March 26, 2009

Get a Grip

Posted by JSpur at March 26, 2009 12:02 PM

This morning's edition of The Wall Street Journal reports that AIG's Paris unit is scrambling to find replacements for two executives who have tendered their resignations in the wake of the bonus "outrage." Apparently, something like $264 billion in derivatives contracts will be declared in default if the two men are not replaced to the satisfaction of French bank regulators. This is because such contracts typically contain "key man" or "change of control" clauses that are triggered if certain important personnel leave and aren't satisfactorily replaced.

Here is one example- among many- why it was more than just stupidity or greed for AIG to pay retention bonuses. Losing some of the people it currently has puts billions of dollars at risk.

So, listen up people. Your outrage about these bonuses may be "justified." But by indulging yourself in it, instead of controlling it, you are potentially costing yourself (and me, and every other taxpayer) money.


I guess the idea behind such a clause is that the contracts require some kind of complicated maintenance to be done by appropriately-trained personnel? It seems a bit shady that these guys were able to write a dead-man's switch into the contracts such that the derivatives blow up if they were to get fired later on.

Posted by: Arcane Gazebo | March 26, 2009 8:37 PM

The Journal story reports:

"according to a person familiar with the matter; the provision is often included in derivative contracts where parties want to preserve a way out if something about their counterparties changes."

In other words, these clauses are often inserted to benefit the party on the other side of the trade from AIG. They are not uncommon- real estate funds often have them in their documents as protection for the investors in the event there are changes of senior management at the fund sponsor- this so the investor can reevaluate how that change may affect the integrity of its investment.

Given how complicated some of these derivatives trades are, AIG's counterparties may well have wanted a way to protect themselves should the people they were dealing with on the other side suddenly disappear. Which would go a long way toward explaining the need to retain such people, and even pay them money to incentivize them to stay.

Posted by: JSpur | March 26, 2009 8:51 PM

It is only a problem because AIG some deluded souls think that something bad would happen to the economy if AIG went completely bankrupt, laid off all employees and shafted its stockholders and bondholders. In practice, AIG had an obsolete business model, and zeroing out the entire corporation would make room for a new generation of financiers. Preserving AIG is basically cargo cult thinking, confusing finance and economics.

When FDR proposed a bank holiday, economists and pundits predicted all sorts of dire things, but as one sensible analyst put it, Americans weren't going to climb trees and start throwing coconuts at each other just because all the banks were closed. As it turned out, the banking business emerged quite nicely, and few coconuts, if any, were thrown.

When a productive enterprise, like an airline goes bankrupt, it provides an opportunity. The airplanes, runways, trained pilots and staff, landing slots and so on do not vanish into dust. They just become available at reduced prices for a new generation of airlines. If AIG goes away, there are no productive assets involved, save perhaps for some office furniture, so it would be even easier for new insurers and financial operators to emerge.

The entire finance industry is based on expensive computing, limited information, and costly communications. These constraints no longer exist. There is no reason that two kids in a garage can't set themselves up as Federal Reserve credit resellers, insurers or trading house operators.

Personally, I think it's time to move on. The real world has already done so.

Posted by: Kaleberg | March 26, 2009 10:43 PM

Your comments make considerable sense but, sadly, they are irrelevant- and have been since Sept 15 2008 or thereabouts, when the government bailed out this turkey. The Treasury will never let AIG go under now that we have sunk all these billions into it, and my basic point is that it makes no sense to let an unruly mob, whose interest is primarily in retribution and payback directed at people who have long since really and truly "moved on" and are beyond their reach, cost us yet more billions and billions in the form of good money after bad, just to save a few measly hundreds of millions in bonus dollars, which were promised with the good intention of mitigating our future losses.

To the extent your hypothesized two kids in a garage turn out to be successful someday, it's a pity to think that much of their earnings will be taxed away to pay for the mistakes we are making today, including specifically those made simply because anger was allowed to drive decision-making, instead of rational analysis.

Posted by: JSpur | March 26, 2009 11:04 PM
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