Monday, March 16, 2009

How to Close AIG’s Bankruptcy Loophole

People are understandably upset about the recent half-billion in bonuses at broke insurance giant AIG. It’s not just people with names like Bernanke, Geithner, Obama, and Frank, but also millions of people who ordinarily pay no attention to the foibles of the banking industry.

AIG has apologized for the bonuses, explaining in a letter to Treasury Secretary Tim Geithner that it was contractually obligated to pay the bonuses. As outrageous as AIG’s position is, perhaps we should thank them for sending that letter, because reading between the lines, it points to the solution to the problem.

The half-billion in bonuses AIG executives just received are nothing new, but are part of a much bigger problem. AIG is not the first company to pay out bonuses in order to have less money available to the bankruptcy court when it finally gets there. Bonuses paid out in the final days before the bankruptcy filing can potentially be retrieved by the bankruptcy court, but executives of a company like AIG, where bankruptcy is highly probable but not imminent, can pillage the company all they want in the meantime.

There is a legislative solution to this. A new law should prohibit a publicly held corporation that is losing money in a big way from paying bonuses or large executive salaries. Instead of paying those bonuses when they are due, the company should be required to defer any such payment in order to keep the money available for the bankruptcy court. Of course, not every company that starts losing money in a big way ends up in bankruptcy. If the company can turn itself around and become decisively profitable again, then it can pay the deferred bonuses and salaries — but not until then.

As a first approximation, I think this rule ought to apply to a company whose net losses since its last full year of profitability exceed the amount of profit it made in that year. The rule should require that all bonuses and executive compensation over $500,000 per year be deferred until the company has proved its profitability by earning back all its losses. It should also prohibit executive stock options for the same period of time, since that could become an enormous loophole. I believe if Congress acts quickly, it can have a law in place before the next time AIG feels compelled to pay bonuses, potentially saving taxpayers another half a billion dollars.

And the half-billion that AIG just paid out? A bankruptcy judge might be able to retrieve that bonus money — if AIG goes into bankruptcy in the next few days. And I believe that can be done. With all the money that the Treasury has put into AIG, I believe the Treasury Secretary has the legal standing to go into court and file papers to put AIG into involuntary bankruptcy. Perhaps we can petition Geithner to do that. It’s true that shutting down AIG will have horrendous repercussions. But remember how upset people were to learn how AIG had spent half a billion dollars in taxpayer money. How much more upset will they be when they realize that AIG is burning through approximately that amount of taxpayer money every day, with no end in sight? The fact is, there is no possibility of a happy ending to the AIG story. It is already horrendous, and getting worse by the day. And so, perhaps now is the time to pull the plug and stop the bleeding.