Wow, I should not be surprised, but this is a stunner nevertheless.
It had generally been assumed that the AIG payouts of 100% on credit swaps (when the insurer was under water and bankrupt companies do not satisfy their obligations in full) was the result of some gap in oversight plus traders at AIG exercising discretion (they were unhappy about bonus rows and had reason to curry favor with dealers, who were potential employers).
The article makes clear that AIG had been negotiating to settle on the swaps prior to getting aid from the government, and was seeking a 40% discount. The Fed might not have gotten that much of a discount, but there was clearly no need to pay out at par.
This massive backdoor subsidy to the likes of Goldman, DeutscheBank was authorized by Geithner while he was at the New York Fed.
From Bloomberg:
[Elias} Habayeb, 37, was chief financial officer for the AIG division that oversaw AIG Financial Products, the unit that had sold the swaps to the banks. One of his goals was to persuade the banks to accept discounts of as much as 40 cents on the dollar....
Beginning late in the week of Nov. 3, the New York Fed, led by President Timothy Geithner, took over negotiations with the banks from AIG, together with the Treasury Department and Chairman Ben S. Bernanke’s Federal Reserve. Geithner’s team circulated a draft term sheet outlining how the New York Fed wanted to deal with the swaps -- insurance-like contracts that backed soured collateralized-debt obligations....
Part of a sentence in the document was crossed out. It contained a blank space that was intended to show the amount of the haircut the banks would take, according to people who saw the term sheet. After less than a week of private negotiations with the banks, the New York Fed instructed AIG to pay them par, or 100 cents on the dollar. The content of its deliberations has never been made public.
The New York Fed’s decision to pay the banks in full cost AIG -- and thus American taxpayers -- at least $13 billion. That’s 40 percent of the $32.5 billion AIG paid to retire the swaps. Under the agreement, the government and its taxpayers became owners of the dubious CDOs, whose face value was $62 billion and for which AIG paid the market price of $29.6 billion. The CDOs were shunted into a Fed-run entity called Maiden Lane III...
The deal contributed to the more than $14 billion that over 18 months was handed to Goldman Sachs, whose former chairman, Stephen Friedman, was chairman of the board of directors of the New York Fed when the decision was made.....
“In cases like this, the outcome is always along the lines of 50, 60 or 70 cents on the dollar,” [Donn] Vickrey [of financial research firm Gradient Analytics Inc.] says…..
One reason par was paid was because some counterparties insisted on being paid in full and the New York Fed did not want to negotiate separate deals, says a person close to the transaction. “Some of those banks needed 100 cents on the dollar or they risked failure,” Vickrey says.
As Vickrey indicates, the fact that this was a backdoor rescue means the Fed is acting as an extra budgetary vehicle of the Treasury. This is a violation of the Constitution and shows how patently false the Fed’s claims of independence are.
Update. Some readers have argued “The government was backstopping AIG, ergo it had to honor all contracts.” That argument is rubbish; AIG under Fed supervision stiffed other creditors. From a reader by e-mail:
Liddy sent a letter to Congress which gave a summary the losses at AIG. As I remember it it only 53% of the losses covered by the Fed resulted from activity at AIGFP. Of the 43% realized at the insurance subs a substantial fraction were losses on GIAs with state pension plans-including Californis and Virgina. The losses were in to the billions. Was the Fed suppose to pay 40 cents on the dollar to state pension funds while paying off foreign banks in full?
Now I know the argument goes something like “these were regulated subsidiaries, AIG FP was at the parent level.” Again, I don’t buy it. Creditors in distress who have not declared BK frequently renegotiate their obligations. As readers know well, even credit card issuers will lower the amount due by overextended individuals, and the Fed clearly had more clout here that a mere individual versus has with, say, BofA. The real issue is that the Fed BY DESIGN bailed out banks, including foreign banks, through a device not authorized by Congress.
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I had heard about Geithner’s involvement but not the size of the haircut suggested. That was quite impressive. But it goes to show how in the bag Geithner is to the financial industry. Sockpuppet doesn’t even begin to cover it. At the same time, seeing how the Fed is structured to be run by the banks and for their benefit, this is no surprise. The Fed was always on more than dicey ground Constitutionally even before the current crisis, but with its entry into fiscal policy, both its unConstitutionality and profound conflicts of interest have only been magnified, as in the AIG case cited.