Valuable lessons from A.I.G.

Outrage at the $165 million in bonuses American International Group paid to executives in its Financial Products Unit continues to bring red-faced, loud-voiced senators to microphones and inspires blistering editorials across the country. Those fires have been stoked by the revelation that $93 billion of the $173 billion A.I.G. has received in federal aid was shipped out to banks and other financial institutions at home and abroad.
Critics now are screaming that not a single American taxpayer dollar should be sent abroad to rescue banks there. If a rescue is needed in Britain, France, Germany or elsewhere, it should come from those governments, they say.
What’s going on?
A.I.G. is in the insurance business. One of its most profitable operations — it contributed about $5 billion to the company’s bottom line in 2007 and made A.I.G. a hot stock — involved a highly complex insurance contract called a credit default swap. The “swaps” were agreements to insure that loans made would be repaid — if not by the borrower, then by A.I.G.
Many of the loans insured were collateralized by real estate holdings and by bonds composed of a mix of mortgages, credit card debt and other assets considered safe. When the real estate market collapsed, triggering the recession, borrowers defaulted on their loan payments. People who lost their jobs defaulted on their credit card debt. And A.I.G. faced demands for payments that exceeded its resources.
When A.I.G. faced bankruptcy, then-Secretary of the Treasury Hank Paulson and others studied the ramifications and came to the conclusion that A.I.G. had made guarantees to so many big banks, hedge funds and other financial institutions that its failure would put the world’s financial system at risk. It was, they decided, too big to fail.
The Bush administration backed a rescue with U.S. government money. Sec. Paulson persuaded Edward Liddy to take over as CEO and put his decades of experience in high finance to work. Liddy agreed to accept that Herculean task for a token salary of $1 a year.
As CEO he also decided that A.I.G. had to honor its contractual obligations to take over the soured loans it had insured. Doing so required it to send billions to banks abroad, as it had agreed to do. The obligation fell on A.I.G., and the money could only come from the billions Uncle Sam invested in it.
The work of “unwinding” the guaranteed loans began last September. By December of ’08, Liddy told Congress this week, the outstanding total of the riskiest loans the company had guaranteed had been reduced from $78 billion to $13 billion. Two of the Financial Products executives involved said the hardest work had been done. But Liddy said there still was $1.6 trillion in unresolved trades remaining on the books. Most of these, the company be-lieves, are well secured and will not result in losses.
Liddy, however, warned Congress that “there’s risk that could blow up. And if it were to explode it could cause irreparable damage to the progress we have already made.”
Liddy’s point is that it is important to keep employees on board who understand the complexities of the deals made and are best qualified to resolve them at a minimum cost to the company and to its creditors.

POINT GRANTED, but it still is not necessary to pay huge bonuses to them with federal dollars. Out of obligation to the nation and to restore some honor to their profession, they should accept salaries that are merely large rather than enormous. They should modify the contracts they have on their own volition, just as so many other workers in so many other professions have done, because the recession has made rich contracts unrealistic.
Demands that A.I.G. re-nege on its insurance obligations abroad are quite another thing. A.I.G. had established itself as a reliable source of credit in-surance worldwide. When the crisis came to a head, the company had $2.7 trillion in contracts on its books guaranteeing risks for companies all over the world. An A.I.G. default then, or now, would be calamitous — and because today’s economy is, in-deed, global, the United States would be hurt the most because its economy is the largest part of the world’s economy.
The obligations should also be honored because to renege would stain America’s reputation for integrity.
Two lessons should be learned from all of this: first, that the U.S. should do a far better job of overseeing and regulating its financial institutions be-cause when they are not operated prudently, the whole world suffers. Second, political fulminations and angry finger-pointing are an unproductive substitute for finding successful solutions to this or any other problem.

— Emerson Lynn, jr.