I wrote twice on Tuesday about the bizarre Tim Geithner quote that “the financial condition of the counterparties was not a relevant factor” in his decision to bail out AIG. I called it a “stunner” and said it ought to be “second-day-story number one.”
Now we’re to the fourth day and it’s just us and now The Wall Street Journal editorial page that have even reprinted the quote (Reuters’s James Pethokoukis quotes the WSJ quoting it today), which the WSJ’s news side had in its first-day story but didn’t flesh out.
The Journal leads Review & Outlook today with an editorial on the quote, which Neil Barofsky, the Special Inspector General of the TARP, included in his AIG report released Tuesday.
In the fall of 2008 the New York Fed drove a baby-soft bargain with AIG’s credit-default-swap counterparties. The Fed’s taxpayer-funded vehicle, Maiden Lane III, bought out the counterparties’ mortgage-backed securities at 100 cents on the dollar, effectively canceling out the CDS contracts. This was miles above what those assets could have fetched in the market at that time, if they could have been sold at all.
That pretty much blows a hole in Geithner’s—remember, he headed the New York Fed then—argument, which at best seems like a bumbling headfake to draw attention away from the big banks, foreign and domestic, he bailed out by paying full price for their trash.
Why would the Fed bail out those CDS contracts if the financial condition of the counterparties was not a relevant factor”?
Regulators say that having taxpayers buy out the counterparties improved AIG’s liquidity position, but why was it important to keep AIG liquid if not to protect some class of creditors?
The Journal uses this screw-up for its deregulatory agenda, which it’s perfectly fine to do, noting that Geithner has said that he was worried about the insurance part of AIG, which unlike its CDS was regulated. Maybe so.
But it sure would be nice to see some news reporting explore what’s going on here.
The motive for the counterparties of AIG was to insure or hedge against the insolvency of AIG which had been engineered by the United States Government to prevent the insolvency of Fannie Mae and Freddie Mac.
#1 Posted by Peter L. Griffiths, CJR on Mon 7 Dec 2009 at 10:38 AM
Further to my comment on 7 December 2009, the question may arise as to whether Credit Default Swaps should be outlawed. The main weakness of Credit Default Swaps is the possibility of the loser becoming bankrupt or needing a bailout. This weakness could be corrected by a regulatory upper limit on the permitted stakes.
#2 Posted by Peter L. Griffiths, CJR on Mon 24 May 2010 at 08:49 AM
Further to my comment of 24 May 2010, credit default swaps seem to have become particularly relevant when applied to a particular credit event namely changes of Libor, the interest rate charged between banks both national and international. Changes of Libor seem to have become a substitute for changes of foreign exchange rates. This seems all the more extraordinary when it is borne in mind that banks should only be borrowing from other banks when their debtors are not being recovered.
#3 Posted by Peter L. Griffiths, CJR on Sat 14 Jul 2012 at 10:10 AM