By William K. Black, Thomas Ferguson, Robert Johnson, and Walker Todd
AIG's decision to pay out at least a hundred and sixty five million dollars in bonuses takes the bank bailout program's abuse of the public trust to a whole new level.
This act simply cannot be allowed to stand. The only question is how to stop it.
"Sanctity of contracts" has for some time been TARP's equivalent of Harry Potter's magic wand, the thing you waved to make difficulties disappear (for financiers, of course; if you are an ordinary worker with a pension contract, by contrast, the magic doesn't work for you). AIG clearly takes the Treasury, the Federal Reserve, and the Obama administration for fools, who can be counted on to roll over yet again at the first whisper of the magic words. There is no reason for agents of the people of the United States, whose money AIG plays with, to be so sheep-like.
Remember that this is a firm that is 79.9% owned by the United States government. It is therefore quite possible to abort this outrage by decisive exercise of public authority. Within existing law, there is more than one way to do it, but a direct solution is readily at hand: Firstly, the US trustees in charge of the firm must immediately instruct the corporate treasurer to make no payments of any bonuses. They also need to order him to issue stop payment orders on any checks that fly out the door at the last minute, as with Merrill Lynch. Then the trustees need to split off the derivatives unit from the rest of the firm and separately incorporate it. This step leaves AIG's other businesses free to operate as usual. If the recipients of the bonuses refuse to waive them, then the derivatives unit should at once be thrown into bankruptcy, terminating all obligations to pay them. Right now, press reports suggest that the firm's top management waited until the last minute to inform the government of what was happening. AIG CEO Edward Liddy, accordingly, should be asked to resign at once, for the sake of public confidence and to send a clear signal that gaming the system is unacceptable. It is also past time for an investigation of the validity of AIG's past accounting and securities disclosures and its executive compensation program by the Office of Thrift Supervision, the Securities and Exchange Commission, and the FBI.
This leaves open the question of how to deal with all other obligations of the derivatives unit, including the notorious credit default swaps. We, like most independent analysts, are mystified by the determination of the Federal Reserve and Treasury to keep paying these off at 100% of their face value. But that's an issue for tomorrow. Today the task is to stop a grotesque abuse before it is too late. The path we outline here would do it, without throwing markets into turmoil. Nothing less than public confidence in the United States government as a whole is now at stake.
William K. Black is Associate Professor of Economics and Law at the University of Missouri - Kansas City. He was a senior regulator during the savings and loan scandal and blew the whistle on prominent politicians, including House Speaker Wright and the five US Senators who became famous as the "Keating Five." He was the lead staffer on the successful reregulation of the S&L industry and directed the investigations that led to convictions in many of the worst S & L frauds.
Thomas Ferguson is professor of political science at the University of Massachusetts, Boston and the author of Golden Rule: The Investment Theory of Party Competition and the Logic of Money-Driven Political Systems (Chicago, 1995).
Robert Johnson was formerly a managing director at Soros Funds Management and chief economist of the Senate Banking Committee.
Walker Todd worked for many years in the Federal Reserve System. He was a legal officer of the Federal Reserve Bank of New York and a legal and research officer at the Cleveland Federal Reserve Bank. He is the author of many studies of bank failure, reform of the Fed's discount window, open market operations, and the Reconstruction Finance Corporation of the 1930s.
Part I of Ferguson and Johnson's "Too Big To Bail: The 'Paulson Put,' Presidential Politics, and the Global Financial Meltdown," appears in the next issue of the International Journal of Political Economy.