How Much Worse Can AIG Get?

March 17, 2009

Today is a day for dark warnings about what might happen at AIG should the bonuses not get paid:

"It’s going to blow up," said a senior Financial Products manager, who spoke on condition of anonymity because he was not authorized to speak for the company. "I have a horrible, horrible, horrible feeling that this is going to end badly."

Um, hasn’t it already ended badly for AIGFP? Hasn’t the unit already lost hundreds of billions of dollars and effectively bankrupted its parent? How much worse can things get? Well, let’s ask Andrew Ross Sorkin:

If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right…
Here is the second, perhaps more sobering thought: A.I.G. built this bomb, and it may be the only outfit that really knows how to defuse it.
A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.
So as unpalatable as it seems, taxpayers need to keep some of these brainiacs in their seats, if only to prevent them from turning against the company.

This is overstated. No one is saying that the government should start abrogating its contracts — which is to say, the contracts entered into by the government. But if a company runs itself into the ground by entering into all manner of bad contracts, and it’s then taken over by the government as the only alternative to letting it fail outright, the case for honoring those contracts is much weaker, and the precedent of reworking some of those contracts does not mean that "the government would start abrogating contracts left and right".

As for the bomb metaphor, the bomb has already exploded. It’s far too late to defuse it. The job of the highly-paid employees at AIGFP is simply to clean up the mess, post-explosion.

Since they know where the shrapnel has landed, are they well placed to "trade against A.I.G.’s book" should they leave? Yes, probably. But AIG is still an insurance company, and AIGFP is, at heart, an insurance company in run-off. It’s hard to trade against such a thing.

Now it’s possible that AIGFP still has a large trading book holding lots of positions which need to be unwound in a relatively short period of time. And it’s also possible that those positions are so complex that only the people who put them on are really qualified to unwind them. But no one at AIG has really come out and said this. So unless and until I’m told that this is a major problem by someone qualified to make that determination, I’m going to stick with my view that the dangers of not paying these bonuses might not be all that great.

Reprinted from

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