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The Treasury will use a $30 billion infusion into AIG to force the company to repay all of the bonuses promised to employees of its Financial Products group, a White House official said.

My suggestion: PAY THESE BONUSES WITH AIG STOCK.

Meanwhile, a Yale Law School student knows how the to stop the AIG bonuses:

Larry Summers claims that nothing can be done about the AIG bonuses. As a former Secretary of the Treasury, he should know better.

Treasury Secretary Tim Geithner should direct the Commissioner of Internal Revenue to challenge the AIG bonuses as unreasonable compensation under the Internal Revenue Code. Finding the AIG bonuses to be unreasonable compensation would render them nondeductible for federal tax purposes, and would strengthen potential shareholder derivative suits to recapture The Great AIG Giveaway.

Section 162(a) of the Internal Revenue Code declares:

“There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including . . . a reasonable allowance for salaries or other compensation for personal services actually rendered.”

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UPDATE: March 16 20093:59pm

NYT: Obama Orders Treasury Chief to Try to Block A.I.G. Bonuses

President Obama vowed to try to stop the faltering insurance giant American International Group from paying out hundreds of millions of dollars in bonuses to executives, as the administration scrambled to avert a populist backlash against banks and Wall Street that could complicate Mr. Obama’s economic recovery agenda.

“In the last six months, A.I.G. has received substantial sums from the U.S. Treasury,” Mr. Obama said. He added that he had asked Treasury Secretary Timothy F. Geithner “to use that leverage and pursue every single legal avenue to block these bonuses and make the American taxpayers whole.”

In strongly-worded remarks delivered in the White House East Room before small business owners, Mr. Obama called A.I.G. “a corporation that finds itself in financial distress due to recklessness and greed.”

“Under these circumstances, it’s hard to understand how derivative traders at A.I.G. warranted any bonuses at all, much less $165 million in extra pay,” Mr. Obama said. “How do they justify this outrage to the taxpayers who are keeping the company afloat?”

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Hat tip: Real Time Economics

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Source:
Larry Summers: Stop the AIG Bonuses. Yes You Can.
Aaron Zelinsky, Articles Editor, Yale Law Journal
HuffPo, March 15, 2009 | 10:16 PM (EST)

http://www.huffingtonpost.com/aaron-zelinsky/larry-summers-stop-the-ai_b_175151.html

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).

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Systemic Risk
March 16, 2009

“Systemic risk is the risk imposed by inter-linkages and interdependencies in a system or market, which could potentially bankrupt or bring down the entire system or market if one player is eliminated, or a cluster of failures occurs at once.

Systemic financial risk occurs when contingency plans that are developed individually to address selected risks are collectively incompatible. It is the quintessential “knee bone is connected to the thigh bone…” where every element that once appeared independent is connected with every other element.”

Source: AIG draft document dated Feb. 26, 2009, ABC News and Barry

Ritholtz website, http://www.ritholtz.com .

We are almost two years into this developing financial mess. Yes, it has been two years since Fed Chairman Bernanke stopped using the word contained in his public remarks when he described the state of things in the money world.

Much of the current activity focuses on the structure of the massive and unprecedented federal bailout of the financial firms and financial system. The bailout is a response to the elevated and intensified level of systemic risk now widely accepted as prevalent and sufficient to justify these unprecedented federal financial actions. The label “systemic risk” is the latest in prominent titling of the state of affairs. Fed Chairman Bernanke’s recent speech elevated the term to “best seller” status.

There are many definitions of systemic risk. In fact it is one of the least precise terms in the current lexicon. It seems to be defined like pornography: “you know it when you see it.” AIG’s self-serving definition is sufficient for this commentary.

Readers may recall our frequent statements about how the failure of Lehman Brothers is the seminal event of our generation. Unpredictably, one of the Federal Reserve’s primary dealers and “AA” corporate credit bankrupted six months after the Fed’s new tools were implemented following the Bear Stearns affair in March of last year. Those Fed tools were specifically designed to support the primary dealers and avoid a repetition of Bear Stearns. Instead, they failed miserably. The “unexpected and unthinkable” happened and the world’s financial environment morphed from an idiosyncratic risk model to a systemic risk model.

History shows that it takes some kind of shock to trigger a systemic risk event. The shock must be bigger and more profound than anticipated. If it is already anticipated both as to size and to type of event, it does not qualify as a shock.

Note that lip-service identification of a systemic risk is not anticipation and preparation. We have heard discussion of bird flu systemic risk for over a decade. Most people on the planet do not act as if they believe it will occur. Thus the precautions are lacking because people are complacent. A pandemic that kills millions of people and overwhelms our health systems will qualify as a systemic risk event. The global financial results would be catastrophic.

Also note that the 9/11 attacks by Al Qaeda had elements of systemic risk in a geopolitical sense, but the risk was contained in a financial sense. The Federal Reserve’s payments system was buried under rubble between the twin towers, yet no meltdown of payments occurred. Payrolls were met throughout the country. Settlements were completed. Defaults did not overwhelm the financial system. The Fed’s contingency plans were placed to avoid risk with Y2K; they mostly worked after 9/11. The Atlanta Fed was the backup for the New York Fed and functioned well. The Fed also massively infused reserves, and its balance sheet expanded rapidly at that time. 9/11 was a tragedy and changed the military and political dynamic of the world. It was not a financial systemic risk event because, unlike in the case of Lehman Brothers, the Fed’s preparations for contingencies worked.

Read the rest of this entry »

The Quote of the Day comes from an OpEd piece in the NYT, titled Rated F for Failure, by Jerome Fons and Frank Partnoy:

“Why, more than a year into the crisis, do regulators and investors continue to rely on ratings? No one has been more wrong than Moody’s and S.&P. Less than a year ago both gave high ratings to 11 of the largest distressed financial institutions. They put the insurance giant A.I.G. in the AA category. They rated Lehman Brothers an A just a month before it collapsed. Until recently, the agencies maintained AAA ratings on thousands of nearly worthless subprime-related securities.”

Interestingly, I discovered Professor Partnoy’s work while researching Bailout Nation. Here’s what I wrote regarding his views on Derivatives, circa 1997:

Immediately after the CFMA legislation was passed, a few observers raised concerns. Frank Partnoy, a former derivatives trader at Morgan Stanley (now law professor at the University of San Diego), is the author of ”F.I.A.S.C.O.: Blood in the Water on Wall Street’,’ a 1997 book warning about the danger of derivatives. In 2000, referring to CFMA, he noted:

“The new bill’s second impact, in the swaps market, is less direct but still worrisome. The act ends an argument about whether swaps qualify for regulation by making it clear that they are not regulated if a participating company or individual has $10 million in assets. That means that the swaps activities of most companies and mutual funds are not regulated. Yet few investors know what swaps are. And there’s almost no publicly available information about specific trades in this market, now bigger than many stock or bond markets. By contrast, futures trading takes place on exchanges; an investor can find closing quotes for futures in a newspaper’s financial section.”

Even Partnoy’s prescient fears failed to anticipate exactly how devastating the results of the Act would be. It was unconscionably enormous in the scale of its potential for financial Armageddon. Either directly or indirectly, unregulated derivatives trading allowed by CFMA were responsible for the biggest bankruptcies in history. It created the monster that brought down AIG, the world’s largest insurance company.

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Sources:
Rated F for Failure
JEROME S. FONS and FRANK PARTNOY
NYT, March 16, 2009

http://www.nytimes.com/2009/03/16/opinion/16partnoy.html

Stock Gambling on the Cheap
FRANK PARTNOY
New York Times, December 21, 2000

http://query.nytimes.com/gst/fullpage.html?res=9C06E6D81E39F932A15751C1A9669C8B63&sec=&spon=&pagewanted=2

Bob Bronson (BRONSON CAPITAL MARKETS RESEARCH) looks at GDP and Valuation:

We prefer the following construct of the stock market vs. GDP. Note that it does not require any multi-year averaging, like the methodology illustrated in the chart at the bottom does, and as required for corporate earnings in Supercycle market P/E valuation metrics. And our metric better identifies the actual peaks and troughs in the stock market, unlike the other metric which is fuzzy. But they both tell the same story: we are getting closer to the stock market bottom, but there still is way to go.

Using GDP, which Buffet has said is his favorite stock market secular valuation metric, also further explains why our index below, as well as our Supercycle market P/E ratio have upward secular trends. This is because the stock market has historically-increasing importance to individuals and families/households, and thus for the whole U.S. economy.

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Thomas L. Friedman – Thomas L. Friedman, a columnist for The New York Times, is a three-time Pulitzer Prize winner and a member of the Pulitzer Prize Board. Friedman was bureau chief for The Times in Beirut and Jerusalem before writing, From Beirut to Jerusalem, which won the National Book Award for non-fiction. His book, The Lexus and the Olive Tree won the 2000 Overseas Press Club award for best nonfiction book on foreign policy. His latest work, The World is Flat: A Brief History of the 21st Century, won the inaugural Goldman Sachs/Financial Times Business Book of the Year award. He has a B.A. in Mediterranean studies from Brandeis University and a Master of Philosophy degree in Modern Middle East studies from Oxford.

Here are the specific details via last night’s AIG press release:

(click for larger charts)

Payments Under Guaranteed Investment Agreements

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Payments to AIG Securities Lending Counterparties

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Collateral Postings Under AIGFP CDS

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Payments to AIGFP CDS Counterparties

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Source:
AIG Discloses Counterparties to CDS, GIA and Securities Lending Transactions
AIG, March 15, 2009

http://www.aig.com/Related-Resources_385_136430.html

AIG DISCLOSES COUNTERPARTIES TO CDS, GIA AND SECURITIES LENDING TRANSACTIONS PDF

http://www.aig.com/aigweb/internet/en/files/Counterparties_tcm385-153017.pdf

aig-coutner-parties (PDF file)

Previously:
Backdoor Bailouts for Goldman Sachs? (March 5, 2009)

http://www.ritholtz.com/blog/2009/03/backdoor-bailouts-for-goldman-sachs/

Solvent Insurer / Insolvent Insurer (March 4, 2009)

http://www.ritholtz.com/blog/2009/03/solvent-insurer-insolvent-insurer/

iBanks Grabbed $50 Billion in AIG Bailout Cash (March 7th, 2009)

http://www.ritholtz.com/blog/2009/03/ibanks-grabbed-50-billion-in-aig-bailout-cash/

After watching Bernanke last night on 60 Minutes, I still believe he has it backwards. He started the interview expressing his thoughts that they first have to stabilize the financial system and then everything will be ok and a recovery will ensue and that once Wall Street is fixed, Main Street will follow. However, it’s Main Street that is the crux of the problem, they have too much debt and that’s leading to the lack of mortgage, credit card, etc… repayments. While the banks were ridiculously leveraged also, the banking system gets ‘fixed’ once consumers start paying their bills again.

With the TALF trying to get banks lending again and other various gov’t steps, the gov’t is trying to put Humpty Dumpty back together again, the Humpty Dumpty that borrowed too much, spent too much and didn’t save enough. On the ‘Stress Test’ that Ben talked about, WFC chairman called the plan “asinine.” Banks led Asian and European stocks higher.

The ongoing debacle that is the AIG bailout has entered a new phase. Outrage to follow.

The latest admission from the (defunct yet living) company is that well over $100 billion in taxpayer monies has gone to counter-parties at 100 cents on the dollar — no haircut, no penalty, no cost to those who made bad bets or chose their counter parties poorly. They were made completely whole by Uncle Sam and the American taxpayer.

This is a complex situation that is one part legitimate, one part outrage.

Some of this money was properly returned: $43.7 billion paid against lent securities is a perfectly valid transaction. $12.1 billion tied to guaranteed investment contracts paid to US states (California and Virginia in particular) is less clearcut — were these transactions with AIG the Insurer or AIG the hedge fund?

The counter-parties that bought credit-default swaps ($22.4 billion in collateral, $27.1 billion in payments) are more likely the structured finance trades, and unworthy of being made whole by taxpayers.

Among those who have partook in Uncle Sam’s munificence were Goldman Sachs, Merrill Lynch, Morgan Stanley, Wachovia and Bank of America. You might be surprised to learn the rest of the charity recipients were overseas banks: Germany’s Deutsche Bank and French bank Société Générale, as well as Calyon/Crédit Agricole (France), Danske (Denmark), HSBC (UK), Royal Bank of Scotland, Banco Santander (Spain), Lloyds Banking Group (UK), Barclay (UK) and Rabobank (Netherlands).

Not only are US taxpayers subsidizing the bad decisions made by executives in the US, we are also bailing out the poor judgment of the rest of the world.

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Previously:
Backdoor Bailouts for Goldman Sachs? (March 5, 2009)

http://www.ritholtz.com/blog/2009/03/backdoor-bailouts-for-goldman-sachs/

Solvent Insurer / Insolvent Insurer (March 4, 2009)

http://www.ritholtz.com/blog/2009/03/solvent-insurer-insolvent-insurer/

iBanks Grabbed $50 Billion in AIG Bailout Cash (March 7th, 2009)

http://www.ritholtz.com/blog/2009/03/ibanks-grabbed-50-billion-in-aig-bailout-cash/

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See also:
All Bailouts Are Counterparty Bailouts
Economics of Contempt, MARCH 14, 2009

http://economicsofcontempt.blogspot.com/2009/03/all-bailouts-are-counterparty-bailouts.html

AIG Says $105 Billion Flowed to Goldman, SocGen, U.S. States
Hugh Son and Robert Schmidt
Bloomberg, March 16 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=awiPvRbKoabA&

A.I.G. Lists the Banks to Which It Paid Rescue Funds
MARY WILLIAMS WALSH
NYT, March 15, 2009

http://www.nytimes.com/2009/03/16/business/16rescue.html

A.I.G. Paying $165 Million in Bonuses After Federal Bailout
EDMUND L. ANDREWS and PETER BAKER
NYT, March 15, 2009

http://www.nytimes.com/2009/03/16/business/16aig.html

AIG to Pay $450 Million in Bonuses
LIAM PLEVEN
WSJ, MARCH 15, 2009

http://online.wsj.com/article/SB123707854113331281.html

Nice Rally last week:

via WSJ

http://online.wsj.com/public/article/hotornot.html

I found the interview tonight quite fascinating . . .

If you think your job is tough, consider Ben Bernanke’s. As Chairman of the Federal Reserve, the task of reviving the U.S. economy falls largely on his shoulders. Scott Pelley has the interview.

The Chairman Part 1

March 15, 2009 4:01 PM

Federal Reserve Chairman Ben Bernanke candidly speaks to Scott Pelley about his personal life, as both visit his old high school and how the current financial crisis is affecting Main Street America.

The Chairman Part 2
March 15, 2009 4:26 PM