Summers: AIG Proves Regulatory Regime is Unsatisfactory

Get ready for a new front to open in the compensation wars. Last week, Reuters reported that Citigroup is writing bonus guarantees to attract traders in London. And once again, A.I.G. is at the center of the bonus battle with news that it will be making good on $165mm of bonus guarantees. The disclosure has, predictably, touched off a firestorm in the court of public opinion, with White House economist Larry Summers firing the first shot on CBS' Face the Nation Sunday. Yes, there is something outrageous about the poster-child for the credit crisis taking $170B of public funds to stay afloat and then paying out big incentive money to employees. But, what can be done? A.I.G. is in a unique position, to say the least. The government, concerned about systemic risk and the devastating market consequences of allowing the company to fail, feels like it must prop up the giant insurer. A.I.G. seems to understand this and, rather than deal with legal challenges to employment contracts, has decided to honor those deals. But let's think of it from an employees perspective. Let's turn back the clock to January 2008. You are a credit default swap salesman. Your space is one of the few seemingly robust parts of the credit market, and there is a healthy bid for your services. You are happy at Broker X, but AIG comes calling and blows you away with an offer. Of course, as is convention in the finance world, you aren't going anywhere without guaranteed money for, let's say two years. Why do you hod out for this? Well, you just never know what can happen, markets turn, bosses leave, things happen, and this is maybe that chance to have a some security for a couple of years. Now it is March 2009 and the world is an entirely different place. The move to A.I.G. was a big stinker, but you were smart to negotiate that guarantee because you are protected. God thing you paid that compensation lawyer big bucks to make sure it was all kosher. Management can come and ask you to take a decrease or defer some money, but why would you do that for a firm that may not be around next month, let alone next year? That's the way it works (worked?) on Wall Street. Are these contracts indeed bulletproof? Should A.I.G. and the government spend time, money and energy renegotiating these contracts? The answer is likely "no". But, what the government will do is add this situation as one more arrow in its regulatory reform quiver. By expressing outrage, the court of public opinion will tend to fall on the government's side, and if you look closely at Summer's remarks yesterday, he said "What the lesson is, is this: We don't really have a satisfactory regulatory regime in place." The drumbeat is continuing in the march toward a dramatic overhaul of the financial regulatory system. The regulatory reform train is finally starting to pickup speed. The Obama plans key points were revealed this morning, and they center around the Federal Reserve getting new powers to monitor and address broad risks across the economy. Also proposed are Changes to bank oversight, more transparency for inter-bank money flows, tougher capital requirements for big banks, and a consolidation of consumer protection enforcement.

The links:

• More bad PR for A.I.G. As if news that it paid guaranteed bonuses wasn't enough to keep the spin-doctors busy, the list of its counterparties that were streamed payments after bailout funds were received is out.
• A great profile of Thain's hubris by Greg Farrell and Henny Sender in the FT Weekend.
• Unhappy Anniversary Bear Stearns; it's hard to believe it's been a year since the powder-keg of Wall Street exploded. WSJ's James Freeman says there is still a lot we haven't figured out since then.
• The WSJ's Real Time Economics blog has a view on what to do first in avoiding another financial calamity.
• Paul Krugman says Europe's financial crisis could be way deeper than that of the U.S.
• Roubini says beware of the dead-cat bounce.
• The G-20 is split on hedge fund regulation.