American International Group in Financial Crisis and Loss of Business Ethics - Case Study Example

A.I.G. in Financial Crisis and Loss of Business Ethics Email Address Telephone ID# Table of Contents Section I: The Overview 2 Introduction 2 1.1 A.I.G. Financial Crisis 3 1.2 The Case for Business Ethics 4 1.3 The A.I. G. Bonuses 5 Section II: Laws and Regulations 6 2.1 ESSA 2008 and TARP 2009 6 2.2 Dodd-Frank Reform and Consumer Protection Act of 2010 9 Section III: The Bottom Line 10 3.1 Federal Regulation or Private Status? 10 3.2 Codes of Conduct, A.I.G. 10 3.3 The Final Word 11 SECTION I: The Overview Introduction The American International Group (A.I.G.) was considered to be a financial bulwark within the international community and of that for the United States. Over its reign in the financial markets, it had a high valuation in stocks, a triple A rating, based on the presumption that it would stand behind its commitments to customers, and a huge derivatives portfolio, all of which were led by Chief Executive Hank Greenberg.1 As it became increasingly apparent during the 2008 financial downturn that A.I.G. could not meet its commitments, one solution made by U.S. Treasury Secretary Hank Paulson, was to nationalize A.I.G. to the tune of $100 billion. Some of the causes that contributed to the crisis were that the Federal government expanded lending criteria to make low-income home buyers able to buy with low interest rates and low down payments. There were also rapid growths in credit default swaps along with government-sponsored and private residential mortgage-backed securities which led to house price declines and defaults through a complicated and vague set of transactions.2 Months later, it came to public notice that A.I.G. was paying bonuses to various individuals at A.I.G. whose jobs had already been terminated. So how was it that A.I.G. could receive a bailout from the government and then turn around and pay bonuses to a number of its employees, especially if their positions had already been terminated?3 In effect, the $165 million in bonus payments may have very well been legal as covered by law under the American Recovery and Reinvestment Act (ARRA). As A.I.G. stated, this was paid in order to retain employees whose jobs were vital in functional operations which at a future point would wind down and be closed. For now, those operations had to keep running. President Barrack Obama was apparently ‘shocked’ at these bonus payments yet it was his administration who requested this provision be inserted in the ARRA. In fact, these details had already been revealed in a Securities & Exchange Commission (SEC) report with an estimated $469 million retention payments fully stated as part of the report. The Obama government drafted the ARRA legislation that provided A.I.G. (and other companies) the capital required to make those payments and also provided the exemption to cover retention payments.4,5 1.1 A.I.G. Financial Crisis A.I.G.’s disastrous decline was due mainly to the credit-default swap portfolio, which were insurance contracts on securities. A.I.G. would guarantee the security’s value for a fee although it was known that if the prices for the securities collapsed then A.I.G. would need to cover them. But, all concerned with evaluating the market felt this would never happen and that the securities, for the most part, were risk free. In one of its swap deals at the end of 2007, A.I.G. covered $61 billion in securities with exposure to subprime mortgages and here is where the trouble began as mounting losses, shortly thereafter, required A.I.G. to post the deteriorating values of the securities. While saying these were only paper losses, A.I.G. was also subject to collateral calls and these began to happen as A.I.G.’s counterparties demanded that A.I.G. go ahead and put up the collateral as part of its own arrangement. Ultimately, this strained A.I.G. resources so far that the company finally collapsed.6 Some of these counterparties are Goldman Sachs, Merrill Lynch, UBS, Deutsche Bank, Barclays, Credit Agricole, Royal Bank of Scotland, CIBC, and Bank of Montreal, according to the Wall Street Journal. 1.2 The Case for Business Ethics There is actually a two-part case of business ethics as concerns A.I.G.: one is the timeline of events concerning the deterioration of the value of securities and how this was presented to investors at a December 5, 2007 meeting where A.I.G. CEO Martin Sullivan said the credit-default swap portfolio losses would be ‘close to zero,’7 and two, as part of the restructuring, bonuses were paid out to employees who had lost jobs. These were the retention bonuses made to employees to stay on until no longer needed.8 In 2013, the public, for those who do watch what goes on, now see that A.I.G. has not been punished for having broken any laws. It is still not clear if A.I.G.’s CEO misstated the financial situation, particularly as the bailout occurred shortly thereafter, to a total amount of $182 billion, the largest federal bailout in U.S. history to date. Without this bailout,9 the financial havoc that could have taken place in the United States, could have spread to Europe causing a catastrophic repercussion through a number of countries. By mid-2010, A.I.G. had repaid $51 billion of the bailout money back to the government and promised to repay the remaining balance to the Federal Reserve, which owned 92.1 per cent of A.I.G. as part of the recovery plan. By 11 December 2012, the Treasury Department sold its remaining stake in A.I.G., having earned about $7.6 billion from that sale. This also presented taxpayers with $22.7 billion and subsequently, A.I.G. is now a full private enterprise again.10 Ultimately, A.I.G. was a company that was too large for the federal government to allow failing. The repercussions across the board would have been astronomical and would have hit on a global basis through the many varied global partnerships. What was also clear was the fact that this disaster was also a long time in the making.11 1.3 The A.I.G. Bonuses While there may an argument that the bonuses given by A.I.G. to some of its employees were legal as part of the ARRA arrangement, it is not entirely clear that A.I.G. was part of the arrangement when that section was created in the Act. That section of the Act reads as follows: “The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.”12 Even if there are any sorts of regulations that must be followed, it appears that there are always ways to get around them, to find the loopholes or a presence of vague interpretation which allows for different ways of interpreting a law or regulation. It can be a question of when something occurred as to whether it is considered ‘valid’ practices such as when a law or regulation was enacted as compared to when a company did a certain action.13 The outcome of this was to tax those who received the bonuses at a rate of 90%+ but as it turned out, the employees concerned began paying back the bonuses instead so as not to pay those taxes. Yet there is controversy about those bonuses being paid back as well, as one executive employee, Executive Vice President Jake DeSantis, stated in a letter to his A.I.G. boss, Edward Liddy, Chief Executive, who basically had been working at a salary of $1 per year and was to receive the bonus. In summary, he was upset that Liddy had not stood up for those who were working for that amount, expecting to get the bonuses. So all the work he and others had been doing to assure that the restructuring of the company would be efficient, would now not be compensated. One can only wonder if Liddy made mention of these executives’ salaries while testifying in front of Congress. In fact, he and the others who were working under this promise of the bonus, were not responsible for the defaulting credit swaps. Those employees had already left the company and moved on to new lives. While there was nothing unlawful in giving the bonuses, the repercussions of these actions certainly seem unethical as many promises were made and then broken and the wrong people blamed.14 It is still unclear as to whether these were contracts that were made before the downturn and whether these contracts should have been honoured as written. This, in of itself, can present a whole other case for not only breach of ethics but a breach of contract by A.I.G. to its employees, especially those not involved in the problem department. Ethics can be a vague word when it comes to business and finance because of what is actually proper to do and what is lawful to do. While one could assume that one would reflect the other, the truth is that financial transactions can take place within the confines of law but when measured against an ethical parameter, it would not hold up quite so well. Therein will be the problem in what is good by lawful standards and what is ethically right. Section II: Laws and Regulations 2.1 Emergency Economic Stabilization Act of 2008 (EESA) and Troubled Asset Relief Program (TARP) of 2009. The Emergency Economic Stabilization Act (ESSA) of 2008 was created to assist in the restructuring of economic stability in the United States which occurred at this time. The Troubled Asset Relief Program (TARP) of 200915 was created under the ESSA and assisted in the recovery of A.I.G. which was the world’s largest provider of conventional insurance. Among other things, many relied on A.I.G. for coverage on life savings and it was also a huge player in many global financial markets, including municipal bonds. In order to stave off an even worse collapse if A.I.G. were to go under, TARP was created to step in and assist in recovery16 by providing $70 billion in recovery funds along with $112 billion from the Federal Reserve Bank of New York (FRBNY). By the end of 2012, much of this had been recovered through positive returns, either by A.I.G. directly or by sales from A.I.G. The table below shows the outline of commitments and positive returns. TARP Recovery Commitments and Positive Returns Fig. 1 (TARP(2) 2013) Section 2 of the ESSA provides that the purpose if the act provides ‘authority and facilities needed for the Secretary of the Treasury to restore liquidity and stability17 to the financial system of the United States’ which will encompass home values, retirement accounts and life savings, homeownership, and maximize returns to the taxpayers. Section 3 (8) also refers to the TARP as in troubled assets (9A) as in mortgages, securities, and (9B) any other financial instrument18 deemed necessary to promote financial market stability as transmitted by writing to the appropriate committees of Congress. This also allows for the Secretary to purchase troubled assets from any financial institution as determined by the Secretary as in the A.I.G. case. In Section 101 (B) Consultation, (e), this provides for ‘Preventing Unjust Enrichment’ in that the Secretary shall take steps to ensure unjust enrichment of financial institutions participating in the program. This refers to sales of troubled assets to the Secretary at higher prices than what the seller paid to purchase the asset. The Act also provides that the premiums cannot be more than the Secretary deems necessary to meet the purposes of the Act and to base premiums on product risk. Section 103 in Considerations (1) protects the interests of the taxpayers by maximizing overall returns and minimizing the impact on the national debt and in (2) to provide stability and preventing disruption to financial markets to limit the impact on the economy which will protect American jobs, savings and retirement security. (3) also provides for helping families to keep their homes and to stabilize communities.19 In retrospect, A.I.G., in light of the laws in place, was appropriately regulated once the issues were made known and the appropriate regulations put into place.20 As far as bonuses being paid out, it may very well have been appropriate to make those payments, but certainly they were not popular with the public who would have to carry the tax bill within the funds provided which would pay those bonuses. Perhaps, if the bonuses had been paid from some other holding outside of the A.I.G., there would have been a very different reaction from the public, if there had been one at all.21 Was it appropriate that CEO Sullivan told the investors there was nothing to worry about? If he had told the truth, would A.I.G. be in worse shape now instead of having recourse to the government to get help? That is somewhat hard to say and it would seem that in financial matters, disclosure of the truth is essential22 when things happen. Yet, that rarely happens until a firm such as A.I.G. is forced to testify in front of Congress. Certainly the American government acts in this same manner, such as in the Benghazi disaster of September 2012. It has required Congressional Committees to order hearings under testimony and these, even under oath, have not provided much in the way of disclosure.23 2.2 Dodd-Frank Reform and Consumer Protection Act of 201024 A.I.G. did not ever fall under this act because it provides within this act that government regulation cannot occur when it has a stake over 50 per cent interest in a company. Once its holdings in A.I.G. went under 50 per cent, then federal regulation would trigger its implementation of government regulations.25 If federal regulation were to occur, then there would be a number of new restrictions for the company which includes minimum leverage and risk-based capital requirements. Additionally, there would be restrictions on dividend payments and share buybacks. As of September 2012, it owned 53.4 per cent of A.I.G. but if it were to receive $28.73 on each share as part of the bailout in 2008, then it might trigger the federal regulations. A.I.G. currently owns a savings and loan holding company in Connecticut which is already under federal regulation. In conducting those sales of shares, it would then own 23 per cent of A.I.G., thus putting the company under regulation. Section III: The Bottom Line 3.1 Federal Regulation or Private Status? Perhaps there is something to be said for a financial entity that is federally regulated as opposed to a private entity that has the freedom to do more with its shareholders’ money. But obviously, there is far more risk involved with a private company. The Federal government has, until recently, been barred from regulating insurance holding companies because of a provision in the 11999 Gramm-Leach-Bliley Act. That provision was addressed and removed with the implementation of the Dodd-Frank Act. A.I.G., from this time forward, will be subject to examination, enforcement and the supervisory authority of the Federal government now. While regulations may not be in place, the very nature of A.I.G.’s holdings and influence on the global market make it necessary to have some type of oversight committee that makes sure this never happens again. Such failures are far too expensive in a sluggish economy and as it stands now, A.I.G. will need Federal approval before paying out dividends.26 3.2 Codes of Conduct, A.I.G. A.I.G., under current President and CEO Robert Benmosche, provides a public code of conduct27 on its webpage which is available for all to read and provides outsiders what they can, and should, expect from any employee of A.I.G. Many aspects of working with confidential materials are addressed along the way, including such activities that might lead to money laundering and funding terrorists. This also includes foreign individuals and entities that have offices in other countries. Obviously, those potential clients would have to be reviewed or vetted from the top in order to maintain a clean ‘nose’ in all foreign matters that might compromise the United States. Employees are also not allowed to “engage in speculative trading in securities of A.I.G. or any of its subsidiaries; engage in hedging transactions using A.I.G. securities; ‘Short sell’ A.I.G. securities; or trade derivative securities, such as ‘put’ or ‘call’ options, swaps or collars related to A.I.G. securities.”28 With this in mind, there is a clear message that various activities do not take place without the appropriate approval, either from the top executives, or more likely, the Federal government. While there may not be regulations in place, yet A.I.G. is treading very carefully from now on in keeping everything clean and above board.29 3.3 The Final Word Former A.I.G. CEO Hank Greenberg, along with Starr International, once a prominent company investor, had planned to sue the Federal government over the harsh terms of the bailout which affected shareholders and deprived them of billions of dollars. Greenberg asked A.I.G.’s current board of directors to join the lawsuit as well. When news of this got back to Congress who gave them the bailout, everyone was furious. As was expected, A.I.G.’s board of directors has declined to join in with the lawsuit. It would hardly seem likely they would jump into this lawsuit when the company appeared to be lucky enough to not get pulled to pieces over its financial debacle. Yet, the board may have momentarily considered this action before wisely abstaining from such a procedure. However much employees suffered from the A.I.G. fallout, it must pick up its socks and move on to bigger and better business practices and indulging in a lawsuit against the hand that fed it and helped it survive, would not be an auspicious beginning towards that end. References and Resources Adrian, T., Begalle, B. Copeland, A. and Martin, A. Repo and Securities Lending. Federal Reserve Bank of New York Staff Reports, No.529. Revised 2013. http://www.newyorkfed.org/research/staff_reports/sr529.pdf accessed 1 March 2013. AIG. Code of Conduct. The Right Choice. AIG Online. http://www.aigcorporate.com/corpgovernance/Code_of_Conduct/AIGCoCforGermany_English.pdf accessed 27 February 2013. American Recovery and Reinvestment Act of 2009, Title VII-Limits on Executive Conpensation, Sec. 111, Executive Compensation and Corporate Governance, D(IV), (iii-i). 404. United States Government Printing Office Online. http://www.gpo.gov/fdsys/pkg/BILLS-111hr1enr/pdf/BILLS-111hr1enr.pdf accessed 25 February 2013. Berrospide, J. Bank Liquidity Hoarding and the Financial Crisis: An Empirical Evaluation. Working Paper for Finance and Economics Discussion Series. Federal Reserve Board. 2012. http://www.federalreserve.gov/pubs/feds/2013/201303/201303pap.pdf accessed 2 March 2013. Blundell-Wignall, A., Atikinson, P. and Lee, S.H. The Current Financial Crisis: Causes and Policy Issues. 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AIG’s Announcements, Fed’s Innovation, Contagion and Systemic Risk in the Financial Industry. Referred Research Paper – Entrepreneurship and Finance. 2011. http://www.swdsi.org/swdsi2012/proceedings_2012/papers/Papers/PA111.pdf accessed 1 March 2013. Senate Committee Hearings. Witness Testimony. CRS Report for Congress. Congressional Research Service. 25 September 2009. http://www.fas.org/sgp/crs/misc/98-392.pdf accessed 27 February 2013. Sinha, S.K. and Ahmad, Z. Global financial crisis – with special reference to insurance industry. African Journal of Marketing Management, 1(8), 184-189. November 2009. http://www.academicjournals.org/ajmm/PDF/Pdf2009/Nov/Sinha%20and%20Ahmad.pdf accessed 27 February 2013. Sjostrum, Jr., W.K. The AIG Bailout. Washington and Lee Law Review. 66(3). Article 2. http://scholarlycommons.law.wlu.edu/cgi/viewcontent.cgi?article=1062&context=wlulr TARP Act. Troubled Asset Relief Act of 2009. Amend Emergency Economic Stabilization Act of 2008. 6 January 2009. http://www.gpo.gov/fdsys/pkg/BILLS-111s383enr/pdf/BILLS-111s383enr.pdf accessed 27 February 2013. TARP (2). Investment in AIG. Department of the Treasury Online. 2013. http://www.treasury.gov/initiatives/financial-stability/TARP-Programs/aig/Pages/status.aspx accessed 26 February 2013. Task Force. The Financial Crisis of 2007-2009: Causes and Contributing Circumstances. Banking Law Committee. Section of Business Law, American Bar Association. 2009. http://apps.americanbar.org/buslaw/committees/CL130055pub/materials/201001/causes-report.pdf accessed 1 March 2013. Tatom, J. AIG and the Fed: Prologue to Future Financial Regulation? University of Munich. Research Buzz, 5(2). 1-9. 2009. http://mpra.ub.uni-muenchen.de/14122/ accessed 28 February 2013. http://mpra.ub.uni-muenchen.de/ accessed 28 February 2013. Webel, B. Government Assistance for AIG: Summary and Cost. Congressional Research Service. 7 February 2013. http://www.fas.org/sgp/crs/misc/R42953.pdf accessed 28 February 2013. Read More