This comes via the website The Agonist (Hat tip Scott). I have bolded the important bits:
So what are AIG’s arguments for making these bonus payments?
- All 450 employees of AIG in London, where the derivatives contracts were booked and managed, signed retention contracts at the request of management in early 2008. This was at a time when AIG was falling apart but not yet taken over by the U.S. government. The retention contracts called for certain amounts to be paid out of profitability, which now is no longer available, and fixed amounts to be paid regardless. These fixed amounts are the bonuses now under question, and there is more due in 2009.
- Once AIG was taken over by the U.S. Treasury, the mission changed to winding down the portfolio. There was no real reason why employees would want to stay under such circumstances, so the retention contracts took on added importance. Most of the payments are in the $1,000 to $50,000 range, but seven executives are to receive in excess of $3 million.
- New AIG management sought advice from outside counsel on whether it could renege on these retention bonuses. Getting outside lawyers to give advice on these matters is standard procedure in banking because it gives cover to the management for difficult decisions. Banking lawyers are peculiar resources, because they are not frequently consulted, but when they are their opinions carry irrefutable weight in decision making
- The lawyers said breaching the contracts would expose AIG to serious consequences. First, under Connecticut law the parent company could be sued by the employees for willful abrogation of a legal contract. The suits would be easy to win and the penalty is double the amount under dispute. Second, all of AIG’s derivatives contracts around the world have standard cross-default clauses, which say that if AIG fails to make a payment in excess of $25 million, all swaps, options and similar derivatives contracts could be placed in default. Failing to make this bonus payment of $165 million could lead to massive claims of default against AIG on all of its derivatives contracts.
- AIG management made a third argument. The portfolio has been reduced by 25%, which is probably where all the billions of dollars of Treasury money went when Goldman Sachs, Deutsche Bank and other big players agreed to an early termination and close out of their contracts with AIG. Every closed contract distorts the hedged position of the AIG portfolio, and expert traders are needed therefore to adjust the hedges appropriately. If these traders weren’t kept on staff by AIG, billions of dollars could be lost through inaccurate hedging. Moreover, some of the contracts are “bespoke” – Londonese for complex and one-of-a-kind – and only existing AIG traders and support staff understand them enough to be able to close them out.
- AIG management is working to reduce the contractual retention bonuses due the rest of this year, and they expect to get agreement from the staff on a 30% minimum reduction. Staffing has been reduced from 450 people to 370. All employees have seen their retirement fund wiped out since it was held in AIG stock. Management have agreed to salaries of $1.00. The effect of all these adverse changes is that the current employees are working for far less than they were in 2007 and 2008, and possibly for less than they could achieve in the market.
The post also says:
There is a sub-plot here as well – a second story arc as the TV people would say – involving the U.S. government. Treasury Secretary Geithner didn’t know about these payments until last week, when the Federal Reserve notified him that round two of retention payments was due on the 15th of the month (apparently round one worth $55 million was paid out last December 15th). It appears that the Federal Reserve seems to be heavily involved in the details of what goes on at AIG now that it is effectively owned and managed by the government, even though it is the Treasury that is the actual owner.
Read the full post over at the Agonist. It is very informative.
UPDATE: 1000 ET. Angela Somers, Special Counsel at Allen & Overy (formerly at Cadwalader), gives a good view on the legal issues involved here via CNBC. The long and short for me is that bankruptcy could have prevented this as I have noted in a previous post. However, Somers does say that, even in bankruptcy these employees would have been needed.
The Real Story Behind Those Greedy AIG Bankers – The Agonist