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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.