The 22nd Book: The Book Of The Dead

Impressive and somewhat justified outrage about the AIG bonuses swirled through the news and blogs this weekend.  The story that no one is noticing is that Federal support for the AIG security lending business is much greater than the Federal support for the credit derivatives business.  Who broke AIG? Regulators and those who love them will prefer to tell a story about mysterious, unchecked credit derivatives, but the truth seems to be a bit more complicated and prosaic.

Let me start on a positive note by lauding Josh Marshall, who nicely captures the current disillusionment accompanying the discovery that he who pays the piper does not, in fact, call the tune:

We're collectively taking our country's future in our hands, spending vast sums of money to keep these companies from suffering the consequences of their own folly and (in many cases) criminality. And in return we're receiving cavalier dictates about pay-outs and bonuses from executives who by any reasonable measure work for us -- dictates we promptly accede to. There's a beggars can't be choosers problem there. And the disconnect is so mighty that it fuels the impression that the whole enterprise is not what it seems, not what we've been told, that in addition to picking up the tab we're being played for fools.

Hilzoy sneaks a peek at the truth of the situation but quickly backs away:

As far as I can tell from reading this explanation from AIG, and this letter from its CEO to Sec. Geithner, there are two issues. One is contractual: they promised their employees all this money back in the spring of 2008. To which I can only say: what sort of idiot would commit a company to paying a bonus to an employee even if that employee took down the company?

...The second, which is much harder to accept, is that no one but the idiots who put these trades together understands them well enough to unwind them. (See pp. 3-4 here.)

Well, well.  Who indeed would retain the idiots who "took down" the company?  As the letter to Geithner explains, AIG FP is hardly monolithic.  They divided their acvtivities into 22 "risk books", each of which must be managed.  I strongly suspect that the credit derivatives books only represents one or a few books - corporate, multi-sector, sub-prime, and prime would be four logical credit derivative divisions (the letter mentions a "regulatory capital CDS book" of $234 billion).  However, AIG FP has huge ongoing operations in currency swaps, commodity swaps, and interest rate swap and option products in multiple currencies, so it is entirely possible that all the credit derivatives are packed into the 22nd book, the book of the dead.

Some folks are clearly under the illusion that all 370 AIG FP employees spent their days (and nights!) writing credit derivative swaps that were doomed to disaster.  Let me just sketch an alternative hypothetical scenario for the outraged to contemplate.

Joe Cassano, who ultimately emerged as the leader of AIG FP after several rounds of managerial changes, was one of several contenders for the top post.  His rivals, some of whom may have had serious disagreements with his personal style and professional judgments, could elect to stay on in senior posts at the satellite offices in Tokyo, Hong Kong, Wilton, Paris, and wherever, or they could leave for high paying jobs at hedge funds or other investment banks.  Some stayed. 

In the spring of 2008 it was clear that the Cassano-led charge into credit derivatives was an impending disaster and Cassano was on the way out.  Would it better for the AIG board to (a) sack Cassano and let his disgruntled rivals quit for jobs at other firms, or (b) sack Cassano and guarantee a bonus pool to those who agreed to stay on and attempt to pick up the pieces?

The idea that the only correct answer is (a) is absurd.  Now, in attempting to pick up the pieces the AIG board may have erred in not fully separating the wheat from the chaff; I have no doubt that some of the people collecting guaranteed bonuses were part of the Cassano problem, just as I am sure that many were not.  That said, the firm is down to 370 employees from 450 in the spring of 2008 (again, from the letter), so some sort of right-sizing is happening.  As a political matter Republicans would be insane to rise up in defense of this people.  However, folks interested in a post-partisan understanding of the issues might want to reflect before condemning.

Finally, let me point out that there is a tremendous misdirection play going on here being perpetrated by our current regulators and those who love them.  As I have said before, the losses at AIG FP never seemed to add up to enough to break the entire company.  In fact, other units of AIG were also also chasing yield in the housing market; here is a Bloomberg story from June 2008 about AIG's problem with securities lending:

June 27 (Bloomberg) -- American International Group Inc. plans to absorb losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse during the past year.

...The securities-lending business caters to banks and brokerages that borrow for themselves and clients to hedge trades, cover bets that a stock will fall and avoid trade- settlement failures. AIG's life-insurance subsidiaries invest their premiums in stocks and bonds. To make extra money, they lend out those securities through a central pool that invests cash collateral.

AIG said in regulatory filings that about $9 billion of the markdowns on mortgage-backed securities resulted from temporary market-value declines that it expects to be reversed. Those unrealized losses don't affect earnings.

The securities lending business has never caught the public's imagination in the way that M&A buccaneers or "Master of the Universe" traders did.  However, we see by the latest AIG release that more only slightly less Federal support went to buck up AIG's collateral lending then went in [direct and indirect] support of their credit derivatives activities.

AIG FP was supported on credit derivatives, some municipal investment agreements, and maturing debt.  Of a total of $52.4 billion in direct support for that unit from Sept to Dec 2008, $27.4 was related to credit derivatives.  [In a separate entity, Maiden Lane III, we learn that an additional $27.1 billion was paid to AIG FP credit derivative swap counterparties, for total support of roughly $54 billion for the credit derivatives.]

On the last page of the filing (insufficiently glamorous to get its own pie chart) are the payments made in support of AIG's security ending, handled in a different division.  The amount: $43.7 billion.  Without benefit of a calculator I can assure you that $43.7 billion is much larger than $27.4 billion just a bit less than $54 billion yet I note that public outrage is much less.

So que pasa?  Well, bashing highly paid Wall Street financiers peddling products no one understands is a lot more fun than bashing a bunch of collateral clerks doing something or other about which no one cares.

This misdirection is aided and abetted by the mysterious Powers That Be, who hope to persuade the world that the problem was in mysterious, unregulated derivatives, thereby letting our current drop of regulators off the hook for the AIG debacle.  Here is Exhibit A, from March 5 2009:

WASHINGTON (Reuters)—The securities lending unit of American International Group Inc. was being successfully wound down and had manageable losses if not for the firm's massive credit default swap exposure, New York Insurance Superintendent Eric Dinallo said on Thursday.

Mr. Dinallo told lawmakers that AIG's financial products unit, which had written about $440 billion in CDS, should have been subject to more and better regulation.

"Without the crisis caused by Financial Products, there is no reason to believe there would have been a run on the securities lending program," Mr. Dinallo told the Senate Banking Committee in prepared remarks. "We would have continued to work with AIG to unwind its program and any losses would have been manageable."

Rubbish.  DiNallo had specific oversight responsibility while the securities lending area lent out AIG's securities, took in cash or bonds as collateral, then sold the collaterl in order to buy sub-prime mortgages that went bust.  Now the Feds have ponied up $44 billion to keep that going, and DiNallo wants to play "pass the parcel", as the Brits quaintly put it.

The alliance between the current crop of regulators (who failed badly) and the political element that always favor more regulation of everything will assure that credit derivatives remains the whipping boy.  As Exhibit B, here is a NY Times editorial from yesterday ranting about credit derivatives and failing to note even in passing the enormous AIG losses in the seemingly well-regulated securities lending area.

As I said, the interest of those who always favor more regulation lies in insisting that the problem with AIG was an absence of regulation.  Now that we know the extent and direction of the government support for AIG it will be interesting to see whether the Times business people (who have been OK on this) follow the real story.  The Times did note problems with Dinallo's Senate testimony (deeply buried):

“The creation of financial supermarkets can have what I would call a knock-on effect,” said Eric R. Dinallo, the New York State insurance superintendent.

He said state insurance regulators had done a good job keeping A.I.G.’s insurance subsidiaries solvent. But then A.I.G.’s derivatives business — A.I.G. Financial Products, the purveyor of the now-notorious credit-default swaps — got into trouble. The financial products unit was not an insurance company and was beyond state purview, Mr. Dinallo said. But it was under the same umbrella with the insurance companies, and in the crisis, it threatened to strip the insurers’ capital away.

“Thank God, there are still some separations intact,” Mr. Dinallo said.

Mr. Shelby expressed doubts that A.I.G.’s state-regulated insurance companies were entirely innocent. He said they had engaged in a risky securities lending business and ended up needing $35 billion of the Fed’s bailout last fall.

“Are you trying to evade your responsibility?” he asked Mr. Dinallo. “You can claim here today that you have little responsibility for all of these problems?”

Mr. Dinallo said that it was true that the securities in the lending program were the property of A.I.G.’s insurance companies, but that the lending activity had been orchestrated by another part of A.I.G. — a special unit set up and controlled by A.I.G. the holding company. State regulators had no jurisdiction over the special unit, but it could layer big risks back onto the insurers, he said.

In any case, Mr. Dinallo said that the New York State Insurance Department spotted the problem in 2006 and began quietly working with A.I.G. to unwind the risky investments. But they ran out of time. Only about a quarter of the portfolio had been cleaned up by the time last September’s crisis struck.

NO WAY: From the letter to Geithner explaining the AIG risk position we learn that "in the interest rate book" a move of one basis point would, if unhedged, result in a value change of $700 million.

By way of comparison, $700 billion of ten year Treasuries change in vaue by (roughly) $700 million if the yield changes by 1 basis point.  Does that seem like a lot of ten year Treasuries?  Total public debt of the US is about $6.7 trillion, so that would be 10% of the total (What, you want a maturity schedule?)

I doubt that AIG FP is swinging that large a long or short Treasury or futures position, which leaves me wondering what that number means.  Gross "long" positions added to gross "short" positions?  Maybe...

Comments

[kim]

And Jane Hamsher says 'Who stole our country and how are we going to get it back'. Hah, hah, hah. 8:45AM the time of the day.
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[clarice]

I think you made a typo here:"That said, the firm is down to 370 employees from 40 in the spring of 2008 "

I really think you need to write a treatise pulling all this together, TM. You seem to be the one person who understands this all.

[MayBee]

I just saw an ad for Stein Mart (the discount clothing store).
The WORLD IS ENDING because the woman in the ad says she thinks "Michelle Obama would go in there...I really do!"

[matt]

I wonder how much of the complexity was purposely created to block a clear view of the companies finances and financial relationships. It reminds me of Kozlowski at Tyco and his "deal a day" cooking of the books. There were always 20-30 buyouts and mergers to cloud the true financial condition of the company.

[Charlie (Colorado)]

...22nd book, the book of the dead.

I hope you're proud of yourself for that.

O nobly-born AIG CDO book, the time hath now come for thee to seek the Path [in reality]. Thy breathing is about to cease. Thy guru hath set thee face to face before with the Clear Light; and now thou art about to experience it in its Reality in the Bardo state, wherein all things are like the void and cloudless sky, and the naked, spotless intellect is like unto a transparent vacuum without circumference or centre. At this moment, know thou thyself; and abide in that state. I, too, at this time, am setting thee face to face.

[MayBee]

Suggested defenses for AIG:

But $165 million is only .1% of the total bailout!

or
This was last year's business

[MayBee]

Geithner is going to issue a signing statement, nullifying the bonuses.

[Jane]

This was last year's business

So was this:

Prior to his inauguration, President Obama met with Democrats in Congress and threatened to veto any bills that placed tougher restrictions upon the usage of TARP funds.

[bgates]

Taking the concept further,

But $165 million is only 0.00458% of the 2010 federal budget.

[bad]

I was trying to concentrate on the finanacial issues but keep getting distracted by "Gross Positions."

Are we supposed to make a list?

[clarice]

Is Gross Positons a version of the Song Celestial book from India or something?

[barb in ATL]

MayBee,

I saw that ad for Stein Mart this morning too. I vowed never to shop there again.

[James H]

If a move of one basis point changes the value of their totals positions by $700 million, that implies the total positions have a value of $7 trillion. Conceivable but doubtful. I suspect the $700 million figure is in error.

[TCO]

We should have let the pig go tits up a while ago. The interventionists like kim have transferred huge amounts of taxpayer money to cover losses by Goldman Sachs and Warren Buffet. The sooner that pig got stopped and all the trades unwound under a Chapter 11, the better. The delay is costing more money. What are we on, round 4 of bailouts. Bad deal, kim, ya RINO commie.

[kim]

You lie about my belief in interventions, TCO. Why do you do so?
============================================

[Tom Maguire]

...22nd book, the book of the dead.

I hope you're proud of yourself for that.

I have been insufferably cheering for myself - "Ra, Ra, Ra."

I think you made a typo here:"That said, the firm is down to 370 employees from 40 in the spring of 2008 "

The "5" key is sticky on this keyboard, so I steer away from numerically-oriented posts. More emotion, fewer numbers!

This was last year's business

I love this game.

[hit and run]

MayBee:
This was last year's business

Hah!

http://blogs.abcnews.com/politicalpunch/2009/03/two-weeks-ago-w.html>Tapper, 2 weeks ago:

TAPPER: AIG, is the administration confident that it, that it knows what happened to the tens of billions of dollars previously given to AIG?

GIBBS: Is it confident -- I'm sorry?

TAPPER: That they know -- that you guys know what happened to the previous billions before you hand over this next $30 billion.

GIBBS: Yes -- yes, the -- I mean, I don't think it's a -- well, obviously, you've got a huge insurance company that is losing money, not the least of which because of its sheer size and sheer size and decrease in the growth in our economy. It experiences a far bigger drop, largely because of its size. But, again, the steps that -- that Treasury and -- and others took were to ensure a larger systemic problem wasn't one that we had to deal with here today in letting something just die.

TAPPER: But in terms of specifically the -- I guess it's like $150 billion before, you guys are confident...

GIBBS: Yes.

[TCO]

I hold you accountable, you fucking cunt. You think you can spout that anti free market crap and do it under a Repulican guise and I will hold the blowtorch of truth to your cherry asshole. Do you track, moron. You dumb. You bad.

[bad]

Tapper's running a thread on that exchange from two weeks ago. Maybee reminded him.

[bad]

TCO take your meds.

And don't use profanity when addressing me.

[Ignatz Ratzkywatzky]

OK. How does that troll-blocker work again?

[Roy Mustang]

Considering AIG should have gone Chapter 11, I really find it hard to muster up an argument that would allow these workers to keep their government infused bonuses.

[TCO]

Bad: Ok.

[mel]

OK, and whereas I jump into fray to ask a few pertinent questions.

"Whose securities was AIG lending?"

"Did they lose the actual securities being lent, or the overnight commitments to pay for borrowing them?"

"Was this sucking chest wound of a loss from AIG's general investment account, the one that backs their normal insurance business?"

If any member of the administration or Congress can answer those questions, I'll listen. Will they answer those questions is a whole nuther story. Demagoguery is so much easier.

[bad]

Sen. Grassley says AIG execs. should aplogize, then resign or commit suicide.

LUN

[Charlie (Colorado)]

TCO, I realize the long sentences may have thwarted your minimal ability to maintain concentration, but Kim has not been one of the people in favor of the bailouts, and obscene ranting won't make it any more true.

[mel]

Grassley first, thankyouverymuch. Made any money trading corn lately, Chuck?

[mel]

Not You ChaCo!

[Charlie (Colorado)]

"And the most mystical of the bands, the Nine Unknown Men, ceremonially donned football helmets, turned to the rising sun and chanted

There is only one god
He is the Sun God!
Ra! Ra! Ra!"

[Charlie (Colorado)]

Not You ChaCo!

Here I thought it was a remark about my sense of humor.

[clarice]

TCO. You called bad a "cunt" on a JOM thread?

Have you no sense of restraint whatsoever? I think you'd better apologize and then leave until you can exercise some adult self-control.

[bobby b]

"We should have let the pig go tits up a while ago."

Yeah, and we SHOULD have let all the fires out west burn free over the last twenty years, and we SHOULD stop using most antibiotics for trivial infections, and we SHOULD pay more attention to long-term infrastructure instead of building new Murtha-buildings, and we SHOULD be more willing to take spending decreases than we are to take taxing increases, but we WON'T ever never no-how no-way uh-uh take short-term pain if we can delay it even slightly by selling our not-yet-born kids' toys and food and medicines for money to bribe the pain away for a week or two.

[Mark Buehner]

Here's the argument- we are in the process of pouring hundreds of billions of dollars into AIG. Is this a good time to put a bullet in AIG's head? Perhaps we should get our priorities established before we do anything we might well regret.

[SAM]

Regarding your comment about misdirection... the problem very ofiten is that journalists don't understand the topics they cover. They went to journalism school and have not market knowledge, and I bet that whoever wrote the article doesn't know the difference between CDOs and credit derivatives and, therefore, treats them as the same thing. In AIG's case, however, they used credit derivatives to cover CDO's so that might be why credit derivatives are the bogeyman. The other problem is that very few in Congress have a clue about the market and are easily misled and, of course, most of them are lawyers, who spent their time demonizing their opponents -- it's the only language they know. Once they decided credit derivatives were the bad guy, that becomes the meme.

The "idiot" traders you refer to report to people higher up the food chain and trade according to executive approval. The executives want the traders around to unwind the assests because they don't want to be bothereed doing it themselves, and they need scapegoats.

I'm shocked that any company would hand out "performance" bonuses to individuals who didn't perform well. In many companies the performance bonuses are made up of individual and company measures so that the overall bonus paid out may be nicked if the company's or individual's results were below target. That AIG didn't have an over-riding statement declaring bonuses void if the company failed is hard to fathom. There are companies, who didn't get bailout money, that have not paid bonuses to individuals who met their targets because the company's stock dropped.

[Bob]

AIG will continue to get money because
1. AIG manages congresscritters' 403(B) plans.
2. Family members of prominent congresscritters own big blocks of AIG stock.

[Aaron]

I think TCO is right - these institutions need to fail. And we should never again have "too big to fail" institutions as they simply breed moral hazard.

[Rick Ballard]

"Is this a good time to put a bullet in AIG's head?"

I dunno - do you think that the mortuary could keep BNP Paribas, Credit Suisse, DeutschBank and UBS looking lifelike through the summer?

[clarice]

sam, I'm shocked you posted without reading--these are not (per TM) performance bonuses, but rather retention bonuses these people were promised last spring.

[Neo]

At least they still have jobs ...

Iranian children's program ...

A show host announced the boy had won a toy monkey for behaving himself. Then the host asked the boy, “What is this monkey’s name?” The boy said, “Well, my father calls him Ahmadinejad.”

Show Canceled by IRIB, Iran’s state broadcaster

[kim]

Oh, man, do I feel sorry for the kid and his dad. And mom and siblings and all ancestors and cousins out to thirds and thrice removed. Speaking of removed.
==================================

[kim]

This is the sort of governance Nick could get behind. Hey, Nick, does Iran have WMD?
============================================

[ToBB]

Why do the American People continue to put up with this kind of B.S., are we really this dumb? NO one Company or Person is to big to fail. My home based business has failed since Nov of 2008, where is my bailout?
Instead of giving more to large corps, why not split bailout between legal US citizens and let us decide which Companies deserve to be saved. I don't believe we could do much worse than these guys have, We may actually make some impronements.

[Mike]

So whats up with our reps? They can't come up with better terms for the loans to AIG, to stop the theft of these funds? 165 million in bonuses is white collar crime. Isn't the government the major stock holder? But, with no control over the company? The government should have funneled the funds to AIG thru street loan sharks. That way, we could have a little street justice on these execs. Is there a list of executive names and addresses that received the bonuses? How about pictures of the execs, that could be published.

[catherine earl]

It is time that AIG take their medicine like everyone else. If it were up to me, all the lending institutions that were quagmired would go belly up. State employees in Arizona were promised a pay increase for the next three years. Guess what? The state just didn't have the money. So...no increase. AIG needs to step up to the plate and tell the employees sorry...no bonuses, you should be lucky you have a job!!!promised a bonus

[clarice]

catherine, not only were these employees promised the bonus in spring of 2008 if they stayed and heloed AIG, but Dodd wrote into the stimulus bill that these pledges for bonuses would not be effected.

[kim]

We know Dodd and Frank are desperate crooks and demagogues, but Dodd's outrage now, and his chicanery then are so black and white even a child could understand the depth and darkness of the blackness of Dodd's soul.

And Obama is no better. Whether he knew it or not, his administration knew about these bonuses, and allowed them when they might have been able to stop them. His outrage is completely synthetic, and any real outrage he has should be directed at his own administration which allowed him to fall into this particular mess. He'll never understand it and since he is used to externalizing blame and guilt, he'll be trapped into similar scenarios in the future. Get used to him trying to fool you, because he consistently fools himself.
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[janice]

How can these people face their friends, neighbors and family who are suffering from loss of jobs, retirement, and homes?

[SAM]

Clarice,

Nice of you to make assumptions about others... I read the post but misunderstood the bonus information. That's all. Nothing to be shocked about.

But thanks for being the schoolmarm of the comment section. It must be hard to be perfect.

[clarice]

Oh, please, Janice.
If they hadn't stayed on after the promised bonuses and gone to work for UBS or someone else who richly compensated them and AIG tanked earlier would that make you feel better?
You are not paying the least bit of attention to the facts in this case...and frankly, your fe-el-ings are not my favored basis for decision-making.

[clarice]

It's very hard, Sam--very hard work but someone has to do it. Sorry, if I offended you but we seem to have a swarm of agitators posting on the bonuses none of whom seems to have paid the slightest bit of attention to anything but demagoguery and deliberately distracting dtatements..

[jb]

Yes the AIG folks are greedy idiots -- that's a given. But AIG scores a lot lower on the idiot scale than the people we elected to Congress. Congress ranks much higher on the pompous ass scale too.
Why the uproar on the bonuses? The people we elected let this happen -- and are in on the scam to boot. Yes the bonuses and AIG are hideous, but not nearly as hideous as many of the men and women we put in charge of taking care of our country's business -- and our freedom.

[kim]

To your great credit, SAM, but for the error about retention bonuses, the rest of your post makes eminent sense.
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