My Thoughts on AIG

Hi!

I've heard several news podcasts and shows recently that have prominently featured the AIG controversy. Mostly, people want to know what happened and what the government can do about it. The bottom line regarding what happened is this: AIG (though one of it's departments) insured mortgage-backed securities and didn't account for the possibility that real estate values could fall. In fact, their models didn't even entertain the notion! Now, they didn't actually have to pay claims. The problem is that insurance companies can have less of a reserve if their rating is high (AA or AAA). When property values fell, their rating fell, too. This meant that they had to provide collateral cash to companies that had policies with them. This "run" on their cash is why they needed a bailout.

One could consider this a corporate example of a small-time investor buying a bunch of houses (with ARM loans, of course) and then renting them to people for a thin profit margin. When their payments to the banks go up, they don't have enough to cover the difference. Even if the renter keeps paying the rent, the bank isn't getting enough money and forecloses anyway. The difference, of course, is that when the government gave a bunch of money to AIG, it gave it to its policy-holders. This, in my opinion, is total B.S. The policy-holders haven't realized any losses. It's all just accounting based on the terms of the policy...

This leads me to the bonuses paid to AIG employees. Also total B.S. The "we have contracts we have to honor" excuse doesn't hold water. Every day the government legally breaks financial contracts: It's called bankruptcy court. AIG could have easily spun-off the division that made these crazy deals, then had it file for bankruptcy. The rest of the company, the part that insures regular folks with traditional policies, would be fine. It doesn't surprise me at all that many of these people don't want to return their bonuses. That merely displays the kind of hubris and greed that allowed them to be successful in their jobs in the first place! Successful, of course, is a subjective term: They were VERY good at doing what they were rewarded for doing: Short-term bookings at the expense of long-term viability.

This short-term view is the result of Wall Street pressure to perform NOW! Companies aren't rewarded for taking the long-term view (unless, of course, everything collapses and long-term is all that's left). The solution will require a complete overhaul of the mentality of investors. Basically, we need all investors to ask: What Would Warren (Buffett) Do? I'm fairly certain that he didn't have any money in AIG or with Bernie Madoff. Until we start rewarding companies for making sound long-term decisions, we can expect this kind of thing to happen pretty regularly...some appropriate regulation wouldn't hurt either. Don't get me started on how AIG could keep a AA rating while it was pull all this crap...

Thanks,
Matt