AIG Bailout Trial and Whoppers, Um, Crisis Revisionist History

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If nothing else, the legal slugfest over whether the US government did former AIG CEO Hank Greenberg a dirty by imposing tough terms on the failed insurer and giving the kid gloves treatment to the teetering-on-the-brink banks who were certain to be engulfed by an AIG collapse will be highly entertaining. Ben Bernanke, Hank Greenberg, and Timothy Geithner are all scheduled to go on the stand next week, to be grilled by America’s top trial lawyer, David Boies.

Those of you who remember the Microsoft anti-trust trial will recall the high point when Boies made short work of Bill Gates. Even though Boies, representing the US in the trial, won a decisive courtroom victory, the government perversely lost in the sentencing phase. Judge Thomas Penfield Jackson, who was clearly going to impose tough remedies on the Seattle giant, got himself removed from the case by speaking about it to a reporter, a clear violation of judicial ethics. His replacement, Colleen Kollar-Kotelly, was clearly over her head and not inclined to intervene.

In the AIG bailout case, Greenberg is forcing a reexamination of a critical piece of the bailout, the manner in which AIG’s credit default swaps contracts on toxic CODs were paid out in full. Neil Barofsky, as the Special Inspector General for the TARP questioned this action. The lame defense by Geithner, who was head of the New York Fed, was that the Fed lacked the authority to break the CDS contracts. Um, when counterparties need the dough you are about to hand to them to survive, matters like that are negotiable. The continued pretense otherwise is an insult to the public’s intelligence.

It’s not hard to discern the logic that was probably at work. From the Fed/Treasury perspective, the banking system had to be saved. But their idea of “saved” was preserving the incumbents. Even thought Fannie and Freddie had been put into receivership earlier in the month, the idea of putting any of the major banks into resolution, or allowing Morgan Stanley follow Lehman into an unplanned bankruptcy (with Goldman sure to follow) was not something they were prepared to entertain. But the argument made by Greenberg’s camp is that they went further than necessary to salvage the system, by not imposing punitive terms on the banks as well.

Note that contra Greenberg, who is arguing that the AIG bailout was unreasonably harsh (which is actually bizarre given that it was retraded four times, with each redo being more favorable to the global insurer), we argued at the time that the original AIG rescue was the only one that fit the Bagehot rule for dealing with floundering institutions: lend freely, but at a penalty rate, against good collateral.* The point of a rescue is to save institutions facing a liquidity crisis, not to prop up fundamentally insolvent firms. Otherwise you incentivize failure and undue risk-taking (and we’ve seen so much of that post-crisis that it is starting to look like a feature, not a bug). So Greenberg has a basis for questioning how the rescue was conducted.

Various writers that one would not normally expect to be sympathetic to a grasping plutocrat like Greenberg, such as Gretchen Morgenson, Noam Schreiber, and DSWright at Firedoglake, nevertheless relishing the prospect of a Godzilla versus Mothra battle that will expose what happened in the heat of the crisis and why.

But be warned that getting more information does not necessarily mean getting anything approaching transparency. For instance, the depositions of Bernanke, Paulson, and Geithner are all under seal, so details that are potentially important are being kept from public view. The odds are high that the officialdom, both in court and in the media, will try offering more layers of spin. Remember all of the shifting justifications for the Iraq War? And the Fed and Treasury always have the fallback of blaming on their actions on the fog of war, while omitting the fact that the fact that they were in a fog was largely due to decades of weakening oversight and a failure to take the earlier acute phases of the crisis seriously enough (we argued at the time, after the Bear rescue, that regulators’ top priority should be to understand credit default swap exposures, since that bailout was clearly motivated by that concern. Nothing of the kind was done).

The media war over the trial is already underway. An odd and obvious plant ran in the New York Times at its very start:

Ultimately, the appraisals of the New York Fed teams did not matter. Their preliminary finding was that Lehman was solvent and that what it faced was essentially a bank run, according to members of the group. Researchers working on the value of Lehman’s collateral said they thought they would be delivering those findings to Mr. Geithner that September weekend.

But Mr. Geithner had already been diverted to A.I.G., which was facing its own crisis. In the end, the team members said, they delivered their findings orally to other New York Fed officials, including Michael F. Silva, Mr. Geithner’s chief of staff.

On Sunday, Mr. Bernanke was in Washington awaiting the New York Fed’s verdict. In a phone call, Mr. Geithner said Lehman could not be saved.

It’s hard to take this and other claims made in the story seriously, that the Lehman losses were due to the disorderly bankruptcy and its real estate valuations were reasonable. Those points have the hallmarks of unexamined dictation. Mind you, there is no doubt that the narrow point made by the article, that there was a study by Fed officials that found that Lehman was solvent, was done but never presented. But six years after the crisis, with even personnel documents about the New York Fed culture making it into the FCIC archives, this study is suddenly sprung upon the public like Athena emerging full-grown from Zeus’ forehead?

Let us recall what happened: Lehman talked to every conceivable suitor in the months before its collapse. No US firm was interested because they had similarly exposures to US subprime and had an informed view of how weak Lehman was. It came closest to getting a deal done with a long-standing partner desperate to enter the US, the Korean Development Bank, but they were prepared only to do a good bank/bad bank deal, excluding the real estate assets, which would be presumably put through a pre-packaged bankruptcy. That deal foundered because Lehman CEO Dick Fuld insisted KDB take all of Lehman or none.

This account also tidily omits other strong proofs of Lehman’s desperate state. Just a few: its Inland Empire commercial real estate exposures, SunCal and Archstone, were wildly and visibly overstated. Investment banks have plenty of less obvious ways to cook their books. When the do so in such a public manner, it’s a sign that every other less visible asset is also seriously overvalued. Consistent with that, the Lehman black hole, the unexplained losses, were vastly higher than those attributed to the disorderly collapse by Lehman’s own bankruptcy overseer, Alvarez & Marsal. Similarly, Lehman was revealed to be fobbing off collateral to JP Morgan that the bank understood it to be (the term of art at Lehman was “goat poo”). Oh, and remember Repo 105, the end of quarter gimmick that allowed Lehman to temporarily disappear $50 billion of assets, making it capital ratios look less bad? And how about the fact that a last minute private sector effort to cobble together a loan package also failed?

So how does the Lehman story fit into the Fed/Treasury PR campaign? Rest assured here that the real priority of the powers that be is preserving the reputation of the central bank, which took a well-deserved hit as a result of the crisis. Audit the Fed forced more transparency on the Fed, and Obama had to whip personally to get Bernanke’s reappointment through.

The placement of this story may simply be to deflect a Greenberg argument, that the insurer was sound and the harsh terms of the AIG bailout were unjustified. If this somehow ignored study (because it was not credible on its face? Because someone was forward-thinking enough to think a study like this would be useful to have around in case at the last minute the political winds changed and a bailout of Lehman was on?) showed Lehman was merely suffering from a liquidity crisis, that partly undercuts the Greenberg position that AIG was treated unfairly. Remember, the Greenberg claim is that AIG was solvent. If Lehman was solvent too but allowed to go bust, AIG was given better treatment. It’s a reminder that AIG and therefore Greenberg would have gotten nothing, as opposed to very little, had AIG been given the Lehman treatment.

It’s important to note that the trial is already exposing important rewrites of history that are going unnoticed by the press. Consider this innocuous-looking extract picked up by Bloomberg:

A central element of Starr’s complaint is that the Fed’s bailout authority at the time was limited to setting interest rates and that it could not demand a surrender of stock as a condition for lending….

In one document introduced by Boies, a summary of an interview of Baxter by staff of the Financial Crisis Inquiry Commission, the lawyer is quoted saying, “We learned many things in September, and one was that we didn’t have the ability to own shares.”

Baxter told Boies he didn’t remember making the statement and “this is not consistent with my views.”

Note that the exchange is already peculiar; lending against shares is not the same as owning them. But the story has changed an uncomfortable amount of times already as to exactly what the Fed was using as collateral for its emergency loan to AIG.

Consider this extract from a 2010 post, The Most Stunning (and Uncommented on) Revelation in Too Big Too Fail, from Andrew Ross Sorkin’s supposedly-definitive history of what the big boys did during the crisis:

So the story thus far is that AIG is a great big mess that will bring everyone down if it goes. Got that. Geithner accepts that picture, persuades Bernanke. AIG is on the verge of bankruptcy, according to Sorkin, mere “minutes away” (p. 399). The Fed agrees to extend a $14 billion loan to get it through the trading day but it wants collateral. Collateral? From a broke company? How is that going to happen?

Then we get this bit:

Wilmustad understandably wondered how they were supposed to come up with $14 billion in the next several minutes. Then it dawned on them: the unofficial vaults. The bankers ran downstairs and found a room with a lock and a cluster of cabinets containing bonds – tens of billions of dollars’ worth, dating mostly from the Greenberg era. They began rifling through the cabinets, picking through fistfuls of securities that they guessed had gone untouched for years. In an electronic age, the idea of keeping bonds on hand was a disconcerting but welcome throwback. (p. 400)

WTF? This is a company about to go out of business, then it suddenly remembers it has a secret stash….worth at least 1/6 of the initial government rescue commitment? $14 billion was only what they coughed up to satisfy the Fed. How much more was left in those cabinets?

And more important, WHO SUPPOSEDLY OWNED THIS PAPER? This wasn’t held by the subsidiaries; otherwise, AIG would not have been able to pledge it to the Fed. And if it was a parent company holding, why wasn’t it repoed or sold earlier? What entity took the semi-annual interest payments? Take the $14 billion we know about, and assume a 5% interest rate. That’s $700 million. Where did it go? Was it reinvested? Disbursed?

The language further suggests that bonds in this secret trove, while mainly accumulated under Greenberg, had more recent additions, presumably under Martin Sullivan, perhaps Wilmustad. This “unofficial vaults” designation strongly implies this was a secret, off balance sheet cache that threw off a hefty amount of annual income by virtue of its staggering size. That would mean it could be used by the CEO at his sole discretion, for anything from bribes to unreported executive payments that might then be used to open foreign bank accounts or pay for personal or business expenses.

Our post forced Andrew Ross Sorkin to rewrite that section of the book for future editions. From a 2011 post:

Sorkin contends (based on phone calls prompted by the focus on this paragraph) that the securities pledged to the Fed were the share certificates in the subsidiaries and changed his account to reflect that in later editions of his book. Maybe. But even so, that’s a hugely irregular practice at a company as big as AIG, and also flies in the face of the idea of an “unofficial vault”.

So the story is changing yet again? What exactly did the Fed lend against? As Boies flagged with the inconsistency with the FCIC testimony, the story on this key point has already changed an uncomfortable amount of times. So you’ll need to watch carefully to see how much more weaving and bobbing we get from government officials. And while I hope we’ll get to the bottom of what happened, there is an awfully powerful constellation of actors working hard to make sure that does not take place.

* Note that we’ve elsewhere questioned AIG’s underlying solvency. Insurance is the ideal business for running a financial fraud: you take money up front, promising to deliver services later if certain Bad Things come to pass. Whether you actually do pay out is to be determined. While David Merkel looked at AIG’s life insurance subs and thought they were sound, we spent over five weeks with a former state insurance examiner, two other insurance experts, and two heavyweight mathematicians examining the statutory filings for AIG’s US P&C subsidiaries. Even though each sub is supposed to be a stand-alone entity, they were all lashed together with cross guarantees and cross shareholdings. Moreover, the biggest subs, which were in different states, had different fiscal year end dates, making it impossible to net things out. And on top of that, the statutory filings were chock full of accounting red flags and efforts to hide them, like redefining “danger” terms so as to make it hard for anyone other than an astute reader to see how bad they were. However, it must be stressed at the time of the rescue that the general view of AIG was that the holding company was bust but the the underlying businesses all were sound.

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  1. Michael Hudson

    Boies must have some technical legal reason for not arguing what AiG argued at the time: Goldman’s valuation of junk mortgages was way too low, and also AIG was defrauded by Wall Street banks claiming that junk mortgages were sound, not fictitious. Why aren’t these arguments being made: that AIG could have said, “We don’t owe Goldman as much as it says, and perhaps not anything at all. Let’s go to court over it and see.”
    By that time, the junk mortgages would have “revived,” especially if it would have gotten the ability to borrow from the Fed by calling itself a bank.
    Why the special attack on AIG, if not to bail out other Wall Street institutions without another TARP?

    1. Doug Terpstra

      Bingo! It was a Goldman bailout among others, and also, let’s not forget, essential to preserving the divine sanctity of bonus contracts — ultimately crucial to maintaining the new world odor.

    2. trinity river

      Correct me if I am wrong. I have always thought that the only reason AIG was bailed out was to bail out Goldman, et al.

    3. JohnnyGL

      Also, if memory serves, Ambac and MBIA were able to drag things out over years before finally paying up. Didn’t they require actual defaults to occur in the underlying securities, rather than going based on market values?

      Why was AIG unable to take that approach? Was it the terms of the swap contracts?

      1. Yves Smith Post author

        The monolines had different contracts. Theirs actually were modeled on insurance contracts.

        AIG Financial Products had been started by traders. The credit default swaps contracts they used were modeled on ISDA agreements. That meant they included the feature that the protection-writer had to post more collateral based on change in the value in the exposure that was being guaranteed as well as on ratings downgrades.

        It was the ratings downgrades that led to large increases in the amount of collateral that AIG had to post. Goldman was also more realistic about the marks of the CDOs insured than the other counterparties and was pushing AIG hard for more collateral (Goldman could afford to do that because many of the CDOs it had bought insurance for were not ones on its balance but ones it had sold to investors. It had stood as a middleman in those CDS trades, presumably to get additional margin, rather than simply arranging the swap on behalf of its customers).

        1. Sluggeaux

          Of course, having a CDS on the toxic RMBS being turned into a CDO was what made it AAAA. It was only AAAA because it was “guaranteed” by the CDS sold by AIG. Part of the design of this toxic waste was that it got sold as a CDO without the CDS that made it “golden.” Then immediately the seller could turn around and reveal that it was garbage to the CDS guarantor and demand more collateral. Not just additional margin but designed to fail by plan — The Big Short. Nothing but a scam from the get-go, designed by the very people who changed hats and bailed themselves out. The New Ethics: “Heads I win, Tails you lose!”

          1. alex morfesis

            faulty basel 2
            this merry go round was started by the needs of european institutions to come up with capital that was AAA rated to allow expansion of lending in the former soviet satellites. Clintons budget balancing took US Treasuries off the table, and chaneys little party of 9-11 and afteristan did not grow the available treasuries fast enough. There had to be a solution. We forget the Landesbanks having been counterparty guarantors and REmic guarantors, which fed the need for funding of sales of gurrman industrial and consumable products in the former CCCP-1istans and svimvarelands. It was the desperation of these institutions in their search for AAA rated paper which created the pre-funded loan pools which led to the ninja loans…so technically we can blame clinton for having reduced the available treasuries(ok maybe not…but…)…this led to the reduction of interest rates. The japanese survived the 2002 basel 1 rollovers and the carry trade compromise that came from it led to lowered costs for institutional investors. As to lehman, are we not ignoring and discounting the june 2008 internal strife that led to fuld being made to “accept” a certain resignation…lehman died from more than just bad thinking…they were tearing at each other and did not notice the solar eclipse that was about to hit them…fannie freddie and AIG were killed off by questionable downgrades by S&P and Moodys, leading to collateral calls and questionable ISDA rulings…the ratings agencies knew or should have known their actions would have led to an avalanche and it was irresponsible of them to have made the downgrades without communicating with regulators first. I know there are those who hate to hear me harp about this, but Germany has this insane AAA rating when they have NEVER repaid a dime of money anyone has given them in 100 years…they only take the new money and hand it back as payments…of course we could always blame canada instead…

          2. Yves Smith Post author

            No, that is not correct.

            The top tranche of CDOs made of asset-backed securities was rated AAA. It traded as if it was AA paper, so the extra yield was attractive.

            For banks under Basel II and some other financial institutions, if you took an AAA rated instrument, and then bought a guarantee from an AAA rated counterparty, you didn’t need to hold capital. The guarantees were so cheap you could buy the CDO, pay the cost of funding and the hedge costs and show a profit. And the treatment to trading desks that allowed for that accounting treatment was to treat the position as “freeing up capital” and book all FUTURE DISCOUNTED profits in the current period. For traders, this was like handing them free money.

            More detail here:


  2. Clive

    The Fed agrees to extend a $14 billion loan to get it through the trading day but it wants collateral.

    Oh, pu-leeze. Just that statement alone (if true, and I don’t doubt for one second that it is, that the Fed was looking for collateral) shows how out of touch and clueless they (the FRBoNY, the Fed, Paulson, even AIG itself) were.

    I was at a conference at the TBTF I’m acquainted with where, on the Monday morning post- the weekend after the time of the Lehman collapse and in spite of more than a weekend’s worth of analysis the conclusion was that, at that point in time, no-one had any basis in fact for valuing anything. Post-Lehman, all bets were off. AIG might have had some Tangible Net Asset Value but it might just as likely been a hopeless basket case worth zilch. Collateral ? Collateral ??? My arse. The Fed was taking a punt with any lending to AIG and it knew it. For them to suggest it was anything else seriously was, as the piece states above, ridiculous revisionism.

  3. Tony

    I’ll admit to not following this story closely, but at a guess, I would say the valuation argument is 1) too hard to prove and 2) ultimately unnecessary to the case.

    To point 1): My expert vs. your expert and days of dense and ultimately opinion-driven testimony with no certainty in whether or not your guy/gal is more credible/likeable/persuasive.

    To point 2): Ultimately, the valuation methodology was probably the same for every counterparty Goldman dealt with (some version of “the market twitched, you owe me collateral NOW!”). The point of the suit is that depending on what name was on your company letterhead, you were treated differently when those collateral calls overwhelmed you.

    Mostly I think your final point is the real reason. AIG had willingly and stupidly made themselves a fulcrum in the crisis from 2005-2007. They got identified as a scapegoat and a firebreak to launder the systemic losses sustained by the financial industry in 2008.

  4. TedWa

    Fact is all those no-doc, stated income and NINJA loans weren’t worth the paper they were printed on. The TBTF banks controlled the mortgage broker and appraisal profession, thanks to A Cuomo, and they would only hire appraisers that inflated values to where they could write the loans – desperate appraisers and inept with no moral compunctions. It had been going on for years before the collapse and appraisers tried to warn everyone but no one listened. The banks were even giving illegal kickbacks to the brokers inciting aggressiveness.
    The 100 cents on the dollar bailout of AIG was particularly galling.

  5. Peter Pan

    It would be distressing to me if Hank Greenberg were to prevail in this case solely on the basis that the man is a total douche-bag. If only there were a way to extract funds out of the personal pocket books of Greenberg, Fuld, Bernanke, Geithner, Paulson et all, then that would be justice served for the US taxpayer.

    1. Tsigantes

      Call me a Greek naif, but if Ben Bernanke has a salary AND gets 250k per lecture AND his wife works (2nd salary) why don’t they simply buy their house outright since it “only” costs c. 900k???? Why a mortgage?

  6. Sluggeaux

    Am I the only one who thinks that Greenberg and AIG got screwed twice by Goldman? First, by being suckered into taking the glittering premiums for writing CDS on grossly (and under any rational analysis, fraudulently) over-valued RMBS, and then by having a “bail-out” crammed down their throats by Goldman’s “ex”-chairman Hank Paulson and his lackeys Turbo-Timmy and Gentle Ben, so that Goldman could get 100 cents on the dollar? The fictional James Bond had a “License to Kill.” I suppose the responses to Boies examination will be that you’re not a thieving hoodlum when you’ve been appointed by the President and confirmed by the Senate…

    1. Yves Smith Post author

      No, you need to read the story of the AIG Financial Products Group. It was started by Howard Sosin, who was a serious quant. The guy who eventually wound up running it, Joe Cassano, was the classic bullying promoted-over-his-level-of competence boss.

      The underlying Washington Post stories made clear that AIGFP had been set up as a firm within a firm, always a really bad arrangement. That was the deal MIke Milken had with Drexel.

      1. Sluggeaux

        From 1998-2005 wasn’t Cassano lining his own pockets cozily selling insurance to JP Morgan Chase and Goldman via Sosin’s sweet deal? Admittedly, Greenberg was looking the other way; when I say “Greenberg and AIG got screwed” I suppose that I should precisely be saying “AIG Shareholders got screwed,” which since my future annuity is guaranteed by CalPERS, is probably ME…

        1. Yves Smith Post author

          Yes, in fact the WaPo piece, IIRC, takes the point of view that if AIG had not written protection on JP Morgan’s initial credit default swaps, the market never would have gotten going.

  7. weinerdog43

    I think Yves has definitely deflated the magical $14B ‘found money’ theory that Sorkin and the boyz are propagating. Yet, there may be a grain of truth there.

    I’m wondering if that $14B was actually the policyholder surplus (the assets an insurer needs to pay claims) owned by the various AIG subsidiaries (National Union Fire, American Home, etc…). There is little doubt the various subsidiary insurers have to have that money. That’s their job…. to pay claims. But if Timmy & Ben thought they could use that as collateral, then what you really have is a ‘bail in’ like the bank depositors on Cyprus. Policyholders and claimants to that money get an IOU, but Timmy and Benny have saved the banks, (and the holding company). Whew! The boyz are saved. The problem of course is that this is highly illegal and violative of about 50 different state laws. Remember that insurers are state, not federally, regulated.

    I’ve come to the conclusion that keeping insurers out from under the Fed’s authority has been a huge blessing in disguise.

  8. Chauncey Gardiner

    Thank you for calling attention to this lawsuit. As you indicated, …”getting more information does not necessarily mean getting anything approaching transparency. For instance, the depositions of Bernanke, Paulson and Geithner are all under seal, so details that are potentially important are being kept from public view. The odds are high that the officialdom, both in court and in the media, will try offering more layers of spin.”

    I agree that the layers of the story that We the People are likely to be treated to stemming from this episode will merely be another specious narrative from the defenders of the status quo in their ongoing “Revisionist History” effort to hide, diminish, deflect, misdirect and bookend the causes of the Autumn 2008 financial collapse. Their underlying message is: “The system itself was and is fine. It was just the judgmental errors of a few key players, and the “Fog of War” surrounding others, that led to the BK and collapse of these systemically important financial institutions, and the necessity for the massive covert and overt bailouts and transfers of public funds to private hands.”

    Re: … “the regulators top priority should be to understand credit default swap exposures, since that bailout was clearly motivated by that concern. Nothing of the kind was done.”

    Thank you for placing this regulatory responsibility in the present tense. The regulatory understanding and control of derivatives exposures and related systemic risks should be significantly expanded beyond Credit Default Swaps.

  9. bmeisen

    Simon Johnson described Sorkin as “… the Stephen Ambrose of our financial crisis.”

    Gag me with a spoon. Thanks to Johnson’s review I wasted good money and time on “Too Big to Fail”. Can’t even use it as a door stopper – visitors might see that I have it. Then I found Yves, Econned, NA, and my education began.

    Yves deserves the highest national and international accolades for her tremendous efforts to inform us accurately. I am convinced that she has spoken and written the truth at a time when the majority of those who were and are responsible for writing and speaking the truth have been silent at best. I can’t think of anyone who better exemplifies American virtue. Thank you Yves!!!!

    1. Yves Smith Post author

      Please reread the post. The $14 billion was to get it through one trading day, basically to get it to the weekend so the bailout could be cobbled together.

      At the maximum, the Federal Reserve (Fed) and the Treasury committed approximately $182.3 billion in specific extraordinary assistance for AIG and another $15.9 billion through a more widely available
      lending facility. The amount actually disbursed to assist AIG reached a maximum of $184.6
      billion in April 2009.

  10. John

    Institutional failures is the norm. Representative democracy is a farce, except if you are a Wall Street bankster. Then it works great.

  11. Schmoe

    I still have not been able to find a definitive answer as to what the actual loss payments were on their CDO CDS – remember that the vast majority of the collateral was vintage early 2005 and earlier RMBS, although a small amount did reference later RMBS vintages. One analyst report from a boutique buy-side firm I believe stated that loss payments might be $10b – $15b, but remember that AIG completed a $25b secondary offering in May of 2008. Yes, that they did have notable losses in RMBS they purchased as part of a securities lending program, but again I do not believe that the losses were even close to the $25b secondary offering proceeds. Operationally, they were performing OK since commercial p/c rates were favorable and more than enough to offset their mortgage guaranty losses.

    The litigation over the terms of the bailout misses the question – given what I said above why were they downgraded in the first place? I assume that that is not being litigated since there is no recourse for a S&P (I believe at GS and others’ insistence) making a judgment call to issue the downgrade.
    Another odd thing – why did S&P take action the Friday before Lehman failed? AIG had only ~ $300M of direct LEH exposure on its $1T investment portfolio>

    1. Yves Smith Post author

      The monolines, who had much better contracts, were being downgraded. How could AIG NOT be downgraded?

      The Fed did issue annual reports for Maiden Lane III and for the cost of the AIG bailout. The Fed put in something like $30 billion of loans to fund Maiden Lane III (I have the actual information in NC archives, but forgive me for being too pressed to look it up). Remember, those CDOs were composed substantially of the BBB tranches of subprime bonds that were otherwise unsaleable. There was adverse selection in the choice of what went into a CDO even before the toxic phase of subprime issuance started (fall 2005).

      Also, the recovery in value of RMBS, and hence the collateral in CDOs when they were unwound, was due in large measure to ZIRP and QE. So trying to look at the explicit cost of the bailout greatly understates the total subsidies.

      1. schmoe

        Thanks for the response – I will look for that fed document but I do not believe that answers the question of ultimate realized losses on the CDOs. Their 10-K is not much help with this question either.

        As for ABK and MBI, their CDO wraps largely referenced 2006 and 2007 RMBS – and they did not have a large and generally profitable p/c operation to support their holding companies. In fact, ABK and MBI wrote so many CDS from those vintages since AIG exited the CDO market in June of 2005, and their muni wrap businesses were experiencing top line pressure since credit spreads were so low in 2006 – 2007 so they needed to write something (and did GS have a deal for them!).

        As for AIG’s CDOs referencing BBB bonds, that’s a good point and I believe ~ $20b of their CDO CDS were “mezzanine” CDOs (out of ~ $75b total notional CDO CDS), but am not aware of the loss characteristics of vintage 2004 – 2005 BBB RMBS but would be willing to bet that realized losses came from these “mezz” CDOs. As for “adverse selection” of the RMBS referenced, that would not surprise me and maybe that’s what I am missing.

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