Saturday, March 14, 2009

All Bailouts Are Counterparty Bailouts

The recent uproar over the government's refusal to reveal AIG's counterparties on its CDS trades is silly, and reflects a basic misunderstanding of how financial markets work. With regard to AIG specifically: yes, AIG used some of the bailout money to post collateral it owed to counterparties on CDS trades. But it also used a significant amount of bailout money to repay counterparties in its securities lending program (basically a repo desk—AIG lends out securities it owns on a short-term basis in exchange for cash.) To settle transactions with counterparties returning the borrowed securities, AIG has to return the cash (less interest). If the government hadn't rescued AIG, it wouldn't have had enough cash to pay these counterparties back, and it would have essentially defaulted. In fact, a full $19 billion of taxpayer money has gone to AIG's securities lending program so far. So the AIG bailout was also a bailout of AIG's counterparties in its securities lending program. Should the government be forced to reveal the identity of all these counterparties as well? Surely not—and no sane person would disagree. Why should CDS counterparties be any different? More generally, you can see how this reasoning applies to bailouts in general. Yes, AIG's bailout was a bailout of its counterparties, but all bailouts in the financial sector are bailouts of counterparties. The purpose of all bailouts is to avoid insolvency. Avoiding insolvency requires paying counterparties the money they're owed. There's nothing special about the AIG bailout in that regard. Finally, regarding the ubiquitous claim that "taxpayers have the right to know" who AIG's counterparties are: no, we don't. All of AIG's CDS contracts are subject to confidentiality agreements. Becoming the majority owner of a publicly-traded company does not entitle you to breach contracts that are binding on the company.

9 comments:

Don said...

I basically agree with you, but was going to contend that this was simple political venting, which, while histrionic, was important. However, the reporting and commentary have been so bad that I have to agree with you entirely.

Don the libertarian Democrat

Max Sawicky said...

"The purpose of all bailouts is to avoid insolvency."

If you have to be bailed out, aren't you already insolvent?

m said...

I don't believe those "confidentiality" clauses are iron clad or unconditional. Dont' the standard form CDS contracts contain exceptions etc?

Are there not legitimate legal arguments that can be made for disclosure per government regulatory needs.

Kyle said...

Though I agree that counter-party payments are the entire purpose of bailouts, payment disclosure is critical to understanding the effect that these market infusions will have in the long-term. Most critically, how we understand America's role in financing the recovery of international firms. Wealth transfers to other nations' banks creates complicated and highly sensitive economic, not to mention political, conditions for how the Fed and AIG approach structuring pay-outs for the rest of the funds. Though I would defer to AIG to decide who should get what payment amounts when, I would expect my leadership to ensure that the system doesn't disproportionately advantage some players over others. Though you may believe that the general public doesn't have a right to know, the information is vital to further economic policy research and analysis.

Anonymous said...

More to the point, there is a major political problem in not revealing the counterparties. AIG took billions of dollars of the public's money; the public demands and deserves transparency. It's not simply political posturing, and it's not unreasonable to know what AIG is doing with the massive sums of public funds it asked for and received.

Anonymous said...

EoC says: "Finally, regarding the ubiquitous claim that "taxpayers have the right to know" who AIG's counterparties are: no, we don't. All of AIG's CDS contracts are subject to confidentiality agreements. Becoming the majority owner of a publicly-traded company does not entitle you to breach contracts that are binding on the company."

This is not a run-of-the-mill acquisition of a publicly-traded company by another publicly-traded company. The acquisition was funded by tax money, not money freely invested by shareholders who can decide to sell their shares in the acquiring company if they don't like the acquisition. As a political and equitable matter, the public does have a right to know where its money is going.

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