Business Law Prof Blog

Congress and 401(k)s: Pensioners--Invest in TARP or Else!

Congressional leaders and Administration officials, frustrated with the amount of private money sitting on the sidelines in our economic crisis, will soon announce, according to unnamed sources inside the White House, a bill that requires all those who hold 401(k) plans to invest at least 25% of the remaining funds in those plans in the White House's new private-public partnership program that will buy bank's toxic assets.  The unnamed source stated that 401(k) pension plans had been given a "free ride" on the government's bailout plans and need to participate along with everyone else.  Those 401(k) plan holders that refused to invest would be jailed in Gitmo.     

In an unrelated development, the President has order GM to fire race driver Dale Earnhart,.Jr.  "He is a slaker who is not winning any races,"  the President is reported to have said.

What Ex-GM CEO Wagoner Should Have Said to Obama: "You Do Not Have the Authority to Fire Me"

When President Obama and his senior economic advisers decided that GM CEO Wagoner should be fired and this was communicated to Wagoner he responded incorrectly.  He should have said: " You are not my board and you cannot fire me.  I am going to stay until the board fires me."  Consider what a simple refusal would have done -- reasserted the separate roles of public and private industry. Then if and hen Obama had followed up with calls to the GM board, telling them to fire Wagnoer, the board should say: "We will take you advice into account but you do not bind the board, our primary allegiance is to our shareholder and, if insolvent, to our unsecured creditors."  In other words, Wagoner should have grown some cajonies.  And when the President asked Wagoner as he has asked his successor Henderson, to hire adminsitration embedded employees, Wagoner and or Henderson should have said no.  

On the merits of Wagoner's job performance, the board should have fired him because his "reorganization plan" was a joke.  Wagoner, in fashioning a plan, should have laid out significant haircuts to wages and debt repayments, even if the groups had refused to assent, and told the government to condition any bailout grant on their agreement.  If the groups then refused, GM declares Chapter 11.

Geithner's Plan: They're All Fannie Now

Geithner's new ambitious plan hinges on one assumption -- some financial institutions are too big to fail. Once one buys into that assumption, government intervention becomes inevitable.  The banks that are too big to fail have the implicit backing of the United States government and the United States government must take steps to make sure that those banks do not misuse the implicit guarantee.  We therefore need a bigger, badder regulatory agency, more regulatory powers, and a right to take over financial institutions that are insolvent.  Inevitability, the regulation must go global, as the institutions must be stopped from moving offshore to do what they cannot do here.  The alternative, now dismissed, is that no financial institutions are too big to fail and that those financial institutions that make bad bets will cost those who own them and run them their investments and salary.  This system is the one we, more or less, used to have.  Once we leave it, we cannot go back.  This is a one way ratchet to global government financial regulation.

AIG: And Worse

Now there is news that AIGs successful subsidiary businesses, real insurance companies, are suffering from the pasting taken by the holding company executives over bonuses.  Moreover, competitors in the insurance business are complaining that the insurance company subs, too retain business, are aggressively offering lower rates "subsidized by the government."  And, by the way, Senator Dodd's wife was on the board of one of the subs.

Geithner's Toxic Asset Plan: Can It Be Gamed??

I hope Geithner has stopped all the ways to game his proposal.  I am not hedge fund guy, paid millions to game the markets, but I suggest the following.  A hedge fund makes an investment of $7 in a bank's toxic assets and, under the program,the government matches the investment with another $7 and with a loan for $86.  The fund then hedges its risk with a default swap, written by the selling bank itself perhaps for a small fee (added to the purchase price), for a $7 loss if the investment (on resale or collection) does not pay back the loan with interest and $14.  The result?  All upside to the fund, all downside to the government with the largely free use of government money. The incentive for the fund?  Take huge risks on the worst bank assetsin order to make a killing with government money.  Will the government stop the hedges?  Not if it wants private money to get in the program.  No wonder the financial stocks are soaring: another opportunity to play the government for a sucker.

Sweden: A Raw Capitalist Compared to the US

We have been lectured by China on monetary prudence and now we are doing something that Sweden will not due, bail out car companies.  Sweden refused to bail out Saab.  "Let the markets decide," Sweden announced.

Government Prints Money

We used to laugh at small country dictators who, once having ruined their country's economy and having borrowed beyond their country's capacity to pay, decide to inflate their currency.  Their inflated currency worked for a short period of time, allowing debt repayments with cheap cash, and then created hyperinflation.  The United States, through the IMF, used to lecture these small country dictators on the inappropriateness of the tactic -- advocating reduced government spending and balanced government budgets.  Now, we are the violators.  The government is buying billions of its own debt (Treasuries and Fannie and Freddie debt) from banks and crediting the banks with cash through the banks accounts with banks in the Federal Reserve System.  It is the equivalent of printing money; it increases the supply of money in circulation and, unless reversed, will lead to hyperinflation.  The government believes they can time the credit markets -- increase the money in circulation and then, when inflation appears, decrease funds in time to stem inflation.  It is a dangerous gamble, too dangerous. 

AIG: And Worse

We now find out that AIG was incompetent in unwinding its problems with government money. And for these its experts get bonuses??  AIG was unwinding its credit default swap positionswith government money by buying the assets that were underlying the positions.  This, in theory, makes sense.  Rather than pay increased collateral for the increased risk of default by AIG on the contracts, AIG buys the debt instruments insured by the credit default swap from the counterparty and cancels the swap contract.  The problem?? AIG overpaid for the underlying assets; paying par value for assets that have discounted value due to increased credit risk.  The counterparty then pockets the gain from the overpayment and taxpayers take the hit. Taxpayers break even only if the can resell the assets at par value when markets recover.  Even if the counterparty does not own the underlying assets it will go out and buy cheap and sell them dear to AIG that pays with government money.  To make a long story short: AIG is playing the sucker in these unwinding strategies with taxpayer money.  Can it get worse??

AIG: It Gets Worse

The scramble of politicians in response to populist outrage over the AIG bonuses gives one a sense of what it was like on the Titanic when it startedd to started to go down.  Hostile folks are milling outside the AIG building looking at armed guards, AIG personal are resigning and not coming to work, and AIG and politician e-mail boxes are overflowing with venom.   Politicians and pundits are panicked and saying very, very silly things:  AIG employees should commit sucide; the government should tax 100% of the bonuses;  the government as shareholder should claw back the bonuses.    Traditional corporate law has answers:  The CEO of AIG< Liddy, can break the contracts, wait for lawsuits, if any, make his defenses on the circumstances of the individual contracts, and settle those suits that have merit.  If Liddy does not do so he (and the board of directors) can be sued by shareholders (for waste or breach of fiduciary duty) or removed by shareholders (or both).  The government's AIG shares are owned by a trust with trustee appointed by Geithner.  If they refuse to act the government has to sue or remove them (from breach of a trustees duty to a beneficiary or for a breach of the trust agreement).  If Liddy's defense is that Geithner passed on the contracts and ratified them (as a representative of a controlling shareholder) then Giethner should be removed by our political process.  The President should fire him and if the President does not he should be accountable at the next election.  It is not complicated.

The contractual defenses are an array of traditional long-shot defenses--duress, fraud, unconscionability, impracticality, force majeur -- to set aside the deal and contract interpretation doctrines to recall payments that are not owed due to unsatisfied conditions or other terms.  The "sanctity of contracts" worry of Sorkin of the New York Times is a laugher.  Where was he when high paid ball players refuse to show up to work unless contract terms in place on salary where not increased due to a good past season??  Contracts are enforced by reputation and by law.  AIG is not worried about its reputation any more; it has none -- good business still are and still will be if AIG breaches.  In court AIG has defenses and will settle based on the costs to plaintiffs of suing and the likely of AIG prevailing on a long-shot defense -- normal stuff.  Contracts, Mr. Sorkin, will survive just fine thank you. 

AIG Bonuses

AIG executives are claiming from $165 million to $450 million, depending on who you believe, in contractually stipulated bonuses after the company lost $60 billion last quarter, the largest quarterly loss by a private corporation in modern history.  The government has loaned or otherwise granted AIG with $170 billion in cash and has executed value guarantees for another several hundred billion dollars of toxic assets.  Needlesstosay, the press is all over the story and politicians are outraged, outraged.  The truth of the matter is that the government is using AIG to funnel money government money to other banks, both international and domestic, that the government could not, politically and/or legally, otherwise fund.  Why should United States taxpayers bailout out French, British, German, Swiss, and UAE banks??  Why should taxpayers give money to Goldman Sachs or Merrill Lynch??  The entire AIG bailout is tawdry and dirty.  The government should have refused any funds and forced the AIG holding company into bankruptcy, which would have led to AIG spinning off its profitable insurance subsidiaries.