AIG and the Bonus Fiasco
Read the passage below on credit default swaps, and the case of AIG and the Bonus Fiasco in our textbook (Case #3). Then, focus on answering the following questions:
What is AIG’s most essential asset(s)? Ethics comes from the top of the organization. How did AIG’s leadership handle the situation? How would you, as CEO of AIG,
handle the situation
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AMERICAN INTERNATIONAL GROUP AND THE BONUS FIAsco* = v
After two decades of rapid growth and expansion in an envi- when the rating agencies suddenly lowered its credit r322; fl A:
ronment of very little regulatory oversight and unbounded Not only did this cause the cost of borrowing to go up fir f
optimism about the power of the markets to create limitless AIG, but it also triggered the requirement that the comps-’33 3 ‘ r
wealth, the U.S. financial system came crashing down in post collateral with its counterparties. Unable to do so. -« A a
the second half of 2008. What staned as a sudden decline in approached the government for a bailout. In the nex: feta
housing prices after years of speculative growth very soon months, the government pumped an astounding $85 Lees r
snowballed into a full-fledged financial crisis. Major bank- into AIG alone to prevent it from going bankrupt. Insults: r
7‘3 p ing companies such as Citicorp and Bank of America found companies are generally supposed to be risk-averse anti :r: v
their equity base wiped out by loan losses. Investment dent. How did AIG get into such abig mess? a-
banking firms such as Merrill Lynch and Bear Stearns, The primary culprit for the problems of AIG vs ; A. ‘1
{L‘ which operate largely outside the regulatory framework of somewhat exotic financial product called credit newt
h the Federal Reserve, were in even bigger trouble because swaps (CDSs). In simple terms, these swaps represerages:
3 they were highly leveraged. Fearing a complete financial an insurance cover to holders of mortgage-backed sessrw
meltdown, Henry Paulson, secretary of the Treasury in ties: If the value of the securities went down, AIG was ,k Q
i 5-33: the Bush administration, announced a bailout package of make good the losses suffered by the owners. In g a. a:
$750 billion on September 16, 2008, to restore confidence times, when real estate prices were climbing steadii} ems;
in the banks and to jump-start the credit markets. year, the CDSs were pure profits for AIG. Emboldeze; we. ‘ i
What exactly does the government do in a bailout? A what it perceived as negligible risk and motivated ’7; 5 W
bailout can take many forms. For example, the government prospect of ever-increasing profits, AIG sold hundrea; a: : f i
can buy stock in a troubled institution, thus shoring up its billions of dollars’ worth of these instruments. Ali-ratings: 7, t
“t equity base. insurance is a business regulated by the states, these “as: z
The very fact that the government has an equity stake ucts were outside the range of regulation.
may be taken as an implicit government guarantee by Right from the beginning, there was considerable : em» ’ 3
creditors, suppliers, and clients because concerns about troversy about whether the government should uy t: f,
solvency and ability to stay in business are assuaged. out any failing firm in a market economy. Even those war y
i Alternatively, the government can extend a loan to the were not ideologically opposed to the bailout were
institution, to be paid back when the company becomes tical whether the government efforts would be enoug: t
f profitable again. Another approach is for the government save the company. There were also concerns about he?
to buy preferred stock in the company. In this case the company would spend the bailout money. f
government is entitled to a fair return on the investment. Immediately after the first bailout was announced- m:
Finally, the government can buy distressed assets of the attracted considerable negative press when it was recessij:
a institution, thereby helping it to clean up its balance sheet. that AIG executives attended a lavish retreat in Caiifrrsn. i
s Irrespective of the form of the bailout, all bailouts repre- that featured spa treatments, banquets, and golf r a
sent a temporary or, in some cases, long-term cOmmitrnent Total tab: $444,000. Immediately thereafter, AP rerrfiv
of public money to private companies. that AIG executives spent $86,000 on a luxurious E13 s
As the economic crisis gathered momentum and the credit hunting trip} This was only days after the Fed had exam
i3, markets came to a standstill in the fall of 2008, it became a $37.8 billion loan on top of the $85 billion A a
clear that banks were not the only institutions in trouble. earlier. The company’s response: “We regret that this e m“
n; – American International Group (AIG), one of the largest and was not canceled.”2 f x
most respected insurance companies in the world, found In March 2009, it was disclosed that AIG ha:
itself in even bigger financial distress in September 2008 $218 million in bonus payments to employees of the
cial services division, the very division that was
“i – sible for issuing the credit default swaps that got the , W,
Al * This case was prepared by Professor Abdul A. Rasheed of the University of into trouble, Overall, 41 8 managers were the barf-Rat”,
2′ 3 Texas at Arlington, Graduate Student Brian Pinkham, and Professor Gregory fies of these “retention” bonuses, although 53 of \ A”,
G Dess of the University of Texas at Dallas. This case was based solely on were no longer with the company! The highest bong pm q ,3,
library research and was developed for class discussmn rather than to illustrate . , , _ _ . .fi; – 3.7:?»
l either effective or ineffective handling of an administrative situation. Copyright $64 Immon’ SIX ménagcrs men/ed more than $4 mflhc‘: 3′ ” t M
2009 Abdul A. Rasheed and Gregory o. oess. and 51 people received between $1 mllllon and $2 mllL-T’ A
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