A Pain In The AIG‏

March 16, 2009

by Faiz Shakir, Amanda Terkel, Satyam Khanna, Matt Corley,

Benjamin Armbruster, Ali Frick, and Ryan Powers

ECONOMY

A Pain In The AIG

One of the main reasons the federal government had to intervene and use billions of taxpayer dollars to prop up the nation's financial institutions is that they were considered to be "too big to fail." In other words, these companies had become so massive that their collapse would send shockwaves throughout the U.S. and global economies. No company has come to symbolize this problem more than insurance giant AIG, in which taxpayers now have an 80 percent stake after the federal government committed $170 billion to rescue it from bankruptcy. "Given the systemic risk AIG continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high," wrote the Treasury and Federal Reserve in a joint statement on March 2. As New York Times columnist Paul Krugman has explained, "AIG is in trouble because it wrote many credit default swaps, in effect guaranteeing others against losses it lacked the resources to cover. We, the taxpayers, are now covering those losses. ... But this means that US taxpayers have now assumed the downside risks for all of AIG's counterparties." AIG has proved to be in no rush to repay this favor, highlighting the risk in the government's current strategy.

BONUS OUTRAGE: On Saturday, AIG revealed that it still planned to pay $165 million in bonuses to executives in its financial products unit, the same unit "that brought the company to the brink of collapse last year." As the New York Times pointed out, these awards "are in addition to $121 million in previously scheduled bonuses for the company's senior executives and 6,400 employees." After finding out about the scheduled payments, Geithner called AIG chief Edward Liddy to tell him that they were "unacceptable and had to be renegotiated." In a letter on Saturday, Liddy replied that AIG was legally bound to "proceed" with the bonuses, and he did not want employees to "believe that their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury." This response set off a wave of outrage from Obama administration officials, even though many of them have opposed tougher restrictions on CEO pay. Yesterday on ABC's This Week, National Economic Council Chairman Lawrence Summers said, "There are a lot of terrible things that have happened in the last 18 months, but what's happened at AIG is the most outrageous." House Financial Services Committee Chairman Barney Frank (D-MA) also said that AIG was "abusing the system."

FINDING OUT WHERE THE MONEY IS GOING: Yesterday, AIG also revealed the names of dozens of the big banks it has paid off with the bailout money. The Washington Post reports, "The disclosure, which the company said was made after consulting the Federal Reserve, revealed that AIG paid more than $75 billion in the final months of 2008 to numerous domestic and foreign banks, as well as to various U.S. municipalities." Major recipients included Goldman Sachs, Deutsche Bank, Merrill Lynch, Morgan Stanley, and Bank of America. Approximately $12 billion also "went to pay off municipalities in dozens of states for whom the firm had created complex investment agreements." The disclosure was an "about-face" for AIG, which had been resisting lawmakers' calls for increased transparency. In fact, all firms that have received money under the Troubled Assets Relief Program (TARP) have been able to escape with inadequate oversight. Bailed-out CEOs have retained their corporate jets and refused to answer questions about how they are spending taxpayer money. Just last week, a House oversight subcommittee grilled TARP watchdog Neil Barofsky on questionable investments made by bailed-out firms and what influence lobbyists have exerted. Barofsky promised officials that he would provide that information when he releases his report.

THE RATIONALIZATION FOR NATIONALIZATION: What this weekend's disclosures highlight is the shortcomings of the Treasury's current strategy to prop up the financial system. Basically, the federal government continues to pump billions of dollars into these institutions without receiving full control over how taxpayer dollars are spent in return. Bank nationalization has been floated by people such as Krugman and NYU economist Nouriel Roubini, to former Fed chairman Alan Greenspan and Sen. Lindsey Graham (R-SC). Geithner, however, has so far refused to say that nationalization is on the table. But it should be. "The American taxpayer would be ill-served to receive anything less for putting in the vast amount of money needed to restructure and recapitalize [the banks]," explained Adam Posen, Deputy Director of the Peterson Institute for International Economics. "And the American taxpayer, just like any acquirer of distressed assets, deserves to reap the upside from their eventual resale." Geithner has put forward a plan to subject the country's 20 biggest banks to "stress tests," in order to assess whether they have the resources to survive. Krugman has explained that these tests could be the key for an administration move toward nationalization, by "not hid[ing] the results when a bank fails the test, making a takeover necessary." As the Wonk Room's Pat Garofalo has written, "Geithner's public-private investment fund may get toxic assets off the banks' books," but it also depends on Wall Street "being willing to buy the junk currently clogging up the banks. And the longer nationalization is delayed, the longer the solvency of the entire banking system will be in question. Thus, more good banks will get dragged down into the mud with the bad."