AIG and the Hindered Haircut

by Dollars and Sense

Timothy Geithner, Ben Bernanke, and Henry Paulson (remember him?) are being grilled today on Capitol Hill as part of investigations of the AIG bailout by the House Committee on Oversight and Government Reform, headed by Edolphus Towns. (I thought we'd done a post a while back that included a good quote from Towns--something about bankers and corruption. But all I could find was this post, with a quote from Towns about BoA's awesome pecans. But I like how he is dogging the bankers and their government backers.)

Here's the NYTimes's latest article on the hearings.

For background on the AIG bailout, please see the article by Marty Wolfson in our Sept/Oct issue, The AIG Bailout Revisited.

There's also a really good article in the Financial Times called The Hindered Haircut; hat-tip to erstwhile D&S megablogger Larry P. (we still get the occasional post, but not like the old days, alas...). The authors ask: why haircuts for Security Capital Insurance counterparties, but not for AIG counterparties? Could it be that AIG's main counterparty was Goldman Sachs?

Finance: The hindered haircut

By Henny Sender, Gillian Tett and Francesco Guerrera | January 26 2010 22:49

It was mid-2008 and a little-noticed wrangle was taking place that will be of particular interest to the US congressional committee that is on Wednesday due to grill Tim Geithner, US Treasury secretary, over the rescue two months later of AIG, America's biggest insurer.

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?

His inquisitors on the House of Representatives oversight committee will want to take him back to the apocalyptic month when the world's financial system came close to meltdown. September 2008 brought not only the collapse of Lehman Brothers on Wall Street but a flurry of rescues that included staving off bankruptcy at AIG. It is the terms of the AIG bail-out that members of the congressional committee will want to examine, amid growing concern that not only might the taxpayer have been made to foot a higher bill than necessary but that details of a deal done in secret are to be kept under wraps for a decade.

The hearing comes as Mr Obama, after a fraught first year, prepares to deliver his first State of the Union address to a joint session of Congress tonight. It follows a week when not only did the Democrats lose their Senate super-majority, making it more difficult to pass legislation, but Mr Geithner's own position appeared to grow less secure. It was not to him but to Paul Volcker, a former Federal Reserve Board chairman, that the president turned for a blueprint on how to curb future banking industry excesses.

Crucial, therefore, will be the Treasury secretary's account of the most turbulent few days during his time at the stern stone edifice between Liberty Street and Maiden Lane, from which the New York Fed keeps watch over the financial district of downtown Manhattan.

"By not granting the transparency they are basically conspiring to not inform either Congress or the public so that they could, in fact, go about their business in secrecy and the public would not be wise until 2018 when these counterparties are due to become public," says Darrell Issa, a Republican representative who has pushed Congress to investigate the AIG payments. The question is whether the efforts amounted "to nothing less than a backdoor bail-out of AIG's creditors, including Goldman Sachs, Merrill Lynch, Société Générale and Deutsche Bank".

Mr Geithner's supporters say he was part of a team that responded pragmatically to prevent the collapse of the global financial system. But criticism of payments made to AIG—seen variously as a deliberate attempt to funnel public money to creaking banks or a negligent failure to safeguard the public interest—has been fuelled by e-mails showing New York Fed officials attempting to keep details of the transaction from the public.

It emerged this week that the New York Fed is under investigation by Neil Barofsky, the inspector-general overseeing the administration's Troubled Asset Relief Programme, over its disclosure of documents relating to the bail-out of AIG and its counterparties. Mr Barofsky is deciding whether it failed to disclose information about the episode to the Securities and Exchange Commission and his own office.

The issue is emblematic of the controversies that have followed the unprecedented federal response to a crisis in which complex financial products that were nearly impossible to value threatened to drag down the world's biggest banks—and with them the global economy.

Like SCA, AIG had provided credit insurance on CDOs that were falling in value and it, too, found itself facing a group of banks looking for compensation. Under agreements with its counterparties, AIG had to post collateral as the value of the CDOs it insured fell. AIG had pledged some $35bn but was still struggling.

As was the case with SCA, something had to give—only this time around, neither the banks nor the insurer would end up doing the giving. Instead, the New York Fed arrived bearing an early Christmas present for the banks. Fearing that the collateral calls on the CDSs were quickly sapping the $85bn (€60bn, £53bn) it had agreed to lend AIG to nurse it through the crisis, Mr Geithner's operation opened secret negotiations with the banks and agreed to buy underlying CDOs with a face value of $62bn from them.

Read the rest of the article (it's long-ish, but worth it for the basic background info).

Labels: AIG, Ben Bernanke, Goldman Sachs, haircuts, Henry Paulson, Timothy Geithner

 

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1/27/2010 02:06:00 PM