Advancing the AIG Story

Today is AIG day and there’s lots of interesting stuff out there in the press (not to mention Geithner live on C-SPAN).

First, there’s quite a bit of focus on a November 5 presentation BlackRock made to Tim Geithner’s New York Fed concerning the backdoor bailout of Wall Street and foreign banks through AIG. Here’s how The Wall Street Journal reports it deep in its C1 story.

On Nov. 5, the New York Fed received a presentation, a 44-page analysis put together by a unit of BlackRock Inc., saying that the banks had significant bargaining power with AIG and had little incentive to cancel the contracts unless they received par, or 100 cents, on the dollar.

But no one that I can tell points out who BlackRock is: The giant money manager who was then half-owned by Merrill Lynch (which still owns a third of it). Merrill was one of the biggest AIG counterparties, with $7 billion funneled to it by the government through AIG. So the Fed is being advised by one of the AIG counterparties that it can’t give haircuts to the AIG counterparties because “the banks had significant bargaining power with AIG and had little incentive to cancel the contracts unless they received par.”

It would have been nice to have had that context in these stories. Is it worth its own story?

The immediate reason why AIG needed bailing out in the fall of 2008 was the collateral called in by the likes of Goldman Sachs due to both the deterioration of AIG’s credit rating and of toxic assets they’d bought insurance on from AIG. Could the government have stopped the collateral calls without directly giving Wall Street tens of billions of dollars?

The New York Times reports
that some at the Fed thought it could just guarantee the AIG contracts, which didn’t have to be paid out unless and until the assets defaulted. The paper reports some at the Fed worried that it was giving the banks a $30 billion “gift” to the counterparties. That’s because if it had guaranteed AIG’s contracts, there would have been no need for collateral. But then the banks would have had to repay AIG the $30 billion in collateral they’d already forced it to put up against the CDS. Could they have done it?

This alternative, though, would have most likely met with opposition from the company’s counterparties, which would have had to return to A.I.G. all the collateral they had received over the previous year. But with the failure of Lehman Brothers and the seizing up of the money markets still fresh in everyone’s minds, bankers wanted to keep as much cash on hand as possible. According to an Oct. 26, 2008, presentation by Morgan Stanley, an adviser to the Fed, Goldman would have had to return $7.1 billion to A.I.G. and Merrill, $3.1 billion.

That’s a lot of money that Goldman et al were holding there. It’s clear that money (it seems that the Times is implying it was cash) helped prop up these wobbling banks during the fall. Was it so much of a prop that they would have failed if required to return it? I’d like to see an explanation on that. Goldman, an Audit funder, was particularly aggressive in its collateral calls, Bloomberg says, “demanding more collateral while assigning lower values to real estate assets backed by the insurer.”

Of course, these swaps were worth much less than what the counterparties got for them. The Financial Times has a very interesting story (which it nicely gives a lot of space) on the AIG non-haircuts. It digs out an anecdote showing Merrill taking an 86 percent haircut on CDS contracts a few months before the AIG bailouts. Remember the Fed’s French-banks excuse?

On one side of the earlier negotiations stood a group of banks that included Merrill Lynch of the US and France’s Société Générale. On the other: Security Capital Assurance (SCA), a Bermuda-based bond insurer that had run into difficulties as the US subprime mortgage market imploded. At stake was how much money the banks should receive on insurance contracts that SCA provided for complex pools of mortgage securities known as collateralised debt obligations, or CDOs.

Among other reasons, the banks had bought the insurance – called credit default swaps, or CDSs – to protect themselves against a panic just like the one sweeping the markets at that time. But SCA lacked sufficient capital to pay the claims in full and the banks feared that if the insurer went under, they would receive nothing.

Something had to give. After heated talks, Merrill agreed that July to cancel its CDS contracts for a pay-out of 14 cents on the dollar – a severe “haircut”, in market parlance. The other banks also reduced their original claims. At the conclusion of talks that dragged on until May 2009, not a single lender was paid in full.

That is potentially awkward for Mr Geithner, who before joining the administration of President Barack Obama was president of the Federal Reserve Bank of New York, the most important regional component of the US central banking system. What Congress, and perhaps historians, will have to decide is: did the government, through collusion or mistakes, take billions of dollars from the taxpayers’ purse and put them into the coffers of some of the world’s largest banks without forcing them to accept much lower payments? Why, in other words, did the counterparties of AIG wind up with so better a deal than those of SCA did – some of which were the same banks?

The FT story is great and includes a clear description (no easy feat) of the Fed’s bailout of AIG and the money that swapped hands that fall. This toward the end is terrific:

What the AIG drama exposes is that much of the recent innovation on Wall Street was dedicated to creating assets that barely traded and whose values were determined almost exclusively by computer models used by the banks and rating agencies.

In this 21st-century hall of mirrors, it has been possible for tens of billions of dollars of value to vanish or reappear at the click of a computer button – or at the behest of the rating agencies or through a change in accounting rules. That in turn makes it hard for the US government to explain whether the taxpayer really got “value for money” by bailing out AIG – or whether Americans will ever get back all the billions already spent.

And the Journal story referenced above digs out an interesting email:

“I have to think this train is probably going to leave the station soon and we need to focus our efforts on explaining the story as best we can. There were too many people involved in the deals … to keep a determined Congress from the information,” a New York Fed in-house lawyer James Bergin wrote to a colleague on March 6, 2009.

There’s more to come, obviously.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.