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Honoring contracts.
blaisepascal
A lot of hullabaloo is being made right now about AIG, and what they are doing with the bailout monies. It seems that they are paying executives $160,000,000 in "bonuses", and have given $160,000,000,000+ to Suisse Credit, Deutche Bank, and other banks in Europe and the States -- which, some have pointed out, is going to pay for "bonuses" and large salaries of the financiers of those banks. People are upset that AIG is taking our money, our taxpayer money, and giving it away to the already insanely rich. And the common man really doesn't like the fact that the insanely rich are, in fact, insanely rich and don't like what they view as their money going to the insanely rich -- folks who they feel put the country in the crisis it's in now.

There's another way to look at what AIG is doing with the money the Treasury gave it...

A "bank failure" is really about one key thing: the inability for the bank to honor the contracts it has entered into. All a bank has is trust, earned by making and keeping contracts. If a bank fails to keep that trust, it quickly has nothing, and gets shut down by regulators. But if it can make its obligations, both contractual and regulatory, it can keep going no matter how poor it is.

AIG isn't your normal bank, and isn't a normal sized bank, either. Technically, AIG is an insurance company, insuring other companies against loan default risk. Effectively, they co-signed loans for a fee.

Most large-scale loans have conditions attached: If you have an x credit rating, you get one interest rate and or have to post a certain amount of collateral, if you have a lower, y credit rating, you get another, higher interest rate and have to post a higher amount of collateral. If you have a y credit rating, but can get a cosigner who has an x credit rating, you can get the lower rate and the lower collateral, but if you lose the cosigner, you have to make up the difference. The conditions, triggers, rates, collateral, and timing are understood by those who buy and sell the loans. But things can get hairy if you have a loan and somehow lose you cosigner. The "counterparty" -- the guy who's getting your money -- has a legal right, by contract, to say "put up more collateral by the deadline or go bankrupt". If you don't have the collateral, or can't get it (by, say, taking out a loan), or can't get an equally good cosigner, you're screwed.

AIG cosigned a bunch of loans; it was one of their business models. That means that a lot, a lot, of people were using AIG to keep their collateral obligations and interest rates down. If AIG were to fail, a lot, a lot, of people would have to come up with collateral very quickly, and most would fail. That means a lot, a lot, of bankruptcies all at once, all over the world. That would be bad, very bad.

AIG was on the verge of not being able to honor its contracts. If it was unable to honor its contracts, the really bad things described above would happen. So the US Government stepped in.

The US Government gave AIG money for one purpose, and one purpose only: Honor thy contracts, and by doing so, let the world financial system survive long enough to disentangle itself from you.

What did AIG do with this money?

It gave over $160B to various banks, both overseas and domestic, with which it had contracts which required it to do so.

It gave 1 permille of that value to a total of 400 executives which, in 2007, it had signed contracts which required them to issue incentive-based pay for 2008 at 2007 levels regardless of actual performance. It did many other things, all of which paid off people whom AIG had a contractual obligation to pay.

AIG did exactly what we gave them the money for: they honored their contracts. If they had failed to do so, then bad things would have happened. If the Government steps in and abrogates some of their contracts because "we" don't like the terms, even if the contracts truly suck, then the end result is that AIG then has a reputation for not honoring their contracts, so their cosignature is worthless, collateralization requirements kick in, margin calls happen, everybody goes bankrupt.

Honor thy contracts, or bad shit will happen.


Pissed that AIG executives are getting bonuses? Suck it up and deal. Let AIG use the money to do what we told them to do: Honor their contracts, and pay the shitty bonuses. Honor their contracts, and pay off the bad loans they never should have cosigned.

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No.

I will not stand by - and no intelligent person will stand by - while their money is used to "honor contracts" that should never have been made in the first place. The phrase "casting pearls before swine" has never been so appropriate!

Honoring contracts is only appropraite when those contracts are honorable. The police do not arrest someone when they have evidence of a hit being planned and then let the guy go when he gives them the argument, "I have a contract to perform this hit. You must let me fufill my contract."

>It gave 1 permille of that value to a total of 400 executives which,
>in 2007, it had signed contracts which required them to
>issue incentive-based pay for 2008 at 2007 levels regardless of
>actual performance.


So, you want to compound one massive mistake with another massive mistake? Let me give you another great slogan: "Two wrongs don't make a right."

>Honor thy contracts, or bad shit will happen.

Let me give you a small clue here - Bad things have already happened. It has nothing to do with anyone honoring their contracts. Thats a short-sighted, tip-of-the-iceberg vision. It has everything to do with the fact that these contracts should never have been made in the first place!

My Gods, Bu! What kind of drugs have you been taking, hon!? Please let me know so I can not take them. They're baaaaaaaad juju!

Rick,

The law is long-settled on contracts. Contracts have to meet certain requirements to be valid: they have to be for legal actions, they have to have "consideration" going between the parties (i.e., a contract that says "I will give you $5" is not legally enforceable, a contract that says "I will give you $5 in exchange for X" is enforceable), the parties have to be legally capable of coming to an agreement, etc.

A contract which says "AIG will pay Bob Smith incentive-based compensation for calendar year 2008 at levels no less than incentive-based compensation paid at 2007 in exchange for Bob Smith's continued employment during 2008" has all necessary components of a valid contract. If Bob Smith didn't quit during 2008, he has fulfilled his side of the contract.

The law does not, has not in the past, and in many real senses, cannot invalidate a contract made between two private parties merely because the contract turned out to be bad for one party or the other. "This contract should never have been made in the first place" is not considered a legally valid justification for not honoring a contract.

"Appropriate" has nothing to do with it. Honoring contracts is legally required when those contracts are legally valid, honorable or not. The police do arrest people for contract hits because murder is illegal, contract hits are specifically illegal, and the contract is not legally valid. Honor has nothing to do with it. The courts have enforced many a dishonorable contract which turn out to be legally valid. Many a judge has proverbially held his nose while signing enforcement orders over bad contracts.

It may be bad public policy to have bailed out AIG, effectively assuming their obligations. It would be disasterously bad, horribly bad government-ending bad, to say that the Government doesn't have to honor obligations it has assumed because it doesn't like them.

Your outrage over the AIG bailout and the guaranteed "incentive-based" compensation (calling them "bonuses" or "incentive-based" is misleading; once the contracts guaranteed their values, they became non-incentive-based, fixed salaries), and your proposed solution of abrogating the contracts because you don't like them has the effect of saying that the "full faith and credit of the US Government" means nothing if the Government doesn't like it. While that is technically true now, refusing to pay $164M in guaranteed pay is setting the bar extremely low.

The best that could happen if AIG refused to pay would be that they would be sued, lose, and have to pay anyway, but they would also have to pay the legal bills.

I've heard two ideas presented in Congress for dealing with the $164M in bonuses that make legal sense to me:

1) Geitner suggested, somewhat tongue in cheek, that instead of giving them the next cheque for $3B to bail them out, we give them $2.836B instead. In part, he said that to put the issue in scale. Compared to the overall scope, $164M is small change.

2) Barney Frank suggested we flex our muscle as shareholders and take AIG to court, in a shareholder suit, asking the court to have AIG abrogate the contracts as exceeding the bounds of what they could do. There are problems with this, in that the US Government isn't a shareholder (rather, a trust with the Treasury as sole beneficiary is the shareholder, specifically and explicitly to keep the US Government from micromanaging AIG), but it would be a perfectly legal, non-legislative, way of dealing with the situation. My feeling is that the suit would fail -- AIG was, at the time, a private party capable of entering into such a contract, which isn't for an illegal act, and isn't beyond the scope of employment contracts which companies engage in all the time.

But risking the trust the world has in the "full faith and credit" of the US? My Gods, Doc! What kind of drugs have you been taking, hon!? They're baaaaaaaaad juju!

Agreed, much as I hate to admit it.

This is why, on a lower level, I'm so infuriated by the attempts to re-open the state employee contracts. If the state doesn't have to honor the agreement it's made, what's the use of having the agreement? Sure, you can point at this or that provision that might be questionable, but it's still a contract that was agreed to in good faith by both parties and it should be treated as such.

The issue with the state employment contracts isn't that the State can, or wants to, abrogate the agreement. It wants to honor a different agreement instead, one which (unfortunately for the State) doesn't exist yet and which the Unions seem to have no desire to make. I have no problem, legally or ethically, with the state asking for the contracts to be reopened. But I also have no problem, legally or ethically, with the unions telling the state "No".

Contracts are reopened and renegotiated all the time when situations change, but all parties have to agree to reopen them. Sometimes it works for companies to ask unions to reopen their contracts and even get concessions. One example I'm aware of happened in the early '80s, when Harley Davidson went to the unions and said "Our financial situation is bad, please open the contracts to renegotiation so we can all continue working". The unions said "If it's so bad, and so important, you won't mind showing us the books to prove your case, right?". HD said "No problem, here they are". The unions said "Shit, that's bad, let's renegotiate...."


You should really call Wolf, Bu.

But he says there's a great quote in Rolling Stone: "Too big to fail means too big to be allowed to exist."

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