Tuesday, November 17, 2009

Geithner Vindicated in TARP Watchdog Report

That's right, vindicated. Read the whole report. It makes clear that the NY Fed did try to negotiation haircuts with AIG's counterparties, but not at all surprisingly, the counterparties (and the French regulators) refused, and the NY Fed was left with no choice but to pay par value. Geithner, contrary to popular belief, didn't have the powers of a bankruptcy court. It's funny how quickly the Immaculate Negotiation argument breaks down in the real world. (I will be accepting apologies in the form of cash or personal checks.) Despite the overtly political "conclusions" and "lessons learned" sections (sadly, the only sections journalists read), the SIGTARP report (finally) gets a lot of the real facts out in the public domain, so we can finally talk about them now. The SIGTARP report confirms that: 1. First, AIG tried to negotiate haircuts on its CDS contracts, but counterparties refused (as was their right):

AIG was attempting to resolve its liquidity crisis caused by the collateral posting requirements by negotiating a cash payment to the counterparties in return for terminating the credit default swaps. ... While FRBNY was conducting analysis on alternative solutions, AIG’s attempts to negotiate the termination of its multi-sector credit default swap book with its counterparties were failing. AIG requested FRBNY’s assistance in securing these terminations.
2. Contrary to the constant claims of ill-informed pundits, the NY Fed did try to negotiate haircuts with AIG's counterparties:
On November 6 and 7, 2008, FRBNY assistant vice presidents, vice presidents, senior vice presidents, and executive vice presidents contacted eight of AIGFP’s largest counterparties (Société Générale, Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, Calyon, Barclays and Bank of America) by telephone. They described a proposal under which each counterparty was asked to accept a haircut from par. Seven of the eight counterparties told FRBNY officials that they would not voluntarily agree to a haircut. The eighth counterparty, UBS, said that it would accept a haircut of 2 percent as long as the other counterparties also granted a similar concession to FRBNY. FRBNY officials told SIGTARP that their concerns about credit rating downgrades limited the time available for negotiation about reductions in payments.
3. The NY Fed tried to get the French bank regulators to help them negotiate haircuts with SocGen and Calyon—two of AIG's biggest counterparties—but not only did the French regulators refuse to help, they specifically instructed SocGen and Calyon not to agree to any haircuts (rendering UBS's conditional acceptance of a 2% haircut moot). From the report:
During these negotiations, an FRBNY executive vice president and senior vice president contacted the Commission Bancaire to inform them that the FRBNY was conducting negotiations with Société Générale and Calyon, two of the counterparties with the largest credit default swap contracts with AIG, and was requesting their support. The Commission Bancaire then contacted the firms. The Commission Bancaire spoke again with FRBNY and forcefully asserted that, under French law, absent an AIG bankruptcy, the banks could not voluntarily agree to less than par value for the underlying securities in exchange for terminating the swap contracts. Thus, the French banks claimed they were precluded by law from making concessions and could face potential criminal liability for failing to comply with their duties to shareholders.
4. Like I said before, the counterparties refused to accept haircuts because (a) they were contractually entitled to par value, and (b) the government's bailout of AIG had removed the threat of bankruptcy, without which there was no mechanism whatsoever for forcing the counterparties to agree to workouts:
According to an FRBNY senior vice president, the counterparties that FRBNY approached that resisted being paid anything less than the equivalent of par in exchange for terminating their credit default swap contracts cited several reasons for this, including:
  • They had collateral already posted by AIG to protect against the risk of AIG default. The combination of collateral in their possession plus the fair market value of the underlying CDOs also in their possession equaled the par value of the credit default swaps. Thus, from the counterparty’s perspective, offering a concession would mean giving away value and voluntarily taking a loss, in contravention of their fiduciary duty to their shareholders.
  • In addition to the collateral, they had a reasonable expectation that AIG would not default on any further obligations under the credit default swaps because the U.S. government had already demonstrated that it would not allow AIG to go bankrupt.
  • They had already incurred costs to mitigate the risk of an AIG default on its obligations that would be exacerbated if they were paid less than par value.
  • They were contractually entitled to the par value of the credit default swap contracts.
------------------------------------- I also want to knock down one of the more specious—and frankly shocking—arguments that Barofsky makes in the report. He criticizes the NY Fed for "refus[ing] to use its considerable leverage as the regulator of several of these institutions to compel haircuts." Think about what this means: Barofsky is criticizing the NY Fed for not threatening to misuse its regulatory authority for purposes of retaliation. First of all, there would be serious questions about the legality of any such regulatory action, since the Fed would be using one of its regulatory tools for something other than its intended purpose. What's more, this criticism for not misusing regulatory authority is coming from, amazingly, an inspector general. (You think Barofsky is accepting campaign contributions yet?) It takes real chutzpah for an inspector general to criticize a regulator for not threatening to misuse its regulatory authority. Maybe we need an inspector general for TARP's inspector general. The SIGSIGTARP.


jck said...

This is all right if you assume that closing the positions was the only option but it wasn't. The U.S. could have saved AIG instead of destroying it by using its sovereign rating to guarantee AIG's liabilities, in which case posted collateral (dependent on the AIG's rating) would have reverted back to AIG and no additional collateral would have gone to the banks. To be sure this is a CoC event, but would the banks even the french banks have activated the termination clause if AIG had the triple A backing of he U.S. govt. I doubt it. The negotiations were conducted in an atmosphere of panic and Tim got taken for a ride by the "bankers" because he didn't look at all the options or maybe other options were rejected outright by the Ayatollahs of moral hazard.

Anonymous said...

Your claim that Barofsky criticized the FED for not misusing its regulatory authority is an unsupported straw man.

If there had been a credible threat of AIG bankruptcy no negotation would have been necessary. The entire deal was structured in a way that virtually guaranteed a "bailout" for counterparties. For Barofsky to suggest that this was not intentional defies credibility. Geithner is a crony capitalist crook.

As the real economy worsens, and knowledge of this disgusting public theft filters into the public's consciousness, there will be a reckoning.

Pete DZ said...

Surely for AIG to "use" the US's AAA rating it would have had to be explicitly nationalised, which would have triggered a whole wave of claims against it anyway?

Anonymous said...

Child has infected (pathogen subprime) leg (AIG), infection spreading into vital organs (16 counter parties). The leg presents a systemic threat. Child could die of systemic failure.

What the 2nd guessers are essentially saying is the doctor should have done anything other than treat the vital organs. Maybe they should have sawed off the leg and sent the kid home. Or maybe they should have saved the leg with topical antibiotics (a lifeline only to AIG), but denied the lifeline (imposing a severe haircut) to the vital organs (the systemically important counter parties).

Sorry, I'm taking my kid to Dr. Geithner. You fools can take your kids to Dr. Jekyll.

Anonymous said...

Sorry, I'm taking my kid to Dr. Geithner. You fools can take your kids to Dr. Jekyll.

Fine just dont ask the rest of us for any donor organs.

Anonymous said...

Your comments just proves the point. You support the doctors who want to let the organs die.

Seemingly for no other reason than they outrage people. The mob demands they die.

Of course, in a systemic financial crisis, not only does my "child" die because of your lunacy, almost all "children" die.

Anonymous said...

you are saying, then, that the settlement of AIG contracts DID provide a lifeline to the "vital organs", are you not?

regardless of whether geithner was right or not. regardless of immaculate negotiation with the vital organs (or lack thereof).

Cetamua said...

The truth of the matter is that if politicians and pundits didn't want to be put in such a situation, they should've have listened to Brooksley Born in 1996 and regulate credit derivatives.

They refused to listen, and that's that. To which I say to them: accept the blame, live with the consequences and suck it up.

Anonymous said...

I think it would be very interesting to compare what Brooksley Born was recommending with what Geithner did with CDS reform while at the NY Fed.

Just a hunch, but I betcha NY Fed Geithner equalled her recommendation.

On the lifeline, the AIG settlements provided a lifeline to the economy, which was threatened with systemic collapse. Individual counter parties may or may not have needed a lifeline at that moment in time, and the individual facts there are not really relevant, IMO, e.g., Saddam Sachs did not NEED a lifeline. But so what?

Anonymous said...

It was Dr Geithner who got the kid sick to begin with.

Anonymous said...

anon @ 1:48-- correction:

"On the lifeline, the AIG settlements provided a lifeline to the virtual economy, which was threatened with systemic collapse.

Anonymous said...

meanwhile, back in the real world:

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Anonymous said...

EoC, is Elizabeth Warren falsely claiming credit for forcing the Treasury Department to refuse (she is implying they intended to accept Goldman's initial asking price) the Goldman Sachs initial asking price for the their TARP-related warrants?

She makes the claim in several places, including in a video interview recently done with the New Yorker magazine

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