When the housing market collapsed and faulty loan activity was exposed, it was only logical that the mortgage lenders, like banks, would be demonized for their risky behavior. But, in recent days, AIG, an insurance company (not a bank or mortgage lender), has been demonized even more; especially by our Congress.
I think a lot of people are mad at AIG (American International Group) because they received billions of dollars in taxpayer bailout money and they think AIG acted irresponsibly by giving out some bonuses. But, I don't think any lay person, who is now mad at AIG for those bonuses, really understands why an insurance company received that amount of bailout money in the first place; and, why they were said to have been "too big too fail".
If you listened closely to the Congressional hearings that were being conducted to grill AIG's interim CEO over the coals, you would have heard many angered references to the Financial Products Division of AIG and their receipt of $168 million in bonuses. But, again, most of us probably don't really know what the Financial Products Division did to warrant such anger.
AIG is basically an international insurance company that could insure almost anything in the world. 99 percent of what they do is regulated by some form of government; depending on what country or state they are selling their insurance products in. Normally, all their insurance activity has to be supported by a sufficient amount of cash reserves to guarantee that there is enough insurance payout money available in the event of a mass catastrophic loss of insured items. For example, when Katrina hit, a company like Allstate, because of state and Federal regulations, had enough cash reserves to cover all the insured properties that were lost to that specific catastrophe.
Not all of what AIG did as an insurer was actually regulated, however. This was especially true when it came to insuring mortgage loans, business loans, and many other types of loans. Not that they did anything illegal; but, in essence they were not being fiscally responsible.
The Financial Products Division was a very small division of AIG. It was heavily involved in the unregulated activity of insuring loans between two parties where the party receiving a loan might have had less than a good credit rating. Under normal circumstance, that kind loan would not have even happened if it wasn't for AIG providing an insurance on that kind of loan.
To facilitate these somewhat questionable loans, AIG insured that loan by using a product or vehicle called the Credit Default Swap or CDS. The first Credit Default Swaps were initially hatched up by JPMorganChase in the late 1990's. The fact that CDS's were exempt from any regulation stems back to the "Enron Loophole" that was created when Bill Clinton signed into law the Commodity Futures Modernization Act of 2000. That law was originally authored by Republican Senator Phil Gramm and, under the "derivatives" sections of that law, any CDS's were freed of any regulatory oversight.
In a normal mortgage loan environment, a borrower goes to a lender, like a bank, and says that they want to buy a house. The lender, then, in deciding whether or not they want give out a loan for that house, wants to know what the price of the house is; what the amount of down payment will be; and, what ability the borrower has to fulfill the terms of the loan. Up until the invention of the CDS, the lender assumed all the risk for giving out that loan. If the borrower defaulted on the mortgage, the house, which had been used as collateral for loan, would be taken and resold to recoup the money that the borrower lost on the deal. Even in the best housing market, a home loan that was defaulted on generally represented some amount of loss for the lender.
Now enter AIG with their CDS's. For just a small percentage of the interest payments that the lender will receive from the borrower on that home loan, AIG says that they will protect the lender against any losses that could result from the borrower defaulting on their loan. In effect, that insurance product, the CDS, would make the lender whole when there was default. The lender, then, becomes free of all risk. In essence, the real risk has been transferred to AIG. This transference of risk is technically what is called a "Swap" as the name Credit Default Swap so implies.This fact, alone, facilitated many more loans than should have been because lender risk was being eliminated. What has also been swapped at the same time was the borrowers credit rating for AIG's once-formerly excellent AAA credit standing. So, on paper, the lender looks as if they are only giving out loans to the best credit-rated borrowers. But, that was only an illusion. It is also important to note that AIG was fully exposed on their portion of the loan guarantee because the collateral for the loan remained, contractually, with the lender.
In a booming housing market, the CDS is a great profit-maker for an issuer like AIG. As housing values increased, AIG's risk would continue to lessen; and, ultimately, would go to zero. Yet, they would still get income. Over the life of a 30-year mortgage, it's nothing but a win-win for AIG. But, when the housing market collapsed and housing prices fell by as much as 50 percent, AIG was then on the hook for massive amounts of money as foreclosures rose. Further, they applied CDS's to all kinds of non-home loans and those loans, too, became a liability as this recession increased the number of bankruptcies .
But, it was worse than that. AIG wasn't the sole seller of CDS's. Banks also bought into the AIG/CDS scheme and they, too, started selling CDS's to each other for every kind of loan under the sun. Hedge funds, also, got into the game. So, as a result, you had everyone from AIG to world Banks to world Hedge funds who were covering each other's butts and none of them had enough cash to bailout the other when things started to unravel. It was a massive interconnected web that could easily collapse under its own weight.
That's why, when, last year, Hank Paulson and Tim Geithner originally started to look at the possible failure of AIG, they only saw a massive ticking, time bomb. But, this time bomb was a lot more like the small conventional charge that could easily be used to initiate a chain reaction that was akin to that in an atom bomb. And, that is why AIG could not be allowed to fail.
AIG is a big company with over 100,000 employees; worldwide. Most of what they do is both a regulated and quite ethical business activity. Even in the Financial Products division, I don't think that the majority of those people, who were selling and bundling the CDS products, were actually aware of how exposed the world was to their activities. After all, the housing market was just clocking along with ever-increasing house value. For sure, I hardly think that any of those employees of the Financial Products Division sought out AIG in some twisted belief that they could personally destroy the world's economy. Instead, they were just recruited to blindly do a job. I'm quite sure that they, like most of the employees in any corporation, didn't have any big-picture view that was greater than their own day-to-day activities. So, to demonize the employees of the Financial Products division is somewhat misplaced. The true villain in this mess is the management that allowed CDS's to happened without the substantial funding that was needed to cover all the expenses associated with a deflated housing market and a recession. That was the greed and that is where the anger should be aimed. Further, the fact that CDS's were even allowed to be sold all stems back to laws that were put in place in 2000. So, our Congress is to blame for not thinking through or actually reading the bill that Phil Gramm put forth and that Bill Clinton signed. And, Bill Clinton is at fault for signing something that his staff of experts -- now all part of the Obama Administration --- should have better understood.
Lastly, I have attempted to give you the most simplistic explanation of a CDS's as I could. The actual CDS products got more and more complex over time with different financing structures and various forms of hedging and leveraging. Because of these complexities and because of all the tentacles that have jutted out from this kind of insurance product, no one really knows the exact amount of risk that is associated with them. Currently, it is estimated that there is a worldwide risk of $45 trillion dollars; but, it could be a lot more than that. While Obama/Geithner want to impose regulation on these kinds of products, I am quite sure that the industry, itself, doesn't want to ever sell another one of them; seeing the extreme risk that they can carry. For this reason, I think excessive regulation isn't warranted. All that is really needed is to mandate some form of substantial loss reserves for the company selling the CDS.
Showing posts with label Bonuses. Show all posts
Showing posts with label Bonuses. Show all posts
Monday, March 30, 2009
Saturday, March 21, 2009
Was AIG Used As A Strawman?
This morning, anyone who read The Drudge Report would have seen this picture and the bold printed "REGULATE" title at the top of the page. Right now, it is just a teaser without a detailed story behind it. But from the top line heading that appears above that picture, it implies that the Obama Administration is preparing to REGULATE banking and Wall Street salaries and bonuses. And, maybe, even, all corporate pay.This brings me to a question: "Was the AIG flap a completely "fabricated" strawman which will allow Obama to do what he always wanted to do...control executive pay in America" Was this entire flap allowed to happen in order to move towards the complete regulation of salaries in this country? Don't forget those infamous words of Rahm Emanuel: "Never let a good crisis go to waste!"
You've got to wonder. Is this just the first step towards a broader and even more expansive form of socialism than that which exists in the socialist governments of Europe? This move by Obama is absolutely disturbing me; and, it should be seriously disturbing to all Americans who believe in the benefits of a free enterprise system.
$168 Million Bucks That Stop At Obama's Desk
Senator Dodd blames Obama's Treasury Secretary, Tim Geithner. The White House says it's Dodd and AIG's fault. Representative Maxine Waters is blaming Dodd, Tim Geithner, and the President (See Video & Audio).
It's almost like a scene out of a Three Stooges' movie with Congress slapping the White House and AIG; the White House slapping Congress and AIG; and Maxine Waters slapping everybody as if she was dragging a stick across the slats of a picket fence. You can take your pick as to which group looks more like Moe, Larry or Curly. But, my bet is that Maxine Waters is more like Moe because she's the smart one out of this whole mess by claiming that the President is out of touch.
If you note, the Republicans are increasingly backing off; letting the Democrats dogfight themselves. The expression "eating their own" would be an understatement.
When it's all said and done, it will be Obama that suffers the most. It was his Treasury Secretary that presented the bailout targets and the specific amounts to Congress. He was even involved in the original TARP bailouts because it was him, Hank Paulson, and Bernanke that worked on all of the bailout monies that were handed out in 2007. Obama certified that past activity of the Bush Administration by hiring Geithner.
Therefore, with Obama as the target, you can easily say "the buck stops here." In this particular case, it's $168 million bucks that are stopping in Obama's face.
What is really interesting is the idea that such a relatively small amount of money (as compared to other "trillions" that Obama is spending) may hurt this President the most. Like someone once said: "I's the little things that matter!"
It's almost like a scene out of a Three Stooges' movie with Congress slapping the White House and AIG; the White House slapping Congress and AIG; and Maxine Waters slapping everybody as if she was dragging a stick across the slats of a picket fence. You can take your pick as to which group looks more like Moe, Larry or Curly. But, my bet is that Maxine Waters is more like Moe because she's the smart one out of this whole mess by claiming that the President is out of touch.
If you note, the Republicans are increasingly backing off; letting the Democrats dogfight themselves. The expression "eating their own" would be an understatement.
When it's all said and done, it will be Obama that suffers the most. It was his Treasury Secretary that presented the bailout targets and the specific amounts to Congress. He was even involved in the original TARP bailouts because it was him, Hank Paulson, and Bernanke that worked on all of the bailout monies that were handed out in 2007. Obama certified that past activity of the Bush Administration by hiring Geithner.
Therefore, with Obama as the target, you can easily say "the buck stops here." In this particular case, it's $168 million bucks that are stopping in Obama's face.
What is really interesting is the idea that such a relatively small amount of money (as compared to other "trillions" that Obama is spending) may hurt this President the most. Like someone once said: "I's the little things that matter!"
Friday, March 20, 2009
AIG Bonuses: It's A Contract, Stupid!
The days of a contract being someone's good name and a handshake are long gone. In today's complex and litigious society, the legal and binding cement that keeps two parties honest is the contract.
Like it or not, the people at AIG, that received those retention bonuses, got them because they had a contract. That contract was a legal agreement between AIG and themselves. Those contracts were done as part of conducting normal business activities and were negotiated in good faith between AIG and each of those employees. The fact that AIG received bailout funding from the Federal Government can't negate those contracts because they were written before AIG accepted that funding. Anyway, the acceptance of Federal bailout money was a contract between AIG and our government and was totally independent of those retention bonus contracts.
Our Congress knew this and knew that they couldn't override those legal documents by, somehow, passing a law that would retroactively negate them. That would definitely be unconstitutional. So, the Democrats in Congress and some obliging Republicans decided to do an end-around by passing legislation that would penalize the recipients of those bonuses with a 90 percent, retroactively applied tax rate. Even so, that action may be unconstitutional, too, because it may violate Article I, Section 9, of our Constitution by passing legislation that could be defined as a "bill of attainder". A "bill of attainder" is the passage of any law that would specifically target and punish a single person or select group of people. Whether or not our Congress' actions are unconstitutional, will depend on whether or not the focus of yesterday's legislation is too limited in its scope.
This could have all been avoided if Chapter 11 bankruptcy had been allowed to happen. In that case, all those bonus contracts would have been null and void under our existing bankruptcy laws. But, if you recall, the bailout was needed because AIG was another one of those companies that was too big to fail. That was our government's choice in this whole mess. By doing so, the Federal government allowed all the preexisting AIG contracts to stand. Now, it appears we want to pick and choose those things we don't like about AIG's business and we want to do so retroactively.
AIG isn't at fault here. All this anger is totally misplaced. We, as the people who elected our current representatives to govern us, are at fault. Our representatives were too stupid to think through all the consequences of bailing out this company and now they want to change the rules to divert attention away from their own stupidity. When our government "unconditionally" gave money to AIG, they did so in good faith and AIG accepted it without a lot of detailed strings attached. That was our fault.
What was done, yesterday, by our Congress, shows what little regard our representatives have when it comes to the rule of law and the importance of established, legal contracts. And, this isn't the first time. Right now, there is a mortgage "cram down" bill working it's way through Congress that would totally obliterate mortgage contracts by allowing a Federal Judge to set new contractual terms and that would, in effect, only benefit the homeowner and not the lender.
In a similar attempt to thwart an international agreement, the Democrats in Congress ignored the contractual commitments of NAFTA and have now blocked Mexican trucks from entering our country to bring in Mexican goods for sale. As a result of that action, we have had trade tariffs imposed on 90 U.S. goods and products being exported to Mexico (See Full Story).
Another form of contract that was dissolved, and by Obama himself, occurred when he declared that companies receiving bailout funds must restrict their executive pay to a $500,000 ceiling. I don't know about you, but when I went to work for a company, they made an offer of a specific salary and I accepted that fact. That was a binding contract under the labor laws of this country. But, now, Mr. Obama seems to think employment contracts mean nothing anymore.
How many more contracts is this government going to void? Obama and the Democrats talk about the importance of the rule of law when it comes to protecting the terrorists at Guantanamo; but, they seem to ignore the same rule of law when it comes to protecting Americans in America. Are we now moving to some form of a lawless dictatorship or a communist-like Politburo? It's sure starting to look that way!
Like it or not, the people at AIG, that received those retention bonuses, got them because they had a contract. That contract was a legal agreement between AIG and themselves. Those contracts were done as part of conducting normal business activities and were negotiated in good faith between AIG and each of those employees. The fact that AIG received bailout funding from the Federal Government can't negate those contracts because they were written before AIG accepted that funding. Anyway, the acceptance of Federal bailout money was a contract between AIG and our government and was totally independent of those retention bonus contracts.
Our Congress knew this and knew that they couldn't override those legal documents by, somehow, passing a law that would retroactively negate them. That would definitely be unconstitutional. So, the Democrats in Congress and some obliging Republicans decided to do an end-around by passing legislation that would penalize the recipients of those bonuses with a 90 percent, retroactively applied tax rate. Even so, that action may be unconstitutional, too, because it may violate Article I, Section 9, of our Constitution by passing legislation that could be defined as a "bill of attainder". A "bill of attainder" is the passage of any law that would specifically target and punish a single person or select group of people. Whether or not our Congress' actions are unconstitutional, will depend on whether or not the focus of yesterday's legislation is too limited in its scope.
This could have all been avoided if Chapter 11 bankruptcy had been allowed to happen. In that case, all those bonus contracts would have been null and void under our existing bankruptcy laws. But, if you recall, the bailout was needed because AIG was another one of those companies that was too big to fail. That was our government's choice in this whole mess. By doing so, the Federal government allowed all the preexisting AIG contracts to stand. Now, it appears we want to pick and choose those things we don't like about AIG's business and we want to do so retroactively.
AIG isn't at fault here. All this anger is totally misplaced. We, as the people who elected our current representatives to govern us, are at fault. Our representatives were too stupid to think through all the consequences of bailing out this company and now they want to change the rules to divert attention away from their own stupidity. When our government "unconditionally" gave money to AIG, they did so in good faith and AIG accepted it without a lot of detailed strings attached. That was our fault.
What was done, yesterday, by our Congress, shows what little regard our representatives have when it comes to the rule of law and the importance of established, legal contracts. And, this isn't the first time. Right now, there is a mortgage "cram down" bill working it's way through Congress that would totally obliterate mortgage contracts by allowing a Federal Judge to set new contractual terms and that would, in effect, only benefit the homeowner and not the lender.
In a similar attempt to thwart an international agreement, the Democrats in Congress ignored the contractual commitments of NAFTA and have now blocked Mexican trucks from entering our country to bring in Mexican goods for sale. As a result of that action, we have had trade tariffs imposed on 90 U.S. goods and products being exported to Mexico (See Full Story).
Another form of contract that was dissolved, and by Obama himself, occurred when he declared that companies receiving bailout funds must restrict their executive pay to a $500,000 ceiling. I don't know about you, but when I went to work for a company, they made an offer of a specific salary and I accepted that fact. That was a binding contract under the labor laws of this country. But, now, Mr. Obama seems to think employment contracts mean nothing anymore.
How many more contracts is this government going to void? Obama and the Democrats talk about the importance of the rule of law when it comes to protecting the terrorists at Guantanamo; but, they seem to ignore the same rule of law when it comes to protecting Americans in America. Are we now moving to some form of a lawless dictatorship or a communist-like Politburo? It's sure starting to look that way!
Tuesday, March 17, 2009
AIG Bonuses: Another Diversion
The $168 million of taxpayer money that is being used on bonuses for the AIG execs may be worth some outrage but, in contrast to all the other billions and trillions of possibly wasted taxpayer money, it is just a "gnat" in the grand scheme of things.
Right now, there is widespread outrage, from both the right and the left, over the AIG bonus thing. Where was that same outrage when billions of wasted dollars were uncovered in the first TARP bailout? Where was the outrage over nearly $10 Billion (not millions of dollars) that were being spent for pork projects in the recent $410 billion spending bill? And, why not the same outrage over Obama's $3.7 trillion dollar budget proposal or his $800 billion not-so -stimulus, Stimulus Program? Neither of which is hardly targeted to recover this economy!
With AIG, we are literally crying over a couple of grains of rice that have fallen off a wheelbarrow full of rice that is destined to be dumped over a cliff. We have completely lost our focus. For the Obama Administration, the AIG bonuses debacle is just what they wanted. It focuses America's anger on AIG and takes the heat off of them for all of their own wasteful spending. Believe me, this is a political diversion that is both intentional and welcomed.
This whole thing with the AIG bonuses reminds me of an "Everybody Loves Raymond" episode where Raymond's brother, Robert, has fallen on some hard times and is only eating bologna at every meal in order to get by. Raymond and his wife, Debra, decide to give him $1000 as a loan. However, because Robert doesn't want to be indebted, he refuses the money. Then, Ray and Debra, still feeling sorry for Robert, just decide to give him the "thousand", outright, as a gift. As the story proceeds, Robert decides to use the money for a vacation in Las Vegas instead of using that money to improve his lifestyle. As a result, Raymond and Debra get angry and want the "gift" back. However, Robert says "no" to returning the money and reminds them that it was given as a "gift" and not as a loan and without any strings attached. The story ends with Robert still going to Vegas but now, with Raymond as a travel partner. Sound familiar?
The problem with all these monies that are being spent by our Federal Government, specifically by Obama and by our Democratic Congress, is that we are sending money, out the door, with absolutely no strings attached and with little thought behind it. Therefore, you wind up with all the corporate Roberts of our world going to Las Vegas on the taxpayer's dime. Then, after the fact, we start asking for the money back or we start trying to attach the strings on how that money will be spent. This is just ridiculous and, surprisingly, it takes the plot of a decade-old situation comedy to remind us of that fact.
Right now, the Obama Administration is just starting to write the rules on how the stimulus program monies will be spent and we and the recipient states are just now starting to find out about rules. However, some of that stimulus money has actually gone out the door without those rules in place. There's an age-old adage that says "haste makes waste." Believe me, the AIG bonus waste will look like child's play as compared to all the other waste that we will ultimately see when the stimulus money has all been spent and after Obama's trillion dollar budget money goes flying out the door. Waste is just commonplace in Government programs. For many years, the Medicaid/Medicare program waste has been running at a rate of about 14% per year and no effective means of abating it have ever been instituted. What makes us think that the Stimulus Program or Obama's fat budget will be any different?
This article from the Washington Post "Anger Over Firm Depletes Obama's Political Capital" seems to say it all about the outrage. But, in addition, it seems to show that a lot of that anger may now be aimed at Obama and the Democrats.
Right now, there is widespread outrage, from both the right and the left, over the AIG bonus thing. Where was that same outrage when billions of wasted dollars were uncovered in the first TARP bailout? Where was the outrage over nearly $10 Billion (not millions of dollars) that were being spent for pork projects in the recent $410 billion spending bill? And, why not the same outrage over Obama's $3.7 trillion dollar budget proposal or his $800 billion not-so -stimulus, Stimulus Program? Neither of which is hardly targeted to recover this economy!
With AIG, we are literally crying over a couple of grains of rice that have fallen off a wheelbarrow full of rice that is destined to be dumped over a cliff. We have completely lost our focus. For the Obama Administration, the AIG bonuses debacle is just what they wanted. It focuses America's anger on AIG and takes the heat off of them for all of their own wasteful spending. Believe me, this is a political diversion that is both intentional and welcomed.
This whole thing with the AIG bonuses reminds me of an "Everybody Loves Raymond" episode where Raymond's brother, Robert, has fallen on some hard times and is only eating bologna at every meal in order to get by. Raymond and his wife, Debra, decide to give him $1000 as a loan. However, because Robert doesn't want to be indebted, he refuses the money. Then, Ray and Debra, still feeling sorry for Robert, just decide to give him the "thousand", outright, as a gift. As the story proceeds, Robert decides to use the money for a vacation in Las Vegas instead of using that money to improve his lifestyle. As a result, Raymond and Debra get angry and want the "gift" back. However, Robert says "no" to returning the money and reminds them that it was given as a "gift" and not as a loan and without any strings attached. The story ends with Robert still going to Vegas but now, with Raymond as a travel partner. Sound familiar?
The problem with all these monies that are being spent by our Federal Government, specifically by Obama and by our Democratic Congress, is that we are sending money, out the door, with absolutely no strings attached and with little thought behind it. Therefore, you wind up with all the corporate Roberts of our world going to Las Vegas on the taxpayer's dime. Then, after the fact, we start asking for the money back or we start trying to attach the strings on how that money will be spent. This is just ridiculous and, surprisingly, it takes the plot of a decade-old situation comedy to remind us of that fact.
Right now, the Obama Administration is just starting to write the rules on how the stimulus program monies will be spent and we and the recipient states are just now starting to find out about rules. However, some of that stimulus money has actually gone out the door without those rules in place. There's an age-old adage that says "haste makes waste." Believe me, the AIG bonus waste will look like child's play as compared to all the other waste that we will ultimately see when the stimulus money has all been spent and after Obama's trillion dollar budget money goes flying out the door. Waste is just commonplace in Government programs. For many years, the Medicaid/Medicare program waste has been running at a rate of about 14% per year and no effective means of abating it have ever been instituted. What makes us think that the Stimulus Program or Obama's fat budget will be any different?
This article from the Washington Post "Anger Over Firm Depletes Obama's Political Capital" seems to say it all about the outrage. But, in addition, it seems to show that a lot of that anger may now be aimed at Obama and the Democrats.
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