Notes from Howard's Sabbatical from Working. The name comes from a 1998 lunch conversation. Someone asked if everything man knew was on the web. I answered "no" and off the top of my head said "Fidel Castro's favorite color". About every 6-12 months I've searched for this. It doesn't show up in the first 50 Google results (this blog is finally first for that search), AskJeeves says it's: red.
Thursday, March 19, 2009
Nate Silver on Why AIG Paid the "Bonuses"
Nate Silver of 538 writes Why AIG Paid the "Bonuses". He of course has interesting things to say and starts with real data from their 10K filings.
3 comments:
Anonymous
said...
You knew I wouldn't be able to resist.......
So as I understand it now, the company wanted to, and is, paying the wizards who, created the toxic financial instruments, "bonuses" for 2008 (yes, i see now that they were not really "bonuses", but guaranteed compensation/salary that is equivalent to and based upon their acutal bonuses received in 2007, such that total annual compensation doesn't suffer...poor dears in down years.
Side Bar - For some reason, perhaps taxes, they wanted it structured like a bonus and called a bonus, when it wasn't really a bonus. What's up with that?
Here's what was written in the piece:
"The most significant component of Capital Markets operating expenses is compensation, which was approximately $423 million, $544 million and $481 million in 2007, 2006 and 2005, respectively. [...] In light of the unrealized market valuation loss related to the AIGFP super senior credit default swap portfolio, to retain and motivate the affected AIGFP employees, a special incentive plan relating to 2007 was established. Under this plan, certain AIGFP employees were granted cash awards vesting over two years and payable in 2013. The expense related to these awards will be recognized ratably over the vesting period, beginning in 2008."
They knew that these CDS vehicles were going to blow up and that the AIGFP employess would not make any bonus based upon actual earnings for the division. The comany must have been terrified of losing the wizards who designed these toxic assets. Why? I don't kow the real answer...and it's not because they are the only ones who can unwind them. However, now that the taxpayers own AIG, we are left with yet another obvious situation where "wall street" gets to privatize the profits, and socialize the losses. If these people were so happy to be compensatated on the basis of performance from 2004-2007, when a chimp could have made money in the CDS/CDO market (the actual quote from the piece is "any idiot could have made money trading credit default swaps in 2005 or 2006.", why suddenly did they become salarymen.
So, basically they were working on commission, i.e., make sales and get paid bags of money, but when the "evil market" (my phrase) turned against them, the poor little traders needed protection. So these guys who created and sold the CDSs (insurance on CDOs), make a bundle for a couple of years, have the foresight to know that the market is collapsing, renegotiate their pay package to pay them the same amount they were making during the "go-go years, and we end up paying for it, when they should have been fired two years ago, and under investigation for possible criminal actions.
Enough!
While the academic analysis, provided by 538, of what happened may be quite interesting and perhaps correct in some capacity, I must admit I couldn't really grasp it in a quick readthrough. I do not accept the premise that the traders are not responsible for the loses in the market. They created the CDS market. If you don't fully understand your market, and/or are not willing to accept responsibility for your loses...Don't gamble in it, especially with other people's money.
Rather than the asymmetrical agency bias model, I think there is a much simpler model which applies to these Skinnerian rats. I think that they operate simply on an amoral basis of risk/reward or positive/negative reinforcements. I believe that they engaged in very risky behavior because as far as they were concerned, for their own personal situation, there was far more reward than risk. At a certain point the attraction of big bonuses for several years(personal gain) completely obliterated the normal internal concern for others and society at large (through the creation of risky financial insturments and markets). In the absence of any meaningful negative external consequences (such as say, fear of prosecution) they had no "skinnerian" reason to curtail their actions. Hell, it is now obvious they weren't even worried about losing their jobs, even with the knowledge that their actions were going to possibly bankrupt the company. These people live in a world quite apart from the rest of us, not just physically, but emotionally and most telling, morally.
One may say that the failure of AIG is a market failure. One could make the same argument for all the recent failures on "Wall Street", that they were all "market failures". There's just one small problem with that argument; these are the same people who created the markets, managed and ran the markets, and regulated the markets (by begging for and/or bribing (legally thru campaign donations) congress to lower regulatory standards over the last 20 years).
Riddle me this Batman, if these "bonuses" aren't payable until 2013, why were they paid out 2009?
Maybe AIGFP argued that full and immediate payout was triggerd by a change in ownership event because the Treasury now owns 80% of AIG. If that's true, that's even worse than the bonuses themselves.
Current value of typically AIG CDS....100% face value thanks to Uncle Sam.
Current Value from the insights gains into the behavior and morals of the financial wizards at AIG because of the bonus fiasco.....Priceless
And people wonder how the Republican party can so easily get 48% of the popular vote running on an anti-science, anti-intellectual, anti-"elite" platform.
Yes, "asymmetrical agency bias" sounds like something Greenspan would have uttered. And yes, it completely blows away "devalued illiquid assets" for it's "huh?" factor.
I suppose the venom is because I see this issue as a moral failure at its core, and much of the professional analysis wants to stay in the financial, political or economic arenas.
Although I have to say, I think my venom to thoughtful argument quotient is getting better.
3 comments:
You knew I wouldn't be able to resist.......
So as I understand it now, the company wanted to, and is, paying the wizards who, created the toxic financial instruments, "bonuses" for 2008 (yes, i see now that they were not really "bonuses", but guaranteed compensation/salary that is equivalent to and based upon their acutal bonuses received in 2007, such that total annual compensation doesn't suffer...poor dears in down years.
Side Bar - For some reason, perhaps taxes, they wanted it structured like a bonus and called a bonus, when it wasn't really a bonus. What's up with that?
Here's what was written in the piece:
"The most significant component of Capital Markets operating expenses is compensation, which was approximately $423 million, $544 million and $481 million in 2007, 2006 and 2005, respectively. [...] In light of the unrealized market valuation loss related to the AIGFP super senior credit default swap portfolio, to retain and motivate the affected AIGFP employees, a special incentive plan relating to 2007 was established. Under this plan, certain AIGFP employees were granted cash awards vesting over two years and payable in 2013. The expense related to these awards will be recognized ratably over the vesting period, beginning in 2008."
They knew that these CDS vehicles were going to blow up and that the AIGFP employess would not make any bonus based upon actual earnings for the division. The comany must have been terrified of losing the wizards who designed these toxic assets. Why? I don't kow the real answer...and it's not because they are the only ones who can unwind them. However, now that the taxpayers own AIG, we are left with yet another obvious situation where "wall street" gets to privatize the profits, and socialize the losses. If these people were so happy to be compensatated on the basis of performance from 2004-2007, when a chimp could have made money in the CDS/CDO market (the actual quote from the piece is "any idiot could have made money trading credit default swaps in 2005 or 2006.", why suddenly did they become salarymen.
So, basically they were working on commission, i.e., make sales and get paid bags of money, but when the "evil market" (my phrase) turned against them, the poor little traders needed protection. So these guys who created and sold the CDSs (insurance on CDOs), make a bundle for a couple of years, have the foresight to know that the market is collapsing, renegotiate their pay package to pay them the same amount they were making during the "go-go years, and we end up paying for it, when they should have been fired two years ago, and under investigation for possible criminal actions.
Enough!
While the academic analysis, provided by 538, of what happened may be quite interesting and perhaps correct in some capacity, I must admit I couldn't really grasp it in a quick readthrough. I do not accept the premise that the traders are not responsible for the loses in the market. They created the CDS market. If you don't fully understand your market, and/or are not willing to accept responsibility for your loses...Don't gamble in it, especially with other people's money.
Rather than the asymmetrical agency bias model, I think there is a much simpler model which applies to these Skinnerian rats.
I think that they operate simply on an amoral basis of risk/reward or positive/negative reinforcements. I believe that they engaged in very risky behavior because as far as they were concerned, for their own personal situation, there was far more reward than risk. At a certain point the attraction of big bonuses for several years(personal gain) completely obliterated the normal internal concern for others and society at large (through the creation of risky financial insturments and markets). In the absence of any meaningful negative external consequences (such as say, fear of prosecution) they had no "skinnerian" reason to curtail their actions. Hell, it is now obvious they weren't even worried about losing their jobs, even with the knowledge that their actions were going to possibly bankrupt the company. These people live in a world quite apart from the rest of us, not just physically, but emotionally and most telling, morally.
One may say that the failure of AIG is a market failure. One could make the same argument for all the recent failures on "Wall Street", that they were all "market failures". There's just one small problem with that argument; these are the same people who created the markets, managed and ran the markets, and regulated the markets (by begging for and/or bribing (legally thru campaign donations) congress to lower regulatory standards over the last 20 years).
Riddle me this Batman, if these "bonuses" aren't payable until 2013, why were they paid out 2009?
Maybe AIGFP argued that full and immediate payout was triggerd by a change in ownership event because the Treasury now owns 80% of AIG. If that's true, that's even worse than the bonuses themselves.
Current value of typically AIG CDS....100% face value thanks to Uncle Sam.
Current Value from the insights gains into the behavior and morals of the financial wizards at AIG because of the bonus fiasco.....Priceless
Too Tall
I see we're back to the venom.
And you gave me crap for using the phrase "devalued illiquid assets"?
And people wonder how the Republican party can so easily get 48% of the popular vote running on an anti-science, anti-intellectual, anti-"elite" platform.
Yes, "asymmetrical agency bias" sounds like something Greenspan would have uttered. And yes, it completely blows away "devalued illiquid assets" for it's "huh?" factor.
I suppose the venom is because I see this issue as a moral failure at its core, and much of the professional analysis wants to stay in the financial, political or economic arenas.
Although I have to say, I think my venom to thoughtful argument quotient is getting better.
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