AIG will pay >$400MM to group that blew up firm

Posted by Marc Hodak on March 14, 2009 under Executive compensation, Scandal | 5 Comments to Read

That’s right.  The tax dollar whirlpool known as AIG will pay employees of its Financial Products group over $400 million in “retention” bonuses, a group of people that arguably no one else would hire.

The outrage about “Epic fail = Huge bonuses” is understandable.   But this isn’t really about bonuses.  It’s about guaranteed payments that the media insists on calling “bonuses” when, in fact, they are deferred obligations from contracts that may predate the crisis and current management.  Unfortunately for a certain lonely Treasury official, it may not predate his involvement.  He is desperately waving the media spotlight off to any another direction.

Sure, Treasury Secretary Geithner fulminated, ordering AIG CEO Edward Liddy to withhold the payments.  But Liddy is bound by contracts to pay them.  If he tries to withhold the payments, he will not only risk a costly lawsuit that he is almost certain to lose, but to the extent he might prevail, he will risk the retention of people he really does want to keep, those needed to keep the insurance divisions humming who will be asking themselves, “What is a contract with AIG worth if the government can simply have them ripped up with a phone call?”

Geithner’s problem is that he was an architect of the AIG bailout last September, which he coordinated as head of the New York Fed.  In his defense, Geithner was under extreme duress to complete the mammoth deal in incredibly short order.  Can he be blamed for overlooking certain things in that mid-September ’08 pressure cooker?

“Uh, excuse me Timmy, I know we have only a few hours to get this wrapped up before global markets face a cardiac arrest, but we have a few contracts worth $0.4 billion here that look a little problematic.  Can we divert some of our people’s attention to take another look at these?”  In reality, they probably didn’t even know those contracts existed.

Someone at AIG did know.  The company’s culpability very likely dates back to the hiring of these people.  Without knowing the details, we can guess that they were brought in during heady times, when their contribution to the firm’s results still looked misleadingly positive.  These people were lured with fat money promises that wondrously failed to include an “unless-you-blow-the-company-up” clause.  In hindsight, that would have been nice.

Unfortunately, one of the bedrocks of our civilization is that an agreement is an agreement, even if one party doesn’t like it after the fact.  The company executives who agreed to that crappy contract were ignoring its unintended outcomes.  The people arguing now for withholding the payments are no better, consciously ignoring the secondary effects of abrogating any contract that gives high government officials displeasure, however justified.

Ultimately, these payments are an unintended result of the bailout itself.  If the government had sought to usher AIG through a bankruptcy instead of a bailout, these executives would have had their future bonuses placed on a pile of other claims for a bankruptcy judge to sort out.  Messy?  Certainly.  Worth it to keep a bunch of yahoos from cashing in after destroying their company?  Well, that depends on which part of the brain we want working on these problems.

We can turn it over to the part of our brain that says “Epic Fail = Huge bonuses!  Bullsh*t!!  Off with their heads!”  Or we can engage the part of our brain that weighs many things including contractual rights, moral hazard, corporate responsibility, global financial solvency, etc.–i.e., the part our civilization depends on.

Me, I would have let AIG fail, and let the contract holders fight it out in restructuring.  But at least I know that is not a dispassionate position based on all relevant information.

UPDATE:  It seems that AIG’s Liddy figured out that (a) most of these guys in the Financial Products group won’t be going anywhere if their non-contractual pay gets cut, and (b) not all of their compensation is contractually obligated.

For example, salaries.  The 25 highest-paid executives in that unit, the ones presumably in line to get the highest “bonuses,” will have their $270K – $500K salaries cut to…$1.  Technically, that’s not a clawback, but it sure feels like one.  The remaining officers of the unit will get their salaries cut by 10 percent, and see reductions in their non-cash compensation, as well (think 401K matches, health benefits, etc.).

For the sake of AIG’s shareholders (that’s us), I’m hoping that these cuts will not push away the few people in the group best able to get them out of the mess their colleagues created.  Other than that, this seems like the best solution to this sticky problem for Mr. Liddy, and one that may pull Mr. Geithner’s bacon out of the fire, for now.  It respects the contracts that have been signed while reducing the costs to the firm without materially affecting retention risk.  (I’m guessing that they would have been entitled to those bonuses if they were fired, but not if they quit.)  So, in order to get those unearned future bonuses, they will have to stick around living off of the unearned recent bonuses.  Not bad.