Friday, March 20, 2009

The AIG bonus kerfuffle is beyond absurd, but what else would you expect from a flawed bailout program with conflicted motives littering the landscape

From Information Arbitrage:

Note to the Administration: The AIG Flap is Because of YOU

The AIG bonus kerfuffle is beyond absurd, but what else would you expect from a flawed bailout program with conflicted motives littering the landscape? Congress and the Treasury should be ashamed of themselves: they've committed hundreds of billions of taxpayer dollars yet work to undermine its value and efficacy, in real time. A casual observer from another planet looking at the recent flap would invariably say: short the US - or at least its legislators.

Consider a few observations:

  • They (Congress, Treasury and the Administration(s)) entered into a bailout program with the stated (and reiterated) idea that sick institutions must be kept alive, e.g., preserving value for common stock and debt holders;
  • They initially worked to minimize the Government ownership associated with bailout funds, hurting the US taxpayer's return on investment while ostensibly allowing the recipients free rein over how to deploy the funds;
  • When it became clear that the capital injections were insufficient for the largest and most troubled institutions, more funds were committed on the same unstructured basis as before;
  • When even these amounts were deemed inadequate, either more money was put in (AIG) or senior claims were converted to subordinate claims (Citigroup's investors' conversion of preferred shares into common stock);
  • As ownership in bailed out instituions crept up, notwithstanding the earlier desire not to have the Government involved in the management of bailed out firms, Congress decided it was time to pass judgment on how the businesses were being run; and
  • Now we have a Congress smelling blood (and a PR opportunity), passing odd and abusive legislation to convey their moral outrage (hypocracy, anyone?), while simultaneously damaging the US taxpayers' massive investment in the bailed out firms (and any firm either forced or desperate enough to take Government money).

President Obama, Congress and our friends at Treasury, you can't have it both ways. Either you are making investments and letting the private sector decide what to do with it or you are taking control and restructuring troubled businesses. By choosing a middle-of-the-road strategy, you have guaranteed failure. Troubled institutions are not getting fixed, and you have wasted US taxpayer money and damaged investor sentiment. All of this could have been avoided by supporting a Good Bank/Bad Bank initiative from the outset (one Government-controlled Bad Bank; many Good Banks). This would have enabled you to:

  • Clearly segregate illiquid bad assets from the sound operating businesses, focusing US taxpayer dollars on bridging the liquidity gap for the Bad Bank while raising private capital for the Good Banks;
  • Replace legacy managements and Boards of Directors to avoid the PR damage and ongoing concerns about the stewardship of restructured institutions;
  • Hire a team to work out the Bad Bank over months and years, paying a small management fee and carry on the assets sold while staying out of the management and compensation policies of the privately-funded Good Banks;
  • Avoid micro-managing private institutions with massive public ownership and driving the value of the public stakes into the ground.

I'm hoping it is abundantly clear that the Government's plan for handing sick institutions has been an unmitigated disaster. The primary argument against Good Bank/Bad Bank - the difficulty valuing the illiquid, bad assets - almost looks like a joke today. Yes, it would have been difficult. But yes, it could have been done. The collateral damage associated with the Administration's handling of AIG and Citigroup is only just beginning to be felt. What is now a public relations circus which makes for entertaining reading is anything but funny: it threatens the value of the bailout funds already deployed and has boxed the Government into a corner. Congratulations on showering your moral outrage on AIG; the fact that this issue could have arisen is simply indicative of your ongoing failure."


This was bound to happen because it's a hybrid plan, in which the government and AIG have different interests and timetables. Let's remember the plan. It was to give AIG a bridge loan ( although we bought basically bought it, and it was more like a collateral loan ) which would allow AIG to keep going until the TAs appreciated, and to keep AIG from selling its Asian holdings and such. The problem is that keeping them going is costing more and more, and the appreciation of the TAs and holding out on a fire sale is looking more and more dubious.

The one place that I disagree with you is that AIGs not being able to raise capital could have caused a collateral run. To that extent, somebody was going to foot the bill to keep those CDSs from exploding. So, I believe that we should have done more or less what you said, but it still would have cost a lot of money. I think that the government has been reluctant to make that obvious.

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