AIG Paying Out Millions in Bonuses
TSF - March 14, 2009
by Janet Tavakoli

In the above article (see link to WSJ article above), Mr. Liddy said the company had entered into the bonus agreement in early 2008 before AIG got into severe financial straights and was forced to obtain a government bailout last fall. In the fourth quarter of 2008, AIG lost $61.7 billion, but it was in trouble long before that due to AIG Financial Products Group, even if AIG did not own up to it at the time.

According to the article, "The large bulk of the [bonus] payments at issue cover the AIG Finance Products Group." Yet, this group had problems as far back as the second quarter of 2007, and AIG was in severe financial straights long before the first quarter of 2008. In my opinion the government interfered with the "sanctity" of AIG's credit derivatives contracts claiming it was in the public's interest, and as a matter of public policy, Treasury could have found a way to alter AIG's bonus agreements given the extraordinary circumstances.

In August of 2007, I challenged AIG’s accounting saying they had large unreported losses. I was challenging AIG’s earnings for the second quarter of 2007, and contrary to Liddy’s representations in the above article, AIG had grave concerns by the first quarter of 2008.

This is an excerpt from Chapter 10 of Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).

For example, AIG wrote credit default protection on a whopping $19.2 billion “safe” investment that had exposure to subprime loans (a super-senior tranche of a CDO backed by BBB rated tranches—the lowest rating that is still investment grade—of residential mortgage-backed securities, and these were backed by a significant amount of subprime loans. By August 2007, the prices of the collateral backing the super senior had tanked.) Anyone who buys insurance knows that even if you are “safe,” if you are in a high risk category, your cost of insurance goes up. If AIG were to pay someone to take over its insurance-like obligation, AIG would have to pay more than it had received, and AIG should have shown this as a loss. [See also the notes section of my book]

AIG’s stance seemed bizarre given that five insurance executives from AIG and Berkshire Hathaway’s Gen Re Corp (even Warren Buffett cannot control every action of every employee) were under investigation (and eventually found guilty) of conspiracy to inflate AIG’s reserves and mislead investors about AIG’s earnings.

I told Dave Reilly at the Wall Street Journal: “There’s no way these aren’t showing a loss.” That is simply a market reality. This is Wall Street speak for: In my humble opinion, you are a big fat liar. AIG responded: “We disagree.” That is Wall Street speak for: No, YOU are a big fat liar! [This was August 2007]

Before Dave Reilly wrote his article, he talked to experts, including me, for background. Then he called AIG to ask them for their thinking. AIG stood firm. Then Reilly called me again. He didn't want the Wall Street Journal to look stupid, but told me “they pay me to go out on a limb.” He said he needed me to go on the record. It would make the article more forceful. I did not think that AIG would tell Reilly: You know, you have a point, maybe we should recheck our homework, but I did not anticipate arguing with AIG in the Wall Street Journal’s “Heard on the Street” column. I hesitated. AIG, a large global conglomerate, has the resources to crush me like a bug. On the other hand, I am not fat. I finally agreed to go on the record.

By June 2008, AIG recorded two back-to-back quarters of its largest losses ever. AIG took more than $20 billion in write-downs on its derivative positions through the first quarter of 2008; net losses for the fourth quarter of 2007 were $5.3 billion, and in the first quarter of 2008, AIG reported losses of $7.8 billion. In February 2008, its auditor said it found “material weakness” in AIG’s accounting.

End of Book Excerpt

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008), and
Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (John Wiley & Sons January 2009)


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