AIG Bailout: Corrupt, Regulator-Organized Gift to Few Privileged Banks

08 July 2010. By David Caploe PhD, Editor-in-Chief, EconomyWatch.com

I – Saving AIG ???

When the government began rescuing A.I.G. from collapse

in the fall of 2008 with what has become a $182 billion lifeline,

it was required to forfeit its right to sue several banks —

including Goldman, Société Générale, Deutsche Bank and Merrill Lynch —

08 July 2010. By David Caploe PhD, Editor-in-Chief, EconomyWatch.com

I – Saving AIG ???

When the government began rescuing A.I.G. from collapse

in the fall of 2008 with what has become a $182 billion lifeline,

it was required to forfeit its right to sue several banks —

including Goldman, Société Générale, Deutsche Bank and Merrill Lynch —

over any irregularities with most of the mortgage securities it insured in the precrisis years.

But after the Securities and Exchange Commission’s civil fraud suit filed in April against Goldman for possibly misrepresenting a mortgage deal to investors,

A.I.G. executives and shareholders are asking whether A.I.G. may have been misled by Goldman into insuring mortgage deals that the bank and others may have known were flawed.

This month, an Australian hedge fund sued Goldman on similar grounds.

Goldman is contesting the suit and denies any wrongdoing.

II – Who Knew What When ???

Unknown outside of a few Wall Street legal departments, the A.I.G. waiver was released in May

by the House Committee on Oversight and Government Reform

amid 250,000 pages of largely undisclosed documents.

The documents, reviewed by The New York Times,

provide the most comprehensive public record of how the Federal Reserve Bank of New York and the Treasury Department

orchestrated one of the biggest corporate bailouts in history.

The documents also indicate that regulators ignored recommendations from their own advisers

to force the banks to accept losses on their A.I.G. deals

and instead paid the banks in full for the contracts.

That decision, say critics of the A.I.G. bailout, has cost taxpayers billions of extra dollars in payments to the banks.

It also contrasts with the hard line the White House took in 2009

when it forced Chrysler’s lenders to take losses when the government bailed out the auto giant.

Analysts say the documents suggest that regulators were overly punitive toward A.I.G.

and overly forgiving of banks during the bailout —

signified, they say, by the fact that the legal waiver undermined A.I.G. and its shareholders’ ability to recover damages.

“Even if it turns out that it would be a hard suit to win,

just the gesture of requiring A.I.G. to scrap its ability to sue is outrageous,”

said David Skeel, a law professor at the University of Pennsylvania.

“The defense may be that the banking system was in trouble, and we couldn’t afford to destabilize it anymore,

but that just strikes me as really going overboard.”

“This really suggests they had myopia and they were looking at it entirely through the perspective of the banks,” Mr. Skeel said.

Regulators at the New York Fed declined to comment on the legal waiver

but disagreed with that viewpoint.

“This was not about the banks,” said Sarah J. Dahlgren, a senior vice president for the New York Fed who oversees A.I.G.

Last month, the Congressional Oversight Panel,

a body charged with reviewing the state of financial markets and the regulators that monitor them,

published a 337-page report on the A.I.G. bailout.

III – Why No Consideration for Alternatives ???

It concluded the Federal Reserve Bank of New York did not give enough consideration to alternatives

before sinking more and more taxpayer money into A.I.G.

“It is hard to escape the conclusion that F.R.B.N.Y. was just ‘going through the motions,’ ” the report said.

About $46 billion of the taxpayer money in the A.I.G. bailout was used to pay to mortgage trading partners

like Goldman and Société Générale, a French bank, to make good on their claims.

The banks are not expected to return any of that money,

leading the Congressional Research Service to say in March that

much of the taxpayer money ultimately bailed out the banks, not A.I.G.,

a point we have made here at Economy Watch any number of times.

Even with the financial “reform” legislation that Congress recently introduced,

David A. Moss, a Harvard Business School professor, said he was concerned that

the government had not developed a blueprint for stabilizing markets when huge companies like A.I.G. run aground,

and, for that reason, regulators’ actions during the financial crisis need continued scrutiny.

“We have to vet these things now because otherwise, if we face a similar crisis again,

federal officials are likely to follow precedents set this time around,” he said.

Under the new legislation, the Federal Deposit Insurance Corporation will have the power to untangle the financial affairs of troubled entities,

but bailed-out companies will pay most of their trading partners 100 cents on the dollar for outstanding contracts.

But Sheila C. Bair, the chairwoman of that very same F.D.I.C., has said that

trading partners should be forced to accept discounts in the middle of a bailout.

Regardless of the financial parameters of bailouts, analysts also say that

real financial reform should require regulators to demonstrate much more independence from the firms they monitor.

IV – An Embarrassing Deference by Regulators

In that regard, the newly released Congressional documents show New York Fed officials deferring to bank executives

at a time when the government was pumping hundreds of billions of taxpayer dollars into the financial system

to rescue bankers from their own mistakes.

While Wall Street deal-making is famously hard-nosed with participants fighting for every penny,

during the A.I.G. bailout, regulators negotiated with the banks in an almost conciliatory fashion.

On Nov. 6, 2008, for instance, after a New York Fed official spoke with Lloyd C. Blankfein, Goldman’s chief executive, about the Fed’s A.I.G. plans,

the official noted in an e-mail message to Mr. Blankfein that he appreciated the Wall Street titan’s patience.

“Thanks for understanding,” the regulator said.

From the moment the government agreed to lend A.I.G. $85 billion on Sept. 16, 2008,

the New York Fed, led at the time by Timothy F. Geithner, and its outside advisers all acknowledged that a rescue had to achieve two goals:

stop the bleeding at A.I.G. and protect the taxpayer money the government poured into the insurer.

One of the regulators’ most controversial decisions was awarding the banks that were A.I.G.’s trading partners

100 cents on the dollar to unwind debt insurance they had bought from the firm.

V – No Alternatives ???

Critics have questioned why the government did not try to wring more concessions from the banks,

which would have saved taxpayers billions of dollars.

Mr. Geithner, who is now the Treasury secretary, has repeatedly said that as steward of the New York Fed,

he had no choice but to pay A.I.G.’s trading partners in full.

But two entirely different solutions to A.I.G.’s problems were presented to Fed officials

by three of its outside advisers, according to the documents.

Under those plans, the banks would have had to accept what the advisers described as “deep concessions”

of as much as about 10 percent on their contracts

or they might have had to return about $30 billion that A.I.G. had paid them before the bailout.

Had either of these plans been implemented, A.I.G. may have been left in a far better financial position than it is today,

with taxpayers at less risk and banks forced to swallow bigger losses.

For its part, the Treasury appeared to be opposed to any options that did not involve making the banks whole on their A.I.G. contracts.

VI- A Conspiracy of Jester’s ???

At Treasury, a former Goldman executive, Dan H. Jester, was the agency’s point man on the A.I.G. bailout.

Mr. Jester had worked at Goldman with Henry M. Paulson Jr., the Treasury secretary during the A.I.G. bailout.

Mr. Paulson previously served as Goldman’s chief executive before joining the government.

Mr. Jester, according to several people with knowledge of his financial holdings,

still owned Goldman stock while overseeing Treasury’s response to the A.I.G. crisis.

According to the documents, Mr. Jester opposed bailout structures that required the banks to return cash to A.I.G.

Nothing in the documents indicates that Mr. Jester advocated forcing Goldman and the other banks to accept a discount on the deals.

Although the value of Goldman’s shares could have been affected by the terms of the A.I.G. bailout,

Mr. Jester was not required to publicly disclose his stock holdings because he was hired as an outside contractor,

a job title at Treasury that allowed him to forgo disclosure rules applying to appointed officials.

In late October 2008, he stopped overseeing A.I.G. after others were given that responsibility,

according to Michele Davis, a spokeswoman for Mr. Jester.

Ms. Davis said that Mr. Jester fought hard to protect taxpayer money and followed an ethics plan to avoid conflict with all of his stock holdings.

Ms. Davis is also a spokeswoman for Mr. Paulson, and said that he declined to comment for this article.

VII – What WERE Some Alternatives ???

The alternative bailout plans that regulators considered came from three advisory firms that the New York Fed hired:

Morgan Stanley, Black Rock, and Ernst & Young.

One plan envisioned the government guaranteeing A.I.G.’s obligations in various ways,

in much the same way the F.D.I.C. backs personal savings accounts at banks facing runs by customers.

On Oct. 15, Ms. Dahlgren wrote to Mr. Geithner that

the Federal Reserve board in Washington had said the New York Fed should try to get Treasury to do a guarantee.

“We think this is something we need to have in our back pockets,” she wrote,

as quoted in this extraordinary – but, seemingly, systematically ignored –

story from the ever-dynamic duo of Louise Story and Gretchen Morgenson that appeared –

one would imagine after a LOT of behind-the-scenes conflict – in the New York Times.

Treasury had the authority to issue a guarantee

but was unwilling to do so because that would use up bailout funds.

Once the guarantee was off the table, Fed officials focused on possibly buying the distressed securities insured by A.I.G.

From the start, the Fed and its advisers prepared for the banks to accept discounts.

A BlackRock presentation outlined five reasons why the banks should agree to such concessions,

all of which revolved around the many financial benefits they would receive.

BlackRock and Morgan Stanley presented a number of options,

including what BlackRock called a “deep concession”

in which banks would return $6.4 billion A.I.G. paid them before the bailout.

VIII – For Whose Benefit ???

The three banks with the most to lose under these options were Société Générale, Deutsche Bank and Goldman Sachs.

Société Générale would have had to give up $322 million to $2.1 billion depending on which alternative was used;

Deutsche Bank would have had to forgo $40 million to $1.1 billion,

while Goldman would have had to give up $271 million to $892 million, according to the documents.

Société Générale and Deutsche Bank both declined to comment.

Ultimately, the New York Fed never forced the banks to make concessions.

And yet two Fed governors in Washington were concerned that

making the banks whole on the A.I.G. contracts would be “a gift,”

according to the documents.

Gift or not, the banks got 100 cents on the dollar.

And on Nov. 11, 2008, a New York Fed staff member recommended that

documents for explaining the bailout to the public not mention bank concessions.

The Fed should not reveal that it didn’t secure concessions “unless absolutely necessary,” the staff member advised.

In the end, the Fed successfully kept most of the details about its negotiations with banks confidential for more than a year,

despite opposition from the media and Congress.

IX – Bizarre New York Fed “Script” For Dealing with Banks Involved  

During the A.I.G. bailout, New York Fed officials prepared a script for its employees

to use in negotiations with the banks and it was anything but tough;

it advised Fed negotiators to solicit suggestions from bankers

about what financial and institutional support they wanted from the Fed.

The script also reminded government negotiators that bank participation was “entirely voluntary.”

The New York Fed appointed Terrence J. Checki as its point man with the banks.

In e-mail messages that November, he was deferential to bankers,

including the e-mail message in which he thanked Mr. Blankfein for his patience.

After UBS, a Swiss bank, received details about the Fed’s 100-cents-on-the-dollar proposal,

Mr. Checki thanked Robert Wolf, a UBS executive, for his patience as well.

“Thank you for your responsiveness and cooperation,” he said in an e-mail message.

“Hope the benign outcome helped offset any aggravation. Thank you again.”

Oh no, Mr. Checki, thank YOU !!!

The Congressional Oversight Panel,

which interviewed A.I.G.’s trading partners about how tough the government was during the negotiations,

concluded that many of the governments efforts were merely “desultory attempts.”

X – Contrast with Chrysler Bailout & That Pesky “Waiver”

All of this was quite different from the tack the government took in the Chrysler bailout.

In that matter, the government told banks they could take losses on their loans

or simply own a bankrupt company;

the banks took the losses.

During the A.I.G. bailout, the Fed seemed more focused on extracting concessions from A.I.G. than from the banks.

Mr. Baxter, in an interview, conceded that the way that the New York Fed handled the negotiations

meant that any resulting deal “took most of the upside potential away from A.I.G.”

The legal waiver barring A.I.G. from suing the banks

was not in the original document that regulators circulated on Nov. 6, 2008

to dissolve the insurer’s contracts with the banks.

A day later a waiver was added

but the Congressional documents show no e-mail traffic

explaining why that occurred or who was responsible for inserting it.

The New York Fed declined to comment.

But two people with direct knowledge of the negotiations between A.I.G. and the banks,

who requested anonymity because the talks were confidential,

said the legal waiver was not a routine matter —

and that federal regulators forced the insurer to accept it.

XI – What Are the Implications for AIG – & Taxpayers ???

Even if the waiver was warranted, experts say it unfairly handcuffed A.I.G.

and has undermined the financial interests of taxpayers.

If, for example, the banks misled A.I.G. about the mortgage securities A.I.G. insured,

taxpayer money could be recouped from the banks through lawsuits.

Unless A.I.G. can prove it signed the legal waiver under duress,

it cannot sue to recover claims it paid on $62 billion of about $76 billion of mortgage securities that it insured.

If A.I.G. had the right to sue, and if banks were found to have misrepresented the deals,

or used improper valuations on securities A.I.G. insured to extract heftier payouts from the firm,

the insurer’s claims could yield tens of billions of dollars in damages because of its shareholders’ lost market value, according to Mr. Skeel.

XII – Let’s Keep This Quiet, Guys

Throughout the A.I.G. bailout, as Congressional leaders and the media pressed for greater disclosure,

regulators fought fiercely for confidentiality.

Even after the New York Fed released a list of the banks made whole in the bailout,

it continued to resist disclosing information about the actual bonds in the deals,

including codes known as “cusips” that label securities.

“We need to fight hard to keep the cusips confidential,”

one New York Fed official wrote on March 12, 2009.

It was not until a Congressional committee issued a subpoena in January 2010

that the New York Fed finally turned over more comprehensive records.

The bulk remained private until May of this year,

when some committee staff members put them online,

saying they lacked the resources to review them all.

As Tom Hagen said in Godfather II, when they learned Frankie Pentangeli was still alive,

“[Hyman] Roth, he, he, played this beautifully.”

Indeed – only all this is fact, not a brilliant elegant fiction.

 

David Caploe PhD

Editor-in-Chief

EconomyWatch.com

President / acalaha.com