AIG has once again been paying out sums of money so enormous that you need to annex part of your brain just to comprehend them. It’s spending its bailout cash on the debatable (the wronged counterparties in its derivatives trading) and the outright bad (its employees via fat bonuses).
First, the juicy villainy. Over the weekend, AIG announced it was going to press ahead with the bonuses that were part of a lawful package agreed before the messy business of the last few months; its CEO, Edward Liddy told Tim Geithner by letter that “quite frankly, AIG’s hands are tied. Outside counsel has advised that these are legal, binding obligations of AIG, and there are serious legal, as well as business, consequences for not paying.” Larry Summers, Obama’s jowly economic advisor, acknowledged the legal constraints, but through very gritted teeth, adding that “every legal step possible to limit those bonuses is being taken”. Now Obama himself has stepped up to the plate, saying he’s told Geithner to “pursue every legal avenue possible to block these bonuses”. Check out the video of him here, doing a weird line in faint, arch amusement at the crumbling financial world he’s inherited.
There’s a worry that if the bonuses are not paid, and AIG won the resulting legal case, it could claim back costs and double the value of the bonuses as damages, though the Wall Street Journal’s law bloggers think that the US government has a pretty good case against AIG nonetheless. Andrew Ross Sorkin also makes the good points that a) we need to keep AIG’s top staff on and use their knowledge of the situation and b) it could create a snowballing of similar legal cases if a precedent was set.
But once again in this crisis, the bonuses get the most coverage while actually paling next to larger sums that can’t be as easily and snappily attached to some financial villain. As the Wall Street Journal and the FT have noted, the real story here is the standard that’s being set for companies who have been stung by the actions of other companies. Banks like Deutsche Bank and Goldman Sachs, and municipalities in states like California and Virginia, are having their potential losses from dodgy derivatives and securities they invested in through AIG erased with bailout cash.
Numbers include: $7bn given to Barclays, $4.1bn to Societe General, $4.5bn to Bank of America. $85bn in all was used, over half of AIG’s bailout pot, in making sure these banks wouldn’t feel AIG’s pain. It is presumably felt that the banks, who could be held equally accountable for investing in products that relied on heavy leverage and high levels of credit, need to have their confidence buoyed at such a critical stage. And the FT claims that this action “is widely regarded as a ‘blueprint’ for the level of government support that can be expected in the derivatives industry”, so it’s only going to continue across the industry.
It’s part of the plan to stabilise the global derivatives market, which at one point reached a brain-melting total of $1.14 quadrillion. That’s over a thousand trillion dollars, or $11400000000, a number only Dr. Manhattan can properly conceive of, but when you realise that’s the sort of level that losses could even remotely reach towards, £85bn is actually a pretty worthwhile spend if it’s going to get the international credit market moving again. It’s happening alongside the reopened clearinghouse for derivatives, that’s been running since last week.
The lesson now is to start properly assessing the risk of derivatives, something that Gillian Tett in the FT says AIG was “extraordinarily complacent” in doing, as well as attacking the ratings agencies and regulators. But, as Sorkin noted, a banker will only want to stay at AIG if their salary and bonus package is right; similarly, derivatives will only be traded if the returns are right, and that zeal for compensation will always attempt to steamroller regulation. A new systemic overhaul in how regulation is managed is what’s needed, but how to enact that is way outside this bloggers comprehension…