind up (which is essentially what they are doing now), or they might get a job elsewhere in the financial market (plausible when contracts signed early in 2008, probably much more problematic now) or they would sit on a beach and not work- they probably are rich enough that many of them don't have to if they don't want to. Which brings one to Liddy's decision.

Apparently, if you believe Liddy, (which I will until I see evidence to the contrary), he thought it important to keep the AIG FP employees working to wind up the business - for the benefit of the US taxpayer. With up to $2.6 trillion at stake that doesn't seem a bad call. So yes, one could say to employees, let's spend our time renegotiating your bonus contracts, or one says to oneself, let's keep them happy even if we don't think they deserves the money.

If one is going to blame anyone I think it is the people at Federal Reserve who seemed to agree with Liddy. If they had applied pressure to Liddy, he would have been in a better position to go back to the employees and ask for compromise or cancellation of bonuses.

To me being concerned over getting back the $79 billion already advanced by US taxpayers and minimizing potential loss from the still $1.6 trillion portfolio out there would seem more important than $165 million in bonuses.

Majority opinion seems to be: Obsess over the symbolic trivia, rather than the big picture.

The priorities of Americans has often been a mystery to me. I guess this is really just one more example.

In the footnote to history category, I didn't understand why these executives were receiving "bonuses" rather than salary. Over at this post on the Political Animal site, there is a comment posted by: jeri on March 19, 2009 which explains the general practice and probably AIG's perspective at time contracts signed in early 2008:

"Let's consider the motivation for these bonus/retention contracts:

1. Executives want to guarantee each other very generous pay no matter what happens.

2. Ordinarily this could be done by paying high salaries. But the tax code does not allow companies to deduct salaries over $1M when determining corporate taxes. "Performance-related" pay, however, is OK and can be deducted.

3. So companies keep salaries at or below $1M and pay the difference in so-called "performance bonuses". The motivation is not to incentivize executives, but to keep their high pay fully deductable from corporate taxation.

4. When performances became so obviously terrible and difficult to explain, it was necessary to call the bonuses something else. "Retention contracts" sounded like a good name."

On the other hand, Johnny, if the legislation had not been toyed with by Treasury -- if it stood in its original form -- then the AIG employees would have been in a position to demand their bonuses.

Perhaps that would have led to legal action. Perhaps not.

But if it has to be "performance-related pay" to be deductible, how can they make it unrelated to performance?

But if it has to be "performance-related pay" to be deductible, how can they make it unrelated to performance?

The "performance" in this case was not leaving the sinking ship, and taking their plugs with them.

... how can they make it unrelated to performance?

The technical term for this is a "tax scam". :-)

Ironic, isn't it, that AIG is meanwhile suing the federal government for denying another piece of creative tax accounting.

From ral's NYT link: "A.I.G. is effectively suing its majority owner, the government, which has an 80 percent stake and has poured nearly $200 billion into the insurer in a bid to avert its collapse and avoid troubling the global financial markets. The company is in effect asking for even more money, in the form of tax refunds. The suit also suggests that A.I.G. is spending taxpayer money to pursue its case, something it is legally entitled to do. Its initial claim was denied by the Internal Revenue Service last year."

Hard to make this stuff up.

bedtimeforbonzo:
Which was the original?
I thought Dodd had clause in which would have prevented all bonuses to TARP recipients. Treasury said- that includes retroactive application, could be challenged, so Dodd added clause making it not applicable retroactively.
If the original clause, prohibiting all bonuses including retroactive had been in, Liddy would have had to say to workers, we can't pay, let's negotiate something - eg deferred bonus payable after US taxpayers made whole.

KCinDC:But if it has to be "performance-related pay" to be deductible, how can they make it unrelated to performance?

I haven't read the contract, but I bet the language specified completion to satisfaction of AIG, or the required performance had such a low level, no one could fail to perform.

It would seem that this was a widely used technique to get around tax rules. The real issue here is whenever legislators try to use taxing authority to make policy, ever more complicated rules result, and someone comes along and goes around, under or over the fence. Why should salary of whatever amount not be deductible?.Here is where I have great sympathy for simplifying tax rules- simple vertical and horizontal equity. All the special interests, tax lawyers and tax accountants would scream but everyone else would be better off.

In Canada in the mid-60s the govt decided to simplify our Income Tax Act. The book containing the new act was about an inch thick. It didn't take long before the desire to use tax act to promote policies "for the greater good" overcame the concept of simplicity. I have no idea how thick our act is now. My impression is that is a small fraction of the size of the US code.

"If the original clause, prohibiting all bonuses including retroactive had been in, Liddy would have had to say to workers, we can't pay, let's negotiate something - eg deferred bonus payable after US taxpayers made whole."

That's the way I understand the original clause -- in which case, as you say, it would have put the AIG employees in a position to negotiate, in which case they would not have had a very strong hand to play, in which case this whole "scandal" would have been sizably less in scope. I think.

"in which case they would not have had a very strong hand to play",

The ones who had already performed and left could have been SOL; the ones still needed to wind down the rest of the portfolio- who knows- Fed/Treasury might have signed off on their compensation packages -which might have done nothing to alleviate the national outrage- but could have focused it on Fed/Treasury.

Nate Silver has an interesting take on possible consequences of the anti-bonus legislation:http://www.fivethirtyeight.com/2009/03/tax-banks-not-bankers.html

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