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Explanations

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So, it’s Sunday morning, and as is usual on Sunday mornings, I’m not much interested in doing anything serious.

Of course, there are some serious things I have to do–I’ve got a book in revision, and I can’t stop now–but that’s different than thinking seriously about stuff I just like to think seriously about.

Still, something has occurred to me that seems relevant to something, so here goes.

One of the things I’ve gotten from my rereading of Too Big To Fail is an explanation of AIG and its bonuses that what actually happened there was not what we were told had happened there.

This may seem esoteric and beside any point related to everyday life, but it isn’t. 

Let me try to explain.

AIG is a massive, global insurance company.  One of the things they deal in are what are called “credit default swaps,” which are really nothing more complicated than insurance policies on investments.

Companies paid AIG premiums–just like you do with a life or auto policy–and in return, AIG promised to make them whole if the investment that had been insured tanked.

This has enormous implications in the financial meltdown of 2008, which I won’t go into here.   One of the other things I’ve been learning a lot about is banking law as it relates to the risks banks are allowed to take, and there’s no need to go into all that here.

What I want to concentrate on at the moment is the government bailout of AIG. 

As lots and lots of investments started to tank, AIG started having to pay off on its insurance policies.  And since the number of investments that tanked was far higher than anybody had anticipated, AIG just didn’t have the cash on hand to cover all its obligations.

The problem was that if AIG simply went bankrupt and stopped paying out on the policies it had issued, then the clients who had bought those policies would suddenly lose lots of money.

This would suddenly put thousands of banks into bankruptcy, too, who would  not have been there if the insurance policies they’d bought had paid out what they’d bought them to.

The US government was getting phone calls from the governments of other nations, because an AIG bankruptcy was threatening to bring down the economies of several small nations, and one or two larger ones.

Think about being, say, France, and having two thirds of your banks go bankrupt on the same day.  Nobody can get cash for the week-end.  Stores can’t stock their shelves. 

So the US government did what it had to do and gave AIG an $80 billion dollar cash infusion, and then, a few weeks later, another $80 billion.

And that’s when the excrement hit the rotary blades.

Why?

Because almost as soon it was announced that the government had given AIG the second infusion of money, the press began to report that AIG was using a hunk of that money to pay employee bonuses.

Now, this sounds completely inexcusable–bonuses, to people who had been losing money for the firm?  From a firm that had just almost gone bankrupt?

The outcry went on for weeks, with op eds, indignant press conferences by Senators and Congressmen, and death threats against AIG’s upper management.

In the meantime, the upper management was growing crazy trying to explain–to people who would not listen–that the story was all wrong.  Eventually, what came out in the media were stories that said:  well, AIG can’t legally avoid paying the bonuses, it’s in the contracts they have with their people.

Now this wasn’t wrong, but it didn’t even begin to cover the actual situation.  The problem was a word–“bonuses”–which did not actually mean what everybody thought it meant.

To most of us, a “bonus” is money we get over and above our salaries because we’ve done a particularly good job, or because it’s Christmas.

At AIG, however, the word “bonus” was being applied to something else altogether.

The deal AIG had with its traders on the floor was that they got paid a percentage of the profits of the entire company.  The perecentages were small, but the company made lots of money and the traders were paid well.

Unfortunately, in any quarter in which the company as a whole lost money–the traders got paid nothing.

Nada.

Not a dime.

This made the traders’ situation bad enough even when the company had just one bad quarter.

AIG, however, was looking at losing quarters for a minimum of the next two years before they were turned around and making a profit again.

That meant that their traders would  have to plod on without getting paid for two years if they wanted to stay with the company.

Most of the traders did not want to go on with the company under those conditions, and I don’t think we have to resort to lectures about greed to understand why.  Most of us would not be willing to work for a company for two years without seeing a dime.

AIG was suddenly faced with the prospect of losing all its experienced personnel just when it needed them to turn the situation around.

So, in order to hold onto its people, long before it asked the US government for money, it made a detailed accommodation for 2009 and 2010 to make sure these guys got at least a base salary.

But they couldn’t call it a salary without doing all sorts of complicated legal things with their incorporation documents, and that would take months.   They looked around frantically for what they already had legally established that would let them do what they wanted to do, found “bonuses,” and called the money that.

This was not an unreasonable thing to do, and it was not what it became known as in the press–using the American taxpayer to pay bonus money to failing employees. 

This would have been good information to have at the time–especially in an election year.  And yet, as far as I know, nobody explained it, ever.

And that’s not that only thing that wasn’t explained.

Even as we speak, “bonuses” are still the public watchword for inflated salaries and corporate greed on Wall Street.

What almost nobody in the general public realizes, however, is that the vast bulk of those bonuses were paid in the firm’s stock and subject to withholding periods. 

A trader might make $100,000 in salary and then get a bonus of $4.5 million–but the $4.5 million would be stock he wouldn’t be allowed to sell any of for at least five years.

When the companies started tanking, that stock became worth less and less.  When Lehman went bankrupt, its employees lost all the money in their bonus accounts.  Since Lehman stock was worthless, so were their bonuses.

If there’s one thing the press is supposed to be doing, it’s explicating issues like these.

I’m still not a fan of the bailout, and I still think we should  have let the banks go bankrupt and unwound them so that ordinary citizens didn’t get hurt (which is what deposit insurance is for) while at the same time telling investment bank customers that, well, they weren’t insured, tough.

But discussion of things like the TARP funds are much less productive if nobody knows what they’re actually talking about. 

And nobody does, because nobody explains it.

Written by janeh

June 19th, 2011 at 9:15 am

Posted in Uncategorized

One Response to 'Explanations'

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  1. Well, it wasn’t too deep a secret, because I don’t follow financial stuff in particular and I knew, and Dad doesn’t have an Internet connection and he knew. But I agree, we have people who would rather report a bogus scandal than a boring or complicated truth.

    Also worth noting that the TARP was probably the most sensible and necessary of the various spending bills, and the AIG bit seems to have been the best of that. In some cases, the people who got us into the mess came out of it very nicely, and it’s tricky for people who never heard of ANY of the banks going in to keep track of the distinctions.

    On the broader question, I thought it was a very bad sign when we didn’t reinstate Glass-Steagal. “You can either be a community bank with the Federal government going over your books and insisting on precautions, but with your depositors insured, or an investment bank, and the investors take their chances.” Instead we have 2,000 pages describing how the new rules will be written–the rules themselves to follow and be done by unelected officials. This seems to me to be a huge opportunity for corruption and pettiness.

    Which may be the point.

    robert_piepenbrink

    19 Jun 11 at 11:33 am

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