We’ve heard from a couple of people now that the guys at the most destructive business in the world, the Financial Products division of AIG, may have taken out a form of credit default swaps on their own bonus payments. Indeed, the rumour is that somehow they took out the CDS with AIG itself.
This is a pretty wild story, and we’re not sure we find it all that credible. It seems mind-boggling, and almost insane. What good would it do you to insure your own bonus with the firm that promised to pay it in the first place? If your employer can’t afford to pay out your contractual bonus, wouldn’t it also be unable to pay out the insurance you took on the bonus?
Except this is AIG we’re talking about. A great many of the counterparties on AIG knew that AIG wouldn’t be able to pay out on the CDS they purchased. They gambled, it seems, that the government would bail out the company. It seems all too possible that the brainiacs running the Financial Products unit may have actually made the same gamble.
If you think about the structure of the bonuses, they closely resemble the kind of unsecured debt on which financial institutions and other investors bought credit default swaps. The contracts were a promise to pay at a future date. To the extent that there was a risk of AIG not paying, it makes sense to buy CDS to reduce this risk. Guys who dealt with this kind of product every single day may well have sought to create a bonus protection product for themselves.
Could this be why AIG has to pay the bonuses? Could AIG have doubled down on its promise to pay the bonuses? That also seems insane. But no more insane than the standard AIG business practices we’ve discovered.
As we said, this is just a rumour right now. Something people are talking about but without anything to substantiate it. It seems totally incredible but these are incredible times.