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Why Did AIG's Counterparties Get 100 Percent Repayment?

By Michael Barone, Thomas Jefferson Street blog

Congress has been bellowing about the bonuses paid to AIG-FP personnel, and Sen. Christopher Dodd is in deep, deep doo-doo for having inserted into the stimulus package language that guaranteed them. Dodd's defense is that he wasn't aware of AIG's bonuses. Huh? He was Chairman of the Senate Banking Committee.

But there's a larger issue, one involving 1,000 times as much money as the AIG bonuses: Why didn't AIG's counterparties have to take a haircut? We should be less interested in AIG's bonuses than in the 99.91 percent of the money that has been passed through to its counterparties, none of whom seem to be at systemic risk. Why didn't the people who set up the AIG bailout--which would be then-Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and New York Federal Reserve President and current Treasury Secretary Timothy Geithner, require that AIG's counterparties take a haircut?

That's a question posed by a variety of commentators, leading off with CNBC's philosopher-in-the-trading-pits Rick Santelli.

In the Washington Post Steven Pearlstine makes the same point in criticizing AIG $1-a-year CEO Edward Liddy. "A more hard-knuckled executive would have gone to the counterparties of those derivatives contracts and suggested that it would be a real shame if AIG were forced to file for bankruptcy, and offered some sort of workout."

And former New York Attorney General and Governor Eliot Spitzer has the same idea:

But wait a moment, aren't we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes--income taxes to sales taxes--to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden. Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won't be laid off. Why can't Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion capital infusion, and aren't they sitting on more than $100 billion in cash? Haven't we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn't they have accepted a discount, and couldn't they have agreed to certain conditions before the AIG dollars--that is, our dollars--flowed?

Say all the bad things you want about Spitzer (I will join in on some of them), but he makes a good point, even if he gets a little incendiary when he charges that the 100 percent repayment of AIG's counterparties was "an inside job" for the benefit of the likes of Goldman Sachs, of which Treasury Secretary Henry Paulson had been CEO. Spitzer does not address the issue of whether the ouster of Maurice Greenberg as AIG's CEO in 2005 that he engineered opened the way to AIG's ruin. Greenberg argues that it did, that he would have reduced AIG's credit default swaps trades after the firm's bond rating went down rather than ramp them up as the new, more-or-less-Spitzer-installed management did. Of course no one can be sure about a counterfactual like this, and both Spitzer and Greenberg are interested parties.

Republicans have an issue in the AIG bonuses, and they're using it in the New York 20th congressional district special election which will take place March 31. But on the larger and more important issue of paying off the counterparties, the political responsibility is mixed. Henry Paulson and Timothy Geithner were both responsible, Geithner first as President of the New York Fed and now as Treasury Secretary.

Now Speaker Nancy Pelosi is trying to get her party off the hook on the AIG bonuses by passing a bill placing a 90 percent tax on them. This is a de-escalation, I suppose, from the proposal the day before on Rep. Carolyn Maoney's proposal for a 100 percent tax. Marc Ambinder links to the case made by Harvard Law Professor Laurence Tribe that this might not be a constitutionally forbidden bill of attainder. But it sure smacks of one. Better instincts were shown by House Majority Leader Steny Hoyer and Ways and Means Committee Chairman Charles Rangel. Hoyer said it might be a violation of the equal protection clause, while Rangel is quoted as saying, "It's difficult for me to think of the code as a political weapon," he told reporters outside his office. "Is this an indictment or a bill?" Hoyer's point may be dubious as a legal argument (the bill of attainder clause is more on point), but both he and Rangel have the right instinct: Congress shouldn't pass laws that punish specific individuals. Parenthetically, some House Republicans and conservative bloggers would like to take Rangel down for his sloppiness on taxes and disclosure forms. They should keep in mind that he's the only person standing between us and House Ways and Means Committee Chairman Pete Stark, who is next in line in seniority.

Pelosi seems not to have the qualms expressed by Hoyer and Rangel, or perhaps she's just panicked at the possibility that Democrats may be held responsible for a law they passed without giving any member of Congress time to read the text. But if abstract notions of fairness didn't persuade her, perhaps she will come to regret that she didn't heed the advice of the invaluable Megan McArdle: "I don't think you'll get much voluntary cooperation from banks if you declare that any acceptance of government funds will involve substantial risk that they will appropriate your paycheck."

A more general point can be made. When the government starts micromanaging private companies, there will always be the potential for bailout favoritism, crony capitalism and persecution of unpopular individuals. In other words, one messy political issue after another.

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