The sanctity of AIG's contracts

[Joanne98]

(updated below - Update II- Update III)

Larry Summers, Sunday, on AIG’s payment of executive bonuses:

We are a country of law. There are contracts. The government cannot just abrogate contracts. Every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve system.

Associated Press, February 18, 2009:

The United Auto Workers’ deal with Detroit’s three automakers limits overtime, changes work rules, cuts lump-sum cash bonuses and gets rid of cost-of-living pay raises to help reduce the companies’ labor costs, people briefed on the agreement said today.

The UAW announced Tuesday that it reached the tentative agreement with General Motors Corp., Chrysler LLC and Ford Motor Co. over contract concessions, as GM and Chrysler sent plans to the Treasury Department asking for a total of $39 billion in government financing to help them survive.

Concessions with the union are a condition of the $17.4 billion in government loans that the automakers have received so far.

Apparently, the supreme sanctity of employment contracts applies only to some types of employees but not others. Either way, the Obama administration’s claim that nothing could be done about the AIG bonuses because AIG has solid, sacred contractual commitments to pay them is, for so many reasons, absurd on its face.

As any lawyer knows, there are few things more common – or easier -- than finding legal arguments that call into question the meaning and validity of contracts. Every day, commercial courts are filled with litigations between parties to seemingly clear-cut agreements. Particularly in circumstances as extreme as these, there are a litany of arguments and legal strategies that any lawyer would immediately recognize to bestow AIG with leverage either to be able to avoid these sleazy payments or force substantial concessions.

Since the contracts are secret and we’re apparently just supposed to rely on the claims of AIG and Treasury Department lawyers, it’s impossible to identify these arguments specifically. But there are almost certainly viable claims to be asserted that the contracts were induced via fraud or that the bonus-demanding executives themselves violated their contracts. Independently, it’s inconceivable that there aren’t substantial counterclaims that AIG could assert against any executives suing to obtain these bonuses, a threat which, by itself, provides substantial leverage to compel meaningful concessions. Many of these executives were, after all, the very ones responsible for the cataclysmic losses.

The only way a company like AIG throws up its hands from the start and announces that there is simply nothing to be done is if they are eager to make these payments. One might expect AIG to do so -- they haven't exactly proven themselves to be paragons of business ethics -- but the fact that Obama officials are also insisting that nothing can be done (even while symbolically and pointlessly pretending to join in the populist outrage over these publicly-funded "retention payments") is what is most notable here.

Legal strategies aside, just as a business matter, one of the first steps taken by every company in severe distress is go to its creditors, explain that it cannot make the required payments, and force re-negotiations of the terms. That’s as basic as it gets. To see how that works, just look at what GM and other automakers did with their union contracts – what they were forced by the Government to do as a condition for their bailout. Obviously, if a company goes into bankruptcy, then contracts to pay executive bonuses are immediately nullified, but the threat of bankruptcy or serious financial distress is, for obvious reasons, very compelling leverage to force substantial concessions. And the idea that, in this economy, AIG executives (of all people) will be able simply to leave and go seek employment elsewhere unless they receive their "retention bonuses" (even assuming that’s an undesirable outcome) is nothing short of ludicrous.

There may be other reasons why the Treasury Department decided it wanted AIG to pay these bonuses (Marcy Wheeler considers some of those reasons here), but this claim from Larry Summers that the sanctity of contracts precludes any alternatives is not just false, but insultingly so. It's difficult to recall anything quite so vile as watching hundreds of millions of dollars in taxpayer money flow to AIG executives. One would expect the Obama administration to do everything possible to prevent that from happening. Instead, they seem to be doing the opposite.



UPDATE: Jane Hamsher has more here on AIG's insultingly frivolous claims as to why these contract obligations are unavoidable, and here FDL has a petition, to be delivered to the House Financial Services Committee during Wednesday's hearing on the AIG payments, demanding full disclosure before any more payments are made.

On a related note, could someone please reconcile Larry Summers' emphatic declaration that "we are a country of laws" with this:


Continued>>>
http://www.salon.com/opinion/greenwald/2009/03/16/aig/index.html

[Joanne98]

1. The Semtex in the AIG Retention Contracts

By: emptywheel Sunday March 15, 2009

Here's how I understand the white paper AIG just used to convince Tim Geithner that, while the US government can force car companies to cut the wages of line workers, the US government cannot force banksters to cut the wages of the thugs who broke the global financial system. There's a lot of mumbo jumbo about contract law, but that's not the real reason AIG is arguing Geithner can't strip the bonuses. It's the "business reasons" that amount to a deliberate threat:

For example, AIGFP is a party to derivative and structured transactions, guaranteed by AIG, that allow counterparties to terminate in the event of a “cross default” by AIGFP or AIG. A cross default in many of these transactions is defined as a failure by AIGFP to make one or more payments in an amount that exceeds a threshold of $25 million.

In the event a counterparty elects to terminate a transaction early, such transaction will be terminated at its replacement value, less any previously posted collateral. Due to current market conditions, it is not possible to reliably estimate the replacement cost of these transactions. However, the size of the portfolio with these types of provisions is in the several hundreds of billions of dollars and a cross-default in this portfolio could trigger other cross-defaults over the entire portfolio of AIGFP.

Translated, I take that to mean that AIGFP is a party to a bunch of contracts insured by AIG the US government. And if AIGFP somehow does something that equates to a default on those contracts, then AIG the US government is on the hook for hundreds of billions of dollars.

The white paper goes on to explain just one scenario that might trigger a default in terms of these contracts.

Departures also have regulatory ramifications. As an example, the resignation of the senior managers of AIGFP’s Banque AIG subsidiary would allow the Commission Bancaire, the French banking regulator, to appoint its own designee to step in and manage Banque AIG. Such an appointment would constitute an event of default under Banque AIG’s derivative and structured transactions, including the regulatory capital CDS book ($234 billion notional amount as of December 31, 2008), and potentially cost tens of billions of dollars in unwind costs. Although it is difficult to assess the likelihood of such regulatory action, at a minimum the disruption associated with significant departures related to a failure to honor contractual obligations would require intensive interactions with regulators and other constituents (rating agencies, counterparties, etc.) to assure them of the ongoing viability of AIGFP as well its commitment to honoring counterparty contracts and claims.

I take this to mean that if a bunch of AIGFP managers quit because they didn't receive bonuses promised in their contracts, then France could, if it wanted, to appoint its own designee. And if that happened, then it would equate to a default and those contracts would kick in, at a cost to AIG the US government of at least tens of billions.

In other words, I take this to be a threat: "if you don't give us our bonuses, we'll trigger a default event that will cost AIG the US government tens of billions of dollars." It's just a polite way of saying, "Pay us the $100 million ransom or we start exploding the suicide bomber vests we're wearing."

Frankly, I have no idea whether this particular threat--France responding in a way that would set off a default--is real, or whether there are similar events that those AIGFP managers demanding their ransom could easily trigger.

But what they're doing is pointing to one relatively preventable area, noting that we might be able to defuse the explosion before it went off if we worked hard enough with the French, but saying that that, in general, is the kind of thing the AIGFP managers might contemplate if they don't get their bonuses.

AIG agreed to pay the guys whose gambling AIG the US government insures hundreds of millions of dollars in bonuses. And the gamblers are now saying they would be willing to blow their own gambles--ignite their semtex vests--if we refuse to pay up.

http://emptywheel.firedoglake.com/2009/03/15/the-semtex-in-the-aig-retention-contracts/

[Joanne98]

2. Under Cassano, Troubled AIG Unit Was Charged With Major Securities Law Violation

We’ve been doing a little digging into Joseph Cassano, who until last year ran AIG’s financial products unit, known as AIGFP. That’s the unit, of course, whose staffers just got $165 million in bonuses despite undertaking those credit default swaps that helped bring the company down. And it was under Cassano that those deals were made.

As we noted earlier, the FBI and British authorities have lately been probing AIGFP. But it looks like under Cassano, the unit has been in criminal investigators’ crosshairs before.

According to a “brokercheck report” put out by the financial regulatory agency FINRA, and unearthed by the blog Zero Hedge, the Justice Department in 2004 criminally charged Cassano’s unit with helping another firm, PNC Financial Services, to conceal certain assets from its books. In the end, AIG came to a settlement with DOJ and SEC, in which it paid a very hefty fine — $80 million.

Here’s the full relevant portion of the FINRA report:

Charge Details:
THE DEPARTMENT OF JUSTICE (”DOJ”) FILED A CRIMINAL COMPLAINT AGAINST AIG-FP PAGIC, CHARGING AIG-FP PAGIC WITH VIOLATING TITLE 15, US CODE SECTIONS 78J(B) AND 78FF(A), CODE OF FEDERAL REGULATIONS, SECTION 240.10B-5 AND TITLE 18, US CODE SECTION 2. THE COMPLAINT ALLEGED THAT AIG-FP PAGIC VIOLATED FEDERAL SECURITIES LAWS BY AIDING AND ABETTING SECURITIES LAW VIOLATIONS BY A PUBLIC COMPANY, PNC FINANCIAL SERVICES GROUP, INC. (”PNC”), IN CONNECTION WITH A TRANSACTION ENTERED INTO IN 2001 WITH PNC THAT WAS INTENDED TO ENABLE PNC TO REMOVE CERTAIN ASSETS FROM ITS BALANCE SHEET. THE COMPLAINT ALLEGED THAT AIG-FP PAGIC KNEW, OR WAS DELIBERATELY IGNORANT IN NOT KNOWING, THAT THE PNC TRANSACTION DID NOT SATISFY THE REQUIREMENTS OF GAAP FOR NON-CONSOLIDATION OF SPECIAL PURPOSE ENTITIES.

Disposition Details:
AIG, AIG-FP AND AIG-FP PAGIC ENTERED INTO A SETTLEMENT WITH THE DOJ COMPRISING SEPARATE AGREEMENTS WITH AIG AND AIG-FP AND A COMPLAINT FILED AGAINST, AND DEFERRED PROSECUTION AGREEMENT WITH, AIG-FP PAGIC. UNDER THE TERMS OF THE SETTLEMENT, AIG-FP PAID A MONETARY PENALTY OF $80,000,000 AND THE DOJ AGREED (I) THAT IT WILL NOT PROSECUTE AIG OR AIG-FP IN CONNECTION WITH THE PNC TRANSACTIONS OR THE BRIGHTPOINT TRANSACTION THAT WAS SETTLED BY AIG WITH THE SEC IN 2003 AND (II) TO SEEK A DISMISSAL WITH PREJUDICE OF THE AIG-FP PAGIC COMPLAINT IN DECEMBER 2005, IN EACH CASE PROVIDED THAT AIG, AIG-FP AND AIG-FP PAGIC SATISFY THEIR OBLIGATIONS UNDER THE DOJ AGREEMENTS. THE OBLIGATIONS OF AIG, AIG-FP AND AIG-FP PAGIC UNDER THE DOJ AGREEMENTS RELATE PRINCIPALLY TO COOPERATING WITH THE DOJ AND OTHER FEDERAL AGENCIES IN CONNECTION WITH THEIR RELATED INVESTIGATIONS. THE DOJ FILED THE MOTION TO DISMISS WITH PREJUDICE THE AIG-FP PAGIC COMPLAINT ON DECEMBER 16, 2005; THE COURT SIGNED THE ORDER GRANTING THE MOTION TO DISMISS THE AIG-FP PAGIC COMPLAINT ON JANUARY 17, 2006, RESULTING IN A FINAL DISPOSITION OF THE AIG-FP PAGIC MATTER.

The details of the PNC matter aren’t clear. But as Zero Hedge notes, had the SEC come down harder on Cassano and AIGFP, it’s conceivable that the agency could have helped stop the practices that would ultimately destroy AIG and that contributed to the current financial crisis.

Leaving the SEC aside, there’s no evidence that AIG sanctioned Cassano in any way after this episode. Indeed, as we’ve noted, when he resigned as CEO of AIGFP last year, he was initally given a $1 million-a-month consulting retainer.

http://www.popmartian.com/politrix/2009/03/under-cassano-troubled-aig-unit-was-charged-with-major-securities-law-violation-2/