Sweetheart Deals

March 18, 2009 7:50 pm

Over at DealBook, Steven Davidoff has a run-down of just what those newly-released AIGFP bonus contracts tell us.

Here’s the key take away …

This was not a boilerplate contract. Rather, it was highly negotiated. And it was highly negotiated to pay retention fees at high levels without regard to performance. This is obviously shocking. But it makes me wonder: perhaps one area of direction here should be actually looking at who negotiated this and why?

It strikes me that the A.I.G. financial products division received an unbelievably sweet deal. Did its managers slip it under the radar? Did the managers act in good faith? And who at A.I.G. signed off on this and did they focus on the risks and rewards? Yet more avenues for possible litigation.

Meanwhile, Daniel Gross points to the big question

Congress should also hear from the many AIG counterparties who together have received billions of dollars of taxpayer funds so far through AIG. These folks bought insurance from or did business with a company that was unable, as it turned out, to make good on its financial commitments. And yet because the government didn’t let AIG file for Chapter 11 bankruptcy protection, these counterparties have been made whole. I’d like to hear Goldman Sachs CEO Lloyd Blankfein tell Congress why it was appropriate for taxpayers to make a payment to Goldman of $5.6 billion in credit-default swaps, and why Goldman shouldn’t eat at least a portion of the losses it would have suffered had the taxpayers let AIG fail. It would be nice to hear from the half-dozen German banks, including the state-owned Landesbank Baden-Wuerttemberg, who have benefited from one of the biggest transfers of taxpayer wealth to Europe since the Marshall Plan. Or from executives at Citadel, the beleaguered hedge fund that received $200 million in payments from AIG’s securities-lending business. They should be duly sworn in and forced to explain why taxpayers should pay these claims just because their firms bought insurance without determining whether the insurer could pay the claims.

As you know, like many others, we were hitting like crazy on this point long before the story became all bonus all the time. Who are the counter-parties? To a great degree, we now know who they were — at least the major ones. Deutsche Bank, Goldman Sachs, a bunch of other banks in Europe. But in many respects these big institutions were just pass throughs. Hedge fund X goes to Goldman to place a bet against the US housing market. Goldman outsources a big chunk of the risk to AIG. Hedge fund X wins the bet, collects from Goldman, which in turn collects from AIG. The transactions are obviously much more complicated; but that’s the rough trajectory.

The best article I saw on this today was Serena Ng’s in the Journal. Many discussions of these credit default swaps have conditioned us to think of them as de facto insurance policies. So I buy a bunch of mortgage debt. But I also buy some CDS insurance to cover myself against the risk of my investments going under. But that’s not what was happening in a lot of these cases. A lot of this was smart hedge fund managers who could see the housing meltdown coming three or four years ago and placed bets against it.

Not that there’s anything wrong with that, so long as you place your bets with institutions that can cover your winning hand.

But why are we paying off these debts? Like Dan Gross said above, do we really need to cover all of Goldman’s exposure dollar for dollar? Maybe we split it fifty-fifty? Remember, Goldman says their balance sheet is strong and it’s share price is holding up relatively well. Maybe they can help the taxpayer managed a bit of this heavy lift?

And not just Goldman. I’m picking on them because their exposure to AIG’s arrested collapse was especially great. And there were a lot of Goldman alums at least fortuitously involved in saving AIG. But the same logic applies to all the other counterparties.

It’s a complex business. And even a lot of right-thinking economists are worried that these hedges and sellings of risk back and forth are so tied up and knotted together that cutting the cord could trigger a chain reaction toward the kind of meltdown we only barely avoided last fall.

Maybe so. But when you look at these payouts up close, that rationale for making these people whole is very questionable. At a minimum it’s worth bringing a few of those CEOs up to Capitol Hill and asking them just why they got our money and why we can’t have some of it back.

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