Recouping Taxpayer Investment In AIG

Andrew Ross Sorkin wrote the book, literally, on what it meant for American International Group to be “too big to fail.” But apparently the New York Times journalist isn’t keen on seeing AIG succeed either.

In a recent column, Sorkin blasted AIG for, of all things, making a profit. “Last week, the American International Group reported a whopping $19.8 billion profit for its fourth quarter,” the column begins. Sorkin quickly makes it clear that, in his view, this is not something to celebrate.

As Sorkin explains, AIG booked the substantial profit in large part because it was able to use the huge net operating losses it sustained during its dark days to offset its current and anticipated future profits and obtain a tax benefit. Because of the extent of its losses, AIG may not need to pay taxes for at least a decade.

Using past net operating losses, known as NOLs, to offset gains for tax purposes is common practice. What makes AIG’s situation unique is that companies that file for bankruptcy or are taken over usually lose the ability to use their past net operating losses and must start with a clean slate. Technically, AIG was taken over in 2008 – by the federal government, when taxpayers acquired a majority stake in the company. The Treasury, however, issued special notices allowing AIG, along with fellow bailout recipients General Motors, Citigroup, Fannie Mae and Freddie Mac, to continue to use their NOLs to offset future profits.

This exception could certainly be irksome to companies like Ford or Wells Fargo, which did not need federal money to get themselves through the downturn (though, as Sorkin described in his book, Wells Fargo was among the large banks that were strong-armed into temporarily accepting federal bailout money to avoid highlighting the dire straits of competitors, like Citigroup, that were on the ropes). Yet I think the Treasury came to the answer that makes the most sense for its constituents – namely, for U.S. taxpayers. Since the question is taxes, that constituency is the only one that really matters.

Companies are normally prohibited from using losses that predate a bankruptcy or takeover, in order to avoid creating a market in which profitable companies could simply purchase failing ones to reduce their tax liability. Since the government doesn’t pay taxes, we can be pretty sure it is not going to get into the business of buying up troubled companies for their NOLs. The normal reasoning behind the prohibition, therefore, doesn’t apply to AIG and the other companies in its situation.

Meanwhile, the government and, by extension, taxpayers, have a lot to gain from helping AIG along the path to recovery. Uncle Sam still owns 77 per cent of AIG’s shares, down from a high of 92 per cent. To recoup the nearly $50 billion it has invested in the company, the government needs to sell those shares at $29 apiece. Shares hit that price for the first time since July 2011 on Feb. 24, after rising largely on the strength of the quarterly profit figures. According to estimates last year from analysts at Bank of America and JPMorgan Chase, the tax benefits from the losses helped lift the company’s stock price by $5 to $6 a share.

Sorkin doesn’t deny any of this. In fact, it is he who cites the estimates of how much the tax benefits contributed to the rise in stock values. However, he insists that the Treasury was wrong to let AIG keep its losses. His argument seems to boil down to three main points.

First, there is the contention that “bending” the rules, as he puts it, is just fundamentally wrong on principle. I suppose one could argue that the tax treatment of AIG and other bailout recipients creates some degree of unfairness; investors will be able to indirectly buy tax losses from the government, in the form of the government’s stake in the bailed-out companies, when they can’t buy those losses directly. That objection, however, is fairly minor when set against what taxpayers stand to gain from getting AIG back on its feet and out of government hands – not mention getting their money back sooner rather than later.

Second, Sorkin cites the lost income the government could get out of making AIG pony up in the short term. “The government,” he says, “is missing an easy stream of guaranteed taxes from a company that taxpayers bailed out.” Last quarter, AIG’s tax benefit boosted its profit $17.7 billion – money that Sorkin argues should have gone into the Treasury’s coffers. That’s all well and good, except for the fact that that tax bill would have had the biggest effect on AIG’s majority shareholder – the government itself. It makes no sense to force the government to pay itself money. This is especially true since any hit to AIG stock prices would delay the day when taxpayers can finally cash out an investment they never really wanted in the first place.

Also, there is no such thing as a stream of “guaranteed taxes” from a company, unless that company somehow has a stream of guaranteed profits subject to tax. Sorkin’s logic must be that AIG remains too big to fail – and too big to lose money, too, as long as the government owns it. He might as well take that line of though a step further and propose having the government take over the entire financial sector, or maybe all private industry, and fund itself with the guaranteed profits and tax revenues that would result.

Finally, Sorkin resorts to taking a cheap shot at AIG employees, including CEO Robert H. Benmosche. Essentially Sorkin argues that since the tax benefit will be profitable for AIG employees, whose shares will increase in value just as the government’s shares will, it must be wrong. “The tax break for AIG also perversely benefits employees who are paid based on the company’s performance and usually in stock, which is being lifted by this backdoor handout,” he says. “The biggest beneficiary is Robert H. Benmosche, AIG’s chief executive since 2009, who has been granted tens of thousands of shares.”

Sorkin doesn’t fail to point out that some of the employees who will benefit “helped create many of the problems that led to [AIG’s] role in the financial crisis.” For good measure, the print edition of the paper also carried a photo of a smiling Benmosche sitting, as the caption noted, “at his villa in Dubrovnik, Croatia” – just in case anyone failed to get the message that Benmosche is a Wall Street fat cat who can’t be allowed to benefit from government policy in any way.

The government took its stake in AIG in 2008. Benmosche did not arrive until 2009, a time at which AIG had been given up for dead by many executives, who consequently wanted no part of it. Much of its subsequent recovery can be credited to his hard work. In fact, Sorkin himself named Benmosche his “Executive of the Year” for 2010, saying, “The bailout of AIG will never be popular. But if Mr. Benmosche can keep the insurer on the same path, he should be.” If Benmosche can bring AIG’s stock prices high enough to allow for a government exit, he deserves every penny he will get from his own rising portfolio value.

Sorkin’s complaints come down to a triumph of ideology over common sense. Banks and bankers are bad, or at least behaved badly in Sorkin’s view, and therefore ought not to be allowed to benefit from future good results, even if most of that benefit actually accrues to the taxpaying public, whose interest Sorkin ostensibly wants to protect.

That’s OK. The beauty of our system is that pundits can make silly and circular arguments without actually hurting anyone. Out in the real world, where senior executives and policy makers must operate, decisions have real consequences. Benmosche and AIG have generated some unexpected value for taxpayers, and the Treasury’s position will allow taxpayers to capture that value sooner rather than later. Makes sense to me.

 

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