More and more revealing pieces of the AIG bailout puzzle keep emerging as various subpoenas and FOIA requests extract more and more details.
One odd bit is why the Fed decided to take out the AIG credit default swap counterparties at par, rather than simply guarantee the contracts?
The Fed keeps protesting that the rescue was about saving AIG, how important it was to the economy (the FCIC testimony from Thomas Baxter, the NY Fed’s general counsel, goes on at some length to defend that idea), but the most logical explanation for this choice is the obvious one: the rescue was primarily a back-door bailout of big financial firms.
The New York Times has a story up tonight on this aspect of l’affaire AIG:
Although that rescue provided $85 billion, the company’s problems continued to grow, requiring it to deliver additional collateral to its counterparties. By late October 2008, A.I.G. had put up nearly $30 billion to satisfy the banks, about half the value of the mortgage bonds they held.
Amid this increasingly perilous situation, Fed officials discussed how to eliminate the risk of even more collateral calls, the internal documents show. One proposal involved the government guaranteeing the contracts; this meant the banks would no longer be able to demand collateral because the government would cover any losses on the mortgage bonds
Yves here. So why did this idea go nowhere?
Under this proposal, the $30 billion in collateral would have been returned to the insurer to help pay off some of its loan from the Fed….According to an Oct. 26, 2008, presentation by Morgan Stanley, an adviser to the Fed, Goldman would have had to return $7.1 billion to A.I.G. and Merrill, $3.1 billion.
Yves here. We are given other proximate reasons, which don’t add up:
The debate within the Fed centered on which part of the government could provide the guarantee, according to the documents. Staff at the Board of Governors told Fed officials in New York that a Fed guarantee “was off the table,” according to an e-mail message to Mr. Geithner and others on Oct. 15 from Sarah Dahlgren, the New York Fed official overseeing the A.I.G. rescue.
“We countered with questions about why it was so clearly off the table and suggested, as well, that perhaps this was something that Treasury could do,” Ms. Dahlgren continued.
Yves here. Why the knee jerk reaction? The NY Fed clearly didn’t buy the logic, and the ultimate solution, of the 100% payout, put more Fed monies at risk (any other course of action that kept the Fed from funding the purchase of CDOs, which is what happened, would have had a lower price tag). Or was it that the Board of Governors saw getting cash to the banksters as a principal aim of the AIG rescue, which would make anything that would make the counterparties return collateral unacceptable (note sports fans, here the NY Fed is doing a better job of trying to limit Fed exposure than the Board of Governors. This also supports the view that seeing the AIG rescue just as a Geithner/NY Fed issue misses the fact that for something this big and visible, the Board of Governors must have been involved in major decisions). So what did Bernanke know, and when?
vlade 
fresno dan 
Carter 
MichaelC 
RC 
Siggy 
deepsouthdoug 
psychohistorian 
Dave 
Yves Smith 
Posts
Yves,
did you have a look at the “Payback time?” FT article?
The reference to SCA is great (I missed that bit for a long time. DOH!). If ML/SocGen could accept VERY significant haircuts from them (ML got something like 14c in a dollar), then any arguments on “sancity of contract” is clear nonsense.
The “if you don’t pay par you’re toast with rating agencies” is a clear miunderstanding (at best) as well. The contract (CDS)’s par was not the face value – unless the underlying CDOs were 0. The par was the MTM, which was not something anyone could easily calculate (all parties agree at least on that). Anyone can cancel the derivative contract at MTM (subject to the cpty agreement) without any rating agencies batting an eyelid, and anyone who says differently either doesn’t understand how things work or is deliberately misleading.
Fed should have been able to force the buyout of the contract at the current MTM, which was +/- collateral already posted. CDS buyouts happen all the time, it’s how most of the prop traders realise PnL.