AIG paid bonuses of $1 mn or more to 73 employees at its financial-products division, including 11 who no longer work for the company, New York Attorney General Andrew Cuomo said. The top 10 bonus recipients received a combined $42 mn, he said.

AIG's financial products unit lost $40.5 bn last year.

"AIG made more than 73 millionaires in the unit which lost so much money that it brought the firm to its knees forcing a taxpayer bailout," Mr. Cuomo wrote in the letter. "Something is deeply wrong with this outcome."

Cuomo has launched an investigation into the bailed-out company, which received taxpayer funding of more than $170 bn, following revelations that it distributed $165 mn in executive bonuses. The bonus payouts for the Financial Products unit are expected to reach $450 mn, while bonuses for the entire company could be around $1.2 bn.

Eleven AIG personnel who received retention bonuses of $1 mn or more no longer work for the firm, including one who received $4.6 mn.

So much for renaming these bonuses "retention" bonuses in the dead of night last fall, when all eyes were on the Bush administration handing over power to the incoming Obama administration.

And since the government owns 79.9% of AIG, why doesn't it feel it has the power to yank back the bonuses?

What Really Happened at AIG?

The AIG debacle is a portrait in miniature of the entire meltdown on Wall Street and the government's bailout.

Wasn't AIG a big advocate of the notion that financial innovation would spread credit risk round the global financial system, a notion that former Federal Reserve chairman Alan Greenspan applauded? Spreading the risk around sure sounds better than having it all concentrated on bank balance sheets, right?

But the AIG fiasco shows that it's high time America sets up a wind farm outside of D.C. to capture the output of such gaseous rhetoric, that might solve our nation's energy needs.

AIG blew up in Wall Street's face.

And now it's blown up in ours.

Fear of Employee Lawsuits

The argument in support of the bonus payments has it that if AIG did not pay out bonuses, its employees would sue the insurer. Some say this: Go ahead and sue. Then you'll have your faces all over the media, risking themselves as the poster boys of AIG greed.

Why Congress Feigns Outrage Now

The AIG bonus story isn't going to disappear anytime soon, given the fact many of the Congressmen who signed off on the government bailouts are up for re-election.

That includes the entire House of Representatives including Representatives Barney Frank and Maxine Waters. Also up for re-election are Senators Charles Schumer, Christopher Dodd, Arlen Specter, Richard Shelby, Charles Grassley, Harry Reid, Ron Wyden, James Bunning, John McCain, and Tom Coburn.

AIG's Mess Dissected

Don't be thrown by the term credit default swap. It's basically another term for insurance on asset-backed bonds. AIG sold up to $500 bn worth of this form of insurance on mortgage-backed and other credit-backed bonds during the bubble years.

Banks like Countrywide Financial, Wells Fargo, and Wachovia pointed their conveyor belt of mortgages at Wall Street, and the Street then sliced and diced all sorts of mortgages, including subprime and option only or 'pick a payment' loans, splitting out the interest and principal payments, into cash flow streams or what are called tranches for these bonds.

The bonds were then collected into pools of bonds called collateralized debt obligations. Senior tranches were thought to be the safest, but then Wall Street, in Homer Simpson fashion, cooked up something called 'super senior' tranches, purportedly the safest of the safe.

Then here comes AIG. It strayed into selling insurance on these bonds, along with selling plain vanilla insurance on houses, cars, property, as well as selling life insurance because it wanted to jump on the fee bandwagon. And jump it did. AIG's balance sheet soon took on a lot of water as it ballooned to $2.7 tn.

The bonds were clearly built on junk, but investors would not have known that, because AIG's insurance, presto change-o, magically transformed these bonds into Triple-A rated bonds.

And sure enough, Wall Street, including Lehman Bros., Bear Stearns, and Merrill Lynch as well as the banks overseas like Société Generale, Deutsche Bank and HSBC believed they did not have to set aside more funds in capital reserves to back up these bonds, because of the AIG insurance. AIG for its part didn't set aside enough to cover potential claims payouts.

Now why didn't Wall Street protect itself here with rainy day reserves? You got it--because its risk models did not, repeat, did not include scenarios of widespread defaults and delinquencies on mortgages.

Instead, they figured the worst case scenarios might be another  9/11, or Asian or Russian or Latin American debt crisis, or another Long Term Capital hedge fund blow up, but not mortgage defaults.  

Never mind that detail--investors clamored for their high yields, and the profits started pouring in like slot machines in all of Las Vegas simultaneously hitting the jackpot.

Here Come the Downgrades

Wall Street and financial players worldwide eventually cooked up a total of $2.2 tn in toxic debt, says the International Monetary Fund.

But then mortgages started defaulting big time in 2007. The credit rating agencies, which had tossed holy water on these bonds and sanctioned them as triple A, did a double take and started downgrading these bonds en masse, hundreds of billions of dollars worth of bonds came under the knife.

In fact, JPMorgan Chase recently studied $450 bn in mortgage-backed securities concocted between '05 and '07, and found a huge $305 bn of those bonds were already in default. Lehman, Bear Stearns and Merrill had bundled more than $550 bn in mortgages into CDOs in 2006 alone.  

And then AIG was downgraded, too, triggering collateral calls.

What that means is, when the credit-rating downgrades hit, that touched off clauses in contracts that AIG had with banks and other counterparties, whereby the insurer had to pony up collateral in the event of downgrades.

What that means is, the downgrades forced AIG to put up more cash to back up its positions. When the collateral calls sucked it dry, that fateful September weekend that Lehman collapsed,  the US government had to bail out AIG with first an $85 bn loan, and taxpayer assistance has since metastasized to $170 bn.

Why Pay Out the Collateral at All?

But why did the US government pay out $22.4 bn in taxpayer money to cover AIG's collateral payments when it took over AIG? Isn't the US government a triple A rated entity?

Wouldn't that triple A rating then be conferred on AIG's insurance products, including the triple A bonds wrapped with the AIG swaps?

Shouldn't the conferral of the US's triple A rating onto AIG thus stop any downgrades? Again, why did the government pay AIG's collateral calls, again, given the conferral of the government's triple A rating? Did Wall Street snooker the US government here?

Made Whole

Then the New York Federal Reserve under Timothy Geithner, now Treasury Secretary, also stepped in last fall and bought $27.1 bn worth of CDOs, the underlying bonds, from Wall Street firms and banks overseas to avoid AIG having to pay out on the insurance, or the credit default swaps. 

It now appears to have paid 16 investment banks this $27.1 bn for the troubled assets, according to a filing with the Securities and Exchange Commission. The CDOs are housed in an off-balance sheet vehicle at the Fed called Maiden Lane III.

The Damage Done

Since that weekend in September 2008, AIG has forked over $120 bn in cash, collateral and other payouts to banks, municipal governments and other derivative counterparties around the world.

At least $20 bn of US taxpayer money went to European banks. The biggest winners were French banks, with Société Générale receiving $11.9bn and BNP Paribas $4.9 bn. Deutsche Bank of Germany received $11.8 bn and Barclays of the UK $8.5 bn.

The list also includes Goldman Sachs, which received at least $13 bn. This comes after months of claims by Goldman that all of its AIG bets were adequately hedged and that it needed no "bailout."

If the smartest guys on Wall Street, the executives at Goldman, were so good at hedging, why did they take $13 bn?