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.



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 rc2538@columbia.edu.