Too big to fail, but not too big for a smackdown: The AIG saga
U.S. legislators are so furious with the retention bonuses AIG paid some of its top executives that they're about to claw it back.
The House of Representatives passed a bill on March 19, 2009, to place a 90 per cent tax on bonuses paid to employees with family incomes above $250,000 US at companies that have received at least $5 billion in government bailout money.
The target is AIG, but some of the shrapnel will hit mortgage giants Fannie Mae and Freddie Mac among others that appear to have been reckless with the bailout money from Washington.
But nothing rankles like AIG.
It received $182 billion in bailout money and paid about $165 million in bonuses to about 400 employees in its financial products unit.
What is AIG?
American International Group and its companies are major insurers the world over. While based in New York, it has extensive dealings in Asia. The U.S. Federal Reserve says AIG acts as an insurer for more than 100,000 entities, including operations that employ more than 100 million Americans, and has more than 30 million U.S. policyholders.
What is a retention bonus?
Edward Liddy, who was lured out of retirement by the government to become the CEO of AIG, insists the bonuses are necessary to keep key people from leaving and save AIG from even deeper losses. He admits the bonuses would not have been as rich if he were running the place in May 2008 when the contracts were signed.
Although it may sound absurd to pay someone more money to come to work, a company might rely on the bonuses for several reasons.
A top broker might qualify for a bonus if the company is concerned he might leave and take clients with him. A company filing for bankruptcy protection would want to keep its senior people around while it restructures.
That seems to have been the issue with AIG.
'We can't keep them from getting bonuses, but we can keep them from having their jobs.' —Barney Frank, House financial services committee
Liddy says many of the employees who took bonuses ran trading accounts worth $1.6 trillion. If those people hadn't been encourage to stay and unwind the accounts, the financial losses could have been immense, at further cost to the U.S. taxpayer.
Liddy told U.S. lawmakers he has asked for some of the bonuses to be returned, and says some former employees actually returned them all.
Why not just stop the cheques on the bonuses?
The contracts that led to the bonuses were signed in May 2008 before the bailouts began, so AIG might have a legal requirement to pay them.
"Maybe it's time to fire some people," said Representative Barney Frank, chair of the House financial services committee. "We can't keep them from getting bonuses, but we can keep them from having their jobs."
That might feel good, but it might not solve the problem. Fired employees could still be entitled to the bonuses.
Besides, it seems to indicate a misunderstanding of retention bonuses. They are paid to keep an employee at the company for a set period of time. Already, at least 11 people who received million-dollar retention bonuses left AIG months ago.
Why is it in trouble?
Problems at AIG did not come from its traditional insurance operations, but primarily from its business insuring mortgage-backed securities, credit default swaps and other risky debt. And it looks as if the prime beneficiaries of these bonuses are the people who dreamed up these securities.
Its serious problems began in September 2008 when Moody's downgraded its credit ratings, and AIG had to seek more cash for collateral against its insurance contracts.
While it would try to sell some of its assets, its problems required a huge cash injection that only a rich government could provide.
Why is the U.S. bailing AIG out?
If AIG doesn't have enough cash, it could default on its obligations and the buyers of its insurance. These are giant banks and financial companies. Without AIG, they would have found themselves without protection against losses on the debt they hold.
Officials with the U.S. Federal Reserve said they believed it could also lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance. So, the U.S. government agreed to provide an $85 billion emergency loan to rescue AIG, in return for a 79.9 per cent equity stake in AIG.
That was the first bailout. But AIG's troubles continued. In November 2008, the U.S. government restructured previous loans, bringing the total rescue package for the company to about $150 billion.
"The economy and capital markets remain in turmoil, and we are taking additional steps to preserve the value of our businesses and maximize the ultimate proceeds for the benefit of all stakeholders, including taxpayers," Liddy said in a statement.
So, the U.S. government agreed to give AIG access to an additional $30 billion in new funds and to ease repayment terms, which brought the bailout to around $182 billion.
"We're going to be able to pay back the Federal Reserve," said Liddy. "The new $30 billion is a standby line. It's not necessarily something that we think we'll have to draw on right away."
What happens if it fails?
The U.S. Treasury Department believes if AIG goes down, the potential losses to the U.S. and global economy would be "extremely high," and has suggested that if in future there is no improvement, more money will have to be invested.
This isn't just a matter of dollars and cents. It's about our fundamental values.— Barack Obama, U.S. president
The consensus is that Washington really dropped the ball by allowing Lehman Brothers to fail in September 2008. The government believed investors would buy stocks in more secure institutions and the marketplace would sort itself out.
But investors panicked and sold stocks of almost every company — good or not — as they pushed out of the market. Stock prices plunged, and major banks suddenly became desperate for cash, requiring governments all over the world to prop up their financial institutions.
And AIG is much bigger, much more connected company than Lehman Brothers.
Why is it controversial?
Even before the issue of the bonuses, AIG almost went out of its way to appear irresponsible, critics suggested.
In October 2008, after taking millions in bailouts, AIG sent some of its executives on an $86,000 hunting trip in Britain. When the news of the event broke, AIG apologized. Then it cancelled yet another retreat it had scheduled for later in the month.
It also was revealed over the March 14-15, 2009, weekend that AIG used more than $90 billion US in federal aid to pay out foreign and domestic banks, some of whom had already received multibillion-dollar government bailouts.
Goldman Sachs received $12.9 billion of the AIG money and so did three European banks:
- France's Société Générale at $11.9 billion.
- Germany's Deutsche Bank at $11.8 billion.
- Britain's Barclays PLC at $8.5 billion.
The money went to banks to cover their losses on complex mortgage investments, as well as for collateral needed for other transactions.
U.S. President Barack Obama suggested it's more than just unseemly.
"All across the country, there are people who work hard and meet their responsibilities every day, without the benefit of government bailouts or multimillion-dollar bonuses. And all they ask is that everyone, from Main Street to Wall Street to Washington, play by the same rules," said Obama. "This isn't just a matter of dollars and cents. It's about our fundamental values."
What's the Canadian connection?
Bank of Montreal is buying some of AIG's assets, picking up the Canadian life insurance business for $375 million Cdn.
BMO says the deal will give its clients access to a broader range of investment products and is expected to boost BMO's earnings within a year.
AIG Life of Canada has about 300 employees and 400,000 customers.
As well, Manulife Financial wants to purchase AIG assets in China and Japan.
How bad are things now?
For the full year 2008, AIG lost $99.3 billion US, or $37.84 per share, compared with a profit of $6.2 billion, or $2.39 per share, a year earlier.