AIG

The following is a letter sent on Tuesday by Jake DeSantis, an executive vice president of the American International Group's financial products unit, to Edward M. Liddy, the chief executive of A.I.G.

Dear Mr. Liddy,

It is with deep regret that I submit my notice of resignation from A.I.G. Financial Products. I hope you take the time to read this entire letter. Before describing the details of my decision, I want to offer some context:

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

You and I have never met or spoken to each other, so I'd like to tell you about myself. I was raised by schoolteachers working multiple jobs in a world of closing steel mills. My hard work earned me acceptance to M.I.T., and the institute's generous financial aid enabled me to attend. I had fulfilled my American dream.

I started at this company in 1998 as an equity trader, became the head of equity and commodity trading and, a couple of years before A.I.G.'s meltdown last September, was named the head of business development for commodities. Over this period the equity and commodity units were consistently profitable — in most years generating net profits of well over $100 million. Most recently, during the dismantling of A.I.G.-F.P., I was an integral player in the pending sale of its well-regarded commodity index business to UBS. As you know, business unit sales like this are crucial to A.I.G.'s effort to repay the American taxpayer.

The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity — directly as well as indirectly with the rest of the taxpayers.

I have the utmost respect for the civic duty that you are now performing at A.I.G. You are as blameless for these credit default swap losses as I am. You answered your country's call and you are taking a tremendous beating for it.

But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn't defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut.

My guess is that in October, when you learned of these retention contracts, you realized that the employees of the financial products unit needed some incentive to stay and that the contracts, being both ethical and useful, should be left to stand. That's probably why A.I.G. management assured us on three occasions during that month that the company would "live up to its commitment" to honor the contract guarantees.

That may be why you decided to accelerate by three months more than a quarter of the amounts due under the contracts. That action signified to us your support, and was hardly something that one would do if he truly found the contracts "distasteful."

That may also be why you authorized the balance of the payments on March 13.

At no time during the past six months that you have been leading A.I.G. did you ask us to revise, renegotiate or break these contracts — until several hours before your appearance last week before Congress.

I think your initial decision to honor the contracts was both ethical and financially astute, but it seems to have been politically unwise. It's now apparent that you either misunderstood the agreements that you had made — tacit or otherwise — with the Federal Reserve, the Treasury, various members of Congress and Attorney General Andrew Cuomo of New York, or were not strong enough to withstand the shifting political winds.

You've now asked the current employees of A.I.G.-F.P. to repay these earnings. As you can imagine, there has been a tremendous amount of serious thought and heated discussion about how we should respond to this breach of trust.

As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.

Many of the employees have, in the past six months, turned down job offers from more stable employers, based on A.I.G.'s assurances that the contracts would be honored. They are now angry about having been misled by A.I.G.'s promises and are not inclined to return the money as a favor to you.

The only real motivation that anyone at A.I.G.-F.P. now has is fear. Mr. Cuomo has threatened to "name and shame," and his counterpart in Connecticut, Richard Blumenthal, has made similar threats — even though attorneys general are supposed to stand for due process, to conduct trials in courts and not the press.

So what am I to do? There's no easy answer. I know that because of hard work I have benefited more than most during the economic boom and have saved enough that my family is unlikely to suffer devastating losses during the current bust. Some might argue that members of my profession have been overpaid, and I wouldn't disagree.

That is why I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn. This is not a tax-deduction gimmick; I simply believe that I at least deserve to dictate how my earnings are spent, and do not want to see them disappear back into the obscurity of A.I.G.'s or the federal government's budget. Our earnings have caused such a distraction for so many from the more pressing issues our country faces, and I would like to see my share of it benefit those truly in need.

On March 16 I received a payment from A.I.G. amounting to $742,006.40, after taxes. In light of the uncertainty over the ultimate taxation and legal status of this payment, the actual amount I donate may be less — in fact, it may end up being far less if the recent House bill raising the tax on the retention payments to 90 percent stands. Once all the money is donated, you will immediately receive a list of all recipients.

This choice is right for me. I wish others at A.I.G.-F.P. luck finding peace with their difficult decision, and only hope their judgment is not clouded by fear.

Mr. Liddy, I wish you success in your commitment to return the money extended by the American government, and luck with the continued unwinding of the company's diverse businesses — especially those remaining credit default swaps. I'll continue over the short term to help make sure no balls are dropped, but after what's happened this past week I can't remain much longer — there is too much bad blood. I'm not sure how you will greet my resignation, but at least Attorney General Blumenthal should be relieved that I'll leave under my own power and will not need to be "shoved out the door."

Sincerely,

Jake DeSantis

The diamond 'overhang'

Responding to the global recession, the De Beers diamond cartel has cut back production at its South African mines and reduced the price of its rough diamonds between 15 and 20 percent. Even so, industry sources in South Africa are now estimating that diamond prices could fall another "59-63 percent." But the real fear of the diamond cartel is not just that retail prices will decline - it has managed that problem before - but that the public will begin to sell its hoard of diamonds, or what is called at De Beers "the overhang."

At the heart of this concern is the reality that, except for those few stones that have been permanently lost, every diamond that has been found and cut into a gem since the beginning of time still exists today. This enormous inventory, which overhangs the market, is literally in - or on - the public's hands. Some hundred million women wear diamonds, while millions of other people keep them in safe deposit boxes as family heirlooms.

De Beers executives estimate that the public holds more than 500 million carats of gem diamonds, which is more than 50 times the number of gem diamonds produced by the diamond cartel in any given year. The moment a significant portion of the public begins selling diamonds from this prodigious inventory, the cartel would be unable to sustain the price of diamonds, or maintain the illusion that they are such a rare stone that their value is, as the ad slogan claims, "forever."

As Harry Oppenheimer, who headed the cartel for more than a quarter of a century, pointed out, "wide fluctuations in price, which have, rightly or wrongly, been accepted as normal in the case of most raw materials, would be destructive of public confidence in the case of a pure luxury such as gem diamonds, of which large stocks are held in the form of jewelry by the general public."

The genius of the cartel was creating this "confidence" in the myth that the value of diamonds was eternal. In developing a strategy for De Beers in 1952, the advertising agency N.W. Ayer noted in a report to De Beers: "Diamonds do not wear out and are not consumed. New diamonds add to the existing supply in trade channels and in the possession of the public. In our opinion old diamonds are in 'safe hands' only when widely dispersed and held by individuals as cherished possessions valued far above their market price."

In other words, for the diamond illusion to survive, the public must be psychologically inhibited from ever parting with their diamonds. The advertising agency's basic assignment was to make women value diamonds as permanent possessions, not for their actual worth on the market. It set out to accomplish this task by attempting through subtly designed advertisements to foster a sentimental attachment to diamonds that would make it difficult for a woman to give them up. Women were induced to think of diamonds as their "best friends."

This conditioning could not be attained solely by magazine advertisements. The diamond-holding public, which included individuals who inherited diamonds, had to remain convinced that the gems retained their monetary value. If they attempted to take advantage of changing prices, the retail market would be chaotic.

Even during the Great Depression of the 1930s, there was only a limited overhang, since the mass-marketing of diamonds had begun only a single generation before the crash. So even though demand for diamonds almost completely abated, De Beers, by shuttering all its mines and borrowing money to buy up the production of the small number of independent mines that still existed, was able to weather the crisis.

Today, however, with many generations of the diamonds it mass-marketed overhanging the market, and most of global diamond production in independent hands, it no longer is in a position to bring supply and demand into balance. Adding to this precarious situation, diamond cutters, manufacturers and dealers, have, as of Feb. 15, an estimated $40 to $50 billion worth of diamonds in mines in the pipeline that will intensify the downward spiral when the gems reach the market later this year.

If falling prices shatter the carefully nurtured illusion that the value of the glittering stones kept in jewel boxes and vaults is eternal, and the public begins selling even part of its hoard, De Beer's nightmare scenario would come true: The overhang would flood the market.

Where is the money?

Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollars as there were only two pieces of 1 dollar coins circulating around.

• There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
• B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.
• The net asset of the country now = 3 dollars.
• Now C thought that since there is only one piece of land in the country, and land is non producible asset, its value must definitely go up. So, he borrowed 1 dollar from A, and together with his own 1 dollar, he bought the land from B for 2 dollars.
• A has a loan to C of 1 dollar, so his net asset is 1 dollar.
  B sold his land and got 2 dollars, so his net asset is 2 dollars.
  C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.
  Thus, the net asset of the country = 4 dollars.
• A saw that the land he once owned has risen in value. He regretted having sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C.
• As a result, A now owned a piece of land that is worth 3 dollars. But since he owed B 2 dollars, his net asset is 1 dollar.
  * B loaned 2 dollars to A. So his net asset is 2 dollars.
  * C now has the 2 coins. His net asset is also 2 dollars.
  * The net asset of the country = 5 dollars. A bubble is building up.
• B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollars. The payment is by Borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.
• As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollars.
  B owned a piece of land that is worth 4 dollars, but since he has a debt of 2 dollars with C, his net Asset is 2 dollars.
  C loaned 2 dollars to B, so his net asset is 2 dollars.
  The net asset of the country = 6 dollars; even though, the country has only one piece of land and 2 Dollars in circulation.
• Everybody has made money and everybody felt happy and prosperous.
• One day an evil wind blew, and an evil thought came to C’s mind. "Hey,
  what if the land price stop going up, how could B repay my loan. There is only 2 dollars in circulation, and, I think after all the land that B owns is worth at most only 1 dollar, and no more."
• A also thought the same way.
• Nobody wanted to buy land anymore.
• So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
  B owed C 2 dollars and the land he owned which he thought worth 4 dollars is now 1 dollar. So his net asset is only 1 dollar.
  C has a loan of 2 dollars to B. But it is a bad debt. Although his net
  asset is still 2 dollars, his Heart is palpitating.
  The net asset of the country = 3 dollars again.
• So, who has stolen the 3 dollars from the country?

• Of course, before the bubble burst B thought his land was worth 4 dollars. Actually, right before the collapse, the net asset of the country was 6 dollars on paper. B’s net asset is still 2 dollars, his heart is palpitating.
• B had no choice but to declare bankruptcy. C has to relinquish his 2
  dollars bad debt to B, but in return he acquired the land which is worth 1 dollar now.
• A owns the 2 coins, his net asset is 2 dollars.
  B is bankrupt, his net asset is 0 dollar. (he lost everything)
  C got no choice but end up with a land worth only 1 dollar
  The net asset of the country = 3 dollars.

End of the story… but…

• There is however a redistribution of wealth.
  A is the winner, B is the loser, C is lucky that he is spared.

A few points worth noting…

• When a bubble is building up, the debt of individuals to one another in a country is also building up.
• This story of the island is a closed system whereby there is no other country and hence no foreign debt. The worth of the asset can only be Calculated using the island’s own currency. Hence, there is no net loss.
• An over-damped system is assumed when the bubble burst, meaning the land’s value did not go down to below 1 dollar.
• When the bubble burst, the fellow with cash is the winner. The fellows having the land or extending loan to others are the losers. The asset could shrink or in worst case, they go bankrupt.
• If there is another citizen D either holding a dollar or another piece of land but refrains from taking part in the game, he will neither win nor Lose. But he will see the value of his money or land go up and down like a see saw.
• When the bubble was in the growing phase, everybody made money.
• If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A) and take part in the game. But you must know when you should change everything back to cash.
• As in the case of land, the above phenomenon applies to stocks as well.
• The actual worth of land or stocks depend largely on psychology.