Sunday, March 22, 2009

The AIG Debacle

The AIG Saga: A Brief Primer
By Dean Baker

The awarding of $165 million in bonuses to AIG executives has dominated the news in the last week. There has been widespread outrage over the idea that taxpayers' dollars are being used to reward the people who effectively bankrupted AIG and cost the government more than $160 billion in bailout funds to meet the company's obligations. This primer addresses some of the issues raised by both the bonuses and the much larger sum going toward the AIG bailout.
The Bonuses: What Did They Know and When Did They Know It?
One of the silliest distractions in the AIG saga has been the various accounts of when AIG told Treasury Secretary Geithner of the bonuses and when Geithner passed the information along to President Obama. This discussion is silly because Geithner almost certainly knew of the bonuses ever since the initial takeover on September 15th. He just didn't think they were important.

Geithner was the chair of the New York Fed at the time of the original takeover. In that capacity, he was the person directly overseeing the takeover. As the chairman of the New York Fed, Mr. Geithner was undoubtedly familiar with the Wall Street culture and knew that financial firms paid out large bonuses each year to their most-valued employees. Since he did not issue any directives to AIG telling them not to pay bonuses, it was reasonable to expect that AIG would do so, just like it always did.

In other words, Geithner had every reason to believe that AIG would continue to pay out bonuses even after it was bailed out by the government, because he did not tell it stop paying bonuses. He may not have considered this issue important until the last week. And, he may not have known the exact size and the structure of the bonuses, but for all practical purposes he has known for six months that AIG would be issuing million dollar bonuses to certain employees, in spite of the fact that it was dependent on massive infusions of government money to stay alive.
Should the Government Have Gotten Something in Return for Giving Tens of Billions to the Banks?
When the government lent hundreds of billions of dollars to the banks through TARP, it got preferred shares of stock in return, in addition to placing conditions on the banks' conduct. By contrast, the government received absolutely nothing for the tens of billions of dollars that it passed on to the banks through AIG. It may have been desirable to ensure that AIG's defaults did not lead to the collapse of the major banks that were its counterparties, but this could have been accomplished by directly giving these banks capital through TARP or some equivalent mechanism. There is no obvious reason why it was necessary to give the money through AIG without getting anything in return.

It is worth noting that if the government had instead lent the AIG money to the banks through TARP, and under similar conditions, it would own an even larger share of these banks. Obviously the banks prefer that the money instead pass through AIG without conditions, but there is no reason that the taxpayers should prefer this route.

It is also worth noting that several of the recipients of AIG money were foreign banks. While the public has an interest in the stability of the world economy, which means preventing major foreign banks from going bankrupt, there is no obvious reason that American taxpayers should be forced to bail out foreign banks of wealthy countries. It is possible that there is some quid pro quo under which foreign governments are bailing out U.S. banks on losses suffered in their countries, but there has been no public acknowledgement of such an arrangement.

There is a possible alternative explanation. The government may have made these payments in order to preserve the international reputation of the U.S. financial industry. If that is the case, then this is a rather expensive subsidy to the financial industry. To date there has been no explanation as to the reason for making these payments.
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