Misdirection. As bailout billions fly around Washington DC, be wary of the frantically waving right hand. More likely than not, it’s pulling your attention away from the left hand that’s pulling off nasty little tricks.
After DC fanned the populist outrage over retention “bonuses” paid to AIG’s troubled Financial Products division, Congress has since been consumed with using the tax code to retroactively target those greedy executives and grandstanding to see which congressperson can express the most disgust.
The public’s focus is squarely on the $165 million paid to AIG executives and what on what the government can do to limit compensation at companies receiving bailout funds. And given the shenanigans surrounding the rest of the bailout funds, many in Washington probably prefer it remains that way.
Debating government oversight of compensation is a bit of a red herring. When Chrysler received government loan guarantees in the ‘70s, the necessity of cutting wages was agreed to before Congress voted. Similarly, when the Big Three automakers approached Congress late last year looking for a handout, few had an issue with the government asking for executive compensation and union contracts to be revisited.
It’s a simple case of the Golden Rule: He who has the gold (or Chinese-financed deficit spending) makes the rules. Congress could have better addressed the AIG bonuses upfront if the legislation wasn’t so rushed.
So why is Treasury Secretary Timothy Geithner wanting to keep the focus on this topic by expanding it? “The issue of excessive compensation extends beyond AIG and requires reform of the system of incentives and compensation in the financial sector,” Geithner said Monday in testimony to the House Financial Services Committee.
In Monday’s committee hearing it seemed that Geithner opted to stoke the compensation furor rather than directly address the few brave congressmen and women who pressed him on where the bulk of the bailout funds were going.
Less than 0.1% of the $180 billion received so far by AIG went for bonuses—payments that Obama’s Treasury Department and Senator Christopher Dodd wrote language to protect in the so-called stimulus bill. Though the campaign of “change” promised transparency, the White House, Treasury Department and majority of Congress seem hesitant to discuss the remaining $179,835 billion.
Like the stimulus bill, the bailout bill was hastily written and pushed through with negligible review, discussion or debate. Almost $335 billion in Troubled Asset Relief Program (TARP) funds have been committed to date and it doesn’t appear a single troubled asset has been removed from any bank balance sheet.
Where did the money go? Though the Treasury Department isn’t saying much, the Wall Street Journal is reporting that in the case of AIG, billions in TARP funds are being funneled to US banks, foreign banks and investment houses that used “naked” credit default swaps (CDSs) to gamble on the collapse of the housing bubble.
No wonder DC isn’t talking. The TARP bailout is essentially like using taxpayer monies to cover a Las Vegas casino’s house losses because the bookmaker got the line wrong.
Unmerited executive bonuses are simple to understand, so they make for an easy distraction. CDSs are a little more obscure… and those who profited from them, along with their lackeys in public office, seem intent on keeping it that way.
Basically, a CDS is a contract that allows an “investor” to bet that a credit instrument, like a bond or loan, will go into default. All the buyer needs to do is make a small (often less than 0.25% of the contract amount) annual payment to the issuer—one shiny quarter, well played, can earn you $100.00. These unregulated derivative “investments” even allow for betting that a company’s credit rating will be downgraded.
As it is for Amish folk vacationing on the French Riviera, the problem with these swaps is the rampant nudity. Since CDSs are basically unregulated, naked or unsecured swaps are allowed. An investor can purchase a CDS even though he does not own any of the insured instruments or have a stake in the company being bet against. Naked swaps aren’t about prudently hedging an investment; they are just cheap bets with long odds and a ridiculously high upside.
AIG’s Financial Products division was a major player in the CDS market that exploded to a notational value of $45 trillion by the end of 2007. Once considered sucker bets because defaults and bankruptcies are historically rare, naked CDSs exposed AIG to devastating losses because a number of institutions used the swaps to speculate correctly on the demise of the securitized mortgages that glutted the market. AIG bet otherwise, held no offsetting investments, and priced the swaps too cheaply. When the market went bust, the otherwise profitable AIG faced ruin because of one risk-laden business unit.
Before the dust could settle, billions in bailout out dollars where pouring into AIG. No one told the public anything other than “AIG is too big to fail.” When folks went in for a closer look… BAM! The bonus and compensation furor was ignited.
The truth, however, is that the billions being pumped into AIG were being paid out to speculators who arguably should have taken a haircut.
Goldman Sachs, for example, got an estimated $12.9 billion of the AIG dollars even though the Goldman noted on a March 20th, 2009 public conference call that their exposure was minimal if AIG had been liquidated.
AIG's other trading partners—such as Bank of America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche Bank, and Barclays—received $32.7 from AIG to settle the derivative contracts, essentially pushing more cash to the same group that had already received TARP money or foreign banks that taxpayers might take issue with subsidizing.
The dirtiest secret of all is that these institutions were fronting bets placed by hedge funds. Note that in 2008—the year that most investors realized staggering market losses—the top 25 hedge fund managers garnered a total of $11.6 billion in compensation because their funds reaped hundreds of billions by betting on the housing bust. TARP dollars insured that these bets were paid in full instead of being used to address “troubled assets.”
Hedge fund managers, as exemplified by George Soros who put up tens of millions in “soft money” to get Obama elected, are notorious for pumping millions into campaign coffers—65% to the Democrats and 35% to the Republicans in 2008. SNAP! Don’t look at that! What do you know, Soros—who personally made $2.9 billion using swaps to bet on the housing bust—just cropped up in the Wall Street Journal with an op-ed piece calling for CDS regulation… joined days later by Geithner expressing the same opinion. Kind of like Bonnie and Clyde calling for improved bank security… after they robbed the banks.