Why is the Administration Tolerating AIG Feather-Bedding and Intransigence?

Why is AIG being permitted to continue to give the finger to the government, and ultimately, the US public that saved its bacon?

The sort answer, is that the US government’s need to resort to accounting fictions is being used skillfully against it.

The latest AIG stunt is that it is refusing to sell its derivatives business. Remember that AIG owes the taxpayers a mind-numbingly large amount of money, but intransigent CEO Robert Benmosche has refused to execute on the agreed-upon plan, and instead is off on his own mission.

And why might that be? This is yet another, classic management favoring “heads I win, tails you lose” bet that is given more respectful treatment than it deserves by the Financial Times:

AIG has shelved plans to sell the whole of its derivatives portfolio, which nearly destroyed the insurer in 2008. It believes that keeping up to $500bn worth of complex positions could help it to survive as an independent entity and repay US taxpayers….

Yves here. Having AIG survive as an independent entity was NEVER an objective of this exercise, never. The fact that that management/company flattering notion is given any credence at all is appalling. Many storied companies are dead or very much diminished due to poor management decisions: A&P, Woolworths, Polaroid, U.S. Steel, Pan Am, TWA. AIG has no God-given right to exist.

The logic of the “let us hang on to the money” is that AIG can improve returns by keeping the money longer. But that was never the purpose of this exercise. The intent was very clear: that AIG was to be dismembered. And that is a fine outcome. Taxpayer money recouped, systemic risk eliminated. And AIG is hardly a deserving candidate for any kind of break. It was extraordinarily badly managed from an operational standpoint; Sorkin’s Too Big Too Fail makes it clear than the company had antiquated accounting systems and was unable to gauge its cash needs (another sign of how badly the company was run: I am told a Greenberg relative was buying the stock all through 2008 through the bailout on insider reports that everything was fine, the concerns were way overblown). As important, AIG has never been a good corporate citizen. It is a master of loophole-bending, aggressive lawyering to avoid claims payment, jurisdiction shopping, bribes (see here and here), kickbacks and dubious accounting.

Let’s return to the Financial Times:

Gerry Pasciucco, who joined AIG after it was rescued by the government in September 2008 to wind down AIG Financial Products, said the troubled unit would still be out of business by the end of this year….

The original plan…was to sell off all the positions and close down AIGFP as soon as possible. But Mr Pasciucco said that derivatives with a notional value of between $300bn and $500bn – or between 15 and 25 per cent of the derivatives portfolio’s original size – would not be sold. The assets could either be managed by AIG or outsourced to an external fund manager, he added.

AIG’s management, led by chief executive Robert Benmosche, believes that such a move reduce the need for fire sales and enable AIG to reap the benefits of rallying credit markets, Mr Pasciucco said. AIG recorded billions of dollars in paper profits on its derivatives in the third quarter of 2009…..

AIG executives said the Treasury and the New York Federal Reserve, which took an 80 per cent stake in the insurer in return for more than $80bn in federal funds, had been consulted on the decision to keep the derivatives. Peter Hancock, the derivatives expert who has just been hired to oversee AIGFP, among other responsibilities, is also believed to back the move.

Yves here. I prefer Rep. Brad Sherman’s take on this matter:

If [Benmosche] holds onto [the assets] and their value goes down, the taxpayer loses, and if they go up, he and AIG’s shareholders win… “It’s heads he wins, tails we lose.

Yves again. This is basically a market timing bet. And how seriously ought we to take this?

The Fed’s massive securities purchases had the effect of suppressing volatility, which would be particularly flattering to derivatives positions as AIG has found. As the Fed stops its market interventions, AIG will no longer have this wind in its sails. As Nouriel Roubini noted:

… the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage- backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low…. the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring.

Yves again. Now AIG claims to have in fact reduced its portfolio’s exposure to changes in volatility (known as vega) considerably. But if that is indeed true, that AIG has been unwinding its riskiest trades (riskiest measures in volatility terms) one might think what remains would be easier to value (I’d be curious for reader input on this notion, plus whether “gross vega”, the measure that AIG keeps citing, is really the best way to look at portfolio-wide exposure to vol).

There is another possibility, that now that AIG has wound down the portfolio by a bit more than half, that, what is left is utter dreck, so this is a kick the can down the road exercise, to camouflage the full extent of the losses as long as possible. But even in that case, there is still a market bet operative.

Ultimately, this incident is yet another symptom of the problematic governance arrangements in place with AIG. The authorities find it necessary to pretend that AIG is a private company when it never should have been afforded that privilege. AIG was unquestionably bankrupt. The Swedish model, which most experts consider to be best practice, is to fire top management and the board. Their replacements are given specific targets and timetables, are required to report on their results and progress pretty frequently. and have considerable latitude in how to meet their goals,. This is similar to the way private equity investors manage portfolio companies.

But what do we have with AIG? Rather than take 100% ownership of AIG, it has taken only 79.9%, which was a bit of a fiction, since the original Fed loan was secured by all the assets of AIG. But the not taking full ownership was to avoid consolidating AIG debt on the Federal balance sheet (that’s is why the Feds similarly own 79.9% rather than all of Freddie and Fannie). So that means AIG is still subject to an SEC reporting regime, with minority shareholders. That still might have been workable had the government demanded letters of resignation from all board members as a condition of the bailout (the idea being they would leave as soon as replacements were found; two stepped down after the bailout, and three did not stand for re-election last May). Uncle Sam has installed three trustees to oversee AIG, but they did not make much of an impression on Ed Liddy, Benmosche’s predecessor, and Benmosche seems impervious to outside influence.

As we noted last August, which started with a remarkable quote from Benmosche, then AIG’s new CEO:

Benmosche told employees that he “had the luxury to say to the government, I’m not going to rush to do this. I’m appalled at how much pressure has been put on all of you to just sell it no matter what, because the Fed wants out, or the Treasury wants out. If they want out in a hurry, they shouldn’t have come in in the first place.”

For anyone who followed the rescue, this is a staggering bit of hubris and revisionist history. First, the idea that the government “came in” implies that this was some sort of normal investment process, as opposed to AIG begging the Federal government for a rescue, even though states, not the national government, are the main regulators of insurance business (the AIG Financial Products business was overseen, if you can call it that, by the Office of Thrift Supervision. AIG structured its operation so as to get them as supervisor precisely because they were guaranteed to do next to nothing).

Next, the original deal called for AIG to pay back the money in two years. That inconvenient fact has been airbrushed out of the story Benmosche tells us. AIG made great assurances that the operating units were worth a lot of money and paying back the loans would be no problem. They accepted a high rate of interest given the riskiness of the loans and the desire of the Federal government to keep the heat on AIG. This original deal in theory fit Bagehot’s rule: lend generously, at a penalty rate, against good collateral.

But AIG fooled itself, or maybe just everyone else. Those supposed crown jewels were worth a lot less than AIG thought.Once they had established they would not be permitted to fail, they started retrading the deal. When AIG realized it couldn’t sell some operating units, pronto, suddenly it started complaining the interest rate (I think Libor plus 8 1/2%, forgive me for working from memory) was too high. Oh, and they happened to need more money too, a wee oversight in their initial demand. So the deal was reworked to give them better terms, a bigger commitment, and NOTHING ADDITIONAL was obtained. This was a free concession, a very bad move in deal land.

The government owns 79.9% of AIG. Any private sector owner who had an overwhelming majority interest and got that kind of attitude from a CEO would fire him immediately. But no, we live in a world where arrogant members of the financial services industry engage in looting, dictate terms to the government, and try to rewrite history to make baldfaced lies seem plausible. Why shoudn’t the government pressure AIG? The idea that owners don’t pressure companies (the subtext of this remark) is an absurd misrepresentation. Go talk to the management of any underperforming company owned by a PE or venture capital firm. For the most part, they do not play nice, and would never tolerate Benmoshe’s posturing, and he knows that. He is simply playing the media and the public for fools.

When you think this AIG drama can’t get any worse, predictably, it does.

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21 comments

  1. NYT

    If you want to avoid ever again having to do visible bailouts of failed banks, like we saw in September 2008, then it makes perfect sense to hang on to AIG.

    THe next time a bank gets in trouble they can just bail them out via the AIG back door without ever having to go to Congress.

  2. RPB

    “Why is the Administration Tolerating AIG Feather-Bedding and Intransigence?”

    Because Obama was/is unqualified and surrounded himself with self-serving assclowns and he has no hope but to listen to him – because he does not know a god damn thing about economics (and he knows this too).

    That’s the bottom line.

    1. dlr

      Guess he doesn’t know anything about Constitutional Law, either, based on his unwillingness to stand up and do the right thing there. He decides to hold 50 prisoners indefinitly without trial because ‘it would be too difficult to get a conviction. And then describes this in Orwellian terms as “swift and certain justice”. Think I am exagerating? Here’s the quote from Wendy Kaminer at the Atlantic:

      “Having endorsed ad hoc, indefinite detention without trial for some Guantanamo prisoners, the president is now said to be open to codifying a system of indefinite detention, Politico reports, citing a statement by Lindsey Graham: “The White House is considering endorsing a law that would allow the indefinite detention of some alleged terrorists without trial as part of efforts to break a logjam with Congress over President Barack Obama’s plans to close the Guantanamo Bay prison, Sen. Lindsey Graham (R-S.C.) said Monday.” The White House used up 50 words to say little in response: “Sen. Graham has expressed interest in habeas reform and other policy ideas. We will review constructive proposals from Sen. Graham and other members of Congress that are consistent with the national security imperative that we close Guantanamo and ensure the swift and certain justice the families of victims have long deserved.”

      Obama has no principles, that I can see. He is just a short sighted, opportunistic, self-seeking pretty boy from Chicago. America got rooked.

  3. Richard Kline

    To me, Reason 1 why the government is doing such an indescribably inept job of bossing the bailees of the Great Stealout is that, manifestly, Paulson, Summers, Geithner, Bernanke, Rubin, and others in the level of the loop do not _want_ to tell financial oligarchs what to do. That class believes that the businesses know better, and so the job of government is to give said private businesses whatever they need ‘to get back on their feet.’ These officials and their representatives negotiate bad terms because really the terms are only visuals for the rubes, as said officials just loathe the idea of government telling Big Wealth what to do.

    1. dlr

      More like officials want to find out what their bosses want them to do, and then do it for them. This is crony capitalism, kleptocracy, pure and simple:

      kleptocracy — “a term applied to a government that takes advantage of governmental corruption to extend the personal wealth and political power of government officials and the ruling class (collectively, kleptocrats), via the embezzlement of state funds at the expense of the wider population,”

      Bernanke, Geithner, Paulson, Summers, Rubin, Obama, Bush, are all bellied up to the bar, eagerly awaiting the favors to come for their service to their corporate pals.

  4. DoctoRx

    Of course, for Henry Paulson he had already taken almost a billion out of the system-taxfree since he divested GS stock to work for the govt–so this was his return of the favor to the”system”.

    Re the title of the post and the tone, it’s very good government-oriented. Why is AIG giving the finger to the govt? Simon Johnson’s “The Quiet Coup” continues to provide the answer.

  5. Patitio

    “…because he does not know a god damn thing about economics ”
    Even if he doesn’t know anything he could be reading Naked Capitalism and learning something!

  6. i on the ball patriot

    “Why is AIG being permitted to continue to give the finger to the government, and ultimately, the US public that saved its bacon?”

    Asked to choose between bacon, sex, NASCAR and TV sports, 98 per cent of scamericans would fall down and cry.

    ———

    Market timing,
    Is a thing of the past,
    As long as mark to bullshit,
    Continues to last …

    When you sit and play,
    In a clearly rigged game,
    You deserve to see,
    Your pocket book go lame …

    Deception is the strongest political force on the planet.

  7. Francine McKenna

    And another thing… With these half-assed purchases by the government and their 79.9% ownership, the entrenched boards never voted out the old auditors and put in fresh new eyes to look at old tricks and fictions. PwC is still the auditor of AIG and Freddie Mac, Deloitte is still the auditor of Fannie Mae, KPMG of Citi, Wells Fargo/Wachovia.

  8. Siggy

    Why is the Administration tolerating AIG . . . ???

    A very good question, yet, still unanswered here.

    MetLife wants to buy a big Life Ins. component; but, there is this little tax problem. perhaps the tax problem can be resolved, the sale can go forward and the dismemberment of AIG can then proceed.

    Perhaps it would help if we cleared the air. The initial bailout was made by the Fed, a government chartered oligopoly. Perhaps the fed should sell its interest to the Treasury. Then we could nationalize AIG and proceed with prompt corrective action.

    On the other hand we’ve engaged in so much trampling of the Constitution and 200 plus years of settled contract law; what the hell just go to nationalization. On the other hand, the Fed really would like the AIG affair to evaporate because the real issue had very little to do with AIG itself but much much more with regard to infusing some liquidity into insolvent primary dealer banks.

    And oh yes, how is that GS was a primary dealer bank before it ever sought access to the Fed’s Discount Window? Can someone explain that?

    Now comes Hank Paulson. His book is rather early to the scence, it, and his interviews, appear to be very self serving, if not a preemptive spin on any potential jury pool. And the Fed continues to stonewall audits and like inquiries. What is troubling is the fact that while much of the information is now a part of the public record, there apparently remains a great deal that has not been exposed.

    I conclude that the Fed is tolerating AIG’s actions because it has foul fish of its own to bury.

  9. Independent Accountant

    Francine:
    Suppose Uncle Sam replaced AIG’s CPAs, PWC with D&T, which “audits” the Fed and audited Merrill? What then? Or with KMPG which “audits” Citigroup? What then? There is not point in swapping one Big 87654 firm for another.

    YS
    I suspect AIG’s remaining derivatives portfolio is the “utter dreck” (UD) you surmise it might be. Time will tell. Uncle Sam may not want AIG to unwind this UD if say, Citigroup, or any other TBTF owns similiar UD. Suppose AIG sells the UD, that would establish market prices for UD. Will the other TBTF’s then need massive writedowns? We may be seeing an Uncle Remus tale unfolding, “Please don’t throw me in the briar patch” said Brer Rabbit.

  10. MichaelC

    I love this bit:

    “But the not taking full ownership was to avoid consolidating AIG debt on the Federal balance sheet”

    ‘a bit of a fiction’, indeed. It’s the perfect example of Greece/GS scheme writ large. Accounting rules are gameable by every one at every level to achieve optimal obfuscation.

    AT least this proves to everyone that Geithner,Paulson, etc understand the game as well as their IB pals.

  11. banksta

    Perhaps AIG is claiming considerably lower vega simply due to the nature of VaR: its usually based on 1 or 2 years of historical price data. Since we’ve lapped the enormous spike in realized vol experienced in fall 2008, anyone using a 1-year horizon would see their VaR drop considerably even having done nothing to reduce risk. This might be true even on a 2-year horizon, as recent data entering the data set is probably marginally less volatile than the old data leaving it. Of course, this is true for all the investment banks now reporting lower VaR (although I’m confident some of this is real reduction).

  12. cas127

    Yves,

    Bravo – an outstanding post. Unfortunately, not too many of the reader comments are worthwhile.

    One thought – lamenting/highlighting the corruption of the government is but a single step.

    Let’s think about the steps that we as private citizens/investors can take (independent of the government) to punish/direct AIG to behave more responsibly (or liquidate).

    Since our government is more or less a kleptocracy (we all know it – some of us are just hesitant to act upon it), we need to start seriously thinking about the steps the general populace can take independently of the “government”.

    For instance (not AIG related but bailout related), we can all point out very loudly that “Ally Bank” is really the old GMAC Bank.

    I’m sure that not too many of the general public realize the Ally=GMAC connection – and the Ally commercials are breathtakingly galling in their hypocritical posturing about competitors who mislead *their* customers!

    There’s a “Benmoshe* moment for you!

  13. dlr

    Features of a banana republic

    A collusion between the overweening state and certain favored monopolistic concerns, whereby the profits can be privatized and the debts socialized.

    Devalued paper currency in the international community.

    Kleptocracy — those in positions of influence use their time in office to maximize their own gains, always ensuring that any shortfall is made up by those unfortunates whose daily life involves earning money rather than making it.

    There must be no principle of accountability within the government so that the political corruption by which the banana republic operates is left unchecked. The members of the national legislature will be (a) largely for sale and (b) consulted only for ceremonial and rubber-stamp purposes some time after all the truly important decisions have already been made elsewhere.

    …a money class fleeces the banking system while the very trunk of the national tree is permitted to rot and crash…
    —Christopher Hitchens[8]

    From Wikipedia.

  14. monday1929

    Ah, the old “Fire-sale” ruse has returned. I mocked it in 2008 and wondered how long they could get away with using it. Maybe this is the record breaker use of the term- a fire sale that has lasted over two years.
    THE PRICE IS THE PRICE

    Lee S.

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