I keep hearing this, but never whether the mind numbing complexity is meant in a “Lebesgue integrable semigroups of Krull dimension zero” sort of way, or a “business majors don’t take three semesters of calculus” sort of way. Which is it?
Okay, so we all seem to agree that these payments are outrageous. That’s something.
On the scale of the bail-out bill however they are just an ugly wart and you don’t use a jackhammer to remove a wart; in fact some warts you are better just living with and letting them eventually go away on their own.
Sure these highly compensated jack-asses are just getting paid the money they were promised like any other workers, just on an obscene scale. But such obscenity at this point in this way feeds the mobs anger and an angry mob must smash something before they’ll disperse. These jerks are handy and really, where are they going to go? Stick it out and next year they get a new compensation package calling it something other than a bonus, after the mob has moved along. Leave and they go into an EU market that is poised to regulate these pay structures tighter than the US ever will. If any of them can find a top job what with the huge demand right now for overpaid investment bankers. The risk of theses jerks leaving AIG to collapse without their arcane knowledge is small indeed and no one is likely to feel too sorry for them even if they did end up getting screwed, which won’t actually happen anyway.
But that jackhammer … it is not exactly a precision instrument. First it runs into Constitutional issues what with Bill of Attainder and all that lawyerly stuff. Second as written it can badly hurt people who really didn’t do anything wrong while leaving some real bad actors unscathed completely.
The mob’s anger must be vented. But riots often end up hurting others who did nothing wrong while the fat cats watch from their secure penthouses. My greatest hope is that the few who are hanging onto their “bonuses” see the writing on the wall and return it dispersing the mob a bit more peaceably. They will do just fine next year and they know it.
Voyager, I too will be happy to see reforms taken with slow deliberation and in conjunction with similar reforms in the EU. But it seems clear now that leaving these compensation structures exclusively to free market forces puts all the rest of us holding all the risk when things go bad. Slow is fine so long as slow does not mean forgotten once the crowds go back home and start caring more about Paris Hilton’s latest meltdown again instead.
Somewhere between, but closer to the former. At our place, for example, product pricing is subject to forecasting from teams of trained actuaries, product experts, accountants, lawyers, etc. The products have many, many “moving parts,” and the tweaking of a single benefit (e.g., will it have a guaranteed income benefit, or something else?) can change the regulatory requirements for which accounting and reserving come into play. That effect alone can be enormous.
The pricing exercises are exceedingly dense with details, regression analyses, sensitivity equations. They “shock” the forecasts with various scenarios, because it is NEVER clear-cut. If a firm prices the product for today’s market, they’ll never sell anything. If they price it for a bull market only, they risk assuming unsupportable risk. Which is it? What’s the right pricing / hedging / profitability assumptions? There are industry experts, guys intimately familiar with the design of their firm’s product lines, who would not be surprised when a given round of forecasts come back to hear, “It’s profitable!” or “It’s a loser.” Either one. It’s really complicated.
And our products are straightforward compared to the credit default swaps AIG dreamed up back in their “lab.”
I’m involved with the design of microprocessors, so I know complicated. It is true that the CEO (and I’m not sure how many others) got sacrificed. Liddy is not to blame. However, I think even these guys might have made the problem clearer - if someone from the inside had blown the whistle, we might have gotten some action. There were some obviously wrong things they did: lack of reserves, allowing those without a stake in the bonds to buy credit default swaps on them, for instance. Gretchen Morgensen said that their models didn’t even allow them to model the impact of a decline in housing prices.
Maybe someone did bring it up, and the top execs shot it down. (No one has come forward saying they have so far.) I’d like to know if the extent of the risk was brought up by anyone, and if anyone, up to the board, cleared it.
Krugman brought up the risks multiple times before the crash, but did anyone do it when there was time to prevent the problem?
As I said, they are the predecessors. No one is angry at Liddy for taking too much money (he isn’t) and he is the new guy.
As for job security, if they read the papers they would know that is pretty scarce these days, especially on Wall Street.
How do you assess risk, what is an acceptable level, and do you have reserves for the worst case? I don’t think the problem with AIG was how they priced the credit default swaps - it was a lot more fundamental.
I’m oversimplifying, but not too much–pricing is the safety valve. You can theoretically prepare for any scenario, but that preparation (e.g., the purchase of hedge instruments, reserves, etc.) has a cost, and that cost is reflected in the price of the product, CDS’s included. Obviously, the CDS’s, had their risk been responsibly managed, would have been priced MUCH higher, if they would have been a viable product at all.
Believe me, for products like these, price is the reflection of EVERYTHING, and in this instance, the bargain they offered was made possible because AIG assumed none of the catastrophic risk. They couldn’t. To have prepared properly they would have needed to set aside massive reserves (which are expensed), and the swaps would have cost lots, lots more. There’s a reason AIG could have created the next Great Depression if not bailed out: they sold LOTS of these instruments, to LOTS of other financial giants, 'cause they were really attractively priced.
Consequently, that created the scenario where many conservative companies, who were risk averse, purchased these hedges to be fiscally responsible, never suspecting they were buying a hollow product. AIG collapsing would have created a domino effect that would have crushed the world economy–the misery we’re experiencing now would have paled in comparison.
AIG went without a CFO and a risk assessment manager for over 6 months before the meltdown. The internal controls were gone.
On CNBC a couple weeks ago they had a story saying CFO stay an average of 3 years at a company. They are not there when the results are known.
Looks like a former constitutional law professor is doubting the constitutionality of the House bill.
So they either didn’t understand the risk, or ignored it in order to be able to price this product to move. Thanks, that makes sense.
That I understand, and it is disturbing the number of people who just say “let them go bankrupt” without getting the consequences.
If only they treated the tax payers money with respect, we would not be so pissed. They are causing the hatred.
They are too far removed from the damage they caused.
Yeah, that’s about the size of it. Every firm assumes certain risks when they launch a product; generally it’s the risk that it won’t return as much as they hoped for. AIG’s risk was that they’d be bankrupt without a bailout and they’d jeopardize enough firms’ solvency to create a horrendous crisis. Their risk management team was incompetent or unethical. Or let’s not rule out both.
Yep, and I tend to be a free market, “let 'em fail” kind of guy. But this one is HUGE.
Or ignored, which is sadly not uncommon in the financial sector.
Some people are stating that the current AIG staff weren’t the ones responsible for the meltdown. The responsible ones, we are told, are “long gone” (what they just evaporated?). However, that directly contradicts the same people who say that the current staff are the only people who can set everything in order, because they know what’s what.
So they knew what was going on, but they’re not responsible? Is that what people are saying?
Too true. Risk management people are dispised within the financial services, are generally paid lip service, and often ignored. To be fair, they all say the sky is falling every day, but they get it right sometimes.
Most of the current staff weren’t the original decision makers for the previous company direction for their non-insurance BU’s. The majority of the folks responsible for the ‘hedge funds’ sectors are ‘long gone’ (and no, they didn’t ‘just evaporate’, they went to other companies. Never heard of that before??).
It’s not a contradiction at all of course looked at from a rational or logical perspective. The folks who are still there were involved in the various BU’s, and so have fairly in depth knowledge of the company. Further, they have been working now for months on the strategy that AIG is currently using, i.e. stabilizing the various BU’s, shoring up the image (which is now back in the toilet) and credit (which is an unknown at this point thanks to this lash up) and generally attempting to prepare AIG to be broken up and sold off to try and get us our collective money back. Something that is apparently so hard to grasp by both the American people and the public at large (as well as the brilliant folks here at the SD) that it’s nearly Quantum Physics, seemingly.
I’m sure most of them knew what was going on. But some weren’t in the decision loop or otherwise didn’t have an impact on the decision process. Some undoubtedly did, but so what? If you wanted to try and rebuild the pieces you are going to need some of the folks who know how the thing got broken in the first place. By and large though the folks who were instrumental in the previous decision process for the non-Insurance BU’s are ‘long gone’ and not through mystical evaporation…
-XT
What has been posted is that the executives who made the decisions to invest stupidly are gone–as is most of the business division that dragged down the whole company.
Now that the company is in danger of sinking, the functional people who understand both the ways in which complex trading works as well as how that complex trading is stated on the company’s books, are still at AIG, (probably not for much longer with the current cries of “Burn the witch!” still ringing in the air), as the ones who were issued the payments as an incentive to not flee the company and let it burn after the crash.
I’ve helped a few companies recover from some incredibly stupid decisions, (nothing as large as this, of course), and I can tell you that fixing something with hands-on knowledge of the company practices and history is infinitely easier than walking in cold from the outside and trying to figure it out from reading a three foot stack of balance sheets.
It should also be noted that the original claim for the need to retain those people was not that those were the only humans capable of fixing the problem, but that the company could not find enough capable people to fix it if they suffered a massive exodus. As noted in the earlier link:
With all the torches and pitchforks raised, a lot of the people who had received money to stick around and fix it are now considering leaving–either with or without the money. All the horrified cries of “BAD WORKERS” is very likely now going to cause AIG to fold, meaning that a might of (un)righteous indignation has actually caused the overall bailout for this company to be a complete waste of funds.
The people responsible for the CDS backing of CDO’s with insufficient funds are gone.
It’s not that the financial instrument of a CDS is specifically bad, it’s just another form of insurance. However, they were made so convoluted as to make liability predictions, or even ownership of that debt, difficult to manage.
Not bad? Making a bet on a bet based on a bet that someone you don’t even know, made based on a bet that someone ELSE made isn’t a bad thing, no, having that rube goldberg of a system hold up our entire economy however, IS.
If the CDS was regulated instead of being a cloud held up by vapor and filled with dreams, then it would be a decent instrument, as it stands now though, not so much.
I think you assign too much value to them. I would describe them as a holgraphic image of the dust made from racing horses posted on a shareware site.