In a letter to Congress Tuesday, Treasury Secretary Timothy Geithner said the Treasury planned to use the law to deduct the cost of the bonuses from the government's pending $30 billion cash infusion, and will also extract additional penalties from AIG operating funds.
With angry emails and letters pouring into Congress, a number of legislators had earlier expressed support for a special tax on the so-called retention bonuses paid to 73 AIG employees. Recipients of the funds, at AIG's financial-products subsidiary, include 11 people who no longer work for the company.
Senate Finance Committee Chairman Max Baucus (D., Mont.) and Sen. Charles Grassley (R., Iowa), the committee's top Republican, proposed a 35% tax on employees receiving bonuses and another 35% on the firm that paid it. In a move likely to further unnerve banks, the bill would apply to bonuses earned or paid after Jan. 1, 2009, and would cover not just AIG but all companies that received funds from the government's financial bailout fund.
An AIG spokeswoman has repeatedly declined to comment, except to point to AIG CEO Edward Liddy's letter Saturday to Mr. Geithner, in which he said he found the payments "distasteful." Mr. Liddy was appointed by the Bush administration last year.
The bonuses have crystallized public anxiety over the economic downturn and frustration at the government bailouts, creating a firestorm for the White House. President Barack Obama knew he had little power to stop AIG from issuing the bonuses, even as he stood before television cameras and vowed Monday to "block these bonuses," White House officials said.
By the end of the day, the White House acknowledged its limited options. Its back-and-forth response to the scandal poses a potential threat to Mr. Obama's broad agenda -- especially his ability to wrest fresh bailout funds from Congress, lawmakers say. The bonus flap is also another blow to Mr. Geithner, following criticisms concerning his tax history and the launch of his bank bailout revamp.
White House officials say the president's comments Monday reflected his intention to express personal outrage, even if nothing more could be done to block the payouts. He also wanted to start a new legal review of the AIG contracts, the officials say.
Lawmakers received thousands of calls and emails Tuesday about the bonuses paid to executives in the unit that caused AIG's near collapsed. "It smacks of greed, arrogance and worse," said Sen. Sherrod Brown (D., Ohio).
Mike Markey, an electrician in Swanzey, N.H., emailed his representative and both senators to express frustration that lawmakers hadn't acted sooner. "Why don't you people look into these things before you make a law?" he wrote.
"It's not like we're getting a bailout," says Dana Meier, 46 years old, of Rogue River, Ore., who works out of her home for a company that sells supplements for horses and other animals. "Why is AIG allowed to get away with this?"
Some Republicans, while just as angry as Democrats at the bonuses, were less enthusiastic about a tax penalty, with some questioning the propriety and even the legality of interfering with private contracts.
The law generally allows high taxes on bonuses, even for narrowly defined groups of executives, according to legal experts. Directly singling out executives of AIG in legislation might raise a constitutional issue, however, said Robert Cudd, a partner with Morrison & Foerster LLP in San Francisco.
The fact that AIG was set to pay bonuses to employees at the financial-products division wasn't a secret. AIG disclosed the retention payments in May 2008 in a securities filing, and lawmakers routinely criticized them.
"Fed and Treasury officials have coordinated closely on all aspects of the U.S. government's support for AIG during this extraordinary period," a New York Fed spokesman said.
Though the U.S. government controls AIG through an 80% equity stake and as a major lender, it doesn't have legal authority to freeze payments on its own. The U.S. has committed $173.3 billion to AIG, including $70 billion from Treasury's rescue fund.
In negotiating rescues of AIG late last year, some within the government argued the bonuses should be curtailed. Others said that such a move could cause employees to flee and prompt the firm's collapse. Instead, the government looked for other ways to limit executive compensation, including capping severance pay.
AIG set up a committee in November to examine the bonus issue, says one person familiar with the committee. The group included representatives from the Federal Reserve and Ernst & Young, the Fed's auditor. "If they had wanted to reject the bonuses, they had four months to do so," said this person.
Created in 1987, the financial-products business sold insurance-like contracts to cover a variety of risks using the insurer's triple-A credit rating. In 2007, the business recorded a $10.6 billion operating loss, reflecting the falling value of contracts protecting other firms against losses on assets backed by mortgages. The retention packages in question were tied to levels of pay in 2007 that didn't reflect certain losses incurred by the unit, according to company disclosures.
An administration official said that despite having engineered the first two rescues of AIG while president of the New York Fed, Mr. Geithner didn't know about the pending bonuses until last week.
On March 5, just days after AIG received its fourth round of government aid, the New York Fed informed a Treasury official the payments would be made on March 15, according to an administration official. That information wasn't conveyed to Mr. Geithner until last Tuesday, the official said. The next day, Mr. Geithner called Mr. Liddy and had him perform a legal analysis about whether the payments had to be made. Treasury began its own review of whether it could break the contracts.
On Friday, Messrs. Geithner and Liddy conferred again, and the Treasury secretary didn't protest when the AIG chief said the contracts were inviolable.
By the time National Economic Council Director Lawrence Summers appeared on the Sunday morning talk shows, the bonuses were already in the works, said White House spokesman Robert Gibbs. Government lawyers concluded abrogating the contracts would cost more in legal fees than letting the bonuses go forward.
White House officials say the economic team was reflecting the administration's position. But news of the AIG retention bonuses had hit the newspapers that morning, and anger was building. Some Obama advisers said the economists' language needed to be translated into plainer English. On Sunday evening, the president met with his economic and legal team and told them to keep looking for options on the bonuses.
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