Posted tagged ‘Geithner’

Is the Outrage Over AIG Bonuses Justified?

March 30, 2009

Treasury Secretary Tim Geithner was interviewed by George Stephanopoulos on ABC’s This Week today. Last week, Edward Liddy, the CEO brought in to clean up the AIG mess explained the bonus situation clearly to Congress, although the facts of the matter had little effect on grandstanding by Congressional Democrats. Today, Geitner reiterated some of the basics. Bonuses were paid because there was a contractual requirement to do so. The only way the contracts could have been obviated would have been if AIG was in bankruptcy, which they were not. Geithner explained that they also had to pay obligations to European banks for the same reason. They were contractual obligations.

The first thought that comes to mind is “So why wasn’t AIG put into banksuptcy?'” We’ll leave that aside for now and focus on the bonuses. If it was a legal obligation, can we nonetheless agree that rewarding failure is at least unwise, and perhaps immoral?  Liddy’s testimony sheds light on that issue. AIG has about 115,000 employees. AIG failed. So does that mean that all 115,000 employees failed?  Even rabid Congressmen acknowledge that the failure was in the AIG Financial Products organization, so that the staff dealing with life  insurance and the like, the great bulk of the company, were not responsible.

AIG Financial Products had three types of operations. The operation that brought down the company was the one trading credit default swaps (CDS).  CDS are essentially insurance policies against the bankruptcy of other companies, like Goldman Sachs and Merill Lynch. The disaster came from buying a CDS for x dollars and selling it for more than x dollars. Each speculator in the train of sales thought they were covered by their previous purchase, but when one failed they all failed. So how many AIG employees were actively involved in trading CDS? According to Mr. Liddy, about 20.  Those employees are long gone, without bonuses, as well as the executives who were in charge of the operation in Financial Products, and the general management in AIG who should have been watching the store.

The bonuses were paid to staff in a different operation, one dealing with the trading of other derivatives. Derivatives are complex financial instruments requiring intense day-to-day management, typically including the hedging of foreign currencies. AIG had a portfolio of $1.6 trillion of such financial instruments. Libby judged that even if the bonuses were voided by some means, that the risk of losing $1.6 trillion by passing the trading off to new staff was too great. Better to pay the $165 million and have the experienced people wind down those operations gracefully. That has been happening.

CEO Liddy, the Federal Reserve, and the Treasury Department all understood the situation at every step, and all agreed it was the prudent approach. The facts do not sustain the torrents of moral outrage that have flowed from paying of the bonuses. Liddy expalined it clearly and accurately under oath in his testimony. He repeated it slowly five times for Democratic Congressmen having ideological armor that repels facts. More than a few Conservative pundits have, while understanding the importance of upholding contracts, built up a full head of steam on the outarge of rewarding failure. It is not justified.