Author: Lawrence Cunningham


AIG: What “Taxpayers” “Own” and “Invest”

Meaning.jpgTwo shorthand references often used these days are how “US taxpayers own 80% of AIG” and “the government has invested more than $170 billion” in bailing AIG out. There is something in both common expressions. But the entire corporate finance and corporate governance structure put in place, and endlessly changing, is so unorthodox, that these expressions do not reflect their usually meanings.

Using them can be misleading in two different directions: (1) in terms of the 80% ownership notion, “taxpayers” have vastly diminished rights compared to the usual rights of corporate shareholders and (2) in terms of the $170 billion figure, the taxpayers have vastly less invested than that.

As to the ownership notion, a Trust whose sole beneficiary is the Treasury Department owns a series of AIG preferred stock (called Series C) that is convertible into AIG common stock that would represent 77.9% of AIG’s outstanding common shares, if converted. For now, the Trust also gets to vote on proposals to AIG’s common shareholders, including director elections, as if the preferred were converted, and receive dividends paid on common stock, as if it were converted.

But surely the “taxpayers” do not own that stock and certainly have no right to elect AIG’s directors. The Trust does. That Trust, in turn, is managed by three Trustees. These people are appointed by Treasury, not by taxpayers. The Trustees do not stand for election. Further, the Treasury Secretary is not elected by taxpayers, or removable by them, but is appointed by the President, and removable by him. The President, of course, serves a four-year term, whereas corporate director elections occur annually.

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AIG Defends Bonus Payments

Contract.jpgAs a companion to my post , AIG Contracts Questions, consider the following summary analysis of a fascinating memo, undated, unsigned and “produced quickly,” AIG explains the legal and business grounds for why it had to pay $165 million in bonuses to 400 employees of its complex financial contracts business. These payments, which range from $1,000 to $6 million, cover services during 2008, pursuant to employment agreements, and an employee retention plan, all entered into in early 2008.

After defending the payments on legal and business grounds, the memo promises, somewhat incongruously, how AIG will use its best efforts to reduce bonus amounts that may become due for services during 2009. Following is a summary and elementary assessment of these three parts of the memo: legal, business, future efforts.

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AIG Contracts Questions

Contract.jpgUnder what legal theories may an employer refuse to perform promises to pay bonus compensation to employees? That is the contract law question that US President Barak Obama and New York Attorney General Andrew Cuomo pose to the country today. Both seek to prevent AIG, the beleaguered and possibly criminal enterprise, now nearly 80% owned by the US government after its $170 billion bailout, from AIG’s planned payment of $165 million in cash bonuses to various employees.

AIG says it is contractually obligated to make these payments. The President instructs his Treasury Secretary to “pursue every single legal avenue to block these bonuses.” The New York Attorney General is doing so. His letter to AIG today requests copies of the contracts, background on how they were negotiated and descriptions of the job performance of covered employees.

In the spirit of President Obama’s call and Attorney General Cuomo’s quest, following are some admittedly spontaneously developed and potentially speculative legal avenues to block payment of the bonuses. Please feel free to add or subtract from these preliminary notations.

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Florida on Post-Crisis Economic Geography

Credit to Sean McCabe from Atlantic.jpgRichard Florida, University of Toronto, writes a fascinating piece in the March 2009 Atlantic. It begins as follows: “To a surprising degree, the causes of this crash are geographic in nature, and they point out a whole system of economic organization and growth that has reached its limit. Positioning the economy to grow strongly in the coming decades will require not just fiscal stimulus or industrial reform; it will require a new kind of geography as well, a new spatial fix for the next chapter of American economic history.”

Home ownership became a part of the American dream as a direct result of the New Deal. Then, long term mortgages were invented to reduce monthly payments; government sponsored mortgage finance expanded access; and the mortgage interest deduction (in effect from 1913 to today) spurred home ownership. Maintaining artificially low interest rates from time to time sustained access to the dream. Assembly lines later cranked out automobiles; residential developments in areas outside cities spurred the spatial fix of suburbanization.

That model of economic geography made sense for its time. Then, escaping cities was appealing. “Making and moving things” were the pumps of economic activity. But the current crisis reveals excessive reliance upon home ownership as a means of building and leveraging wealth and expanding consumption beyond fundamental means. Moreover, it shows the relation between those propensities and the spatial fix, especially suburbanization. The economy’s shape has been distorted. The model is certainly unsuited to an economy pumped by “generating and transporting ideas.”

Policy implications follow directly.

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Notes on Bernanke’s Vision of Fin Reg Reform

Wrench.jpgAt the Council on Foreign Relations Tuesday, Fed Chair Ben Bernanke summarized four big ideas for financial regulation reform:

(1) too big to fail: tighter supervision of very large firms whose failure poses systemic consequences;

(2) infrastructure: strengthened infrastructure to trade, clear and settle novel financial instruments like credit default swaps and to stabilize money markets and commercial paper markets;

(3) accounting/regulatory: reform of requirements that exacerbate market swings (like accounting rules requiring valuing assets at prevailing market prices or capital requirements that prevent building capital reserves amid prosperity that can be absorbed amid adversity); and

(4) senior risk regulator: establishing a senior systemic risk authority to oversee all financial institutions at a macro level.

Popular press reports often concentrated on selected items, as with The New York Times report that allocated ¾ of the space to item (3).

More informed assessments appear in other media, especially David Zaring’s blog post at Conglomerate. (David’s summary reflects his and my thinking elaborated in our joint article on the subject, The Three of Four Approaches to Financial Regulation, shortly to be posted on SSRN).

Among the more notable and under-reported parts of the presentation was the follow up Q&A, especially the following colloquy between the Chair and my GW Law colleague, Steve Charnovitz, concerning item (4), the senior risk regulator:

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GW’s “Panic” Conference

GW Panic Conf Logo.jpgIn July 2008, I posted an assessment of whether the then-building financial problems were a panic (mere behavioral phenomenon) or a crisis (reflecting substantive conditions). I reported that we at GW Law School were organizing a conference to explore that and the dozens of profound radiating issues.

We can now formally announce the convening of our conference. It is called the Panic of 2008 and will be held at GW on April 3-4, 2009, at the Law School in Washington DC. (The title does not necessarily answer the question posed in my July post!)

The amazing list of participants, from all walks of relevant life, includes the following:

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Steel, Patience amid Adversity

Climbing Twisting Stair Case.jpgRecent posts on this blog (Dave’s and Deven’s) about the state of the legal profession, and especially lawyer employment and legal scholarship (in comments to both), prompt the following reflections. No doubt, times are tough and may get tougher; but there is likewise little doubt that we, as a people, and law, as a profession, have faced them before and come to prosper. Steel and patience are vital here.

The stock market crashed in October 1987. Corporate finance and deal activity contracted. Law firms lost work. Associates were let go and firms cut back hiring. I graduated from law school in June 1988, and it was difficult to find jobs for many law graduates at the time. Luckily, my firm took me on board in September 1988, anyway, despite there being limited work. Shortly, however, deal flow resumed. By 1990, I had plenty of work. My firm and others resumed normal hiring, and later expanded it.

In September 2001, after terrorists attacked lower Manhattan, the stock market closed for several days. Corporate finance and deal activity contracted. Law firms lost work. Associates were let go and firms cut back hiring. Eventually, work resumed, with deal flow flourishing.

Then a professor, I went to the library to leaf through the law reviews published in the period just after the bombing of Pearl Harbor that brought the United States into World War II. I also read books about law firms during that period.

Amid World War II, people were terrified, deal flow contracted, associates at large firms were let go and hiring contracted. Scholarship appeared to have been cut back, but in corporate and securities law, did not seem to abate or shift course due to the attacks or resulting war. Eventually, the war ended, markets resumed, expanded, deals flowed, associates were hired, paid, made partner, and prosperity resumed.

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Silver Lining and Lesson Department

silver lining in a cloud.jpgA compressed portrayal of US failures evident in the current crisis may arise from the following list of representations:

(A) firms: Countrywide, Fannie Mae, AIG, Citigroup, Moody’s, Lehman Brothers, General Motors;

(B) industries: mortgage origination, mortgage finance, insurance, commercial banking, rating agencies, investment banking, automobile manufacturing and finance;

(C) regulators: state mortgage, insurance and banking overseers; Federal Housing Finance Agency; Securities and Exchange Commission and Commodity Futures Trading Commission; Federal Reserve, Treasury, Office of Comptroller of the Currency; Federal Deposit Insurance Commission;

(D) lawmakers: Congress, Congress, Congress, Congress, Congress.

What representations do not appear on this list? Deloitte Touche et al, the auditing industry, and the Public Company Accounting Oversight Board. Three cheers.

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Keynes Warns: A Trillion Here and a Trillion There

financial instability.jpgThe sums are staggering. One million dollars is one thousand thousand dollars. One billion dollars is one thousand million dollars. One trillion dollars is one thousand billion dollars.

The budget that President Obama presents is $3.7 trillion, which is three thousand, seven hundred, billion dollars; that would leave a deficit between outlays and receipts of one thousand, seven hundred billion dollars.

Government remains committed to investing or providing similarly mind-boggling sums buying into large companies, especially banks, and adding similar amounts to get people buying cars, houses, boats and the like, as in the old days. These confounding figures translate into record-level percentages of the total economic output of the economy.

Where does government get all of this money? The government gets much from taxes, on wages, on certain consumption items, on estates, and on interest and investment returns. But it far from relies on those sources, which are formal, transparent and legitimate tools of transferring private resources for public use.

A principal source of government spending, and borrowing, is simply printing money. The Treasury and the Federal Reserve simply issue it, by fiat. Since 1971 when President Nixon withdrew the US from the gold standard, there is no law that limits the government from printing as much as money as it wants, any time, for any purpose.

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President Obama Outlines Fin Reg Reform

White House Photo 2 25 09.jpg

Yesterday afternoon President Obama outlined his approach to financial regulation reform that is undoubtedly coming our way. He named the following seven goals

1. Enforce strict oversight of financial institutions that pose systemic risks

2. Strengthen markets so they can withstand both system-wide stress and failure of large firms

3. Encourage a financial system that is open and transparent.

4. Supervise financial products based on “actual data on how actual people make financial decisions”

5. Hold participants accountable for their actions, “starting at the top”

6. Overhaul regulations so they are comprehensive and free of gaps and do not result in regulatory competition

7. Recognize that the challenges are global

The President said: “Iif we all do our jobs, if we once again guide the market’s invisible hand with a higher principle, our markets will recover. . . . Our economy will once again thrive, and America will once again lead the world in this new century as it did in the last.”

The President also emphasized the following:

“The choice we face is not between some oppressive government-run economy or a chaotic and unforgiving capitalism. Rather, strong financial markets require clear rules of the road, not to hinder financial institutions, but to protect consumers and investors, and ultimately to keep those financial institutions strong. Not to stifle, but to advance competition, growth and prosperity. And not just to manage crises, but to prevent crises from happening in the first place, by restoring accountability, transparency and trust in our financial markets.”

Hat Tip: Don Marlais

Photo: Official White House Photo taken during the President’s remarks