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Very Abbreviated Takedown on SIGTARP Report on AIG CDS Payouts

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Dear sports fans, your humble blogger, along with a ton of others, got the not-very-embargoed copy of the SIGTARP report on the New York Fed’s conduct with respect to its full payout on AIG’s credit default swaps to its counterparties.

The press is treating the report as if it was tough. I was sputtering with anger when reading it on how soft it was on the Fed. The positioning and framing of the issues was almost without exception far too forgiving. It read as if the findings had been negotiated with the Fed (and SIGTARP lost the negotiations as the “shape of the table” stage), but I am assured not, not by SIGTARP, but by those, as they like to say, in a position to know. That says SIGTARP is almost as badly cognitively captured as the Fed is.

Remember, the GAO covered this ground in a report in September. The SIGTARP did come up with some details, and did weigh in on where it thought the Fed went awry, but there is less new here than today’s headlines suggest.

Look, let’s get real here. The Fed paid out 100% on these contracts. AIG was trying to negotiate them down. Who knows how far they would have gotten, AIG went into crisis mode pretty quickly. There was absolutely no reason to pay 100%. Companies that get into trouble renegotiate their obligations as a matter of course. You cannot get blood from a turnip. And the fact that the Feds stepped in to prevent the financial system from collapsing is NOT THE SAME as an open-ended commitment to honor the obligations of a dead company. To quote the Epicurean Dealmaker:

Tim Geithner and the Federal Reserve got royally played. And you and I, my friends, paid dearly for the privilege.

Sure, the Fed was worried that AIG’s uncontrolled collapse could lead to a complete and utter meltdown of the global financial system. Even now, with the worst of the crisis behind us and plenty of time to reflect, it is hard to criticize this worry as hysterical. It is also true that things were moving way too quickly to sit down and think them through logically, so we should not superimpose unreasonable expectations of measured, rational thought on the Fed’s negotiators. It is also even remotely possible that some of AIG’s counterparties were so inept and unprepared for the insurance company’s troubles that they truly might have blown up themselves if it went down. (Although AIG’s train wreck was so long coming and so well telegraphed that any bank so blind to the obvious and unprepared for the inevitable probably should have been shut down purely on principle.)

But Christ, people, think about it.

What moronic financial entity—fully hedged or not—would really risk global financial catastrophe by throwing AIG into bankruptcy, even if it had the contractual and legal right to do so? Because it insisted on receiving 100% of the proceeds due to it by contract? Even though parties to financial contracts renegotiate existing terms under normal market conditions all the time? What good, for example, would those extra five billion clams—not collected, by the way, until the bankruptcy judge wound the company down, if ever—have done Goldman Sachs if it, Morgan Stanley, and every other major investment and commercial bank were in liquidation too?

Furthermore, what foreign or domestic bank CEO in his right mind has the balls to threaten the government of the United States of America with financial meltdown if it doesn’t cough up another couple billion dollars out of the public purse? Are you fucking kidding me?

AIG’s counterparties had no leverage whatsoever. None.

Of course, Geithner and Bernanke were over a barrel, too, because they didn’t want to do anything stupid to trigger Armageddon either. Among other things, I believe it is in their brief to prevent just such annoyances. I do not claim they should have been able to get all 40% of the target discount from the banks. But nothing? Not even from the guys who claimed not to care?

Give me a break.

That Turbo Timmy and the Fed were “played” is the most charitable interpretation possible of this sorry turn of events. This was criminal. It may merely have been criminally incompetent, but this needs to be treated as a very serious lapse. Yes, I’m sure a very high percent of the CDS contracts needed to be paid out to prevent Very Bad Stuff from happening, but that should have been bifurcated, with the percentage that reflected fair payout as the CDS compensation, the balance as an equity infusion.

Who was the Fed representing? Here we get into the usual debate of was the Fed operating as a government entity (as it likes to pretend when convenient, which is most of the time) or a private bank favoring entity? It most certainly appears to have behaved like the latter. It acted only from the vantage of what was best for the financiers, and gave nary a thought as to whether that might conflict with the interests of other constituencies.

And we get the cute revelation that UBS (which by the way, had very very serious CDO losses, they were certainly not a strong institution) offered to take a haircut, but that was vetoed by the Fed as opposed to

Now I hope to return to this topic later, but let me illustrate how Fed-flattering the framing of the report was. Start with the title: “Factors Affecting Efforts to Limit Payments to AIG Counterparties and Future Exposures.”

Huh? Even before we start, we have about two levels of Newspeak. First, the framing presupposes efforts were made to limit payments. No such efforts took place. And given the utter absence of said efforts, “Factors Affecting” is therefore an apology.

Yes, the criticism is in there, with the report firmly stating that the Fed didn’t exploit “its considerable leverage” and the press dutifully rooted those remarks out, but there was tons of bubble wrap around it. For instance, the report uncritically repeats (page 14) the excuse that the Fed was worried about the impact of an AIG BK on stable value funds. AIGFP had written $38 billion of them. First, did you see any Federal official run to the rescue when the $200 billion auction rate securities market collapsed? That was a retail market, and the users mistakenly regarded it as a near money market equivalent. Loss of access to these funds was far more catastrophic to many investors than taking a haircut on an investment provided by a dud company (those stable value fund investors should have been delighted to get even 60 cents on the dollar. They were so lucky as to have Goldman as a fellow creditor. Does anyone think for one nanosecond that the Fed would have rescued AIGFP if its only creditors were stable value fund investors? Please.

The uncritical reportage of defenses by the officialdom is annoying. While these remarks may be narrowly true (as in someone in the thick of things no doubt did go over who was on the other side of AIG’s trades and what the impact of letting them flounder might be), they are not the operative truths (as in these were at most tertiary issues that did not drive the decision). And including them again deflects attention from the question of what the true motives behind the actions taken and again makes the process look more orderly and deliberate than it really was.

The most useful bit is that SIGTARP actually made a bit of a detour to shred the bogus Goldman claim that it was due a full payout because it has hedged its exposures (in other words, the rescue kept it from being paid out on CDS in the event of an AIG bankruptcy). The report dryly notes those hedges were non-performing airbags.

I would love to go further, but you get the drift of the gist. It is worrisome that an overseer feels the need to play ball nicely.

Update 5:45 PM. Some readers took objection of my failure to mention the half-hearted Fed efforts to negotiate, and I agree I should had addressed this above. But these were not even handled like a negotiation. Fed staffers called the counterparties, individually, with “proposals”. Huh? Having anything less than very top Fed officials someone contact counterparties individually by phone assured nothing would happen. In fact, this was so badly thought out and executed I question whether this was serious, or simply an exercise in CYA.

The way to do this was to haul DECISION MAKERS (CEOs, not minions who can say they are not authorized to commit, and for foreign firms, the most senior guy in the US) to the Fed in person (probably as a group)and tell what the deal is, and tell them the consequences if they mess with the Fed and try forcing their hand. What the Fed did was NOT handle this as a negotiation, it was a lame-low level plea.

Another argument is the French regulators said their banks could not “voluntarily agree” to take less than full value. Fine, this isn’t an agreement. The Fed could simply have said, “this is the deal that the others are being made to accept, take it or leave it.” Trust me, the French regulators would have figured out a way to make this work. Their banks needed the dough. There had to have been to have been cases in other pre-BK negotiations where some French institution accepted a cramdown when the majority of bondholders accepted it (in fact I suspect there are plenty of examples, just in instances less material to the institution than this, just on settling transaction errors and valuation disputes). They could find a precedent if they looked hard enough.

In the bigger picture, the Fed could have simply pretended it was willing to retrade the deal, or do preferential payouts. Remember, it famously DID with Bear, first saying it was lending Bear money for 28 days, which Bear thought was enough of a lifeline to rescue itself. The Fed could have said, “We are paying only X%, the rest is equity (or warrants or a loan). You can take it or leave it.” The onus would have been on the banks to reject this and put AIG into BK. No one would have done that.

Update 7:00 PM: I should have realized that doing this short form would lead to my issues being misconstrued. Hoisted from my remarks in comments:

This is NOT a matter of tone, it is a matter of framing of information and proportion. You can take a neutral tone and still reach very devastating conclusions.

Let me give you a very simple example of how easily perceptions are influenced. A poll that asks, “What do you think of the job Obama is doing” will receive markedly lower ratings than “What do you think of the job Obama is doing as President?” The “as President” confers greater dignity on him and reminds listeners of the difficulty of his job.

First, Barkofsky had to issue a critical report. The GAO had set the stage; there was no defending the outcome. So we are merely talking degrees within a pre-set parameter.

Second, as an example of a “free” and very important win delivered to the Fed is that the report ENDORSES the Fed retrading the original financing of AIG at 11%! The Fed stepped in and provided money on the same terms AIG had sought from private parties, and then REGURGITATES WITHOUT ANY CRITICAL EXAMINATION the Fed’s logic for its conduct. And this is framed in a faux-critical wrapper, “oh, see, another example of the Fed moving too fast, acting before it thought.” Huh? The 11.5% rate WAS an appropriate risk (in fact, too low given the failure of any private sector buyer to step forward). The report is not written clearly enough to be certain, but it looks as if the professed concern was that the interest payouts would lead to further downgrades. If the issue was the cash drain, you could simply have modified the terms so interest was payable from the proceeds of asset sales rather than on a current basis. There was no justification for lowering the rate. Or if that might not suffice, in an extreme version why didn’t the Fed intervene with the rating agencies (you do this counsel to counsel first to make this privileged communication)? AIG is backstopped by the bloody central bank with unlimited check writing authority; why are they subject to downgrades?

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36 comments

  1. Sam

    You are relentless, Yves.

    “I was sputtering with anger…”

    My feelings exactly. The gall of the thing still amazes me. $27B is greater than the GDP of several countries and the USG casually forked it over.

    It would indeed be poetic justice if the USD collapsed to prevent this kind of arrogant behavior from ever taking place again.

  2. BwO

    Yes, we’re all shocked, shocked to find that the Fed bailed out it’s buddies. I don’t get the outrage over this particular point. The whole idea was to give the teetering banks some freshly minted capital. There was no reason to save AIG if you were still going to let Goldman go under. I’m not saying this was democratic or transparent or anything, but please, it was the whole point of the exercise. At the time they thought this was going to be enough to fake everybody out.

    The problem comes afterwards, when it’s clear that Uncle Sam is the only thing keeping the system afloat. Once we already had a crisis we could have nationalized the lot of them and finally removed the metastasizing tumor that our financial system has become. The place to drive the hard bargain was with TARP, not with the AIG fiasco.

    Can I also respectfully point out that I get outrage fatigue from reading this blog now. I know time is limited, and this is just a suggestion, but I think it might be useful to see some *positive* proposals for what we *should* do, and not just a lot of critique of how nothing we can possibly do will work. I’m not asking for a sugarcoating, but someday this war is gonna end, and we will still have an economy and a financial system even if perhaps the thing is denominated in Ameros.

    Why don’t we get ready for that day and try to come up with a better system — financially and politically — instead of spending so much time sputtering.

    1. marc fleury

      He he,

      A friend and I got outrage ‘burnout’ about march last year. He stopped reading, I came back because after all the quality of news flow and discussions here is a notch above the rest. So I take the tone with a grain of salt, or just plain ignore it. Yves is just one pissed off blogger and that is the way it is. She ain’t what she ain’t.

  3. Siggy

    I’m with you!

    SIGTARP is very bad wall paper. AIG is Teapot Dome revisited.

    As to honoring contracts, I very much favor that course of action; however, there does come a time when the reality is that repudiation is the only least cost course of action.

    The initial funding to AIG was made to protect ‘primary dealer banks’. Is there justification for such a move? In a way yes. Lose the ‘priamry dealer banks, and the Treasury’s ability to finance the operation of the government is seriously impaired.

    In consideration of that impaired financing ability someone might have realized that it would be necessary to nationalize the bankrupt banks, declare a bank holiday and proceed with a dissolution of the bankrupt institutions.

    It also might have led to an expedited inquiry into the apparent fraud that had been perpetrated.

    Sadly, it will be history that gets this right and by that time we shall all be dead.

  4. attempter

    Reading about the report earlier in the NYT, I thought it got the point across.

    For me the takeaway was obvious: this is yet more dispositive evidence that the Fed is not a regulator, does not see itself as one, is incompetent and unwilling to be one. Hopefully that’s the point which gets across to the intelligent non-specialist reader.

    Therefore one of the litmus tests of any alleged reform proposal is: does it propose to maintain, extend, or strip Fed regulatory “authority”? If it strips, it’s trying to do the right thing. If it doesn’t, it’s bogus, anti-reform, a wolf in sheep’s clothing.

    I wrote my own blog post on the subject:

    http://attempter.wordpress.com/2009/11/17/regulation-fed-up/

  5. Skippy

    Hay trying to count my bonus here!

    OK where was I 100K for me and 10k for Timmy, 100k for me and 10k for Ben.

    Skippy…money counters, don’t give me that loving feeling like hand counting.

  6. i on the ball patriot

    Is SIGTARP like the 9/11 Commission reports? Will those who disagree and challenge this be labeled tin foil hat and conspiracy nut jobs?

    Non responsive to the will of the people government requires ‘vote of no confidence’ election boycotts.

    Deception is the strongest political force on the planet.

  7. vlade

    I thought GS claimed that the respons it would be ok was that all the CDS exposure with AIG was collateralised on a daily basis (i.e. AIG already posted the money to GS)?
    So if AIG went belly up, GS would simply seize the collateral, w/o waiting for any bankruptcy ruling.
    Of course, it depends on what AIG was posting as collateral…

    1. marc fleury

      I am willing to bet that the ‘run’ dynamic was indeed something along those lines. IB were just brokers of the CDS with AIG at one end and the hedge funds at the other. I bet GS eagerly paid the HF and then turned around with a fait-accompli attitude. Hence the “100% or die” attitude on the IB part.

  8. carol

    Not only Mr SIGTARP Barofsky is too soft in his written analysis, Mr Epicurean dealmaker is too:

    ¨It is also true that things were moving way too quickly to sit down and think them through logically, so we should not superimpose unreasonable expectations of measured, rational thought on the Fed’s negotiators.¨

    Unreasonable?

    Even before Bear Stearns, but certainly after its demise, anybody in finance, but most certainly FED and NYFED, should have seen the AIG debacle coming.

    So yes, we should have been able to expect measured (proper cost-benefit ratio), rational (with careful consideration for the taxpayers) thought of the FEDs. To call that unreasonable is way too soft on the FED, and does not bring us any closer to a solution.

    As an aside, at the time of the bank bailout via AIG I did not understand why the money was not handed out as a sort of bridge loan. It was done to capitalize well connected balance sheet broken banks. However, a mere year after the crisis that capital flees those same banks in the form of record bonuses (no small feat after the previous immoral records).

  9. The Epicurean Dealmaker

    Actually, Yves, while I agree that the SIGTARP report is written in a studiously neutral tone, I think the conclusions it draws are direct and pretty damning. It makes clear that Treasury botched the entire rescue repeatedly and comprehensively.

    Now, the report does not draw a straight line from the inference of incompetence to your conclusion of criminality, but that type of conclusion is one for us to draw, no?

    1. Yves Smith Post author

      Epicurean,

      I object to the “studious neutrality” and that does NOT mean Spitzer or yellow journalism as an alternative. There are SO MANY places where various Fed decisions/actions are given a free pass or treated as reasonable that the Fed, even though it has been criticized here, still gets off far better than it deserved.

      For instance, the conclusion section defends the Fed decision to retrade the initial loan to AIG, and presents the decision to lower the rate and restructure the deal as strictly voluntary, the Fed realizing it made an error, and the initial 11.5% rate having been “imposed” on AIG. This is revisionist history. AIG officials accepted that rate and were confident they could sell businesses quickly, that was what all the press reports said. In fact, if they had sold a couple of businesses fast (now clearly a delusional idea) they would have had enough for the interest payments. Then the story became that because AIG was having trouble raising the dough, the deal needed to be reworked.

      Now we get the new story, that the reason was that the cost of debt service would lead to downgrades. Huh? Where did this come from? And if true, was this merely a cash flow issue (I’ve never understood why the initial rate didn’t stand and the payments were simply deferred, payable out of proceeds of asset sales).

      There is just too much stuff like this in the report, material presented as neutral and factual that is Fed friendly. This “studied neutrality” serves to aspects of Fed conduct and decisions relative to AIG that also deserve criticism and scrutiny. The Fed got a lot of wins in this document that are hidden behind the attack on the payout in full, which was to be expected! The GAO report set the groundword, and Bloomberg had already disclosed that Timmie had approved the decision.

      The report is most damning on the failure of the Fed to be forthcoming.

  10. Richard Smith

    Yves, the mighty TED is drawing your attention to some possibly faux politeness. Barofsky’s no southerner, but…

    …Either way, nice bit of sputtering.

  11. maynardGkeynes

    Bravo Yves! I commend your point on the ARS situation. This should have been a clear application of Bagehot — good collateral that had become illiquid due to a run on the system. Yet the Fed did absolutely nothing to discharge its primary and essential function to provide liquidity for sound collateral. And why not? Because despite Bernanke’s folksy comments on 60 Minutes (and elsewhere) that he truly cares only for Main Street, he doesn’t really think that average folks are important. They are simply not players, like him. The Bankers are.

  12. Francois T

    Yves,

    I share your anger; however, some cold hard facts are discussed at length in the Economics of Contempt blog:

    http://economicsofcontempt.blogspot.com/2009/10/janet-tavakoli-all-bark-no-bite.html

    Writing about Goldman v. AIG+ Fed:
    “The total notional amount of CDS protection that Goldman bought from AIG was roughly $20 billion. But “exposure” in credit derivatives is equal to the cost of replacing a credit derivative in the market, not the notional amount of the transaction. Think about it this way: if you buy a $300,000 homeowners’ insurance policy on your house, and your insurer goes bust, you’re not out $300,000. The cost to you is simply the cost of buying another insurance policy to replace the first one. In Goldman’s case, the cost of replacing its trades with AIG was about $10 billion. Against that $10 billion, Goldman held $7.5 billion in cash collateral. It then hedged the remaining $2.5 billion of exposure with CDS on AIG. This is why Viniar said that Goldman’s direct exposure to AIG was immaterial.

    So what are Tavakoli’s arguments? One is the Immaculate Negotiation argument:

    The government could have stepped in and renegotiated its contracts. … Goldman Sachs would have been out billions of dollars in collateral had a bankruptcy‐like settlement been negotiated with AIG, and that is material.

    Saying that Goldman would’ve taken a material loss if “a bankruptcy‐like settlement been negotiated with AIG” is the equivalent of saying that Goldman would’ve taken a material loss if they’d agreed to take a material loss. It’s true, but there’s no way Goldman would ever have agreed to a “bankruptcy-like settlement” — why would they? As someone who has actually been involved in these kinds of negotiations, let me explain how the AIG/Goldman negotiations would have played out:

    AIG: Would you be willing to accept, say, 70 cents on the dollar?
    Goldman: No.

    THE END

    Seriously, what could AIG have threatened Goldman with? If they didn’t accept a haircut, AIG would file for bankruptcy? Fine, Goldman would’ve just seized the $7.5 billion in cash collateral, and collected the remaining $2.5 billion from its counterparties on the now-triggered CDS on AIG (on which more below), covering Goldman’s full bilateral exposure to AIG. That’s what it means to be “hedged.”

    (This is also why the Fed paid Goldman and the other counterparties 100 cents on the dollar to terminate their CDS contracts with AIG, which this Bloomberg article portrays as some sort of gift to the banks. But the Bloomberg article also relies on the Immaculate Negotiation argument — how, exactly, was the Fed supposed to get the counterparties to agree to take a haircut? The Fed had just demonstrated to the entire world that it wasn’t willing to let AIG file for Chapter 11. How do you suppose those negotiations would have gone? The Fed couldn’t say, “You can either take a haircut to 70 cents or AIG will file for bankruptcy and you’ll only get 50 cents,” because everyone knew the Fed wasn’t willing to put AIG in bankruptcy.)”

    As for the other than GS counterparties, there were some legal complications that were very difficult to circumvent:

    http://economicsofcontempt.blogspot.com/2009/11/geithner-vindicated-in-tarp-watchdog.html

    1. First, AIG tried to negotiate haircuts on its CDS contracts, but counterparties refused (as was their right):

    AIG was attempting to resolve its liquidity crisis caused by the collateral posting requirements by negotiating a cash payment to the counterparties in return for terminating the credit default swaps. … While FRBNY was conducting analysis on alternative solutions, AIG’s attempts to negotiate the termination of its multi-sector credit default swap book with its counterparties were failing. AIG requested FRBNY’s assistance in securing these terminations.

    2. Contrary to the constant claims of ill-informed pundits, the NY Fed did try to negotiate haircuts with AIG’s counterparties:

    On November 6 and 7, 2008, FRBNY assistant vice presidents, vice presidents, senior vice presidents, and executive vice presidents contacted eight of AIGFP’s largest counterparties (Société Générale, Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, Calyon, Barclays and Bank of America) by telephone. They described a proposal under which each counterparty was asked to accept a haircut from par. Seven of the eight counterparties told FRBNY officials that they would not voluntarily agree to a haircut. The eighth counterparty, UBS, said that it would accept a haircut of 2 percent as long as the other counterparties also granted a similar concession to FRBNY. FRBNY officials told SIGTARP that their concerns about credit rating downgrades limited the time available for negotiation about reductions in payments.

    3. The NY Fed tried to get the French bank regulators to help them negotiate haircuts with SocGen and Calyon—two of AIG’s biggest counterparties—but not only did the French regulators refuse to help, they specifically instructed SocGen and Calyon not to agree to any haircuts (rendering UBS’s conditional acceptance of a 2% haircut moot). From the report:

    During these negotiations, an FRBNY executive vice president and senior vice president contacted the Commission Bancaire to inform them that the FRBNY was conducting negotiations with Société Générale and Calyon, two of the counterparties with the largest credit default swap contracts with AIG, and was requesting their support. The Commission Bancaire then contacted the firms. The Commission Bancaire spoke again with FRBNY and forcefully asserted that, under French law, absent an AIG bankruptcy, the banks could not voluntarily agree to less than par value for the underlying securities in exchange for terminating the swap contracts. Thus, the French banks claimed they were precluded by law from making concessions and could face potential criminal liability for failing to comply with their duties to shareholders.”

    According to this analysis, the bottom line is that the Fed/Govermin painted themselves into a corner by showing the world that AIG wouldn’t be left to fail. After that, which banker in his sane mind would’ve accepted a haircut?

    As much as I dislike Timmy Boy, one is left wondering what could the Fed really have done here.

    1. Yves Smith Post author

      I did see point 2. and 3. and neglected to address it, I will amend the post.

      Having anything less than very top Fed officials someone contact counterparties individually by phone assured nothing would happen. In fact, I question whether this was even seen as serious, or simply an exercise in CYA.

      The way to do this was to haul DECISION MAKERS (CEOs, not minions who can say they are not authorized to commit, and for foreign firms, the most senior guy in the US) to the Fed in person (probably as a group)and tell what the deal is, and tell them the consequences if they mess with the Fed and try forcing their hand. This was NOT handled as a negotiation, it was a lame-low level plea.

      The point here is “voluntarily agree” per the French. The Fed could simply have said, “this is the deal, take it or leave it.” Trust me, the French regulators would have figured out a way to make this work. Their banks needed the dough. They could take the position that this was a cramdown.

      In the bigger picture, the Fed could have simply pretended it was willing to retrade the deal, or do preferential payouts. Remember, it famously DID with Bear, first saying it was lending Bear money for 28 days, which Bear thought was enough of a lifeline to rescue itself. The Fed could have said, “We are paying only X%, the rest is equity. You can take it or leave it.” The onus would have been on the banks to reject this and put AIG into BK. No one would have done that.

      1. Francois T

        Yves,
        Thank you for your reply. Point taken about Bear Stern.
        THe more I read about this story, the more I think Timmy didn’t have the inclination, nor the toughness necessary to reach a fair deal.

        But Timmy was working for an independent and semi-private entity that caters to the banksters while using the money of the people.

        Nice position to be in, isn’t it?

  13. Blurtman

    Tim Geithner was head of the NY Fed and is the man responsible for the giveaway. Recall that even though Bloomberg had reported in September 2008 on the AIG bonuses, Geithner denied any knowledge of the “crime.” Only several months later, did he perjure himself in front of Congress by claiming that staff members showed him the AIG bailout stories that appeared on the internet, and that was the first time he learned about it. Why is he not in jail?

    Obama is a fraud. So is the US financial system. Just a collection of “if this, then that” agreements that can be abrogated if it suits the PTB.

  14. Gus

    I think the understated tone was appropriate. If Barofsky used harsher language, it would be easier for him to be dismissed as a partisan or someone with an ax to grind (e.g., Elizabeth Warren has been completely marginalized as a debt-hating radical). Barofsky will get marginalized in the end, but being softer will allow him a longer go at it (during which I hope he uncovers more).

    1. Yves Smith Post author

      This is NOT a matter of tone, it is a matter of framing of information and proportion. You can take a neutral tone and still reach very devastating conclusions.

      Let me give you a very simple example of how easily perceptions are influenced. A poll that asks, “What do you think of the job Obama is doing” will receive markedly lower ratings than “What do you think of the job Obama is doing as President?” The “as President” confers greater dignity on him and reminds listeners of the difficulty of his job.

      First, Barkofsky had to issue a critical report. The GAO had set the stage; there was no defending the outcome. So we are merely talking degrees within a pre-set parameter.

      Second, as I point out in comments above, the report ENDORSES the Fed retrading the original financing of AIG at 11%! The Fed stepped in and provided money on the same terms AIG had sought from private parties, and then REGURGITATES WITHOUT ANY CRITICAL EXAMINATION the Fed’s logic for its conduct. And this is framed in a faux-critical wrapper, “oh, see, another example of the Fed moving too fast, acting before it thought.” Huh? The 11.5% rate WAS an appropriate risk (in fact, too low given the failure of any private sector buyer to step forward). The report is not written clearly enough to be certain, but it looks as if the professed concern was that the interest payouts would lead to further downgrades. If the issue was the cash drain, you could simply have modified the terms so interest was payable from the proceeds of asset sales rather than on a current basis. There was no justification for lowering the rate. Or if that might not suffice, in an extreme version why didn’t the Fed intervene with the rating agencies (you do this counsel to counsel first to make this privileged communication)? AIG is backstopped by the bloody central bank with unlimited check writing authoirty; why are they subject to downgrades?

  15. Independent Accountant

    Timmy Boy had no leverage once it was clear the Fed would not let AIG go bankrupt. As for Vampire Squid (VS) not having any exposure, who is Viniar kidding? Absent VS’s exposure, the AIG bailout would have not occured.

  16. Hugh

    The IG report is disappointing. IG reports notoriously are soft. The few that aren’t are the exception. I am surprised that some feel bondholders are sacrosanct. They aren’t. Their money is at risk just like everyone else’s. I think it needs to be emphasized again that the aid to AIG and the subsequent settlements at par had a lot to do, even mostly to do, with keeping Goldman, not AIG afloat.

    1. Skippy

      I have a problem with these bond holders or as I call them legacy holders. They remind me of permanent parkers in the parking lot of finance, the base of the hole financialy geared *before all others* enchilada. The gearing is to base every thing off them, to fiddle with temps aka share holders et al for maximum profit, at everyone else’s expense. Lot of old money in bonds, the lords will not suffer at any cost.

      Skippy…To bait fish withal: if it will feed nothing else, it will feed my revenge. He hath disgraced me, and
      hindered me half a million; laughed at my losses, mocked
      at my gains, scorned my nation, thwarted my bargains,
      cooled my friends, heated mine enemies; and what’s his reason? I am a Jew: hath not a Jew eyes? hath not a Jew
      hands, organs, dimensions, senses, affections, passions?
      fed with the same food, hurt with the same weapons,
      subject to the same diseases, healed by the same means,
      warmed and cooled by the same winter and summer, as a Christian is? If you prick us, do we not bleed? if you
      tickle us, do we not laugh? if you poison us, do we not
      die? and if you wrong us, shall we not revenge? If we are
      like you in the rest, we will resemble you in that. If a Jew
      wrong a Christian, what is his humility? revenge. If a Christian wrong a Jew, what should his sufferance be by
      Christian example? why, revenge. The villany you teach
      me I will execute; and it shall go hard but I will better
      the instruction.

  17. lalaland

    Dudes: the

    US GOVERNMENT PISSES AWAY BILLIONS OF DOLLARS ON A REGULAR BASIS. Get that through your heads – this is upsetting, and certainly bad decisions were made, but

    OUR GOVERNMENT PISSES AWAY BILLIONS OF DOLLARS ON A REGULAR BASIS. And has for a very long time. We have a thoroughly, legally (for the most part) corrupt system. It has been corrupted over years by special interests who have shaped the very ethical shape of the beast; it is a system unto itself, beyond our control.

    Until we get serious about campaign financing we will continue to have a GOVERNMENT THAT PISSES AWAY BILLIONS OF DOLLARS ON A REGULAR BASIS. Even now, in the midst of the worst recession in 70 years our representatives, who we HAVE ELECTED, are voting against OUR INTERESTS for their CAMPAIGNS.

    It’s not really surprising, or new. Spend your energy curing the root of the problem and the rest will take care of itself (or at least alter the way we get screwed).

  18. Economics of Contempt

    I’m sorry Yves, I think you know I respect you, but your argument simply doesn’t hold water.

    “The Fed could simply have said, “this is the deal that the others are being made to accept, take it or leave it.” Trust me, the French regulators would have figured out a way to make this work. Their banks needed the dough.”

    Yes, SocGen and Calyon needed the dough — that’s exactly the point! If they needed the dough, why on earth would they agree to accept less money than they were entitled to (i.e., haircuts)?

    If the Fed took your advice and said “this is the deal, take it or leave it,” SocGen and Calyon would’ve said: “Are you kidding me? Leave it! We’ll take the 100% we’re entitled to under the CDS contract, thank you very much.” And the Fed would’ve had no way to force them to accept less than par. The end.

    You can’t pretend that this was like any other pre-BK negotiation, because the Fed took BK off the table when it bailed AIG out. It’s not a “pre-BK negotiation” if BK has been taken off the table. The Fed simply could not credibly commit to putting AIG in BK. If they had tried to make that threat (and FWIW, they didn’t), they would’ve been laughed out of the room. Everyone knew they weren’t willing to do that. You knew it; I knew it; the entire market knew it. This is fact.

    Now, I agree with you that they should’ve hauled the CEOs to the NY Fed for these negotiations, if only because CEOs terrible negotiators. (Your post about Dick Fuld inserting himself into Fed/KDB negotiations took the words right out of my mouth.) But this would’ve only marginally improved the negotiations’ chances of success. And once the SocGen and Calyon CEOs informed everyone that the French regulators weren’t permitting them to accept any deal, the rest of the CEOs would’ve quickly balked too. (Nothing drives CEOs’ decision-making more than jealousy; not even you can deny that!)

    Finally, it’s wholly unconvincing to say, “Trust me, the French regulators would have figured out a way to make this work.” Umm, all evidence to the contrary. The undeniable fact is that the French regulators didn’t figure out a way to make it work. Simply asserting that the French regulators would’ve made a 180-degree reversal doesn’t make it true.

    Like I said, all the criticisms of the NY Fed’s decision are premised on the Immaculate Negotiation fallacy.

    1. Yves Smith Post author

      Since you have clearly read Too Big to Fail, I call your attention to the Freddie/Fannie conservatorships. Based on reports at the time (WSJ, I believe) Freddie was clearly a goner, Fannie not, but Paulson was of the view that the market would not accept him taking Freddie out, it would react as if Fannie was toast too regardless of whether the business was viable. This element is not recounted in TBTF (and that omission is quite bizarre), but Rodgin Cohen and the board capitulated under duress. This is a FAR greater demonstration of a regulator exercising authority and forcing his will upon one of his charges that a penny-ante negotiation about money. It not only can be done, it WAS done, and the niceties of normal protocol be damned.

      You are acting is that the only “leverage” the Fed had was in the context of the narrow matters on the table. At a minimum, the Fed regulates SocGen as a primary dealer. Caylon is not systemically important, the Fed could tell Caylon to take a hike. I am not an bankruptcy expert, but I cannot think of a case where a single small party who refused a settlement or offer was able to initiate an involuntary BK. And I don’t know what other licenses the entities have in the US, but access to Fedwire is linked to having certain licenses (I’ll admit my knowledge is thin).

      The idea that the BK was off the table eliminated the Fed’s leverage is spurious. The Fed could easily say, “Don’t even think of taking that legalistic line with us. We are paying you what we are paying you. If you want to try this one in court, be our guest. We will bury you, and watch what happens when we send an audit team in.” I’m sure that crude line could be improved considerably.

      If you had bothered reading the Epicurean, he believes it would be possible to bully the banks to returning a portion of their bonus payment even now. I’m not sure I’d wager on that, but the flip side is the PR blowback would be absolutely devastating, independent of the other considerations he raises.

      The Fed could easily have bullied these companies into compliance had it chosen to. It had leverage on OTHER fronts, which it has gotten badly out of practice in using. We have had a generation of Greenspan inculcating regulators to act as lapdogs, but in other countries I’ve worked in (advanced economies with very large banks) and in the US pre-Volcker, this notion that the banks would have the temerity to negotiate with the Fed as an equal would simply not have been tolerated. They would have been cut off and told this was a one-way communication.

    2. Yves Smith Post author

      Oh, yes, the Fed could have let SocGen and Calyon take the losses. Then the French government would have to bail them out. Why is the US responsible for bailout out foreign companies that refuse to play ball? Did we run in and rescue UBS? It was stuffed to the gills with toxic US product, that was the proximate cause of its rescue by SNB. We didn’t deem ourselves to be responsible for that.

      This idea that they were “entitled” is completely spurious. This “sanctity of contracts” notion is also spurious. Contracts are renegotiated all the time when circumstances change, often without a threat of BK, and with other “threats” applied when parties do not act in good faith. The banks here were not operating in good faith and more aggressive measures would have been completely in order. They had been conditioned by a generation of non-regulators to act like they held the cards when they did not. The idea that any party has an inviolate right is simply not supported in fact. Start with the pensions and health care rights of auto workers. Most people had not problem with that little cramdown. The Fed had tons of leverage.

      AIG was a global player, with AIG FP regulated by the OTS and most of its activity taking place out of London.

  19. marc fleury

    Yves, good coverage. I like the passion :)
    One important fact that I think is not mentioned is that in the CDS bucket AIG was holding there was a 4:1 naked to covered ratio.

    Why is this important? SocGen and reportedly Calyon and DB all held the CDOs. So these guys were taking serious REAL losses on subprime. But for each one taking a loss, there were 4 just SPECULATING, mostly worldwide Hedge Funds through primary dealers IB.

    A first real shame, imho, is that these speculating HF clients would have taken NO LOSS on a default of the payments but the premium they paid, the notional was never put in play by these guys. NAKED CDS IS THE FIRST SPECULATING ABSURDITY.

    To put it in perspective, guys like Paulson (not Hank, the hedge fund guy) were deified as the “geniuses that saw it coming and pocketed $2B out of it”. Top dogs indeed! I squarely put the blame at the feet of the instruments of mass destruction they used, NAKED CDS on synthetic and straight subprime CDOs to speculate. Run some numbers: if Paulson personally made $2B and assuming he gets 50% of a 20% performance fee that means the fund brought in $20B (at least, if he gets 10% it was 100B the fund brought in), well RIGHT THERE is your CDS mess money. And how do we pay for it? with hunger in the US! http://bit.ly/3szpYf

    Second, I am trying to replay the picture in my head, and as the blogger above, I am not sure G-boy had much room to maneuver. It is the “fait accompli” theory. He had his back against the wall. Let me try and explain how I see it.

    GS and most IB were just holding back-to-back agreements.

    Case A: One hedge fund was long, the other short. IB has no beef holding 2 canceling swaps, one short one long with 2 HF. I will call this HF-HF

    Case B: One hedge fund was short, bought from IB, IB re-insures with AIG, the final trade has a structure that looks like AIG-HF, as opposed to HF-HF.

    It is speculated that panic of AUG 07 was triggered by the unwind of a large portfolio of HF-HF. Remember that naked CDS just created 4 times the volume of liquidity that was put in the first place through CDOs on subprime. This to me is a mind-boggling mistake since it created a LIQUIDITY IMPLOSION. Quants started barfing. If the subprime debacle was $250B of real losses, a 4x multiplier meant: on top of $250 of vanishing assets, the HF+IB system had to come up with $1000 (yep, 1 TRILLION) in ACTUAL liquidity over a relatively short period of time. This is assuming 100% of CDOs were covered. Adjust the numbers for the proportion of CDO that were covered (?10%, i am making up) and you still arrive at the pretty scary numbers of $100B of liquidity. This in my mind, is the suspect #1 catalyst for the 07 quant panic. (A liquidity implosion triggered by CDO subprimes and fueled by naked and covered CDS) So a few HF went POOF! and took the market with them, in a generalized LTCM panic moment.

    But more importantly, in the second scenario AIG-HF, you see where the system fell down. Here is how the run plays out imho (pure speculation :). The CDS goes nuclear as the subprime virus spreads, it triggers liquidity needs at the HF level then the IB level. This is where things get complicated. At this point, the liquidity is GONE from the IB and the velocity of the money is nil as the recipients are not putting it back in game. We got a liquidity drain followed by a liquidity desert. So the liquidity stops at the recipients who go cash amid imploding Bear and markets. So first of all any haircut on naked OR on covered would have resulted in a real liquidity loss at the IB level as the CDS horse had left the barn. Anything less than par would have in fact left holes in place AT THE IB level. Of course the real shame to me is that the HF level (or proprietary IB desk) that was speculating all along (naked) got paid in the first place AND triggered the liquidity crunch. The crisis of insolvency was driven and realized by a crisis of liquidity. In retrospect the authorities were right to first treat liquidity problems even in the face of insolvency.

    Then the dynamics laid out in the referenced blog take over, namely, AIG is nationalized anyway, so there is no threat of a legal bankruptcy possible anyway, the french and the german, not only are facing real losses but also understand that the FED will NOT hamper the US IBs and just hide behind their counterparts.

    A tell tale sign is that 2% cut UBS offers. Think about it, the underlying CDOs where 70-90 down? That tells you UBS was acting as a IB broker and had ALREADY paid par on their contracts.

    And why did they pay par in the first place? because unlike their US govt counterparty which you argue, Yves, should have bullied everyone, they had 1/ contractual obligations (IB-HF) that would have resulted in lawsuits bar bankruptcy negociations 2/ They KNEW uncle sam would ultimately FOLD when confronted with the FAIT ACCOMPLI described above.

    G-boy was a tool, a pawn, there was NOTHING he could do. The FED has been put in place to prevent runs on the IB system in 1907, that is its charter, what it does. That is what it did. A/ Audit the FED B/ Ban naked CDS.

  20. Siggy

    This is a very interesting thread. I’ve just begun to read Sorkin’s book and I’m interested in knowing what was not done in regards to considering the possibility that AIG-etal should have been sized, AIGFP put into bankruptcy liquidation and the entire book of AIG CDS contracts rejected. The balance of AIG could then be held in conservatorship and the viable components sold to NEW owners.

    Now what I’m suggesting would have put a major hurt on the orginial recipients of Taxpayer monies. These recipients were, and mostly remain as, ‘primary dealer’ banks. From the viewpoint of the Treasury/Paulson, the issue appears to have been to hold safe the ‘primary dealer’ banks. I do believe that it helped Paulson to chart his course in that he was well aware of GS’s position and nearly so as regards Deutche Bank and SocGen.

    You quite correct to point out the damming fact that the Fed and the Treasury have been dissembling as to the need and reasons for the bailouts. If those reasons are fairly presented there is a secondary fallout that would indeed upset the world’s financial apple-cart. That would be with respect to the massive fraud that existed in the OTC trade for deravitives, especially CDS. If what AIGFP did is not fraud it was a massive tort.

    I see Barkofsky as a messenger who doesn’t want to be killed. SIGTARP is very bad wallpaper and I wonder, when will the public and the regulators address the very eggregious preferential actions that have been taken in the name of preserving the ‘integrity and liquidity’ of the financial markets. The public trust has not been served!

  21. Ginger Yellow

    “AIG is backstopped by the bloody central bank with unlimited check writing authority; why are they subject to downgrades? ”

    Um, because the bloody central bank is trying to get creditors to take haircuts?

  22. Skippy

    Just had a look and yes no vitriol to be found, just hanging Timmy out to dry.

    I still think body’s rotting on the conference table is a good thing, its all about perspective. With out it people make soft palatable decisions that aways come back and bite you in the ass later.

    The only folks I see being saved is at arm length to the throne.

    Skippy…These folks have no need to ascend in death, they have achieved this minor goal already. Why they even bother with us at all is a mystery to me.

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