Collective Punishment for AIG

I have heard the argument that those at AIG should not get bonuses because they destroyed the firm, or because they destroyed the firm and in doing so helped precipitate the current economic calamity to boot. This sort of argument doesn’t make sense to me. The vast majority of those in the bonus pool at AIG had nothing to do with precipitating the firm’s failure. They were marketing insurance products, managing call centers to handle customer inquiries, and other exciting stuff like that. They just happened to live in the same corporate city-state as the evil-doers. Pulling their bonuses based on such an argument is collective punishment.

A more reasonable argument is that without the government assistance, AIG would have gone bankrupt. And if it had gone bankrupt, those who are pulling in bonuses not only would have had no bonus, they likely would have had no job. So then, the argument goes, why should the government’s bailout money – which of course is tax payer money – go to give out-sized bonuses?

That makes sense. But then we come to some follow-up questions.

One is why Paulson didn’t include compensation controls as one of the terms for keeping AIG afloat. You could ask the same thing of Geithner, who frankly is taking on far more grief than he deserves, but the time to have done this was back in September, when the agreement was put together in the first place.

A second is why the argument stops with the boundaries of AIG. We should ask who beyond AIG would have gone bankrupt if the government did not keep AIG from default, and make the same demands on bonuses that are being paid there.

Think of it this way: If time had not been so tight, the creditors would also have been in the bailout meetings. These creditors would have include those on the hook in the event of default due to their CDS exposure. The meeting would have started off with Paulson saying, “We can pull AIG from the brink. It will take a lot of taxpayer money to do so. We want concessions all around, both from AIG and from its creditors, and especially from those creditors that will go under with it.

That is the correct route to collective punishment. A route that starts with questions like this:

True or False: If AIG had gone into default, Goldman Sachs would also have failed.


Originally published at the Rick Bookstaber weblog and reproduced here with the author’s permisssion.

One Response to "Collective Punishment for AIG"

  1. P D Simic   March 23, 2009 at 12:20 am

    You are right on target there. All this public outrage about the $160M of bonuses is a nice entertainment, so people can get emotional and angry about something concrete. This is OK to the extent that it will put some extra pressure on the government and politicians to deal with the banks and AIG in a more responsible and aggressive way. However, this is peanuts, and a diversion from the much bigger problem here; which is about the way the $160B is (and additional $30B is to be) spent by the A.I.G under the watch of this and the previous Treasury (think, Paulson).It is not secret that much of the taxpayer billions was spent on unwinding bunch of CDS contracts that AIG had with Goldman S. and other Wall St players. It is also known that the total CDS “insurance” liability is about $60-80Trillion, which is about 30X times the size of the underlying mortgage market. What this means is that many of these CDS contracts that A.I.G might be unwinding behind the closed door using the taxpayer money could be, for all we know, a speculative contracts in which the CDS counter party is demanding the payment on an asset it insured but *never owned*. This would be illegal in normal insurance business – think of allowing hundreds of people to take a life insurance on a single persons life – but is legal in the unregulated CDS world (such contracts are called “naked CDS”).That is: the taxpayer’s billions may be covering contractual gambling wins of the counter parties, such as Goldman S., not the real losses. If so this would be example of the largest transfer of wealth in the history of the world – from the Main St to the Wall St.The fact that Treasury did not explicitly annul such “naked” CDS contracts even to this day, and certainly not before pouring billions into A.I.G. “bailout”, is economic malpractice of a gigantic proportion, and may even be a criminal malpractice. The $160M of bonuses is peanuts and surely an outrage, but I hope we don’t let it be a distraction from the real DIRTY SECRET behind the A.I.G. bailout.