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AIG Bonuses? Are You Kidding Me?

Over the weekend I was astonished to read fallen and disgraced insurance behemoth AIG (NYSE: AIG) was planning to pay $165 million to executives who work at the division that invented credit default swaps and then peddled them to the financial community. It was a clever trick. The products were not legally "insurance", so they could be sold with no regulatory requirements on reserves, and no restrictions on the commissions that we paid.

AIG claims it's a contractual obligation. They say they have to pay, and they have to pay bonuses in order to retain top tier management. AIG had nearly $1/2 trillion in the toxic Credit Default Swaps on their books as of last Fall. 

Like any sensible taxpayer, I have a couple of minor issues with the idea of paying $165 million in bonuses to employees who ran this ship aground. President Obama has instructed Treasury Secretary Geithner to use every means possible to stop AIG from paying these bonuses. After all, the government is now an 80% shareholder in AIG- can't we stop the bonuses from being paid?

Unfortunately, it's not quite that easy. AIG has a board. The board appoints the CEO to run the company and make day to day management decisions. As 80% shareholders, we can control who gets elected to the board, but that requires a new Board election, and then the replacement of the CEO as an act by the board.

Dear President Obama- let me suggest another course to try to block this insanity. Undoubtedly, these bonuses are tied to the revenues generated by the Credit Default Swap division of the company. I'm sure the management at AIG felt they had created a real product in the early going, but there must have been a point in time when the people at this division of AIG knew there was a possibility the products they were selling with huge mark ups and monster commissions probably had little or no value. 

So Pres- here's another course you might want to pursue. You have a few Secretaries working for you, and the Secretary of the Treasury is just one of them. You also have an arm of your administration called the Justice Department. 

The Justice Department is headed by the Attorney General. I'll just bet you have the AG's cell phone number. Why not give him a call? Wouldn't it be worth taking a look at this entire division of AIG from a criminal perspective? After all, if the people within that division knew there was a possibility they were selling worthless instruments at some point in time, wouldn't that be fraud?  Your newly confirmed Attorney General is Eric Holder, and this would be a great first assignment.

So, let's take it one step further. If you start a formal investigation of this division for fraud, couldn't the justice department take legal steps to suspend those payments pending the outcome of the investigation?

I don't know- seems to me like a logical course to pursue. The gigantic failures earlier this decade were all followed up with Justice Department investigations- Enron, Worldcom and the like all ended up in widespread criminal indictments, and the magnitude of the AIG failure makes those episodes look like pocket change. 
 

Update on Mark To Market- Time To Start Thinking Seriously About the Financials

Mark to the Market accounting continues to dominate the news on the banking front. I have become nearly Evangelical in my views on this matter. I believe there is a lot of value hidden in the assets on the balance sheets of the banks, and I believe I'm the only publication providing any useful commentary on the facts.

For example- I witnessed a heated argument today on CNBC between Kudlow and a Bear on the banking stocks. Kudlow argued mark to the market was too extreme in an inefficient and illiquid market. The Bear argued the toxic assets on the bank's balance sheet would drive them all into insolvency. Neither of the two ever provided the Mark to the Market facts, which is what I have done for you.

Here are the facts- the banks are carrying AAA post 2006 mortgages at $.28 on the dollar, and sub prime mortgages at about $.17 on the dollar. In my view, these discounts represent a tremendous hidden asset on their books. It's just common sense that in a foreclosure and auction situation, there mortgages are simply worth more along the lines of $.50 on the dollar. 

The FASB (Accounting Standards Board) is suggesting it is going to look at a cash flow model as a possible methodology to replace mark to the market. 

It is estimated about 70% of the loans on the books of the banks are still performing. Therefore, could the value of these loan portfolios end up being more like $.70 on the dollar- instead of the $.17 to $.28 that is the current standard? If this ends up being the case, the financials will go crazy to the upside as shorts are forced to cover in the face of an inclining market- or reverse waterfall if you will. I don't think the valuation will be that high, but there's a groundswell of enthusiasm for the concept.

Here's a chart of the XLF - the ETF for the financials that is the one to own if you don't like the idea or have the capital to own the individual stocks. 

I believe there will be a melt up in this sector over the next month or two. I can't say exactly when it is going to happen, or what the technical downside is at today's levels.

Here's today's message on XLF loud and clear- don't buy it now. It might continue working higher, but I believe a correction is in the offing. When it makes its next correction, that will be the time to pile in- and in a big way. Based on today's chart, it looks like $6.90 might be the level.

As an alternative, I might suggest looking at UYG- that's the triple leveraged ETF on the financials- it closed today at $2.38- down from a high of $70 one year ago. UYG will be the most aggressive way to max out your returns when the time comes.

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