AIG $165 million retention bonus

On March 20, 2009, Congress passed a bill that would levy a 90% tax rate on the bonuses received by the AIG executives to recoup taxpayer money. This bill was introduced and voted on in a time of outrage after the scandal broke out.

The New York-based “underwater” insurer company still plans to hand out about $165 million on March 15 because of legally binding contracts, according to a person briefed on the matter. AIG paid "retention" bonuses of more than $1 million to 73 employees. The highest bonus was $6.4 million, with six other employees receiving more than $4 million, and 22 individuals receiving bonuses of $2 million or more, including 11 who no longer work at the company, New York Attorney General Andrew Cuomo said Tuesday March 17. Can you imagine the insurer this month just announced a $61.7bn fourth-quarter loss – the largest quarterly loss reported by a US company.

Why would AIG want to reward the people who destroyed their company? However, these bonuses were included in a previous contract. Even though the cost is obscene, how much more would it cost the taxpayers if that misbegotten company fails? Why didn't Ben Bernanke say something months ago? He receives copies of AIG board meetings and sits in anytime he wants. He should have stopped the bonuses before they were paid by renegotiating the contracts. The people of the United States own 80 percent of AIG. Things have changed since the contracts were signed and there are new owners now who ought to have been able to stop these offending bonuses before they happened.

How does the US government get in this mess? Does US government have to run the daily job for every company they bailout? Why would AIG retain those people who destroyed their company? Why did not AIG management consult US government or new owner before handed out the bonus? Could AIG CEO still pay out the bonus if he owned the current AIG and the bonus would come from his own pocket? Why didn’t AIG board make any objection on it? Why can’t Ben Bernanke and Tim Geithner stop it before the instant?

No More Bailout

US government made a big mistake in bailout Bear Stern in March 2008 in first place. Bear Sterns failure was completely caught off-guard of the Fed without any systematic plan. This raises the moral hazard issues with government bailout. Lehman, AIG and Citigroup did not start to clean up their over-leveraged portfolio until late summer. As the credit crisis got worse and the financial tsunami swept out the Wall Street in the summer, the Fed had to step in with $85 billion bailout to save AIG float on September 16, 2008. Now the bailout bill skyrocketed and could cost the tax-payer up to $175 billion. AIG is one of victims in this massive credit deleverage process with their over-leveraged and greed Financial Production Division with the load of credit default swaps, like 158 years old Investment bank Lehman Brothers who filed Chapter 11 one day early before the AIG bailout.

Where is AIG corporate board overseeing the risk just like $165 million undeserved bonus payment?

Let’s take a look of US corporate governance structure or Sarbanes-Oxley Act of 2002 (see Diagram below):

From the above diagram, Shareholders, management and board are a triangle relationship. Theoretically, board should report to shareholders and be responsible to them only. But in reality, the board directors are often recommended by the management team. The broad directors are too cozy with the executives to oversee them adequately. In many cases, the CEO is the chairman of the board, giving him significant say over who is offered a board seat, which can be worth hundreds of thousands of dollars a year at a major corporation today. America corporations become those people’s ATMs. Now for those bailout firms, US tax-payers back those ATMs. If $165 million bonus would come from AIG CEO’s own pocket, he could find a scheme not paying them at all.

The Fed made second big mistake when AIG was rescued. US shareholders should replace the executives in the Financial Products Division as soon as the bailout was implemented. In AIG scandal, yes, those people certainly don’t deserve any bonuses not even a penny in tax-payer dollars. In last summer, those people should be fired right after the Fed took in stake. In today’s labor markets, they can find thousands people better than them with the skills and experiences as well as responsibility. AIG board and new management team should set up the new moral standard in order to survive.

Revamping Current Corporate Governance Act

The Sarbanes-Oxley Act of 2002, enacted as a response to the Enron, WorldCom, and other corporate scandals, enhanced the regulatory protections offered to U.S. investors. But after this financial crisis, people know that the act could do nothing in protection of investors.

Today US corporate culture is corrupted with too-much greed and self-seeking. From senior management to board members, the greed and self-seeking are driven the current corporate American culture for their own interest. Even the European and Japanese counterparties are too far behind to catch up (see Table below). In sub-prime crisis, the greed and self-seeking are also the culprits in this housing bubble. The lenders don’t care if the borrowers can afford the amount of loans and what are consequences if not. Even worse, the lenders don’t care the depositor’s money will get back or not if the loans default as they know FDIC are behind them. Furthermore, the lenders don’t care what the borrower default implies to shareholders. As the same is true in U.S. investment banking industry, the executives over there have to take excess risk with high leverage to satisfy their greed – fat bonus, which partially led Bear Stern and Lehman Brothers fallout.

In the recent days, you often heard that senior executives cut their own salary or forgive the bonus payments. On November 18, 2008, seven top executives at Goldman Sachs, including CEO and CFO, forgo bonuses for 2008. On December 8, 2008, Morgan Stanley CEO John Mack forgo his 2008 bonus two years in a row amid the difficult financial market conditions, stock price performance and full-year revenues in this challenging environment. Where are their boards? Are those board members decided if having bonus or not? It should not come from the executives’ request. That's weird. Now you can guess how powerful the US executives in the corporate world.

In fact, the corporate executive excess compensations are not new things. It occurred during tech boom’s late 1990s. The CEOs often took home with hundreds million dollar a year even though the firms may not make a penny profit for shareholders yet, especially for those high-fly internet and technology firms. Even weird thing is that Computer Associations management teams manipulated accounting scandal with 35 days a month to enlarge the quarterly sales and revenue numbers, in order to meet the profit target and share $2 billion bonus within three executives. The similar stories are Enron and WorldCom accounting scandals. After 2002 new corporate government law, CEOs found a new way to satisfy their greed by stepping up taking more risk for investors to meet their revenue and profit targets.

Bear Stern, Lehman Brothers and AIG are the examples of those corporate CEO behaviors.  Taking AIG as example, AIG have $450 billion exposure on credit default swaps (or CDS) and $70-80 billion exposure on collateral debt obligations (or CDO). CDS on a bond is in layman language exact same thing as corporate bond.  The only thing different from the traditional bond is a synthetic bond. In other words, when AIG sold out a CDS, it recorded as an over-the-counter credit derivative.  There is a key difference people often ignored that investing in CDS can leverage up the portfolio but not traditional bond investment. If AIG have $100 million to investment in bond markets, the portfolio size with the cash bonds are maximum at $100 million. But in credit derivative markets, for $100 million CDS AIG sold, the daily margin amount is about 5%-20% of total notional depending on the underlying bond credit quality. So in the worse case with 20%, AIG portfolio size can be as big as $500 million but only with $100 million investable capital. That is five times leverage. AIG can amplify the upside profit by taking 5 times leverage. But AIG managers clearly forgot one thing: the leverage can also amplify the downside loss too. If the bond portfolio value drops 20%, AIG essentially wipes out all $100 million capital and becomes insolvent with five times leverage. That’s why AIG could easily lose $100 billion dollar so far to lead the government bailout.  

America should build up a social and shareholder responsible corporate culture by revamping the current corporate governance structure. The current Anglo-American system is a complete failure although it was revamped six years ago. Corporate leaders are driven by the profit motive, and from a business standpoint they're unmoved by the plight of the 50% of the world's population that can't take advantage of capital gains. That’s fine to the shareholders. Today, outrage over executive compensation is widespread in the United States. The corporate executives and boards lost the public trust. Corporate boards should only have an absolute responsibility to shareholders, not just to their senior managers. Rather than allowing managements be paid huge bonuses, they should make senior managements accountable for their performances. It is extremely detrimental to our economy when executives bail out of their companies with millions of dollars in payouts for failed leadership.

Corporate ethics and compliance executives must be empowered to challenge their senior executives’ strategies and policy decisions, and the starting point for this is giving ethics and compliance professionals a seat at the table. Significant re-regulation, particularly in the financial industry and resounding intolerance are expected by anger lawmakers, regulators, prosecutors and the courts for anyone who betrays the public trust in the near future.

Just relying on corporate governance itself is still not enough. This is just first line of defense for the investors. What we need another line of defense is strong federal regulation. History demonstrated again and again that self-regulation will not work very well following so many scandals and failures. America needs though reform in regulations. Since 1980s and 1990s financial deregulations, but federal regulation and oversights will catch up with the fast-growing financial industry. We can’t have not another big “Citigroup” become “Too-Big-To-Fail”. We can’t have another “Leman Brothers” leverage up too high without knowing its true risk exposure. We can’t have another “AIG” performing secret and risky business without anyone watching it. We can’t have another financial tsunami crashing U.S. banking industry again like this without any preparation to the systematic risk. Otherwise, we did not learn any lessons from history. It is the completely failure of U.S. federal regulators.

A Social Responsible America Society

America should build up a social responsible society。Each one should be responsible for own actions and behavior. Reckless spending without considering any consequences should not be encouraged but punished. US housing bubble resulted from those reckless spending. Certainly, reckless mortgage lending is one side to blame but the over-leveraged consumers should also take some blames as they should know better than anyone about his own financial conditions and affordability on the luxury items like homes and cars. Otherwise, the similar disasters will occur again and again in the future.

America should not blame others causing this credit tsunami. Self-proud American should self-examine to find the real root of this. We should not blame Chinese and other countries lending too much money to us. US corporates should not complaint the Fed providing too much cheap easy money in the financial system. US consumers should not complaint banks and mortgage lenders providing them the riskier mortgage products to entice them to enter housing markets. Everyone is responsible for own actions and outcomes. That’s responsible society really means.