AIG gets a French kiss-off

Two executives at Banque AIG, the French subsidiary of AIG's financial products group, have resigned.  There's been talk in recent days that a major departure at the subsidiary could be a disaster, because it risks triggering cross-default provisions in various AIG contracts.  I'm tempted to say that this would send the company into a downward spiral, but then what are we in now?

At any rate, the Wall Street Journal story confirms the worry, though at this point, it doesn't seem particularly likely to actually happen:

The executives at Paris-based Banque AIG, Mauro Gabriele and James Shephard, have resigned in recent days but have agreed to stay on for a transition, according to people familiar with the matter. In the wake of their resignations, AIG must replace them to the satisfaction of French banking regulators.

If they don't, French regulators may appoint their own designee to manage the bank -- an outcome that could trigger defaults under the bank's derivative contracts. The private contracts say that a regulator's appointment of a manager constitutes a change in control, according to a person familiar with the matter; the provision is often included in derivative contracts where parties want to preserve a way out if something about their counterparties changes.

. . . 

Regulators and the company are motivated to find a solution in Paris. AIG described the issues in a five-page white paper submitted to the U.S. Treasury Department earlier this month along with a letter about $165 million in retention payments the company made to employees in the financial-products unit, the unit responsible for the worst of AIG's woes.

The company was rescued by the federal government in September. After a public outcry this month about the bonuses, employees were urged to return them, and now several have quit, according to AIG. The two departing managers at Banque AIG have offered to return their bonus payments, AIG says.

In the white paper, AIG said it had legal obligations to make the retention payments, but it also discussed the "significant business ramifications" of failing to pay. AIG said that employees at the financial-products unit are needed to wind down and sell pieces of that business, which has $1.6 trillion in outstanding trades.

Referring to the circumstances at Banque AIG, the company said that at a minimum, the "disruption associated with significant departures related to a failure to honor contractual obligations would require intensive interactions with regulators and other constituents (rating agencies, counterparties, etc.) to assure them of the ongoing viability of AIGFP as well as its commitment to honoring counterparty contracts and claims."

The risk that the Banque AIG transactions would default if managers departed would represent an unexpected problem for what had been one of the AIG Financial Products businesses that hadn't run seriously aground in recent months, according to AIG securities filings.

As the bonny chap who sent me this said, "Great job, Congress!!"

Though of course, we can't be sure there's cause and effect.  And actually, this presents a greater problem for Europeans than it does for us:  it's their banking system that will suddenly find its regulatory capital underpinning has more holes than a swiss cheese.  A giant wheel of swiss cheese, on which Nicolas Sarkozy is seated, trying to explain to his ex-wife how he came to be wearing a fishnet bodysuit.

Of course, what with this whole grand experiment we've been conducting in financial globalization, what happens to the European banks will kind of also be happening to us.  It's a small world, after all.

But given what a gigantic problem this presents for European banks who have relied on AIG to top up their regulatory capital by insuring various portions of the debt they originated, I think we can expect the French banking regulators to be very eager to help AIG find a way out of this.  That is not to say that they will succeed.  I wouldn't put it past them to do something shortsighted and stupid, like swooping in to appoint new executives just to prove they can.  I would never put it past any organization to shoot itself in the foot with both barrels.  But as yet, this should be only a middling worry for AIG-watchers around the world.