Felix Salmon

Why do AIG’s executives suddenly covet its stock?

By Felix Salmon
January 12, 2010

Paul Smalera asks — but, sadly, doesn’t answer — the big question surrounding AIG’s bonus compensation: why on earth are the company’s executives specifically asking for it to be paid in worthless AIG stock, when they already got permission from the special paymaster to pay bonuses with a special “basket” of stock that reflected the value of four profitable AIG divisions?

It’s certainly true that AIG executives know something we don’t: they know, for instance, the contents of the SEC filing which won’t be made public until 2018. But AIG is saddled with enormous obligations to the government, which have already been restructured at least once, and no one has ever indicated that they can be repaid in full. So long as the government ends up incurring a loss on its AIG bailout — and everybody expects there to be some kind of a loss on the deal — AIG stock should be worthless, no?

I understand that there’s some tiny possibility that AIG will be able to pay the government back in full, and that therefore AIG stock has a small amount of option value. But I don’t think that explains the desire of AIG executives to be paid in stock with a high probability of being worthless and only a small probability of ending up in the money. It certainly seems as though here’s something very fishy going on here. Smalera has one theory:

If AIG does end up spinning off its profitable units, it might be able to construct the IPOs in such a way as to grant executives valuable stock in the new companies in exchange for their worthless AIG shares.

I don’t buy it: the probability of such a scheme working out is, again, too low. But I have to admit I don’t have a better idea.

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When the government paid off AIG’s bets, AIG wasn’t actually bankrupt. They had breached agreements to maintain certain levels of collateral that they provided to back up insurance (credit swaps) they had sold to a few customers. The collateral lost value, but that was only temporary, as it was dependent on panic-driven markets that were decimating asset valuations everywhere (it also wasn’t helped by mark-to-market rules that relied on completely arbitrary valuations for illiquid assets). It is entirely possible that the value of the assets that were used as collateral has risen enough, or may soon in a few years, to cover the amount the government paid AIG’s counterparties on their behalf.

If, instead of making AIG’s counterparties whole, the government had instead said “we will back up their collateral”, then when the panic subsided, the government wouldn’t have had to put up a cent. What has been called a bailout of AIG was really more a hostile takeover. AIG had bargaining power, but the government’s insistence on making their counterparties whole eviscerated that power.

I don’t know the details of the government’s agreement with AIG – it owns 80%, but ownership doesn’t mean they have to replay a loan (or does it still own 80%? AIG has sold some divisions, if the proceeds went to the government, wouldn’t their share be reduced?). Maybe the execs are hoping to stall liquidation long enough to a point where their assets are worth enough for AIG to sell more shares to buy the government out. AIG still has a lot of cash flow, and it’s not like their non-casino operations are worthless.

When the public is told that AIG had to pay big bonuses to keep staff hired for over a year to unwind deals, it means there is a lot of stuff that nobody really knows much about. AIG execs, who may be out of a job if the company is liquidated, aren’t going to forgo cash bonuses for worthless stock just for the PR sake of it. They know something we don’t.

Posted by OnTheTimes | Report as abusive

“I don’t know the details of the government’s agreement with AIG – it owns 80%, but ownership doesn’t mean they have to replay a loan”

The Government doesn’t own AIG. Technically, a trust set up by the Federal Reserve and controlled by the FRBNY holds the shares that are at issue. Those shares at issue (‘amounting to approximately 79.9% of total outstanding shares’) were created anew by AIG and transferred to the Trust. Dividends may not be paid on any common shares until those shares are paid first blah blah blah. Basically AIG is never going to issue any dividends while in the thrall of the FR, so that counts for nothing. Voting control of those shares was transferred back to the AIG boards. So as it stands, the people who owned the preexisting 100% of common shares were diluted and now own (free and clear) 20.1% of common shares, but they (or rather management) votes those shares plus 80% of all shares.

Essentially the Fed bought out (effectively) 80% of each share of AIG and gave control to company management in exchange for 80 billions bucks. There were other loans that resulted in Treasury getting ownership of large chunks of *preferred* shares, but no additional common shares. The 79.9% is collateral on a very low-interest loan.

So technically, the trust ‘owns’ 79.9% of shares. And the trust is owned by the Federal Reserve, not the Federal Government. However, owning common shares amounts to being able to vote, being notified of information by the board, collecting dividend and being able to sell those shares. Since the Trust controls them, they get that last right (although since it is collateral, the Trust cannot sell the shares, but neither can anyone else); all other control of the shares was returned to the AIG board (i.e. management). So management effectively owns whatever shares they help before plus 79.9% of the company.

Near as I could figure, summing those together meant AIG management controlled at least 81% of all shares and likely more.

You went to the pawnshop. You put 80% ownership of your house on the block as collateral, they give you 800,000 dollars, and return the deed to you. For virtually all purposes, you own your house but now you’re 800k richer. You couldn’t sell it until you paid the loan back, but the loan has no fixed payment schedule and very low interest. Feel free to return the money whenever plus oh, 8,000 (eight thousand, not hundred thousand) USD.

That means the government has no legal way to control AIG, except for the rights granted in the loan contracts and in turn, AIG sell out until they pay off the loan. But if they pay off the loan, they’re free and clear, excepting the preferred and the loans that went with that, which are on similar terms above.

That’s why Geithner could not do anything about bonuses, or really do anything about anything at AIG. Stupidest contract I’ve ever seen, and whomever signed it (Timothy Geithner) should have been fired on the spot.

Of course, it makes more sense now, seeing as how Timmy’s main interest was in making Ginourmous vampyre Squids, Ltd. whole along with the other banks. In effect, AIG agreed to act as a shell corporation to allow the Fed to funnel money to our favorite bankers. In return, AIG has suffered no discredit, having made good on tons of stuff, and they aren’t bankrupt (as OnTheTimes says), so while they may have been in trouble, they can make good right now.

So AIG stock may be worth something when AIG gets out from under, and I presume management wants to own the company when it comes out from under the rcok. Meantime, since management controls the company outright (they win every board vote), they can restructure at will, so they can carve off bits and cut themselves bonuses and do whatever they want.

The value of the stock is *indeterminate*, not worthless. At these very low prices it is worth it to slowly buy stock, since 20 millions shares purchased at one cent would add up to 200k USD total.

I don’t know what they’re up to – I doubt they know. It depends on market conditions and whatnot.

['Profit opportunities abound for the patient thief though.']

Posted by sonneblume | Report as abusive

In all likelihood, AIG executives are doing for their own bonuses exactly what they were doing with their company’s collateral all along – acting as though it were actually worth something for as long as it takes to get others to buy in and bear the brunt, then try to hop it while it’s momentarily trading high. Look for their own money to be marinated in shorts, meanwhile. Either way, they fare better than their insurance clientele.

Signs are, there has been neither real reform nor improvement at AIG. History is therefore destined to repeat itself as soon as nobody’s looking.

Posted by HBC | Report as abusive

If I am not mistaken, once AIG and the FRBNY deemed the stock worthless behind closed doors, yet at the same time put on their 10-q common equity of 14.9 billion, didn’t they break the law? The way I see it, the only way for the AIG executives not to get in serious trouble was to take common stock. If the common does indeed get wiped out, which it will, and executives did not take their bonuses in common because they knew it was worthless, isn’t that breaking the law? That is material information that would have to be disclosed, which it wasn’t. Once the FRBNY pulls the credit line, AIG will be forced to restructure out of Chapter 11, which is stated in not so many words from the 10-Q in November. So, if the FRBNY pulls the credit line, and AIG executives knew that was going to happen, thus deeming the stock worthless, and then decided to take pay in a basket, they would be in serious trouble. I see the fact that executives taking common stock as their bonus as a way to aviod criminal conduct.

Posted by bighouse | Report as abusive

here is a clip from Jonathan Weil from Bloomberg:

“Disclosure Shortcomings

The old GM has said repeatedly in its financial filings that its shares are worthless, which shows its officers believed this was a material fact worthy of public disclosure. AIG so far hasn’t taken this step. It’s unclear why its executives didn’t feel a similar obligation.

An AIG spokeswoman, Christina Pretto, declined to comment, aside from encouraging me to read the company’s financial reports. Those say the company may need even more government money later, and that AIG may not survive without it.

The latest twist in the AIG saga provides a reminder of one of the fundamental flaws in the government’s bailout efforts. Rather than insisting that failing banks and insurance companies come clean about the rot on their balance sheets as a condition of accepting taxpayer money, the government plied them with cash first and let them keep their true financial condition hidden.

Beyond Fundamentals

While many financial companies’ stocks and bonds have soared since last spring, that’s not necessarily because their fundamentals are so great or their numbers are so credible. The main thing propping them up is the promise that the government will backstop companies it deems too important to fail. Take away that support and market confidence would go with it, because investors still wouldn’t know which companies’ books to trust.

At least at AIG, some of the secrets are starting to come out. Fed and Treasury officials should feel ashamed for letting AIG’s bosses keep them from the public for so long.”

http://www.businessweek.com/news/2010-01 -06/-worthless-aig-shares-belie-company- s-books-jonathan-weil.html

Posted by bighouse | Report as abusive

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