Notes on the AIG story

Make This One Go Viral: Obama’s Stimulus Bill Explicitly Grants AIG the Legal Right to Hand Out Unlimited Bonuses (Update)

This amendment provides an exception for contractually obligated bonuses agreed on before Feb. 11, 2009, which exempts the very AIG bonuses Obama is condemning every single chance he gets. The amendment is in the final version and is law.

And who’s responsible for that language being there? Sen. Christopher Dodd (D-CT):
Embedded video from CNN Video
Embedded video from CNN Video

Dodd lied. He spent a full day lying to the American people, and now he’s trying to shift blame to others. He and his pal Barney Frank want to publicly name the people who received the bonuses authorized by Congress and this administration in an attempt to deflect blame for their own actions.

And whose idea was it to add the language on the bonuses? The Obama administration’s.

Both Dodd and a Treasury Department official who asked not to be named told CNN the administration pushed for the language because they were afraid that the government would face numerous lawsuits without it.Dodd told CNN’s Dana Bash and Wolf Blitzer that Obama administration officials pushed for the language to an amendment designed to limit bonuses and “golden parachutes” at those companies.”The administration had expressed reservations,” Dodd said. “They asked for modifications. The alternative was losing the amendment entirely.”

(Incidentally, speaking of bonuses from AIG, you know who else got over $100,000 from them? Barack Obama.) Dodd clearly bears considerable responsibility for this mess; but the president who proclaimed “a new era of responsibility” wants him to take all of it, in order to protect Tim Geithner and Lawrence Summers (and possibly himself). I can’t think that’s going to go over well with the Congressional Democrats.As unpopular as it may be to say, though, hammering AIG and the folks who took the bonuses is unwise.  There was actually some reason for these bonuses, for one thing—it may not have been sufficient, but this wasn’t just an attempt to fleece the taxpayer—and for another, the downside here is much greater than the upside, as Ruth Marcus points out:

In the short run, hammering the AIG employees to give back their bonuses risks costing the government more than honoring the contracts would. The worst malefactors at AIG are gone. The new top management isn’t taking bonuses. Those in the bonus pool are making sums that for most of us would be astronomical but that are significantly less than what they used to make. Driving away the very people who understand how to fix this complicated mess may make everyone else feel better, but it isn’t particularly cost-effective.In the longer term, having the government void existing contracts, directly or indirectly, as with the suggestions of a punitive tax on such bonuses, will make enterprises less likely to enter into arrangements with the government—even when that is in the national interest. This is similarly counterproductive.Remember, the contracts were negotiated long before the government put a cent into AIG. “The plan was implemented because there was a significant risk of departures among employees at [the company],” AIG wrote in a paper explaining the plan, “and given the $2.7 trillion of derivative positions at [the company] at that time, retention incentives appeared to be in the best interest of all of AIG’s stakeholders.” . . .”That was then and this is now” is not a valid legal principle. “We are a country of law,” Obama economic adviser Lawrence Summers said Sunday. “There are contracts. The government cannot just abrogate contracts.” He was right. . . .The administration argues that anger over the bonuses, among the public and members of Congress, was at such a level that the president needed to say something to show that he understood the fury. Perhaps, but there is a countervailing risk in stoking this populist rage—especially if the administration needs to come back to Congress for more money for the banks.Once the pitchforks are out, it’s awfully hard to convince the mob to put them down.

Truth to tell, though, I think Marcus has misunderstood the reason for President Obama’s faux-populist outrage; I think this is a deliberate attempt at misdirection.  After all, firing up “the mob” may be risky, but it’s the easiest way to manipulate a lot of people at once.  This whole scenario reminds me of the many mysteries I’ve read/watched in which the person who “discovered the body” actually turns out to be the killer.  What better way to keep people from thinking that you’re the one who did the deed than to be the guy who rushes out into the street shouting “Murder!”—it’s classic sleight-of-hand.  Blow outrage at the man who only took over after the disaster happened (and who at least has a plan to restructure AIG and repay the Treasury, which is more than we can say of anyone else) and at the big shots getting the big bonuses, you get folks made at all those “rich Republicans” (even if most of them actually voted Obama) and (you hope) keep them from looking for evidence of Democratic complicity.That complicity, by the way, goes beyond the White House or the Senate.  Most people remember, vaguely, that New Mexico Governor Bill Richardson withdrew his nomination to Commerce because he was under investigation in a pay-for-play scandal, but most folks don’t know anything about the nuts and bolts of that investigation, or about CDR Financial Products, the company on which it’s focused; unless you live in a county that’s staring at bankruptcy because of CDR’s “black box” deals, you probably don’t know that this scandal goes a long way beyond New Mexico.  In particular, you probably aren’t aware that this scandal is connected to the whole mess with AIG, or that Democratic politicians are tied into it at all levels of government.  The blog The 46 has been tracking this story for a while now; start with the post linked above and follow it out—the whole mess is complicated and will take some real focused attention if you aren’t a financial whiz, but it’s well worth your time.  When you understand the ways in which CDR has been colluding with local companies and politicians to use municipal bond issues to line their own pockets at taxpayer expense, it will blow your mind.Finally, Larry Kudlow offers a note of hope in the midst of everything.  He’s ticked over the way the government has mismanaged the takeover of AIG, calling it a “fiasco” and a “complete farce,” and concluding, “The government shouldn’t run anything, because it cannot run anything”; at the same time, though, he believes there’s reason for optimism:

This week’s decision by the Federal Accounting Standards Board (FASB) to allow cash-flow accounting rather than distressed last-trade mark-to-market accounting will go a long way toward solving the banking and toxic-asset problem.Many experts believe mortgage-backed securities and other toxic assets are being serviced in a timely cash-flow manner for at least 70 cents on the dollar. This is so important. Under mark-to-market, many of these assets were written down to 20 cents on the dollar, destroying bank profits and capital. But now banks can value these assets in economic terms based on positive cash flows, rather than in distressed markets that have virtually no meaning.Actually, when the FASB rules are adopted in the next few weeks, it will be interesting to see if a pro forma re-estimate of the last year reveals that banks have been far more profitable and have much more capital than this crazy mark-to-market accounting would have us believe.Sharp-eyed banking analyst Dick Bove has argued that most bank losses have been non-cash—i.e., mark-to-market write-downs. Take those fictitious write-downs away and you are left with a much healthier banking picture. This is huge in terms of solving the credit crisis.

This follows on a piece he wrote last Friday in which he wrote,

Out of the blue, bank stocks mounted an impressive rally this week, jumping nearly 40 percent on the S&P financial list. One after another, big-bank CEOs like Vikram Pandit of Citi, Ken Lewis of BofA, and Jamie Dimon of JPMorgan are telling investors they will turn a handsome profit in the first quarter, their best money gain since 2007. This is big news. And it triggered the first weekly stock gain for the Obama administration.But this anticipated-profits turnaround doesn’t seem to have anything to do with the TARP. It’s about something called the Treasury yield curve—a medical diagnostic chart for banks and the economy.When the Fed loosens money, and short-term rates are pulled well below long rates, banks profit enormously from the upward-sloping yield curve. This is principally because banks borrow short in order to lend long. If bankers can buy money for near zero cost, and loan it for 2, 3, or 4 percent, they’re in fat city. Their broker-dealer operations make money, as do all their lending divisions.So the upward-sloped yield curve is the real bailout for the banking system.Now, turn the clock back to 2006 and 2007. In those days the Treasury curve was upside down. Due to the Federal Reserve’s extremely tight credit policies, short-term rates moved well above long-term rates for an extended period, and that played a major role in producing the credit crunch. Since interest margins turned negative, the banks had to turn off the credit spigot, and all those exotic securities—like mortgage-backed bonds and various credit derivatives—could no longer be financed.The Fed’s long-lived credit-tightening also wreaked havoc on home prices and was directly responsible for the recession that began in late 2007. At the time, Fed head Ben Bernanke said the inverted yield curve wouldn’t matter. Gosh was he wrong.

In other words, Kudlow’s arguing (and the evidence seems to be with him) that the credit crash was caused by federal over-management of the economy, and that now that that particular form of over-management has ceased, things are starting to recover.  He went on to argue in that column that “if somebody tells the banks they don’t have to sell these loans at distressed prices,” which is what the FASB’s rule change noted above has done,

the banks will enjoy plenty of breathing room to reap the benefits of the upward-sloping yield curve.Let the banks hold these investments over a long period, rather than force them to sell now. The economy will get better, as will housing and other impaired assets.

If his analysis is correct—and the evidence seems to be with him on this—then the recovery has already begun; we simply need to let it take the time it’s going to take.  The one thing that seems to be clear is that further government attempts to manage the recovery will only make matters worse, since the government can’t manage its way out of a paper bag.  That’s not a shot at Democrats, either, as it was no different when Republicans are running the show—the economy is simply too big to be managed.  All you can really do is try to keep the rules as fair as possible and try to manage the inputs so as not to distort the market (since distortions create greater opportunity for bubbles and subsequent crashes).  Here’s hoping our current government can at least resist the temptation to make matters worse.