The real AIG outrage

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NEW YORK (CNNMoney.com) -- When American International Group CEO Ed Liddy appeared before Congress Wednesday, he was allowed to sit in a chair. But it might be more fitting if he were tied to a stake.

Liddy was absolutely lambasted by Democrats and Republicans on the House Financial Services' Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises.

The insurer's decision to proceed with about $165 million in annual bonuses even though AIG (AIG, Fortune 500) has now received four federal bailouts is the type of appalling Wall Street behavior that outrages taxpayers and quickly gets politicians worked up into a rabid lather.

If we're lucky, Rep. Michael Capuano, D-Mass, aka Barney Frank, Jr., will go on a screaming jag like he did when the CEOs of the first banks that got bailout money, a group I like to refer to as the TARP Eight, appeared before Congress last month. "Get that bonus money on the street!"

But hopefully, members of Congress won't just grill Liddy about the bonuses. Don't get me wrong. Paying out $165 million in bonuses to people at a company that lost nearly $100 billion last year is, to quote Woody Allen, "a travesty of a mockery of a sham of a mockery of a travesty of two mockeries of a sham."

However, taking AIG to task for rewarding bad behavior is a no-brainer. Lawmakers can easily prove to their constituents that they are willing to satisfy the public's understandable blood lust. Who wouldn't be against these bonuses?

There is a bigger problem at AIG though. Much larger and important than $165 million in bonus payments.

It's now been nearly six months since the first AIG bailout and the cost of this rescue has ballooned to nearly $170 billion. In other words, an amount more than 1,000 times the cost of the bonuses that everyone is making a fuss about.

Yet, there has been little progress in breaking up the insurance monolith, selling off assets so that AIG can use the proceeds to pay back the government.

So even if the government is able to get some of the bonus money back by changing the terms of AIG's next bailout payments, as President Obama and Treasury Secretary Tim Geithner are suggesting, or taxing the bonuses, as Sens. Chris Dodd, D-Conn., and Max Baucus, D-Mont., are proposing, that does little to solve the bigger AIG problem.

AIG probably needs to be broken up in order for there to be any chance of having some of the taxpayer's bailout money returned to federal coffers.

The insurer finally named names over the weekend and listed the group of so-called counterparties that it paid in order to wind down trades related to its credit default swaps and collateralized debt obligations, two of the risky types of securities that got AIG into such a financial mess.

The counterparty list is a veritable who's who of the world's financial leaders, including Goldman Sachs (GS, Fortune 500), Bank of America (BAC, Fortune 500), British bank Barclays (BCS) and Germany's Deutsche Bank (DB).

So it's nice to see that these big banks got theirs, so to speak. What about us though? Will the American taxpayer ever get some of this bailout money back?

With that in mind, Congress needs to ask Liddy more questions about how the asset sales are going and less about the bonuses.

They need to find out if Liddy is any closer to selling off pieces of AIG that may still have some value to a buyer, such as its life insurance business, auto insurance unit and aircraft leasing division.

What's more, Liddy needs to come clean about whether AIG will be able to unload these pieces for anything more than a fire sale price. If not, then we have to question the entire motivation for the AIG bailout.

The hope back in September was that keeping AIG from bankruptcy would prevent a disorderly liquidation. But since AIG has been kept on life support for six months and still has yet to make a significant asset sale, is this process any better than a bankruptcy reorganization?

One investment banker said that even though a bankruptcy of AIG would not be "politically desirable," it's tough to imagine how the current process for selling AIG would work better than a bankruptcy reorganization.

"I don't know if you can talk about an effective breakup of a distressed company unless there is clarity. Chapter 11 bankruptcy does that," said Marino Marin, managing director of Gruppo, Levey & Co., an independent investment bank based in New York. "There is typically no effective sale of mainstream assets of a troubled company unless they are under Chapter 11 protection."

Russell Walker, a professor of risk management at the Kellogg School of Management at Northwestern University, adds that it will remain difficult for AIG and the government to find willing buyers in this climate, given how tough it is to raise capital.

What's more, there's the issue of price. Unless a buyer wants to do its patriotic duty by overpaying for pieces of AIG, the best the government can probably hope for is to just get a fraction back of the money it's lent to AIG.

"If you are going to buy something and you know the other guy needs to sell then why should you offer anything other than the lowest possible price?" Walker said. "The world knows AIG is a blue light special and that's not in the best interest of taxpayers. Even if you took all the pieces and sold them, I don't think it's worth close to $170 billion."

Antony Page, a professor at Indiana University School of Law - Indianapolis who focuses on mergers and acquisitions and corporate law, agreed with Walker. He said that since AIG is clearly a "motivated seller" any potential buyer is probably thinking that if they wait, they can get an even better deal later on.

Page added that perhaps the biggest problem facing AIG is that even if there are buyers interested in various pieces of AIG, a quick look at how poorly the shares of other big insurers, particularly life insurers, have fared lately shows that few companies would be wise to make a bet on a big acquisition now.

"Many of the potential buyers have problems of their own. The last thing many of them should be doing is consolidating new purchases," he said. "They have to get their own houses in order."

For that reason, Page said the most optimistic scenario he can imagine for AIG now is that the government controls it for at least another two years while it waits for the credit markets to truly recover.

That's right, folks. AIG is likely to be a taxpayer headache until at least 2011. Oy.

Shameless plug alert: Before I started writing The Buzz, I covered the media business for several years at CNNMoney.com. Some of this reporting is the basis of a book I've written about News Corp. CEO Rupert Murdoch called Inside Rupert's Brain, which will be published on March 19 by Portfolio, an imprint of Penguin Group (USA).