AIG and American Corporatist Socialism

By now the dust has settled on the "salvation" of the corporation American International Group, AIG, the multinational insurance giant through the last minute intervention of the American government, which generously opened its coffers for the benefit of this private multinational entity.

There has been much commentary about the necessity of the rescue, much of it focusing on the form of a government issued quickie (no review of credit worthiness, no market based pricing of loan, extremely favorable terms) non-market based loan. Much additional focus has been either to shill justification (salvation of the free market private economic system by these sorts of selective interventions), or criticism (free markets and reasonable behavior within such markets can only be disciplined efficiently only if entities are required to bear the downside of risk to the same extent that they are able to reap the upside rewards). And it is true, to some extent, that there appears to be emerging a good old fashioned corporatist socialist variant of American free enterprise--it seems that for some entities (selected by federal regulators based on factors that are hardly transparent) free market ideology means that they are encouraged to aggressively work in the market to acquire the rewards of risk but are heavily subsidized against loss form those risks. And the American people, though they do not participate in the rewards of free enterprise behavior, will bear the expense of that behavior on the downside. The irony, of course, is that the very people who have transferred wealth to the entity in the form of revenues now also transfer wealth (in the form of taxes) to support the same entities. This sort of system of double revenue sources mimics the much hated system of double corporate taxation in a perverse way.

Indeed, there appears to be something to the criticism of the loan. And AIG itslef supplies the argument. Consider the purpose, context and effect of the loan in AIG's own words:

Addresses Liquidity Issues and Policyholder Concerns

NEW YORK--Sept. 16, 2008--The Board of Directors of American International Group, Inc. (NYSE:AIG) issued the following statement in response to today's announcement by the Federal Reserve Board that the Federal Reserve Bank of New York is providing a two-year, $85 billion secured revolving credit facility to AIG that will ensure the company can meet its liquidity needs:

"The AIG Board has approved this transaction based on its determination that this is the best alternative for all of AIG's constituencies, including policyholders, customers, creditors, counterparties, employees and shareholders. AIG is a solid company with over $1 trillion in assets and substantial equity, but it has been recently experiencing serious liquidity issues. We believe the loan, which is backed by profitable, well-capitalized operating subsidiaries with substantial value, will protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis. We expect that the proceeds of these sales will be sufficient to repay the loan in full and enable AIG's businesses to continue as substantial participants in their respective markets. In return for providing this essential support, American taxpayers will receive a substantial majority ownership interest in AIG.

"We commend the Federal Reserve and the Treasury Department for taking this decisive action to address AIG's liquidity needs and broader financial market concerns. We thank them for their leadership during this critical time for the global financial markets. We also thank Governor Paterson, Commissioner Dinallo, Commissioner Ario, the other state Commissioners, and the Office of Thrift Supervision for their willingness to assist AIG.

"Policyholders of AIG companies around the world can rest assured that AIG's commitments will continue to be honored."

It should be noted that the remarks made in this press release may contain projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. It is possible that AIG's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these projections and statements. Factors that could cause AIG's actual results to differ, possibly materially, from those in the specific projections and statements are discussed in Item 1A. Risk Factors of AIG's Annual Report on Form 10-K for the year ended December 31, 2007, and in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations of AIG's Quarterly Report on Form 10-Q for the period ended June 30, 2008. AIG is not under any obligation (and expressly disclaims any such obligations) to update or alter its projections and other statements whether as a result of new information, future events or otherwise.

American International Group, Inc. (AIG), a world leader in insurance and financial services, is the leading international insurance organization with operations in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services and asset management around the world. AIG's common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.

Press Release, AIG Statement on Announcement by the Federal Reserve Boardof $85 Billion Secured Revolving Credit Facility, Sept. 16, 2008. From AIG's perspective, the loan was perfectly reasonable given the company's financial condition in the long term as they see it. And indeed there has been a suggestion that AIG's problems might be more one of credit rating agency mismanagement than of the actual financial condition and credit worthiness of the entity. See Walden Siew, Swift Cuts on AIG Signal Wave of Downgrades Ahead, Reuters, Sept. 19, 2008 ("Credit rating agencies, criticized for moving too slowly in cutting ratings on Wall Street firms and the complex instruments they devised, are now accused of acting too quickly. As the credit crisis enters a new phase, the pendulum has swung too far back, critics argue. The agencies are still missing the mark, only now they are too aggressive, adding to market volatility, or changing their views within days or weeks."). See generally Larry Catá Bacer, Global Panopticism: States, Corporations and the Governance Effects of Monitoring Regimes, Indiana Journal of Global Legal Studies, Vol. 15, 2007; Larry Catá Backer, Surveillance and Control: Internal, External and Governmental Monitoring of Corporate Insiders After Sarbanes-Oxley, 2004 MICHIGAN STATE DCL LAW REVIEW 327 (2004).

On the other hand, the credit rating agency problem is one endemic to the industry as a whole, and it is one well known to borrowers as big and as sophisicated as AIG. More importantly, however, was the reminder by the board of its slew of profitable and well run operating subsidiaries. Under classical free market theory, as the AIG Board ought to well know, where a sloppily managed conglomerate creates inefficiency and drag on profitability at the top, to the point of market abandonment, a company fails. But failure does not mean collapse. In the case of companies like AIG it means that within bankruptcy the company is reorganized--and the "profitable, well-capitalized operating subsidiaries with substantial value" continue operatng--either sold to other concerns or made independent. As long as the operating entities--the real source of wealth creation, arepreserved and reorganized on more efficient bases, the idea of collapse appears overstated. It is true that the system of large inefficient conglomerates that do not pay sufficient attention to their profitable operating entities might end, and the careers of those who have extracted wealth operating those entities might end as well. But that is supposed to be the ultimate disciplinary vehicle of the free market system.

But instead, AIG suggests a free market nomenklartura system in which discipline is theoretical and inapplicable to either the largest state supported concerns or those who run them (into the ground) playing by the rules that served them weell during the "good times." Thus, for example, again focusing on AIG, the only governance effect of the collapse and governmental save was a cosmetic reshuffling of the controlling organs. In the words of AIG:

NEW YORK--Sept. 18, 2008--American International Group, Inc. (AIG) today announced that its Board of Directors has elected Edward M. Liddy Chairman and Chief Executive Officer. Mr. Liddy, 62, succeeds Robert B. Willumstad. Stephen F. Bollenbach, who was named lead independent director in June 2008, continues in that role.

Mr. Liddy joined the private equity firm of Clayton, Dubilier & Rice, Inc. this year after serving as Chairman of The Allstate Corporation since January 2007. Prior to that, he was Allstate Chairman and Chief Executive Officer from 1999 until 2006 and President and Chief Operating Officer from 1994 until 1998. He led the initial public offering and 1995 spin-off of Allstate from Sears, Roebuck and Co. At Sears, Mr. Liddy served as Senior Vice President and Chief Financial Officer and as Senior Vice President-Operating. Prior to that, Mr. Liddy was Chief Financial Officer of G. D. Searle & Co. Mr. Liddy is Chairman Emeritus of Northwestern Memorial Hospital and serves on the boards of Northwestern University and the Museum of Science and Industry. He is a Life Trustee and former national Chairman of the Boys & Girls Clubs of America. He holds a B.A. from Catholic University of America and an M.B.A. from George Washington University.

American International Group, Inc. (AIG), a world leader in insurance and financial services, is the leading international insurance organization with operations in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services and asset management around the world. AIG's common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.

Press Release, AIG Elects Edward M. Liddy Chairman and Chief Executive Officer, Sept. 18, 2008. One wonders, however, why the board itself did not resign for leading the company to this current mess. More importantly, it is not clear why AIG's corporate officers were not all terminated, as well. Again, a nomenklaura theory, straight from the Stalinist playbook would explain the reflex to retain corporate commisars who fail, while extracting payment from lower level employees and public stakeholders. But one might have thought that the theoretics of free markets would have predicted a different result. An aggressive corporate and securities lawyer might wonder:

1. Whether the board of directors is not now exposed to liability for breach of their fiduciary duty of care. It is likely hard to imaging liability on a transactional theory of breach of duty (Smith v. Van Gorkum, 488 A.2d 858 (Del. Sup., 1985)). But it may be more difficult ot excuse what might be a failure to reasonably monitor. That failure to monitor might be asserted as a failure on one of two levels--first a failure to adequately monitor the activities and decisions of AIG officers; second a failure to either implement or appropriately use reasonable systems of monitoring corporate activity (In re Caremark International Inc Derivative Litigation, (Del. Ch. Sept. 25, 1996). For general discussion, see Larry Catá Backer, Surveillance and Control: Internal, External and Governmental Monitoring of Corporate Insiders After Sarbanes-Oxley, 2004 MICHIGAN STATE DCL LAW REVIEW 327 (2004).

2. Whether corporate officers are liabile for failure to comply with the requirements of the SEC regulations implementing Sarbanes Oxley Act (2002) Section 404. For general discussion, see Larry Catá Backer, The Sarbanes-Oxley Act: Federalizing Norms for Officer, Lawyer and Accountant Behavior, St. Johns Law Review, Vol. 76, pp. 897-952, 2002; Larry Catá Backer,

3. If there is a breach of the reporting or underlying monitoring obligations under the regulations issued pursuant to Sarbanes Oxley Act Section 404, is it possible that this failure gives rise to liability on the part of the appropriate gatekeepers--the outside lawyers and auditors with obligations under that provision. For general discussion, see Larry Catá Backer, The Duty to Monitor: Emerging Obligations of Outside Lawyers and Auditors to Detect and Report Corporate Wrongdoing Beyond the Securities Laws, St. John's Law Review, Vol. 77, No. 4, p. 919, 2003.

4. More interesting, still, is the system that appears to preserve the positions and employment of people who, having taken risks with the wealth of others, fails to produce desired results (the increase in the wealth of the entity). I have argued before that there appears to be two systems of labor markets in the United States. One, limited ot the lower orders, is based on a ruthless application of free market theories of open and fiercely competitive markets with no subsidies for risky behavior that goes bad. The other, available only to the elite members of the the employment workforce, appears to be a highly regulated and protected environment. While there is fierce competition to reach its ranks, once in, however, there is substantial proteciton against abor market discipline for failure. See Larry Catá Backer, Redefining Market Failures: Bear Stearns and the Class Element in Market Discipline, Law at the End of the Day (March 15, 2008).

5. One wonders why it is that AIG is able to keep the fruits of the income from those transactions that caused it be reach the equivalent of insolvency, while being able to take advantage of the favorable loan terms from the American government. Otherwise, it appears that the government loan serves to subsidize the sort of risky behavior with private capital that the private markets would discipline. In other words, the governmenbt loan encourages risk taking not tolerated (or discplined) by private markets. If there is no fear of the discipline inherent in rsk then the market system will be even more ditorted than it might have been had AIG been permitted to faikl and its profitable operations sold to those who might do better with them.

The case of AIG might strike one as strange given the rhetoric of free markets and the value of its disciplinary techniques that has serve as the basis for instituting global private governance over the last decade. This ought to strike one as a strange result. But in the strangeness one can begin to see the contours of American Corporatist Socialism.