Tuesday, March 17, 2009
THE FINANCIAL Products division of American International Group is a monument to corporate greed and irresponsibility. It exploited the AAA credit rating of its parent, the profitable global insurance firm, to underwrite hundreds of billions of dollars worth of financial derivatives without setting aside reserves to cover the potential downside. When it faced a sudden cash shortage last fall, the U.S. Treasury and the Federal Reserve had to take it over, lest the firm's counterparties, which included such pillars of Wall Street as Merrill Lynch and Goldman Sachs, as well as European mainstays Deutsche Bank and BNP Paribas, get dragged down with it. Necessary to preserve the global financial system, the bailout of AIG is nevertheless especially galling because of the firm's recklessness and the staggering cost -- $170 billion at last check, with no end in sight. So everyone felt a surge of outrage upon learning this weekend that Financial Products executives stand to get $165 million in bonuses. The idea that the very people who built Financial Products should now receive so much taxpayer money is, indeed, disgusting.
If fairness and justice were the only considerations, we would join the chorus urging the Obama administration to eliminate the bonuses. Alas, AIG Financial Products still retains tremendous potential to damage the world economy. The firm's remaining $1.6 trillion derivatives portfolio is like one of those delicate, world-destroying time bombs that James Bond used to have to disarm in the movies; the difference here is that the only people who appear to be knowledgeable enough to dismantle the bomb are the ones who built it. Or as the firm's management put it in a recent document, its books "contain a number of complex . . . transactions that are difficult to understand and manage. This is one reason replacing key traders and risk managers would not be practical on a large scale." Translation: Give them the bonuses, or they'll walk out and let Treasury Secretary Timothy F. Geithner try to figure out this mess.
Like most of the people writing about AIG, we have no idea whether this threat is empty. We note, though, that the man closest to the situation, chief executive Edward M. Liddy -- who was brought in by the government to detoxify AIG -- believes that the danger is real and that the potential additional losses from a mismanaged wind-down of Financial Products could run into the many billions of dollars. He counsels paying the bonuses, on the plausible ground that $165 million is the cost of avoiding a much bigger meltdown, for which taxpayers would also be on the hook. In other words, this little episode presents in near-perfect microcosm the broader moral dilemma of bailing out miscreant financial companies.
That doesn't make it any easier politically for President Obama, which is why he went before the cameras yesterday and ordered Mr. Geithner to "pursue every legal avenue to block these bonuses." This forceful statement could mean anything from "don't pay them even if they sue" to "try to negotiate a better deal once the controversy cools." We hope that the president is setting the stage to do whatever it takes to answer legitimate protests about AIG without adding to the existing dangers or jeopardizing the necessary rescues of the banking sector still to come. In his address to Congress last month, Mr. Obama observed that "we cannot afford to govern out of anger, or yield to the politics of the moment." Those remain wise words.
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