AIG

From Riski

Jump to: navigation, search

See also AIG House oversight, Bond insurance, CDO regulation, Commutations and Goldman Sachs.

Contents

Overview

American International Group, Inc. (AIG) NYSE: AIG, also known as AIU Holdings, Inc., is an American insurance corporation. According to the 2008 Forbes Global 2000 list, AIG was once the 18th-largest public company in the world. It was listed on the Dow Jones Industrial Average from April 8, 2004 to September 22, 2008.

AIG suffered from a liquidity crisis when its credit ratings were downgraded below "AA" levels in September 2008.

The US Federal Reserve Bank on September 16, 2008, created an $85 billion credit facility to enable the company to meet increased collateral obligations consequent to the credit rating downgrade, in exchange for the issuance of a stock warrant to the Federal Reserve Bank for 79.9% of the equity of AIG.

The U.S. government revised the credit facility, and eventually increased the total amount available to as much as $182.5 billion.[1]

AIG subsequently sold a number of its subsidiaries and other assets to pay down loans received, and continues to seek buyers of its assets. In March 2009, AIG faced public outrage and media and political backlash for its retention payments of $165 million. Some AIG employees faced hate mail and death threats, and websites had sprung up attacking AIG.[2]

Systemic risk exposures of AIG

  • Source:Statement by Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System before the Committee on Financial Services, U.S. House of Representatives, March 24, 2009 (page 2)
    • Some of AIG’s insurance subsidiaries, which are among the largest in the United States and the world, would have likely been put into rehabilitation by their regulators, leaving policyholders facing considerable uncertainty about the status of their claims. **State and local government entities that had lent more than $10 billion to AIG would have suffered losses.
    • Workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable value funds would decline in value would have seen that insurance disappear.
    • Global banks and investment banks would have suffered losses on loans and lines of credit to AIG, and on derivatives with AIG-FP. The banks’ combined exposures exceeded $50 billion.1
    • Money market mutual funds and others that held AIG’s roughly $20 billion of commercial paper would also have taken losses.
    • In addition, AIG’s insurance subsidiaries had substantial derivatives exposures to AIG-FP that could have weakened them in the event of the parent company’s failure.


  • Direct and Indirect Impact of AIGFP failure AIG, February 26, 2009
    • The large size of their derivatives books: AIG Financial Products Corp. (AIGFP) has approximately $1.6 trillion in notional derivatives exposures
    • Unwinding of the portfolio in an AIG failure would likely cause enormous downward pressure on valuations across a wide range of associated asset classes
    • The large number of counterparties involved in a wind-down of the derivatives books. Counterparties include top banks, sovereign wealth funds, money managers and hedge funds.
    • Total client base: more than 1,500 major corporations, governments, and institutional investors would be affected

House Oversight Committee inquiries

See AIG House oversight.

Feb. 18 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke has been asked by a Republican lawmaker to turn over documents related to the decision to rescue insurer American International Group Inc.

The Federal Reserve should deliver the records by March 2, according to a letter dated yesterday from Representative Darrell Issa of California, ranking member of the House Oversight and Government Reform Committee. Bernanke last month invited the Government Accountability Office to conduct a “full review” of the central bank’s actions tied to the bailout that swelled to $182.3 billion.

“In light of your professed commitments and your apparent desire to cooperate with this committee’s investigation, I am writing to request that you voluntarily produce to this committee all records and communications in the possession of the Federal Reserve” regarding the rescue, Issa wrote.

Issa is seeking to widen the probe into what he’s called a “backdoor bailout” of banks that got funds from AIG after its rescue and efforts by the Federal Reserve Bank of New York to withhold details from the public about the payments. Treasury Secretary Timothy Geithner, who ran the New York Fed when AIG was bailed out in 2008, testified last month that the payments were necessary and that subordinates made disclosure decisions.

The New York Fed, which turned over about 250,000 pages of documents after the oversight committee issued a subpoena, is “not in full compliance” with the demand, Issa wrote in a separate letter to committee Chairman Edolphus Towns. The regulator limited material to the period from September 2008, the month of the bailout, to May 2009, Issa wrote to the New York Democrat.

Senate inquiries about AIG

Senator Grassley sends 2nd letter to pay czar

Sen. Charles Grassley has sent a second letter to U.S. pay czar Kenneth Feinberg asking about reports of severance payments to executives leaving American International Group Inc.

The letter inquires about former General Counsel Anastasia D. Kelly and Suzanne Folsom, who was chief compliance and regulatory officer.

Both left the company at the end of 2009. Ms. Kelly received an exit package of at least $3.9 million and Ms. Folsom received more than $1 million in severance, according to people familiar with the matter. Neither was reached for comment Monday.

Mr. Grassley (R., Iowa) in his letter Monday questioned Mr. Feinberg about a recent investigation by an outside law firm for AIG into whether Ms. Kelly was "properly performing her duties as general counsel." Mr. Grassley asked for details on that investigation.

Mr. Grassley also referred to reports that Ms. Folsom may have received $1 million in severance. He asked for information about the basis of that payout.

AIG said Dec. 30 that Ms. Folsom "left to pursue other opportunities." Unlike Ms. Kelly, Ms. Folsom wasn't a participant in AIG's executive-severance plan, according to people familiar with the matter.

Senator Grassley explores AIG ex-general counsel's severance

Sen. Charles Grassley (R., Iowa) has asked the U.S. pay czar to explain why the recently departed general counsel of American International Group Inc. will receive several million dollars in severance.

The giant insurer agreed last month to award ex-general counsel Anastasia Kelly an exit package totaling roughly $3.9 million, the bulk of which is severance, according to people familiar with the matter. Ms. Kelly resigned from AIG effective Dec. 30, the company said.

AIG determined that Ms. Kelly was entitled to severance under terms of the company's executive-severance plan after her annual cash base salary was reduced to $500,000 under determinations made by the pay czar, Kenneth Feinberg.

"The taxpayers are fed up with massive payouts to executives at companies that took taxpayer money," said Mr. Grassley, the ranking Republican on the U.S. Senate finance committee. He called the payout a "windfall."

An AIG spokesman and Ms. Kelly had no comment. A representative of Mr. Feinberg's office didn't immediately respond to a request for comment.

Senate oversight hearing March 5, 2009

See C-Span archive webcast

Christopher J. Dodd view statement

Witnesses

  • Honorable Donald Kohn view testimony Vice Chairman Board of Governors, Federal Reserve System
  • Mr. Scott M. Polakoff view testimony Senior Deputy Director and Chief Operating Officer, Office of Thrift Supervision
  • Mr. Eric Dinallo view testimony Superintendent, New York State Insurance Department

SIGTARP oversight

See also AIG - SIGTARP.

AIG - Goldman Sachs - Pricewaterhouse conflicts

In fact, Andrew Ross Sorkin told us in his book, Too Big To Fail, Goldman Sachs was still not satisfied in June of 2008 that PwC was pushing AIG hard enough to consider “market participants’ views” on pricing on a timely or suffiicient basis so Goldman could “obtain as much cash as possible from their collateral calls”:

…Sorkin describes a Goldman Sachs June 2008 board meeting where the issue of their collateral dispute with AIG boils over.

“In a videoconference presentation from New York, a PwC executive (PwC is Goldman Sach’s auditor, too) updates the board on its dispute with AIG over how it was valuing or in Wall Street parlance, “marking-to-market,” its portfolio. Goldman executives considered AIG was “marking to make-believe” as Blankfein told the board…the afternoon session proceeded with upbraiding PricewaterhouseCoopers:

“How does it work inside PwC if you as a firm represent two institutions where you’re looking at exactly the same collatteral and there’s a clear dispute in terms of valuation?”

How does it work, indeed. Jon Winkelreid, Goldman’s co-president, may or may not have received an answer that day. Sorkin does not report one. I have never heard one.

I still have not heard a specific explanation for how PwC could preside over a long running dispute between two of its most important global clients, a dispute that was material to at least one of them, obviously, that had the attention of its highest level partners, and not force a resolution based on consistent application of accounting standards sooner.

I mean… We are talking about valuation of the same assets!

I’ve been writing almost as long as I’ve been writing here that PwC should resign as AIG’s auditor. Was it not enough that PwC had been sued by AIG shareholders more than once for its role in accounting errors and restatements? Was it not enough that AIG never got corporate governance right and PwC let them get away with it forever? Is it not enough that now PwC has its own partners testifying against their client on behalf of plaintiffs they settled with in order to extricate themselves from ongoing expensive litigation?

Is it not enough that PwC was clearly torn between two clients (and maybe more who would have been impacted) who held enormous financial sway and lost its independence and objectivity? I think PwC finally succumbed to Goldman Sachs, selling out AIG while still tippy-toeing around the necessity to finally say which one was closest to complying with standards. Actually taking a consistent stand would potentially implicate other clients such as JP Morgan and Bank of America as well as Freddie Mac in a mark-to-model or rather “mark to make it happen” scandal?

AIG bonuses

The American International Group has agreed to cut employee bonuses by $20 million and will distribute about $100 million on Wednesday, according to people with knowledge of the negotiations.

But the reductions may not be enough to appease the company’s critics, who do not accept the company’s argument that it has to honor contracts established before its government bailout.

“A.I.G. has taxpayers over a barrel,” said Senator Charles E. Grassley, an Iowa Republican, in a statement on Tuesday night. “The Obama administration has been outmaneuvered. And the closed-door negotiations just add to the skepticism that the taxpayers will ever get the upper hand.”

A.I.G. first promised the retention bonuses to keep people working at its financial products unit, which traded in the derivatives that imploded in September 2008, leading to the biggest government bailout in history.

The contracts, which were established in December 2007, were intended to keep people from leaving the company and called for the bonuses to be paid in regular installments to more than 400 employees in the unit. The final payment, which was for about $198 million, was due in mid-March, but was accelerated to Wednesday as part of the agreement to reduce its size.

Fearing a firestorm like the one last spring, A.I.G. had been working with the Treasury’s special master for compensation, Kenneth R. Feinberg, on a compromise that would allow it to keep its promise in part, without offending taxpayers.

The agreement calls for employees who still work for the financial products unit to accept 10 percent cutbacks, while employees who have left the company must take 20 percent cuts. Those employees are still entitled to their bonuses under the contract, which adheres to the scheduled payments even if people have lost their jobs. The financial products unit has shed almost 200 people as it has wound down A.I.G.’s derivatives business.

A.I.G. has told all the affected people that if they do not accept the reduced amounts, they will get no bonus at all, according to a person with knowledge of the agreement.

But some people have not agreed to the cutbacks and are insisting on the entire amounts. People with knowledge of the negotiations said that a vast majority of those still employed at A.I.G. had accepted the cuts, but only about a third of the former employees had done so.

The holdouts seem determined to make A.I.G. pay the full contractual amounts, knowing they can make a reasonably good case under law, because A.I.G.’s own lawyers have previously issued an opinion that the contracts are binding. If they succeed, A.I.G. would have to pay them more money at some point in the future, and might even have to pay penalties for breaking its employment contracts.

So, while it appeared on Tuesday that A.I.G. and the Treasury had cut the bonus payment to just half of the $198 million that was scheduled for March, the total amount remains unclear. The company acknowledged Tuesday night that it had cut the original amount by $20 million, but did not confirm that the final payment would be $100 million.

In a previous exchange regarding the bonuses, Mr. Feinberg wrote to Senator Grassley on Jan. 15 saying that the contracted amounts were “grandfathered payments.” He said they were not covered by the new rules he administers curbing executive bonuses at bailed-out companies.

“My staff and I have insisted that employees should have their overall current compensation reduced to take into account the fact of these grandfathered payments,” Mr. Feinberg said.

The last time A.I.G. paid a round of retention bonuses, worth $168 million, it caused such an uproar that some employees received death threats, according to its chief at the time, Edward Liddy.

To mollify the public, employees agreed to pay back roughly $45 million to the taxpayer-owned company.

The complaints subsided, but last October, the special inspector general for the Troubled Asset Relief Program, Neil M. Barofsky, audited the program and reported that only $19 million of the total due back had been received.

SIGTARP investigating AIG/Fed disclosures

"The New York Federal Reserve is being investigated by Neil Barofsky, the special inspector general overseeing the troubled assets relief programme, over its disclosure of documents relating to the bail-out of AIG and its counterparties.

In a statement submitted to the House oversight committee, Mr Barofsky said his team is examining whether the New York Fed improperly withheld information about the AIG bail-out from the Securities and Exchange Commission and his office...

...Mr Barofsky, who is due to appear at the hearing alongside Mr Geithner, says in his testimony that he is pursuing parallel investigations into whether the New York Fed improperly withheld information from the SEC and whether it subsequently withheld documents from his office during an earlier audit of the payments...."

Hu of SEC on Goldman "empty creditor" thesis

"... In a Wall Street Journal opinion article in April 2009—which Ms. Schapiro says prompted the job offer from the SEC—Mr. Hu suggested Goldman Sachs Group Inc. used a kind of derivative called a credit default swap to turn itself into an empty creditor of AIG. He wrote that this may have encouraged Goldman to push for extra collateral from AIG, even when that threatened AIG's existence.

Lucas van Praag, a spokesman for Goldman Sachs, said for a number of reasons the bank "doesn't think that its transactions with AIG are appropriate examples of Prof. Hu's thesis."

The derivatives trade association, the International Swaps and Derivatives Association, later criticized the research, saying the empty-creditor hypothesis is "appealing on the surface" but "is not consistent with either the way credit default swaps work nor with observed behavior in debt markets."

A.I.G. in debt-for-equity swap with New York Fed

"The insurance giant American International Group said on Tuesday that it had closed two debt-for-equity transactions that reduce its debt with the Federal Reserve Bank of New York by $25 billion.

A.I.G. said that under the agreement the New York Fed would receive preferred shares with a liquidation preference worth $16 billion in American Life Insurance Company and $9 billion in American International Assurance Company Ltd., which would be placed in special purpose vehicles.

The insurer said that the special purpose vehicles would prepare the two subsidiaries for initial public offerings or third-party sales, and in a separate statement said it was moving forward with the separation of American Life Insurance.

The liquidation preference is an undisclosed percentage of the estimated fair market value of the two A.I.G. units. A.I.G. retains the common interests in American Life and American International Assurance, and thus would benefit should the market valuation of the two units be in excess of $25 billion.

A.I.G. said that as of Tuesday, its outstanding principal balance under the New York Fed credit facility was about $17 billion and the total amount available under the facility had been reduced to $35 billion from $60 billion.

“We continue to focus on stabilizing and strengthening our businesses, but expect continued volatility in reported results in the coming quarters, due in part to charges related to ongoing restructuring activities,” the A.I.G. chief executive, Bob Benmosche, said in a statement.

Missed dividend payment to the Treasury

"One of the three trustees who oversees U.S. taxpayers' nearly 80% stake in American International Group Inc. recently said he wanted to quit his post, but was persuaded to stay on, people familiar with the matter said.

Separately, the federal government is seeking out possible candidates to add to AIG's board.

Douglas Foshee, who also is president and chief executive of natural-gas producer and pipeline operator El Paso Corp., is one of three trustees overseeing the government's stake in the insurer. He said in a letter about a month ago that he wanted to withdraw as a trustee, but agreed to stay after talking to several individuals, including William Dudley, president of the Federal Reserve Bank of New York, people familiar with the matter said...

...Separately, the Treasury this past week hired an executive-search firm to help seek out possible candidates that it may appoint as directors to AIG's board, according to people familiar with the matter.

The move came after AIG in early November missed a fourth quarterly dividend payment on about $44 billion in preferred shares it issued to the Treasury under the Troubled Asset Relief Program.

Because of the missed payment, the Treasury gained the right to elect two or three directors to AIG's board, but it hasn't decided when or if it will appoint them."

Claims paying capability questioned

"An independent analysis of whether the insurance industry has been setting aside enough money to pay claims has found that the American International Group has a shortfall of about $11 billion in its all-important property and casualty business.

The finding is at odds with the often-repeated refrain that A.I.G.’s troubles were caused solely by its derivatives portfolio, while its insurance operations were sound.

Other researchers have raised doubts about A.I.G.’s total worth since it was bailed out last year, and even the federal government has acknowledged the company may have difficulty repaying all of the money it owes, currently about $120 billion.

But the report by Sanford C. Bernstein documents a big shortfall in A.I.G.’s property and casualty insurance business — the part that has been renamed Chartis, which is supposed to be its core once it has restructured and sold other operations.

The author, Todd R. Bault of Sanford C. Bernstein, called the results “a big surprise” in his report, which was distributed to the firm’s clients on Monday.

A spokesman for A.I.G., Mark Herr, said the company had no comment on the report. The company and its regulators have previously denied reports of hidden weakness in its property and casualty business, including one in The New York Times.

A spokeswoman for the Pennsylvania Insurance Department, which regulates A.I.G.’s largest property and casualty business, declined to discuss the report, but said the state was “continuing to closely monitor the A.I.G. companies.” The spokeswoman, Roseanne Placey, also said that A.I.G.’s most recent regulatory filing showed it was gaining strength.

Insurance regulators in New York, another major regulator, were not available to comment.

A.I.G.’s stock fell by almost 15 percent, to $28.40 from $33.30, in trading on Monday. Sanford C. Bernstein cut its price target for A.I.G.’s stock by 40 percent, to $12 from $20 — an unusually large reduction even for a firm with a track record of research that moves stock prices downward.

Mr. Bault, a senior securities analyst who is also an actuary, explained that he had set out to find something entirely different — whether any American insurers had the strength to raise their prices soon. His first rough cut of the data “made no sense,” he wrote, and when he looked more closely he found that the shortfall at A.I.G. was distorting the industry as a whole.

“At a minimum, if these results are reasonable, A.I.G. would likely have to take some kind of reserve charge,” before bringing Chartis to market in an initial public offering, he wrote. But if Chartis had to bolster its reserves, it “would probably greatly increase the difficulty of implementing such a deal in the first place.”

He estimated that on an after-tax basis, filling the gap would mean coming up with about $10 per diluted share of A.I.G., or about a third of the company’s market value.

Mr. Bault wrote that once he had excluded A.I.G. from his data, the rest of the industry appeared to have adequate reserves across the board.


Federal Reserve timeline

Bloomberg documents the AIG-Fed timeline

"...Below is a timeline outlining New York-based AIG’s disclosures along with comments from the New York Fed and the Securities and Exchange Commission to the insurer.

Nov. 10, 2008: AIG says the New York Fed will contribute as much as $30 billion to a facility to retire credit-default swaps sold by the insurer to protect banks from losses on securities tied to subprime mortgages. The insurer will contribute as much as $5 billion, and the facility, named Maiden Lane III, will buy about $70 billion in collateralized debt obligations from the banks that bought protection, AIG says.

Nov. 11, 2008: Elias Habayeb, then-Chief Financial Officer of AIG’s Financial Services division, e-mails executives that he wants to clear up “confusion” about the price the company will pay to retire derivatives. “The Fed offered all counterparties par,” Habayeb says. “I think we should be clear on that point.”

Nicholas Ashooh, then-senior vice president in charge of AIG’s communications, replies to Habayeb that his proposed explanation “would be very helpful, but I understand that the Fed is very sensitive and we have to clear it with them.”

Nov. 24, 2008: Geithner is nominated for Treasury secretary by President-elect Barack Obama. Geithner is recused from “working on issues involving specific companies, including AIG,” a Treasury spokeswoman later says.

Nov. 25, 2008: Maiden Lane III begins buying CDOs from AIG’s counterparties.

Dec. 2, 2008: AIG submits a regulatory filing detailing the terms of the Maiden Lane III agreement.

The filing contains a so-called shortfall agreement between Maiden Lane III and AIG listing terms of payments should the vehicle need more funds. The accord refers to Schedule A, the document listing counterparties, collateral postings and market declines on the derivative contracts. The Schedule A isn’t included.

The filing states that on Nov. 25, “ML III bought approximately $46.1 billion in par amount of Multi-Sector CDOs through a net payment to CDS counterparties of approximately $20.1 billion, and AIGFP terminated the related CDS with the same notional amount. The aggregate cost of the purchases and terminations was funded through approximately $15.1 billion of borrowings under the Senior Loan, the surrender by AIGFP of approximately $25.9 billion of collateral previously posted by AIGFP to CDS counterparties in respect of the terminated CDS and AIG’s equity investment in ML III of $5 billion.”

Dec. 21, 2008: AIG sends a draft of its regulatory filing detailing the purchase of additional CDOs to New York Fed lawyers. “Counterparties received 100 percent of the par value of the Multi-Sector CDOs sold and the related CDS have been terminated,” the draft says.

Dec. 23, 2008: The New York Fed sends AIG a marked-up version of the filing draft, crossing out the explanation of AIG paying 100 percent.

The New York Fed also crosses out a reference to an amendment of the company’s shortfall agreement and asks if including the amendment is “necessary or helpful?”

Dec. 24, 2008: AIG submits filing saying it retired another $16 billion in credit-default swaps after buying the underlying securities through Maiden Lane III, bringing the total collateralized debt obligations purchased to about $62 billion.

The filing omits the sentence that said “counterparties received 100 percent.”

The filing has the amendment to the shortfall agreement, which mentions Schedule A without including it.

Dec. 30, 2008: The SEC writes a letter to then-Chief Executive officer Edward Liddy telling AIG to provide a Schedule A for the shortfall agreement in its Dec. 24 and Dec. 2 filings. “You are required to file the entire agreement, including all exhibits, schedules, appendices and any document which is incorporated in the agreement,” the SEC’s letter says.

Jan. 13, 2009: Peter Bazos, an outside lawyer for the New York Fed, writes to AIG in an e-mail, asking the company to “Please omit/redact the column headings included in the Schedule” in an amendment of the Dec. 24, 2008, filing.

Diego Rotsztain, then an outside lawyer for the New York Fed, writes the company an e-mail saying “AIG should be getting a call from the SEC to discuss the special procedures to be followed in connection with the submission of the confidential- treatment request.”

Jan. 14, 2009: Anthony Greco, an outside lawyer representing AIG, writes to Bazos and asks, “We will defer to you on this, but could you please provide us the basis for the headings being confidential? The letter appears to be directed towards the information contained in the columns as opposed to the headings themselves.”

AIG files an amendment to the accord. In the page available to the public with the headline “Schedule A to Shortfall Agreement,” the insurer excludes the table listing banks, writedowns and collateral postings.

“The confidential portion of this Schedule A has been omitted and filed separately with the Securities and Exchange Commission,” AIG says in the filing. “Confidential Treatment has been requested for the omitted portions.”

Jan. 27, 2009: Geithner is sworn in as Treasury secretary and will be replaced at the New York Fed by William Dudley.

March 5, 2009: Senators including Christopher Dodd, a Connecticut Democrat, tell Federal Reserve Vice Chairman Donald Kohn that the regulator should reveal the banks that bought credit-default swaps from AIG.

“We need AIG to be stable and to continue in a stable condition,” Kohn tells a Senate panel. “And I would be very concerned that if we gave out the names of counterparties here, people wouldn’t want to be doing business with AIG.”

March 12, 2009: Kathleen Shannon, an AIG deputy general counsel, writes to the insurer’s executives in an e-mail about the conflicting pressures from the New York Fed and SEC regarding amendments to the filings. She says she believes the New York Fed doesn’t want the insurer to include names of the tranches of the securities tied to the swaps or their Committee on Uniform Securities Identification Procedures numbers, or CUSIPs.

“In order to make only the disclosure that the Fed wants us to make,” Shannon writes, “we need to have a reasonable basis for believing and arguing to the SEC that the information we are seeking to protect is not already publicly available.”

AIG’s then-General Counsel Anastasia Kelly e-mails the New York Fed a draft of a letter to the SEC saying that the insurer intends to withdraw its request for confidential treatment because some of the information had been reported by the media.

March 13, 2009: New York Fed lawyer James Bergin writes an e- mail to the New York Fed and AIG executives that he wants to set up a 2 p.m. conference call with the insurer and the SEC. “AIG is still confirming their comfort with certain of the redactions we’d like made on the 8-K schedule,” Bergin writes.

Bergin writes in a separate e-mail that “I’d suggest also we have a call among AIG and FRBNY prior to the 2 p.m. so that we have our ducks in a row.”

March 15, 2009: AIG, under pressure from regulators, releases a statement that discloses the names of its counterparties, which includes banks such as Goldman Sachs and Deutsche Bank AG. The counterparties received about $50 billion in forfeited collateral postings and Maiden Lane III payments since the Sept. 16, 2008, rescue, the statement says. The statement lists a sum of payments to each bank. It doesn’t identify the securities tied to the swaps or list the value of individual purchases by the banks.

March 16, 2009: AIG amends its Dec. 2 and Dec. 24 filings to include a list of derivative transactions and the insurer’s counterparties. The updated Dec. 2 filing includes a Schedule A that lists the names of counterparties on about 165 contracts, while the amended Dec. 24 filing includes about 180 contracts. AIG redacts the notional value of the trades, market declines, collateral posted, tranche names and CUSIPs. Each of the Schedule A documents includes the word “redacted” more than 800 times.

April 28, 2009: New York Fed posts a portfolio breakdown for Maiden Lane III on its Web site. The summary includes the value of assets that are tied to residential- and commercial-mortgage- backed securities and credit ratings for the holdings.

May 15, 2009: AIG amends its Dec. 2 and Dec. 24 filings to include the lists of collateral postings and mark-to-market losses on derivatives contracts. The amended Dec. 24 filing also includes the CUSIPs, tranche names and notional amounts for 10 contracts. The word “redacted” appears more than 400 times in each filing.

May 22, 2009: AIG may withhold the redacted information from Schedule A until Nov. 25, 2018, a decade after the date when Maiden Lane began purchasing assets, the SEC says.

The information “qualifies as confidential commercial or financial information under the Freedom of Information Act,” based on statements from AIG, the SEC says in a letter.

Nov. 17, 2009: Neil Barofsky, the special inspector general charged with policing the Troubled Asset Relief Program, says disclosure of swaps details didn’t bring on the “dire consequences” that Kohn said could accompany its release.

“Notwithstanding the Federal Reserve’s warnings, the sky did not fall; there is no indication that AIG’s disclosure undermined the stability of AIG or the market,” Barofsky wrote in a report. “The default position, whenever government funds are deployed in a crisis to support markets or institutions, should be that the public is entitled to know what is being done with government funds.”

Jan. 7, 2010: Bloomberg reports that e-mails obtained by Representative Darrell Issa show the New York Fed pressed AIG to withhold details from the public about the insurer’s payments to banks.

Jan. 8, 2010: Thomas Baxter, general counsel of the New York Fed, writes to lawmakers saying efforts to limit AIG’s disclosure “did not warrant” Geithner’s attention.

Jan. 13, 2010: Edolphus Towns, the New York Democrat who is chairman of the oversight committee, subpoenas Geithner’s e- mails, phone logs and meeting notes tied to the bailout of AIG.

Jan. 19, 2010: The New York Fed produces more than 250,000 pages of documents in response to the House subpoena. The regulator says that it “assisted AIG in ensuring the accuracy of its disclosures and protected important U.S. taxpayer interests.” AIG was responsible for its disclosures, and the New York Fed asked AIG to remove a reference to the bank payments because it wasn’t “precisely accurate,” the regulator says in a statement.

Fed actions Sept 16, 2008

On September 16, 2008, the Federal Reserve announced that it would lend to American International Group, Inc., (AIG) to provide AIG with the time and flexibility to execute a value-maximizing strategic plan. Initially, the FRBNY extended an $85 billion line of credit to the company. On October 8, 2008, the FRBNY was authorized to extend credit to certain AIG subsidiaries against a range of securities. The terms of the loan were disclosed on this website. The credit extended to AIG under both of these programs is presented in table 1 of the H.4.1 and included in "Other loans" loans in tables 9 and 10.

Fed actions Nov 10, 2008

On November 10, 2008, the Federal Reserve and the Treasury announced a restructuring of the government's financial support to AIG. As part of this restructuring, two new LLCs were created. On December 12, 2008, FRBNY began extending credit to Maiden Lane II LLC, a company formed to purchase residential mortgage-backed security (RMBS) assets from AIG subsidiaries.

Because this LLC is consolidated onto the balance sheet of the FRBNY, the loan from the FRBNY to the LLC is not on the balance sheet. To provide details about the loan and other information about the LLC, table 5 in the H.4.1 statistical release provides detail on the principal accounts of Maiden Lane II.

Fed actions Nov 25, 2008

On November 25, 2008, the FRBNY began extending credit to Maiden Lane III LLC, a company formed to purchase multi-sector collateralized debt obligations (CDOs) on which the Financial Products group of AIG had written credit default swap and similar contracts. Because this LLC is consolidated onto the balance sheet of the FRBNY, the loan from the FRBNY to the LLC is not on the balance sheet. To provide details about the loan and other information, H.4.1 statistical release table 6 provides detail on the principal accounts of Maiden Lane III.

Fed actions March 2, 2009

On March 2, 2009, the Federal Reserve and the Treasury announced a restructuring of the government's assistance to AIG. Specifically, the government's restructuring was designed to enhance the company's capital and liquidity in order to facilitate the orderly completion of the company's global divestiture program.

American International Group said on Monday that it had reached a revised rescue deal with the U.S. government, warding off for now the prospect of crippling credit rating downgrades.

The new deal is the latest revamp to the rescue package, which had already seen the U.S. Treasury and the Federal Reserve give AIG a commitment for $150 billion (107 billion pounds) in government funds.

Here are the key features:

  • New equity capital commitment: Up to $30 billion equity line from the $700 billion Troubled Asset Relief Program, with a five-year term.
  • Terms of Treasury's $40 billion preferred investment eased: The new deal increases equity content of the preferred stake and reduces the annual cost of servicing dividends by more than $4 billion.
  • ALICO & AIA: Foreign life operations American International Assurance (AIA) and American Life Insurance Co (Alico) will be put in special purpose vehicles. The New York Federal Reserve will get preferred stock in the vehicles in return for a reduction in the outstanding balance by up to $26 billion of its $60 billion credit line.
  • Life insurance securitization: AIG plans to give the Fed securitization notes of up to $8.5 billion representing the embedded value of some U.S. life insurance businesses to further reduce government debt.
  • Credit facility: The total amount available to AIG under the facility will remain at least $25 billion.
  • Interest rate cut: The Libor floor on credit facility to be removed, saving AIG about $1 billion per year.
  • AIU Holdings Inc: A new general insurance holding company with AIG's Commercial Insurance Group, Foreign General unit, and other property and casualty operations to be formed. AIG plans to sell a minority stake in AIU. A source with direct knowledge of the matter told Reuters earlier that up to 20 percent of the business may be sold to public, and over time it could be sold off in its entirety.

AIG's Federal Reserve supervisor Sarah Dahlgren

"...Sarah Dahlgren, a New York Fed banking supervisor dispatched to oversee AIG, endorsed the strategy. She had spent nearly two decades at the New York Fed. But she had no experience in the insurance business and relied on the accounting firm of Ernst & Young for insurance advice.

The Fed largely took a hands-off approach to AIG's insurance operation, partly because it felt that too heavy a government presence could make AIG seem weaker and drive away business.

The dozen Fed staffers under Ms. Dahlgren set up shop in AIG's headquarters in Lower Manhattan and focused on the parts of the company that were bleeding red ink. Special attention was paid to AIG Financial Products, which sold contracts that promised to protect major financial institutions against default on securities backed by subprime mortgages. Those contracts called for AIG to come up with billions of dollars in collateral if the value of the contracts fell, a requirement that nearly sank the firm in September.

Ms. Dahlgren had "observer" status at meetings of the AIG board and its committees, and when asked, she made clear the Fed's view on specific issues that arose. "Everything we do, we do in partnership with the Federal Reserve," Mr. Liddy said at Wednesday's hearing.

For instance, when AIG faced the threat of ratings downgrades, the Fed ultimately talked with rating agencies directly, explaining in late February the new government support that would be announced publicly in early March. The government's move prevented the debilitating downgrade that was feared."

Crisis history

Beginning in 2005, AIG became embroiled in a series of fraud investigations conducted by the Securities and Exchange Commission, U.S. Justice Department, and New York State Attorney General's Office. Greenberg was ousted amid an accounting scandal in February 2005; he is still fighting civil charges being pursued by New York state.[3] [4]

The New York Attorney General's investigation led to a $1.6 billion fine for AIG and criminal charges for some of its executives.[5] Greenberg was succeeded as CEO by Martin J. Sullivan, who had begun his career at AIG as a clerk in its London office in 1970.

On June 15, 2008, after disclosure of financial losses and subsequent to a falling stock price, Sullivan resigned and was replaced by Robert B. Willumstad, Chairman of the AIG Board of Directors since 2006. Willumstad was forced by the US government to step down and was replaced by Edward M. Liddy on September 17, 2008.[6]

Currently the firm is lead by:

  • Harvey Golub, Chairman[7]
  • Robert Benmosche, President and Chief executive officer
  • David L. Herzog, Chief financial officer and EVP

Chronology of September, 2008 liquidity crisis

Link here to Wikipedia's account of these events.

Federal Reserve bailout

On the evening of September 16, 2008, the Federal Reserve Bank's Board of Governors announced that the Federal Reserve Bank of New York had been authorized to create a 24-month credit-liquidity facility from which AIG could draw up to $85 billion.

The loan was collateralized by the assets of AIG, including its non-regulated subsidiaries and the stock of "substantially all" of its regulated subsidiaries, and with an interest rate of 850 basis points over the three-month LIBOR (i.e., LIBOR plus 8.5%).

In exchange for the credit facility, the U.S. government received warrants for a 79.9 percent equity stake in AIG, with the right to suspend the payment of dividends to AIG common and preferred shareholders.(Federal Reserve-Press Release-2008-09-16)

The credit facility was created under the auspices of Section 13(3) of the Federal Reserve Act.[8]

AIG's board of directors announced approval of the loan transaction in a press release the same day. The announcement did not comment on the issuance of a warrant for 79.9% of AIG's equity, but the AIG 8-K filing of September 18, 2008, reporting the transaction to the Securities and Exchange Commission stated that a warrant for 79.9% of AIG shares had been issued to the Board of Governors of the Federal Reserve. [9] [10] [11]

AIG drew down US$ 28 billion of the credit-liquidity facility on September 17, 2008.[12]

On September 22, 2008, [13] AIG was removed from the Dow Jones Industrial Average.

An additional $37.8 billion loan was extended in October. As of October 24, [14] AIG had drawn a total of $90.3 billion from the emergency loan, of a total $122.8 billion.

The constitutionality of the portion of the “Emergency Economic Stabilization Act of 2008”, which appropriated $40 billion in taxpayer money to fund and financially support AIG and resulted in the federal government’s majority ownership interest in AIG, is currently pending ruling in the Federal District Court.(Kevin Murray v. Treasury Secretary Timothy Geithner and the Federal Reserve Board represented by The Department of Justice).

AIG payments to counterparties

AIG Schedule A Shortfall Agreement

"...The troubled insurer tried to publicly disclose these details in December 2008 before being thwarted by the Geithner-led New York Fed. A month later Geithner left to head the Treasury Department.

Issa said that the public had a right to see the document. "I mean, think about it: What the government owns it can keep as long as it wants. It would be like saying you can't appraise federal land. Why? It is one of those things that's outrageous. We know we paid a hundred percent for them. We know who got the money. This document shows who ultimately were the beneficiaries. And we believe since that they've asked to have it locked up until 2018 -- and nobody today defended that -- that it's time to release that," Issa said.

A government audit this month found that as of Sept. 30, 2009, the Treasury Department was expecting a $30 billion loss on its TARP-related AIG investment. The value of the securities could ultimately rise, though.

"The way the AIG bailout was engineered was to specifically benefit Goldman Sachs and its trading partners," said Janet Tavakoli, a Chicago-based derivatives expert and founder of Tavakoli Structured Finance. "Goldman's past and present officers used crony capitalism to put their own interests ahead of the public."

The nation's fifth-largest bank by assets ultimately got $14 billion through what members of Congress are calling a "backdoor bailout" of the world's biggest banks.

"The suppression of the details of the [credit default swap] trades protected Goldman Sachs and its trading partners," said Tavakoli, who's examined Goldman's credit default swap arrangements with AIG. "The $182 billion bailout overall kept AIG alive, and its trading partners, including Goldman Sachs, benefited from the funds made available to the securities lending transactions and other subsequent trading transactions."

At the time the document was prepared, Goldman's $14 billion in souring derivatives had a market value of just $6 billion. Goldman had more than $8 billion in collateral from AIG to protect it from losses, meaning it was still about $6 billion short...

AIG disclosure on counterparty payments

Source: A.I.G. Payments to Counterparties Original Document (PDF) New York Times, March 15, 2009

"Collateral on Derivatives:

Many of the institutions that received the Fed payments were owed money by A.I.G. because they had bought its derivatives, known as credit-default swaps — in essence, a type of insurance intended to protect buyers should their investments turn sour.

As it turned out, many of their investments did sour, because they were linked to subprime mortgages and other shaky loans. The swap contracts called, in many cases, for A.I.G. to post collateral to its customers if their investments lost value, or if A.I.G.’s own credit rating went down.

When A.I.G.’s credit rating was indeed downgraded last September, the company suddenly owed billions of dollars in collateral and was unable to honor its promises. That left its trading partners exposed to potentially big losses."

An annotated version of an announcement by American International Group on March 15, 2009, outlining the counterparties involved in credit default swaps and other transactions in which bailout funds were used to meet A.I.G. obligations.

Rating agencies role in AIG crisis

The insufficiently unexamined issue regarding the timing of AIG’s downfall is the AAA pyramid scheme embedded inside of AIGFP’s CDO portfolio. The ratings agencies defined reality in the alternate universe of CDOs, where bona fide due diligence was impossible and opportunities for abusive self dealing were rife.

The newly released CUSIPS, which more of less confirm the information yielded from the prior memo obtained by CBS. And again, the noteworthy point is that, on September 15, 2008, almost none of the subject CDO tranches had been seriously downgraded. They had all been rated Aaa at closing. Their ratings collapsed a few months later. There’s abundant circumstantial evidence that the ratings agencies delayed and dragged out the downgrade announcements for these black box CDOs. But they had must have done the math, and realized that AIG’s reliance on their ratings proved to be fatal.

(Click here for image of Moody's ratings of AIG's CDO portfolio

That’s why I believe that the ratings agencies, cognizant of their indirect role in setting up AIG for its demise, would have been receptive to a request by the U.S. government on September 15, 2008 to show some forbearance and delay announcement of a downgrade just at the moment when the Lehman bankruptcy was close to setting off a financial panic. The downgrades made all the difference in the world, everyone knew it, and the refusal by Dan Jester, Paulson’s special deputy, to forcefully ask Moody’s for a delay in the downgrade is shocking beyond words.

Goldman Sachs drove most costly AIG bargain

"Goldman Sachs Group Inc. was the most aggressive bank counterparty to American International Group Inc. before its bailout, demanding more collateral while assigning lower values to real estate assets backed by the insurer, documents obtained by lawmakers show.

A month before the September 2008 rescue, Goldman Sachs approached AIG about tearing up contracts protecting the bank against losses on collateralized debt obligations, or holdings backed by mortgages, according to a BlackRock Inc. presentation dated Nov. 5, 2008. Goldman Sachs was the only counterparty willing to cancel the credit-default swaps and bear the risk of further CDO losses, provided that AIG make payments based on the bank’s larger-than-average estimate of market declines.

“Goldman Sachs is the least risk-averse counterparty,” according to the presentation, which was prepared by the asset manager for AIG and later given to the Federal Reserve Bank of New York. The firm is “the only counterparty willing to tear up CDS with AIG at agreed-upon prices and retain CDO exposure.” The document was obtained by the Congressional panel scheduled to hold a hearing tomorrow on AIG’s $182.3 billion bailout.

The presentation offers the clearest picture yet of the negotiations between AIG and its counterparties before a rescue that fully reimbursed banks including Goldman Sachs for $62.1 billion in CDOs. The BlackRock materials indicate that Goldman Sachs, which has been pilloried by lawmakers for its dealings with AIG, may have been betting that the securities would rebound from the values it assigned to them..."

Goldman was an AIG conduit which was fully hedged

"...Yet one wonders just how many billions of dollars Goldman had in margin variation between collateral posted to it via AIG, and how the amount of money it had paid to buyers of CDS sold by Goldman. We are certain that since no Goldman client had the same negotiating power as Goldman did with AIG, Goldman likely had a positive balance in the hundreds of millions if not billions simply on the collateral variance.

As page 10 indicates, whereas all counteparties had requested collateral at a price for the underlying CDOs of 49, Goldman was extremely aggressive, demanding collateral for a price-equivalent of 37. The latter compares to a BlackRock model price for Goldman of 44, meaning that even the Fed's advisor in good faith could not recommend such a generous treatment of Goldman in the context of all its other counterparties. Were Goldman to receive the same collateral as everyone else, it would be due 8.1 billion: $1 billion less than the 10/24 collateral request.

Now keep in mind, that of the top 5 counterparties, SocGen, GS, Deutsche Bank, Merrill and Calyon, only Goldman had subsequently sold off its entire CDO book: once again implying that unlike the other 4 firms, who at least held the exposure on their own balance sheet, and thus one can say deserved to receive some insurance, Goldman had bought then sold its entire portfolio, in essence making Goldman nothing than an AIG conduit, which was fully hedged and, as noted above, only had counterparty risk, yet which had the benefit of up to $1 billion in excess cash on its books due to day-to-day marking of its CDS exposure and its advantage collateral arrangement.

Futhermore, as Goldman owned CDS on AIG itself (as a counterparty hedge), Goldman had absolutely no risk in its relationship with AIG whatsoever!!! Of course, It is critical to remember that Goldman not only received par between the collateral previously posted to it, and actual cash from Maiden Lane III, it also made billions by selling actual AIG CDS (which as we claimed previously was done while in possession of material non-public information). Amusingly, while Goldman bought all of its CDO protection from AIG exclusively, it definitely used a very broad seller base when it loaded up on the actual AIG protection. Therefore, Goldman's only, ONLY risk, was that of a complete systemic collapse and the repudiation of all contracts, CDS and otherwise. Which is why Goldman's various agents did everything they could to prevent that from happening, up to and including loading the Federal Reserve with trillions of toxic debt in the upcoming 12 months.

And speaking of the Federal Reserve, while reading the SocGen section, we came across this little stuner on page 3:

We have heard second-hand from a trader that Soc Gen has pledged much of the portfolio to the Fed discount window for future liquidity

Aside from the fact that in October 2008 France-based Soc Gen was not a Primary Dealer (it only just applied for this position a few weeks ago), one needs to turn to page 5 of the presentation to realize that Soc Gen's portfolio had a value of 49 cents on the dollar. What this implies is that in October of last year (and ostensibly prior) Soc Gen, a foreign, non Primary Dealer, had access to the Federal Reserve's Discount Window, where it had pledged securities that had a value of 49 cents on the dollar, and for which the Fed would have taken arguably no haircut, thereby funding the French firm at par for securities that were worth less than half, and which the taxpayer was on the hook for. Indeed, these securities may well have been completely worthless: lower on page 3 we read:

Soc Gen and AIG are currently in dispute over existing events of default and credit events under transaction [ineligible] for 2 deals, totaling $650 million of notional exposure.

We would not be at all surprised if the defaulted securities were part of the crap that had been given to Tim Geithner, at the time head of the New York Federal Reserve.

And what Soc Gen was doing by pledging reference assets to the Fed, we are certain that all the other counterparties (those which unlike Goldman still held on to the securities) were doing as well.

The fact that the Fed was willing to risk taxpayer capital with such reckless abandon, first in the form of accepting literally worthless reference securities from Soc Gen (as documented by BlackRock), and subsequently by bailing out Goldman at well over par (remember the money the firm made on its actual AIG counterparty-risk) protection, would have been sufficient to terminate Geithner's career in any self-respecting banana republic. Too bad America is no longer even that."

Secret AIG document shows Goldman Sachs minted most toxic CDOs

"...Tavakoli also says that the poor performance of the underlying securities (which are actually specific slices or tranches of CDOs) shows they were toxic in the first place and were probably replenished with bundles of mortgages that were particularly troubled. Managers who oversee CDOs after they are created have discretion in choosing the mortgage bonds used to replenish them.

“The original CDO deals were bad enough,” Tavakoli says. “For some that allow reinvesting or substitution, any reasonable professional would ask why these assets were being traded into the portfolio. The Schedule A shows that we should be investigating these deals.”

Among the CDOs on Schedule A with notional values of more than $1 billion, the worst performer was a tranche identified as Davis Square Funding Ltd.’s DVSQ 2006-6A CP. It was held by Societe Generale, underwritten by Goldman Sachs and managed by TCW Group Inc., a Los Angeles-based unit of SocGen, according to Bloomberg data. It lost 77.7 percent of its value -- though it isn’t in default and continues to pay.

SocGen spokesman James Galvin and TCW spokeswoman Erin Freeman declined to comment..."

Bebchuk - "Haircut" derivatives counterparties

"The AIG bailout — at $170 billion and rising — may end up as the costliest rescue of a single firm in history. There is much debate about bonuses paid to AIG’s executives. But there is far too little debate on the government’s willingness to back all of AIG’s obligations.

The company claims any failure by the government to do so would have catastrophic consequences. This claim is exaggerated. Serious consideration should be given to forcing AIG’s partners in derivative transactions — which are mainly buyers of credit default swaps from the company — to take a substantial haircut.

AIG is a holding company, conducting most of its business through insurance subsidiaries organized as separate legal entities. The financial products subsidiary, which has produced the huge losses from derivative transactions that brought AIG down, is also a separate legal entity — but AIG has guaranteed the subsidiary’s obligations.

While AIG has thus far been able to cover derivative losses using government funds, the possibility of large additional losses must be recognized. AIG recently stated that it still has about $1.6 trillion in “notional derivatives exposure.” Suppose, for example, that AIG ends up with losses equal to, say, 20% of this exposure — that is, $320 billion. Suppose also that the value of AIG’s current assets, including the shares in its insurance subsidiaries, is $160 billion. In this scenario, the government’s fully backing AIG’s obligations would produce an additional loss of $160 billion for taxpayers. Should the government be prepared to do so? The alternative would be to put AIG into Chapter 11. In this case, AIG’s creditors, including its derivative counterparties, would obtain the company’s assets. They would end up with a 50% recovery on their claims, bearing those $160 billion of losses themselves.

AIG recently stated that failure to meet all of the company’s obligations could lead to a “run on the bank” by customers seeking to surrender insurance policies and “would have sweeping impacts across the economy.” But insurance policyholders wouldn’t be at risk if AIG failed to meet its obligations. The insurance subsidiaries are not responsible for the debts of their parent AIG, and insurance policy claims are backed both by the subsidiaries’ required reserves and state insurance funds.

Still, what about the concern that losses to derivative counterparties — which are now known to include major U.S. and foreign banks — would substantially deplete the capital of some of them? That concern would be best addressed by the U.S. government (or foreign governments in the case of their banks) infusing capital directly — in return for shares — into the banks that need it. There is no reason to back AIG’s obligations as an instrument for infusing capital (with taxpayers getting nothing in return) into, say, Goldman Sachs or Spain’s Banco Santander.

It is true that the collapse of Lehman Brothers last September led to a crisis of confidence among depositors in banks and money-market funds, which had a dramatic effect on markets. Letting AIG’s derivative counterparties take a significant haircut, however, should not lead to such a crisis. AIG’s obligations are to derivative counterparties, not to depositors. Moreover, governments world-wide are now committed to backing fully the claims of depositors in financial institutions.

It is important to understand that the government can also employ intermediate approaches between fully backing AIG’s derivative obligations and no backing. For example, the government could place AIG in Chapter 11, but commit to provide supplemental coverage that would make up any difference between the value that creditors would get from AIG’S reorganization and, say, an 80% recovery. Such an approach could allow setting different haircuts for different classes of creditors. The government, for example, might elect not to provide such supplemental coverage to executives owed money by AIG.

At a minimum, the government should conduct “stress tests,” estimating potential losses in alternative scenarios, and formulate a policy on the magnitude and fraction of derivative losses it would be willing to cover. A policy that doesn’t fully back AIG’s obligations should be seriously considered.

Mr. Bebchuk is a professor of law, economics and finance, and director of the corporate governance program at Harvard Law School. This op-ed is based on his forthcoming paper, “Is AIG Too Big To Fail?”

Treasury had refused to provide a guarantee

"...Amid this increasingly perilous situation, Fed officials discussed how to eliminate the risk of even more collateral calls, the internal documents show. One proposal involved the government guaranteeing the contracts; this meant the banks would no longer be able to demand collateral because the government would cover any losses on the mortgage bonds. Many of the bonds on which A.I.G. had posted collateral had not defaulted; instead, their market prices had dropped.

Under this proposal, the $30 billion in collateral would have been returned to the insurer to help pay off some of its loan from the Fed, the documents show. A.I.G. executives may have preferred this approach because it would have reduced the company’s reliance on the government rather than expand it.

This alternative, though, would have most likely met with opposition from the company’s counterparties, which would have had to return to A.I.G. all the collateral they had received over the previous year. But with the failure of Lehman Brothers and the seizing up of the money markets still fresh in everyone’s minds, bankers wanted to keep as much cash on hand as possible. According to an Oct. 26, 2008, presentation by Morgan Stanley, an adviser to the Fed, Goldman would have had to return $7.1 billion to A.I.G. and Merrill, $3.1 billion.

The debate within the Fed centered on which part of the government could provide the guarantee, according to the documents. Staff at the Board of Governors told Fed officials in New York that a Fed guarantee “was off the table,” according to an e-mail message to Mr. Geithner and others on Oct. 15 from Sarah Dahlgren, the New York Fed official overseeing the A.I.G. rescue.

“We countered with questions about why it was so clearly off the table and suggested, as well, that perhaps this was something that Treasury could do,” Ms. Dahlgren continued.

Supporters of the plan considered a guarantee a good option because A.I.G.’s debt rating was at risk of a downgrade by the credit rating agencies and the company would then have to post more collateral with the banks.

“If a ratings downgrade happens at any time in the next three weeks or afterward, we will need this to protect any value in the insurance companies and, importantly, to avoid a disorderly seizure,” Ms. Dahlgren wrote.

The New York Fed pursued the guarantee option with the Treasury, the documents indicate. But by Oct. 23, the Treasury had refused to provide the guarantee, according to an e-mail message sent by Ms. Dahlgren to Mr. Geithner. In early November, the Fed decided to make the counterparties whole on their insurance contracts."

Banque de France - AIG's French regulator

Banque AIG is authorized by the Banque de France, and is regulated by the Comité des Établissements de Crédit et des Entreprises d'Investissement, the Commission Bancaire and the Autorité des marchés financiers, in France..."

The Federal Reserve's decision to pay billions of dollars to Goldman Sachs Group Inc. and other big banks as part of its bailout of American International Group Inc. has spawned criticism and conspiracy theories. Treasury Secretary Timothy Geithner, who presided over the New York Fed at the time, was summoned to Congress to explain why AIG paid off the $62.1 billion in soured derivatives in full, far more than they were worth in the market.

One element of the decision hasn't been well explored—how the Fed agreed to the full-payment demands of France's bank regulator and two of AIG's largest creditos, Société Générale SA and Calyon Securities, a unit of Crédit Agricole SA. The French banks and their regulator, it now appears, masterfully outmaneuvered the Americans to avoid discounts, or "haircuts," on their securities.

The Federal Reserve gave in to French demands for full payment for two of AIG's largest creditors, Société Générale SA and Calyon Securities, a unit of Crédit Agricole SA. Dennis Berman says the Fed was had.

The French won the day by using a legal argument that some leading French scholars and corporate attorneys variously described in interviews as highly dubious and lacking real legal ground.

The banks and the regulator, known as the Commission Bancaire, said bank executives could be criminally liable for accepting a discount on their contracts, according to a November report of the inspector general of the Troubled Asset Relief Program.

While true in the abstract, "their argument was very overstated," said Pierre-Henri Conac, a University of Luxembourg law professor and a director of France's oldest corporate-law review. "Banks give haircuts every day."

French banks aren't always the best negotiators, Mr. Conac added, but this time "the French were very good."

A spokeswoman for the Commission Bancaire said "you're the first to call" when asked about the issue, but otherwise declined to comment. Officials for SocGen and Calyon also declined repeated requests for comment, as did a representative for Mr. Geithner.

It's easy, of course, to second-guess the behavior of people caught in the confused, scary world of late 2008. Yet a look at the French role is a reminder of how much of that period remains unexplained. Congress might want to ask: Why did the Fed show such little vigor attacking what now appears a legal Maginot Line?

In November 2008, the Fed, having already committed $85 billion to rescue AIG, was worried about a set of AIG holdings tied to mortgage securities that were draining cash from the company, according to the inspector general's report.

At the top of the counterparty list: Société Générale, with $16.5 billion in contracts. Calyon Securities, part of Crédit Agricole, was sixth, with $4.3 billion. Goldman Sachs was second with $14 billion.

The Fed and AIG finally seized on a plan, according to the inspector general's report. Step one: Let the banks keep $35 billion of collateral already posted by AIG. Two: Purchase the banks' underlying securities, which were derivatives tied to low-grade mortgages. Three: Cancel the contracts. Over one frenzied weekend in early November, Fed and AIG officials struggled with the final step: What should they pay for those securities? By contract, the banks were guaranteed full payment.

There were some factors to suggest a lower, negotiated price was in order. The securities' market value had fallen significantly. And absent the extraordinary U.S. bailout, AIG would have been in bankruptcy, potentially leaving counterparties with zero.

A call went out from the New York Fed to Société Générale and Calyon, as well as to France's Commission Bancaire, according to the report by Neil Barofsky, the TARP inspector general. They wanted to treat all the parties equally. By demanding payment in full, the French helped the other banks get the same treatment.

"\[T\]he French banks concluded they were precluded by law from making concessions and could face potential criminal liability for failing to comply with their duties to shareholders," Mr. Barofsky found in interviews with Fed officials.

The French were "indignant that we would even contemplate asking for this," added one person close to the New York Fed.

Other banks, including Goldman Sachs and Merrill Lynch, rebuffed the Fed on similar grounds at the same time. In the end, no one took a haircut. But the response from the French "played a significant role in complicating" the Fed's efforts at structuring haircuts for all the parties, Mr. Barofsky wrote.

There also were deep worries about stability of the financial system. And it was important to show that contract law was being respected, said the person close to the New York Fed. "Price was a worry, but not the only worry," added this person.

Yet there appear plenty of grounds for challenging the French conclusion, said lawyers and law professors.

"To say that these people would have gone to jail if they cut a deal and signed the same agreement as Goldman Sachs is really pushing beyond what goes on in France," said Christopher Mesnooh, a partner at Paris's Fields Fisher Waterhouse who has authored a book on French corporate law.

"There is no clear-cut provision that would have prevented SocGen or Calyon" from negotiating a discount, said one of Paris' top lawyers, who asked not to be named because he works for the banks.

More information may shake loose as Congress continues its study of AIG. At the upcoming hearings, one can only hope the French role is carefully examined. There may well have been compelling reasons for making good on the $20.8 billion owed the French banks. But —as is now clear—not for the legal reason that the Fed and the French banks claim.


"The two top executives have resigned at the French unit of the American International Group’s financial products business, the insurer said Thursday, as part of an exodus of employees after an outcry over bonuses.

Mauro Gabriele, the president and chief executive of Banque A.I.G., and his deputy, Jim Shephard, resigned because of “shared concerns regarding their ability to conduct business in the current hostile environment toward Banque A.I.G. and A.I.G. F.P. employees generally,” the company said in a statement from New York, referring to A.I.G. Financial Products.

The financial products division, based in London, helped to create the credit-default swaps that are blamed for causing A.I.G. to nearly collapse, necessitating a taxpayer rescue that so far has led to more than $170 billion in bailout funds from the federal government being pumped into the company. News of the Banque A.I.G. resignations was first reported Thursday by The Wall Street Journal.

The departure of the two executives could, in theory, have prompted a default on $234 billion of credit-default swaps. French regulators could have appointed provisional administrators to the job, a move with the potential to activate a “change of control” provision in the derivatives contracts. In practice, neither French regulators nor the American government would have allowed that to happen, officials say.

A.I.G. said it had cautioned Treasury Secretary Timothy F. Geithner in a March 14 letter “that resignations at Banque A.I.G. could raise risks with respect to derivatives written out of Banque A.I.G., and we are in ongoing discussions with French and U.K. regulators, as well as with the Federal Reserve Bank of New York and the U.S. Treasury Department, about this matter.”

The executives “are fully committed to ensure that Banque A.I.G. continues to operate normally and meet its obligations in these extraordinary conditions,” the A.I.G. statement said, “and, as a result, they remain in their roles and have committed to effect an orderly transition. “

Xavier Dubois, a spokesman for the Banque de France, the central bank, declined to comment.

An A.I.G. spokeswoman, Christina Pretto, said the financial products division continued to unwind derivatives contracts. It has reduced the number of trades outstanding by almost 40 percent, to 44,000, she said. The notional value of the outstanding derivatives contracts had fallen to $1.6 trillion by year-end, from $2.1 trillion a year ago, she said."

Bebchuk - The government, AIG and Chapter 11

"... A United States Special Inspector General recently issued a report criticizing the US government for failing to insist that AIG’s counterparties in the market for financial derivatives bear some of the costs of bailing out the company. Indeed, bailouts of failed institutions should never extend the government’s safety net to such counterparties.

The AIG bailout was one of the largest in history, with the US government injecting more than $100 billion into the company. The bailout was brought about by AIG’s large losses on derivative transactions with financial institutions, mostly sophisticated players such as Goldman Sachs and Spain’s Banco Santander.

After the government’s infusion of funds in September 2009, AIG’s losses continued to mount, so the government provided substantial amounts of additional capital two months later. At this point, the government asked AIG’s derivative counterparties to take a voluntary “haircut” – that is, accept a discount on the amount owed to them. When some of these parties refused, the government backed down and financed AIG’s payment of all of its derivative obligations in full.

The US government felt that it had a weak hand, because it was not prepared to allow AIG to default on any of its obligations. This was a mistake. The government should have been prepared to place AIG into reorganization under Chapter 11 of the US bankruptcy code and force the derivative parties to take the desired haircut.

AIG is a holding company, and most of its business is conducted through insurance subsidiaries organized as separate legal entities. The huge losses on derivate transactions were generated by AIG’s financial products unit. Although this unit was also a separate legal entity, AIG guaranteed its obligations toward derivative counterparties.

Had the government placed AIG into Chapter 11 reorganization in November 2008, AIG’s creditors, including its derivative counterparties, would have ended up with the value of AIG’s assets, which consisted mainly of shares in AIG’s insurance subsidiaries. Without necessarily affecting the operations of AIG’s insurance subsidiaries, the reorganization process would have simply shifted ownership of AIG’s assets from AIG’s existing shareholders to AIG’s creditors.

To the extent that the value of these assets would not have been sufficient to cover all of the derivative creditors’ claims, they would have had to bear some losses. Would that have been an unacceptable outcome? Not at all.

The government’s reluctance to use such a process might have been motivated by AIG’s major role in insurance markets around the world. But a reorganization of AIG and a shift in its ownership should not have been expected to endanger insurance policyholders. The insurance subsidiaries were not responsible for the obligations of their parent company, and their claims toward policyholders were backed by required reserves.

In any event, concerns about insurance policyholders should have led, at most, to a governmental commitment to back their claims if necessary. It did not require taxpayers to bail out the parent company’s derivative counterparties.

The government might also have been motivated by concerns that losses to the derivative counterparties would deplete the capital of some significant financial institutions at a difficult time. Again, such concerns would have been better addressed in different ways – in particular, by providing institutions that needed capital with funds directly, and in return for securities. To address a potential capital shortage at Goldman Sachs, say, taxpayers would have been better off providing $13 billon to Goldman in exchange for Goldman securities with adequate value, rather than footing the bill for the $13 billion that AIG gave to Goldman.

In the future, governments should not bail out failing financial institutions’ derivative counterparties, even when they provide a safety net to some of these institutions’ creditors (such as depositors). Governments should not only follow such a policy, but also make absolutely clear in advance their commitment to doing so. Communicating such a commitment clearly would induce parties to derivative transactions not to rely on a governmental safety net, but to monitor whether their partners have adequate reserves.

A governmental commitment to exclude derivative creditors from any safety net extended when financial institutions fail would reduce future costs to taxpayers from cases like AIG. Indeed, it would reduce the likelihood that cases like AIG would ever arise.

Dinallo on ringfenced AIG assets

"... The only reason that the federal rescue of AIG is possible is because there are strong operating insurance companies that provide the possibility that the federal government and taxpayers will be paid back. And the reason why those insurance companies are strong is because state regulation walled them off from non-related activities in the holding company and at Financial Products.

In most industries, the parent company can reach down and use the assets of its subsidiaries. With insurance, that is greatly restricted. State regulation requires that insurance companies maintain healthy reserves backed by investments that cannot be used for any other purpose. I’ve said that the insurance companies are the bars of gold in the mess that AIG has become. There are activities that the states need to improve, such as licensing and bringing new products to market. But where we are strong has been in maintaining solvency.

I would note that at a time when financial services firms are in trouble because they do not have adequate capital and are too highly leveraged, at a time when commercial banks and investment banks have very serious problems, insurance companies remain relatively strong.

There is justified concern about AIG’s securities lending program, which affects only AIG’s life insurance operations. I would like to review for you some facts about that program and the actions the New York Department has taken in regards to that program. It is important to understand that securities lending did not cause the crisis at AIG. AIG Financial Products did. If there had been no Financial Products unit and only the securities lending program as it was, we would not be here today. There would have been no federal rescue of AIG. Financial Products’ trillions of dollars of transactions created systemic risk. Securities lending did not...

... In 2008, New York and other states began quarterly meetings with AIG to review the securities lending program. Meanwhile, the program was being wound down in an orderly manner to reduce losses. From its peak of about $76 billion it had declined by $18 billion, or about 24 percent, to about $58 billion by September 12, 2008. At that point, the crisis caused by Financial Products caused the equivalent of a run on AIG securities lending. Borrowers that had reliably rolled over their positions from period to period for months began returning the borrowed securities and demanding their cash collateral. From September 12 to September 30, borrowers demanded the return of about $24 billion in cash.

The holding company unit that managed the program had invested the borrowers’ cash collateral in mortgage-backed securities that had become hard to sell. To avoid massive losses from sudden forced sales, the federal government, as part of its rescue, provided liquidity the securities lending program. In the early weeks of the rescue, holding company rescue funds were used to meet the collateral needs of the program. Eventually the Federal Reserve Bank of New York created Maiden Lane II, a fund that purchased the life insurance companies’ collateral at market value for cash.

There are two essential points about this. First, without the crisis caused by Financial Products, there is no reason to believe there would have been a run on the securities lending program. We would have continued to work with AIG to unwind its program and any losses would have been manageable. In fact, the New York Department has worked and continues to work with other insurance companies to unwind their securities lending programs with no serious problems. Second, even if there had been a run on the securities lending program with no federal rescue, our detailed analysis indicates that the AIG life insurance companies would not have been insolvent. Certainly, there would have been losses, with some companies hurt more than others. But we believe that there would have been sufficient assets in the companies and in the parent to maintain the solvency of all the companies. Indeed, before September 12, 2008, the parent company contributed slightly more than $5 billion to the reduction of the securities lending program.

But that is an academic analysis. Whatever the problems at securities lending, they would not have caused the crisis that brought down AIG. And without Financial Products and the systemic risk its transactions created, there would have been no reason for the federal government to get involved. State regulators would have worked with the company to deal with the problem and protect policyholders...

...On September 22, 2008, the Department sent what is known as a Section 308 letter to all life insurance companies licensed in New York requiring them to submit information relating to security lending programs, financing arrangements, security impairment issues and other liquidity issues. My staff then conducted a thorough investigation of the securities’ lending programs at New York life insurance companies. The results were reassuring. Almost all of the companies had modest sized programs with highly conservative investments, even by today’s standards. Companies with larger programs had ample liquidity to meet redemptions under stress. What became clear was that AIG, because of the Financial Products problems, was in a uniquely troubling situation...

... Our primary principle throughout the effort to assist AIG has been to continue to protect insurance company policyholders and stabilize the insurance marketplace. And it is appropriate to recognize that all our partners in this effort, including officials from the Federal Reserve Bank of New York, the Federal Reserve Board, the U.S. Treasury, AIG executives and their financial advisors, investment and commercial bankers, private equity investors, other state regulators at all times understand and agree that nothing should or would be done to compromise the protection of insurance company policyholders. The dependable moat of state regulation that protects policyholders remains solid..."

Greenberg alleges Goldman Sachs behind AIG's collapse

" Hank Greenberg, former chief executive officer at American International Group Inc., said Goldman Sachs Group Inc. is responsible for the collapse of the insurer during the economic crisis, the Wall Street Journal reported yesterday.

“It certainly wouldn’t be difficult to come to that conclusion,” Greenberg is quoted as telling the newspaper.

Greenberg blamed new standards for credit-default swaps - -pushed by Goldman or Deutsche Bank AG, he said -- and subprime, housing-backed derivatives sold and then shorted by Goldman as contributing to AIG’s collapse, the newspaper reported.

“Mr. Greenberg appears to base his views on news reports rather than facts,” Lucas van Praag, a Goldman spokesman, said in an e-mail to Bloomberg News. “It is interesting that he doesn’t mention the devastating conclusions about AIG reached by the company’s own auditors.”

To contact the reporters responsible for this story: Sylvia Wier at swier@bloomberg.net; Vivek Shankar at vshankar3@bloomberg.net

Multi-sector CDOs and AIGFP

AIGFP was not regulated by any financial oversight agency. It didn’t even have to keep reserves on potential payouts on these CDSs, and even if it did, it has stated that the reserve amount would have been very small because it did not anticipate significant losses on the underlying debt instruments it was insuring. What AIGFP had going for it, and what the banks liked, was that it was a wholly-owned subsidiary of AIG, which carried a Aaa rating in its own name for everything it did. By virtue of this rating, AIG was viewed as one of the highest quality companies in the financial world – almost as safe and sound as a government.

The most common type of CDOs brought to AIGFP were called multi-sector: they had a little bit of everything mixed into them – loans, bonds, mortgage-backed securities on sub-prime mortgages as well as higher-quality instruments like prime mortgages. As long as none of these different types of instruments experienced unusual rates of default, the entire CDO would be traded on the market at a price close to par, and the ratings agencies would have no cause to downgrade the security.

What began to cause AIGFP trouble with its portfolio of credit default swaps backing up about $72 billion of multi-sector CDOs, was not that there were so many defaults on the CDOS that AIGFP had to make large payments under the swaps. The real problem was a series of collateral obligations AIGFP undertook every time it entered into a CDS, and the collateral conditions varied from one swap to the next.

There were three possible triggers for a collateral payment from AIGFP to the banks that bought insurance in the form of CDSs. The first occurred if the underlying CDOs being insured in the swap experienced a drop in price on the market – say from par value to 48 cents. The second occurred if the ratings given by Moody’s or some other agency on the CDOs were downgraded. The third occurred if AIG’s Aaa rating itself was downgraded.

You can now begin to see the sequence of liquidity disasters that befell AIGFP, and soon engulfed its parent AIG, starting in the summer of 2007 and extending until September 16, 2008 when AIG was near death. First, as the market realized that the US sub-prime mortgage business was experiencing very high and unexpected defaults, everyone looked at multi-sector CDOs that carried a significant percentage of these debt instruments in the security. These CDOs began to trade at lower and lower levels in the market as no one was sure just how impaired they would become.

Second, the ratings agencies began to downgrade dozens of CDOs because of the heightened default risk, and the lower prices in the market.

Third, the ratings agencies realized by 2008 that AIG stood behind the CDO market as insurer for the tune of $72 billion. At first, the long term rating of AIG was lowered, and this began a series of collateral calls from AIGFP’s swap customers. Then, by the summer of 2008, the ratings agencies were looking at downgrading AIG’s short term ratings, and doing so by several notches, which brought into question whether AIG could meet all of its obligations under these swaps. This accelerated the demands for collateral on AIG, which was experiencing a very unexpected triple whammy of collateral calls. By September, 2008, AIG had already coughed up an astounding $30 billion in collateral, and was really only half way through what ultimately it would need to satisfy contractual demands for collateral from the market. It simply ran out of resources to raise any more liquidity, and it faced inevitable default under its swap contracts, which would have led to bankruptcy.

This was the situation facing the Fed by the second week of September, 2008.

The Fed Steps In

The Fed already had its hands full in the summer and fall of 2008. First, Bear Stearns collapsed and was thrown into the arms of JP Morgan Chase, but only after the Fed agreed to take over the Bear Stearns real estate portfolio worth $30 billion in dodgy real estate assets. The quasi-government giants Fannie Mae and Freddie Mac had to be taken over by the government, then Countrywide Financial collapsed and also was pushed into a forced sale to a bank.

There was so much criticism directed at the government for the way in which these rescues were being done, and the amount of taxpayer money spent in the process, that when it came time to deal with the collapse of Lehman Brothers, the Treasury and the Fed threw this firm to the wolves on September 15, 2008. It received no help from the government and was thrown into the bankruptcy courts. This precipitated a global market meltdown.

The trigger for this meltdown occurred at the oldest mutual fund in the US, American Reserve Fund, which took a writedown of $785 million on Lehman Bros. bonds it held in its money market fund. This was announced on the afternoon of September 15, and by the close of business that day massive amounts of withdrawals were taking place at American Reserve since no money market fund had ever experienced such a loss (money market funds were supposed to be as safe as checking accounts).

When the market opened the next morning, mutual funds everywhere couldn’t cope with the withdrawals. The commercial paper market ground to a halt, as did the Eurodollar market for short term loans in London. Stock markets around the globe tanked. The global financial system was nearly paralyzed.

The US government stepped in and guaranteed the safety of all money market funds. It allowed Goldman Sachs and Morgan Stanley, the last two surviving old-line investment banks, to become commercial banks and enjoy the benefits of Fed liquidity. The Fed had been working since the previous week on the dire liquidity situation at AIG, and it had asked JP Morgan Chase and Goldman Sachs to form a bank syndicate to provide AIG with a massive $75 billion loan to solve its liquidity problem.

JP Morgan Chase came up with a package that charged AIG an onerous 11.3% on the $75 billion loan – a full $9 billion a year in interest alone. The banks would take an 80% ownership interest in AIG’s assets. This loan package was also intended to stop the ratings agencies from yet again lowering AIG’s ratings, which would have cost the company yet another round of collateral calls from the market.

There was one big problem, though. When the banks looked at AIGFP’s portfolio of swaps, and the potential collateral demands that could still occur, they realized that AIG, if it could sell all of its assets at decent market prices, still wouldn’t be able to meet the liquidity demands. In other words, the way the market was developing, AIG was headed straight towards default and the bankruptcy courts. Making this situation even worse was the global market collapse occurring at the same time as the result of the Lehman bankruptcy. The banks told the Fed that the loan package had collapsed. The banks effectively threw the AIG problem on to the laps of the regulators, none of whom by the way had any legal responsibility, regulatory oversight, or historical familiarity with AIG. It was an insurance company that had somehow become bigger and more important than even the biggest banks.

In deciding what to do, the Fed had about 24 hours from September 15 to 16 to analyze with the Treasury the AIG situation. They discovered that AIG would default on $103 billion in loans from state and local governments, $50 billion in bank loans and derivatives, $20 billion in commercial paper, and $40 billion in insurance covering 401k retirement packages across the US.

The problems ranged from the horrendous to the horrific. The municipal bond market stood to be devastated by state and municipal loan losses. The Lehman bankruptcy involved $8 billion in commercial paper losses, which led to the Reserve Primary Fund disaster, but AIG’s commercial paper losses were much bigger at $20 billion. The 401k losses would affect tens of millions of Americans. AIG’s loan losses spread to banks all around the world.

The Fed and Treasury, standing in the middle of a global financial collapse the day after the Lehman Brothers bankruptcy, felt they had no choice but to save AIG, a much bigger player with far greater reach and implications for economic and financial disaster. The Treasury authorized an $85 billion line of credit at the Federal Reserve NY for the purpose of lending to AIG the amounts needed to post collateral behind its swaps at AIGFP. The Fed had no plan in place on how to do this, so it simply lifted the term sheet conditions from the JP Morgan failed loan package, and used those terms to lend to AIG.

From September 16 through October, the Fed lent $61 billion to AIG, over half of which found its way into the market as collateral to support its swaps. At the same time, AIG was instructed to begin reducing its swap book. This required AIG to turn to all the big banks with which it had a swap portfolio, and ask to close out, or abrogate the swap contracts. The banks would consider doing this, but would not want to be then left with the CDO risk that caused it to enter into the swaps in the first place. There was some talk of AIG therefore taking over the CDOs as well, which had sunk substantially in value because of the default risk, but it was very difficult to agree with each bank on what these CDOs were worth. In fact, the banks weren’t willing to sell these CDOs at any discount whatsoever, despite what the market said they were worth, so AIG turned to the Fed for help, and authorized the Fed to negotiate on their behalf.

Here is where we come to the gist of the Barofsky report and the criticisms of the Fed. But let us recap two critical facts up to this point. As of September 15, AIG was certainly heading for bankruptcy, within a manner of days. The banks stood to lose billions on their swaps with AIG, because they would be under-collateralized if the CDOs fell further in value, and because they could not easily all at once get replacement CDS coverage for their CDOs.

Second, shortly after September 16, the banks began receiving collateral from AIG, courtesy of the Fed via the $85 billion loan authorization. For the next two months, the banks were made whole as necessary whenever their CDOs fell in value. The banks could look at their portfolio with AIGFP and consider it safe and secure because of the collateral, and as important, because of the guaranty of more collateral to come as necessary, courtesy of the federal government.

The Fed Tries Its Hand at Negotiating

In early November the Fed assigned a team of managers to begin negotiating for the abrogation of the CDSs. They chose the eight largest bank counterparties to talk to, including Goldman Sachs, BOA, JP Morgan Chase, Deutsche Bank, UBS, and top of the list was Societe Generale in Paris. The plan was to ask the banks to tear up the CDS contracts through a legal abrogation agreement. It was common for banks to do this in the derivatives market from time to time, though never before on a large scale. The banks always required the customer to pay them for any potential real market losses they may incur in abrogating the contract, plus interest and a bit of a fee for all the trouble. Abrogations have never been cheap, especially if the customer was desperate to get out of a deal.

What would the banks want? Collectively, they held CDOs worth a face value of $62.1 billion, and these were the underlying CDOs behind the swaps bought from AIGFP. The banks wanted to give these over to the Fed and get $62.1 billion back, because otherwise the banks would be stuck with CDOs that were unhedged for further default problems.

The market price for this collective group of CDOs was in early November $29.6 billion, which tells you just how badly the market had trashed these instruments. But the banks held cash collateral of $35.0 billion to protect against just this contingency, and if you add the two numbers up, you come to a bit over the $62.1 billion in face value. In other words, the banks were sitting pretty. They were 100% covered for the existing market losses on these CDOs, and the market pricing was beginning to stabilize.

Remember that all this collateral came from the Fed on behalf of the now moribund AIG. The banks wanted to do a simple deal. They would give the Fed all the CDOs in exchange for $29.6 billion in cash – their current market value. They would keep all the existing cash collateral, so they would be perfectly whole. They would then abrogate the CDSs and have no further claim on AIGFP, as if the whole mess never occurred. The Fed, meaning the taxpayers, would be out $62.1 billion in cash to clean this mess up.

In preparing talking points for the negotiations, the Fed reminded each bank that it would be appropriate to give back some of the collateral to the Fed rather than keep it all. The Fed, by stepping in a month earlier, had saved the banks from billions of losses had AIG gone into bankruptcy, and these losses might have included a systemic crisis in which a few other banks went under and couldn’t pay their obligations as well. “”Be nice to us, given all that we have done for you,” was the Fed motto.

The Fed then tied the hands of their negotiators in several ways. First, the Fed would not threaten to throw AIG into bankruptcy if they didn’t get a “haircut” on the $35 billion in collateral. This would be unethical because the Fed had no plan to put AIG into bankruptcy and everybody knew it. Second, the Fed negotiators would have to do the same haircut deal with everybody. If Goldman Sachs agreed to return 30% of the collateral, JP Morgan Chase would have to agree to the same thing. Third, the banks were told up front that their participation in the negotiations was entirely “voluntary”; nobody was going to be forced to do anything or accept any haircut.

You should not be surprised that seven of the eight banks refused to take any haircut on the collateral and would therefore return none of it. They argued the cash was theirs, not the Fed’s, and they owned it by the sanctity of a legal contract that the Fed was proposing to violate. Second, AIGFP was not in default and there was no bankruptcy, and there wouldn’t be any, so giving back collateral when there was no legal requirement would constitute a breach of fiduciary duty that the banks had to their shareholders. Unstated in all this was the fact that the Fed wasn’t threatening any consequences if the banks refused to give back any of the collateral.

The kicker that destroyed any possibility of the Fed getting some of the collateral back occurred with the French bank. They told the Fed that it was not simply a fiduciary responsibility they had to follow in keeping cash that was rightfully theirs – it was decidedly against French law to give back the collateral because there was no bankruptcy. The French regulators confirmed this in no uncertain terms to the Fed, with the implication that if the Fed pushed on this point relationships with the French government would be damaged. Remember that all the banks had to agree to the same deal, so each bank had a veto power over any deal, and the French bank had the ultimate veto – it was illegal for them to give back the collateral.

The negotiating team reported all this back to Timothy Geithner, and recommended that the Fed settle all the swap abrogations by allowing the banks to keep all the collateral and thereby effectively receive par value on contracts that in the market were worth less than half that. Geithner agreed and the deal was done. The Fed then promptly kept all these details secret, including the names of the banks involved, and even went to court to maintain this secrecy under the financial equivalent of a “state secret” argument. They recently lost this argument on appeal to a higher court, and the Barofsky report severely berated the Fed for this because no terrible consequences have occurred now that the details are known.

What Went Wrong Here?

The Barofsky report lays a pretty heavy blanket of criticism on the Fed for not just the secrecy of their actions, but the actions themselves. The Fed didn’t have to treat everyone all the same. It could have accepted different levels of haircuts. It didn’t have to put so much faith in the sanctity of contracts when AIG was in virtual suspended animation – bankruptcy in all but name.

These criticisms do not show an understanding of how the Fed works. Like any large American organization, it pays considerable attention to the law. Timothy Geithner had a high powered, high-priced General Counsel sitting as his right side all the way. Geithner was told clearly that as long as AIG was not in bankruptcy, the Fed might damage its reputation by violating the terms of perfectly sound legal contracts and insisting on repayment of collateral when it was not legally required. He was also told the Fed had no ethical right to threaten bankruptcy when the threat could not be backed up later in court with proof it was real. He was probably told – though there is no proof of this in the report – that giving any bank preferential treatment on haircuts exposed the Fed later to lawsuits of unfair treatment.

Timothy Geithner is like most American executives – he is a technocrat. He respects technical advice, especially of the legal kind, and he abides by it. Past presidents of the NY Fed might be different – Gerald Corrigan comes to mind during the Drexel Burnham bankruptcy. He would bang some heads together to get an outcome that satisfied the political pressure on the Fed, even if it meant overriding legal advice. Gerald Corrigan, by the way, now works for Goldman Sachs. He might have in this situation taken Goldman Sachs and JP Morgan Chase aside and said, “I want you guys to get your consortium of banks to agree on a haircut – something like 30% would be nice – and I want all of you to come back and voluntarily request that the CDS collateral provisions be waived in favor of paying back to the Fed some amount of the collateral. I don’t care how you do this, and it is not going to be the Fed asking for it – it is going to be voluntarily offered to us.” The banks would not need to be told that there was a steel hand underneath the Fed’s velvet glove.

Maybe Timothy Geithner would have done this, technocrat though he is, if there were enough political pressure on him to save the taxpayers billions of dollars, but there wasn’t. No one in the Bush administration – certainly not Henry Paulson at Treasury – was demanding fairness for the taxpayers. There was public disgust over the whole bailout process, but this disgust got bottled up in a Congress paid for by the financial industry. Barofsky might have mentioned that lack of political pressure, and the consequent insensitivity to taxpayer needs that the Fed and the Treasury displayed, but he didn’t, maybe because his current paymaster, the Obama administration, isn’t showing any such sensitivity either.

Which brings us to the crux of the problem, only hinted at in the Barofsky report. The real problem for the taxpayers didn’t occur when the NY Fed failed to negotiate the return of some of the collateral in November, 2008. The problem occurred on September 16, when the Fed and the Treasury were suddenly faced with a collapsing AIG. Had there been any forethought and planning for such an event, the reaction could have been very different and far less panicky.

The first response should have been: ”Financial markets worldwide are frozen, and they are going to stay frozen for a long time no matter what we do with AIG." In hindsight, this is exactly what happened. The commercial paper market has taken nearly a year to recover a fraction of its previous activity, and this was only after the Fed had to guarantee transactions. Credit spreads took nine months to begin coming down to normal levels. Banks are lending to each other only because governments around the world now guarantee their bank activity, but banks are still not lending to corporations, small businesses, or individuals.

The housing market in the US exists entirely on the generosity of Federally-managed firms like Fannie Mae, Freddie Mac, and FHA. In other words, the disaster that the Fed faced on September 16 rolled on despite the rescue of AIG.

If AIG had been allowed to fail, the market would have learned a serious lesson about dealing with companies that act like banks but really have no controls or regulatory oversight like banks. The pain would have been greatest at the banks themselves. Some banks like Citigroup and Bank of America would have been even more crippled than they are now, but their current status as zombie banks would not be any different. The damage done to 401ks could have been mitigated by additional federal government guaranties, but even here the cost while enormous would have been less than what was spent paying off AIGFP’s credit default swaps at par.

Suppose you say that it is impossible to expect government bureaucrats to react on September 16 in any different manner. You can argue that any normal person would have panicked too, and that tough-nosed regulators like Gerald Corrigan don’t come around all that often – in fact these days they are all working for Goldman Sachs. Fine. Where, then, was the prudential planning for this catastrophe. All it would have taken is someone in advance of the crisis – a clever lawyer for example – inserting one clause in the agreements with banks before any collateral was posted with them. It would have said “The Federal Reserve Bank of New York reserves the right at any time to demand immediate repayment of any or all amounts of collateral posted with Bank X, with no compensation required to be paid to Bank X in any form by the Federal Reserve Bank of New York, and Bank X hereby waives all rights to petition for a legal stay of said repayment.” If the banks didn’t like this clause, they wouldn’t get their collateral. They could go ahead and sue the government for breach of contract, but in the meantime they would be experiencing real pain with their CDO portfolio and the pressure would be on them to settle. Once the collateral was out the door, the Fed lost all leverage with the banks, and this is why the November negotiations were a foregone conclusion and a waste of time.

Finally, what is fundamentally missing at the Fed and the Treasury, and certainly now with two successive administrations and almost all 535 public servants in Congress, is the sense that the big financial institutions which have created this monstrous mess are dispensible. The problems that have arisen due to their avarice and misjudgments are only going to be solved over time, and are best solved in bankruptcy courts or through FDIC closure processes, not by making these institutions wards of the state until 10 or so years later they are nursed back to health. The public can and has been protected through deposit insurance, but the collapse of lending and credit in general has not been mitigated one whit by anything done so far to rescue these institutions. Let them die a merciful, quick death if death is their fate anyway. We will all of us individually benefit from such mercy as well.

Additional bailouts of 2008

On October 9, 2008, the company borrowed an additional $37.8 billion via a second secured asset credit facility created by the Federal Reserve Bank of New York (FRBNY).[15]

From mid September till early November, AIG's credit-default spreads were steadily rising, implying the company was heading for default.[16]

On November 10, 2008, the U.S. Treasury announced it would purchase $40 billion in newly issued AIG senior preferred stock, under the authority of the Emergency Economic Stabilization Act's Troubled Asset Relief Program.[17] [18]

The FRBNY announced that it would modify the September 16th secured credit facility; the Treasury investment would permit a reduction in its size from $85 billion to $60 billion, and that the FRBNY would extend the life of the facility from three to five years, and change the interest rate from 8.5% plus the three-month London interbank offered rate (LIBOR) for the total credit facility, to 3% plus LIBOR for funds drawn down, and 0.75% plus LIBOR for funds not drawn, and that AIG would create two off- balance-sheet Limited Liability Companies (LLC) to hold AIG assets: one will act as an AIG Residential Mortgage-Backed Securities Facility and the second to act as an AIG Collateralized Debt Obligations Facility.[19]

Publicly Federal officials said the $40 billion investment would ultimately permit the government to reduce the total exposure to AIG to $112 billion from $152 billion.

Privately "[t]he U.S. Treasury said in a draft of a presentation that its $40 billion investment in the American International Group Inc. bailout was “highly speculative.”

A slide with the phrase was included in documents obtained in a Freedom of Information Act request by Judicial Watch, a group that advocates government transparency. The sentence was omitted from another version of the slide in a presentation describing the November revision to AIG’s rescue in which the insurer got $40 billion from the Treasury.

“The prospects of recovery of capital and a return on the equity investment to the taxpayer are highly speculative,” according to the first of the two Treasury slides."[20]

On December 15, 2008, the Thomas More Law Center filed suit to challenge the Emergency Economic Stabilization Act of 2008, alleging that it unconstitutionally promotes Islamic law (Sharia) and religion. The lawsuit was filed because AIG provides Takaful Insurance Plans, which, according to the company, avoid investments and transactions that are"un-Islamic". [21] [22]

Counterparty controversy

AIG was required to post additional collateral with many creditors and counter-parties, touching off controversy when over $100 billion dollars were paid out to major global financial institutions that had previously received Troubled Asset Relief Program money.[23]

While this money was legally owed to the banks by AIG (under agreements made via credit default swaps purchased from AIG by the institutions), a number of Congressmen and media members expressed outrage that "taxpayer" money was going to these banks through AIG. [24]

Post-bailout expenditures

The following week (of September bailout), AIG executives participated in a lavish California retreat which cost $444,000 and featured spa treatments, banquets, and golf outings.[25]

It was reported that the trip was a reward for top-performing life-insurance agents planned before the bailout.[26]

Less than 24 hours after the news of the party was first reported by the media, it was reported that the Federal Reserve had agreed to give AIG an additional loan of up to $37.8 billion.[27]

AP reported on October 17 that AIG executives spent $86,000 on a previously scheduled English hunting trip. News of the lavish spending came just days after AIG received an additional $37.8 billion loan from the Federal Reserve, on top of a previous $85 billion emergency loan granted the month before. Regarding the hunting trip, the company responded, "We regret that this event was not canceled."[28]

An October 30, 2008 article from CNBC reported that AIG had already drawn upon $90 billion of the $123 billion allocated for loans.[29]

On November 10, 2008, just a few days before renegotiating another bailout with the US Government for $40 billion, ABC News reported that AIG spent $343,000 on a trip to a lavish resort in Phoenix, Arizona.[30]

Settlement of credit default swaps

During December 2008, AIG paid $18.7 billion to various financial institutions, including Goldman Sachs and Société Générale to retire obligations related to credit default swaps (CDS). As much as $53.5 billion related to swap payouts are part of the bailout.[31]

On March 15, 2009, under mounting pressure from Congress and after consultation with the Federal Reserve, AIG disclosed a list of major recipients of collateral postings and payments under credit default swaps, guaranteed investment plans, and securities lending agreements. [32]

Goldman Sachs, CDOs and credit default swaps

Goldman Sachs Group Inc. played a bigger role than has been publicly disclosed in fueling the mortgage bets that nearly felled American International Group Inc.

Goldman was one of 16 banks paid off when the U.S. government last year spent billions closing out soured trades that AIG made with the financial firms.

A Wall Street Journal analysis of AIG's trades, which were on pools of mortgage debt, shows that Goldman was a key player in many of them, even the ones involving other banks.

Goldman as Middleman

Goldman originated or bought protection from AIG on about $33 billion of the $80 billion of U.S. mortgage assets that AIG insured during the housing boom. That is roughly twice as much as Société Générale and Merrill Lynch, the banks with the biggest exposure to AIG after Goldman, according an analysis of ratings-firm reports and an internal AIG document that details several financial firms' roles in the transactions.

In Goldman's biggest deal, it acted as a middleman between AIG and banks, taking on the risk of as much as $14 billion of mortgage-related investments. Then Goldman insured that risk with one trading partner—AIG, according to the Journal's analysis and people familiar with the trades.

The trades yielded Goldman less than $50 million in profits, which were mostly booked from 2004 to 2006, according to a person familiar with the matter. But they piled risks onto AIG's books, which later came to haunt the insurer and Goldman. The trades also gave Goldman a unique window into AIG's exposure to losses on securities linked to mortgages.

When the federal government bailed out the insurer, Goldman avoided losses on its trades with AIG covering a total of $22 billion in assets.

A Goldman spokesman says that up until AIG was rescued by the government, the insurer "was viewed as one of the most sophisticated financial counterparties in the world. It wasn't until the government intervened in September 2008 that the full extent of AIG's problems became apparent."

"What is lost in the discussion is that AIG assumed billions of dollars in risk it was unable to manage," the Goldman spokesman added.

An AIG spokesman declined to comment on the firm's trades with Goldman.

More clarity has emerged recently over the roles that firms such as Goldman played, as complex deals carried out by banks are now being untangled in legal and regulatory inquiries. Last month a government audit of part of the AIG bailout described Goldman's middleman role.

One of Goldman's trades with AIG involved a financial vehicle called South Coast Funding VIII. South Coast was one of many pools of bonds backed by individual homeowners' mortgage payments that Wall Street turned into collateralized debt obligations or CDOs.

Merrill Lynch, now part of Bank of America Corp., underwrote the South Coast CDO in January 2006 by stuffing it with packages of home loans originated by firms such as Countrywide Financial Corp., the big California lender.

Once a CDO debt pool is assembled, it is sliced into layers based on risk and return. Merrill sold the safest, or top layer, of deals like South Coast to large banks, including in Europe and Canada.

An auction sign for a property is seen at the front garden of a foreclosed house in Miami Gardens, Fla., in September. The banks wanted protection in case the housing market tanked. Many turned to Goldman, which effectively insured the securities against losses. Then, to cover its own potential losses, Goldman bought protection from AIG, in the form of credit-default swaps.

Goldman charged more than AIG for the protection, so it was able to pocket the difference, making millions while moving the default risks to AIG, according to people familiar with the trades.

The banks eventually realized they didn't need to use Goldman as a middleman.

The trades seemed prudent at the time given AIG's strong credit rating and the fact that AIG agreed to make payments to Goldman, known as collateral, if the value of the CDOs declined. The trades were also low risk for Goldman as long as AIG stayed afloat.

Other banks also acted as middlemen, including Merrill Lynch, which did roughly $6 billion of these deals compared to $14 billion for Goldman, according to people familiar with the trades and the analysis of banks' exposures to AIG.

"It seems shocking to me that Goldman would become so exposed to AIG and kept doing deals with them and laying on the risk," says Tom Savage, a former chief executive of AIG's financial products unit who left in 2001 before the explosive growth of insuring mortgage-debt pools.

The middleman trades began to unravel in mid 2007 when the U.S. mortgage market started slumping. Goldman was the first of AIG's trading partners to notify AIG that the CDOs were losing value and demand collateral. Other banks including Société Générale and a unit of Credit Agricole that had bought insurance from AIG eventually did the same.

A Goldman spokesman said that between mid-2007 and early 2008, Goldman showed AIG "market price levels" at which trades could be undone, allowing AIG to decrease its risk, but "AIG refused to accept that the market was deteriorating."

When Goldman didn't get as much collateral as it wanted from AIG, in 2007 and 2008 it bought protection against a default of AIG itself from other banks.

AIG officials were skeptical of the prices Goldman presented, according to the minutes of a February 2008 AIG audit committee meeting, which noted that Goldman was "unwilling or unable to provide any sources for their determination of market prices."

Additional calls for collateral from Goldman and other banks eventually led to AIG's September 2008 bailout and led the New York Federal Reserve two months later to fully cover $62 billion of insurance contracts Goldman and 15 other banks had with the financial products unit of AIG.

Goldman's other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News.

The Journal analysis of that document in conjunction with ratings-firm reports shows that Goldman underwrote roughly $23 billion of the $80 billion in mortgage-linked CDOs that AIG agreed to insure.

One such deal was called Davis Square Funding VI. That CDO, assembled by Goldman in March 2006, contained mortgage securities underpinned by subprime home loans originated by firms such as Countrywide and New Century Mortgage Corp., one of the first subprime lenders to fail in 2007.

A big investor in Davis Square's top layer was Société Générale, which bought protection on it from AIG, according to the internal memo. The French bank was the largest beneficiary of the New York Fed's Nov. 2008 move to pay off banks in full on their AIG insurance contracts.

A company financed largely by the New York Fed ended up owning both the Davis Square and South Coast CDOs. Société Générale received payments from AIG and the New York Fed totaling $16.5 billion.

Goldman received $14 billion for its trades that were torn up, including $8.4 billion in collateral from AIG.

A representative of Société Générale declined to comment.

The special inspector general for the Troubled Asset Relief Program, which recently reviewed the New York Fed's effort to stanch collateral calls last year, said Goldman officials said the company believed it would have been fully protected had AIG been allowed to fail because of collateral it had amassed and the additional insurance it had bought against an AIG default.

The auditor, however, questioned that conclusion. The report said Goldman would have had a difficult time selling the collateral and that the firm might have been unable to actually collect on the additional insurance.

Goldman created CDOs, bet against then and won

"In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.

Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.

Goldman’s own clients who bought them, however, were less fortunate.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

Goldman and other Wall Street firms maintain there is nothing improper about synthetic C.D.O.’s, saying that they typically employ many trading techniques to hedge investments and protect against losses. They add that many prudent investors often do the same. Goldman used these securities initially to offset any potential losses stemming from its positive bets on mortgage securities.

But Goldman and other firms eventually used the C.D.O.’s to place unusually large negative bets that were not mainly for hedging purposes, and investors and industry experts say that put the firms at odds with their own clients’ interests.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Investment banks were not alone in reaping rich rewards by placing trades against synthetic C.D.O.’s. Some hedge funds also benefited, including Paulson & Company, according to former Goldman workers and people at other banks familiar with that firm’s trading.

Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. Egol available for comment. But Mr. DuVally said many of the C.D.O.’s created by Wall Street were made to satisfy client demand for such products, which the clients thought would produce profits because they had an optimistic view of the housing market. In addition, he said that clients knew Goldman might be betting against mortgages linked to the securities, and that the buyers of synthetic mortgage C.D.O.’s were large, sophisticated investors, he said.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. Some $8 billion in these securities remain on the books at American International Group, the giant insurer rescued by the government in September 2008.

From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

Goldman Saw It Coming

Before the financial crisis, many investors — large American and European banks, pension funds, insurance companies and even some hedge funds — failed to recognize that overextended borrowers would default on their mortgages, and they kept increasing their investments in mortgage-related securities. As the mortgage market collapsed, they suffered steep losses..."

To read the rest of the article... Banks Bundled Bad Debt, Bet Against It and Won

Goldman used AIG to profit by shorting CDOs

Obviously, the people at AIG never figured out what was going on until it was too late. But there's a mountain of circumstantial evidence that the people at Goldman had a keen grasp of the fatal flaws of these CDOs, which they structured. The Times piece is a major addition to that mountain of evidence:

[Former AIG executive Alan] Frost cut many of his deals with two Goldman traders, Jonathan Egol and Ram Sundaram, who had negative views of the housing market. They had made A.I.G. a central part of some of their trading strategies.

Mr. Egol structured a group of deals -- known as Abacus -- so that Goldman could benefit from a housing collapse. Many of them were actually packages of A.I.G. insurance written against mortgage bonds, indicating that Mr. Egol and Goldman believed that A.I.G. would have to make large payments if the housing market ran aground. About $5.5 billion of Mr. Egol's deals still sat on A.I.G.'s books when the insurer was bailed out.

"Al probably did not know it, but he was working with the bears of Goldman," a former Goldman salesman, who requested anonymity so he would not jeopardize his business relationships, said of Mr. Frost. "He was signing A.I.G. up to insure trades made by people with really very negative views" of the housing market.

As further evidence that Goldman used AIG to profit by shorting CDOs, rather than to manage its preexisting risk exposure:

[N]egotiating with Goldman to void the A.I.G. insurance was especially difficult, Federal Reserve Board documents show, because the firm did not own the underlying bonds. As a result, Goldman had little incentive to compromise.

Goldman's seven Abacus deals [Abacus 2004-1, Abacus 2004-2, Abacus 2005-2, Abacus 2005-3, Abacus 2005-CB1, Abacus 2006-NS1, Abacus 2007-18] were unique among all the CDOs in AIG's portfolio. For all the other deals, the collateral manager, the entity that oversaw and managed the CDO after closing, was entirely independent from the bank that originally arranged and structured the transaction. For all the Abacus deals, Goldman acted both as both the arranging bank and the collateral manager. This is no small technicality. In other Abacus deals, Abacus 2006-13 and Abacus 2006-17, Goldman used its "sole discretion" to retire lower rated CDO tranches without regard to seniority. This approach, under documentation drafted by Goldman, upends the entire premise of structured finance.

Most importantly, the government never purchased the Abacus deals when it bought $62.1 billion other CDOs at par, back in November 2008. Why didn't the parties feel a need to take the Abacus deals off of AIG's balance sheet? It's an extremely important question, for which we will not have an adequate answer until we see the actual documentation, specifically: the offering memoranda, the performance reports and swap agreements.

Hiding Behind Societe Generale

The Times story also suggests that Goldman used Societe Generale as a front, to conceal from Frost and others the size of their cumulative bet against these CDOs.

Mr. Sundaram's trades represented another large part of Goldman's business with A.I.G. According to five former Goldman employees, Mr. Sundaram used financing from other banks like Societe Generale and Calyon to purchase less risky mortgage securities from competitors like Merrill Lynch and then insure the assets with A.I.G. -- helping fatten the mortgage pipeline that would prove so harmful to Wall Street, investors and taxpayers. In October 2008, just after A.I.G. collapsed, Goldman made Mr. Sundaram a partner.

Through Societe Generale, Goldman was also able to buy more insurance on mortgage securities from A.I.G., according to a former A.I.G. executive with direct knowledge of the deals. A spokesman for Societe Generale declined to comment.

It is unclear how much Goldman bought through the French bank, but A.I.G. documents show that Goldman was involved in pricing half of Societe Generale's $18.6 billion in trades with A.I.G. and that the insurer's executives believed that Goldman pressed Societe Generale to also demand payments...On Nov. 1, 2007, for example, an e-mail message from Mr. Cassano, the head of A.I.G. Financial Products, to Elias Habayeb, an A.I.G. accounting executive, said that a payment demand from Societe Generale had been "spurred by GS calling them."

As noted earlier in the story:

In addition, according to two people with knowledge of the positions, a portion of the $11 billion in taxpayer money that went to Societe Generale, a French bank that traded with A.I.G., was subsequently transferred to Goldman under a deal the two banks had struck.

See here for an analysis of the ten-figure purchases and sales between Goldman and SG.

The AAA Pyramid Scheme Embedded Inside AIG

The Times reports that Goldman tailored the terms of the swaps to exploit these defective credit ratings:

The terms, described by several A.I.G. trading partners, stated that A.I.G. would post payments under two or three circumstances: if mortgage bonds were downgraded, if they were deemed to have lost value, or if A.I.G.'s own credit rating was downgraded. If all of those things happened, A.I.G. would have to make even larger payments.

Here's an example of how terminology for a general news readership can lead to confusion. In the context of the story, the Times seems to be referencing the ratings of the CDOs, not the subprime bonds held by the CDOs. The distinction is critical because almost all subprime bonds were downgraded in 2007, whereas most of these CDOs were not downgraded prior to May 2008, when they received minor downgrades.

Most importantly, almost all these CDO tranches were rated AAA during November 2007, when, as the Times reports, Goldman was demanding billions in cash collateral. There is no way to reconcile a 40% diminution of value, which Goldman repeatedly asserted, with a AAA rating. It's like saying 2 + 2 = 11. In effect, Goldman was admitting that the CDOs' ratings were a joke.

It was an especially cruel joke on AIG and on the American taxpayer. If the ratings agencies had severely downgraded the CDOs in 2007 or earlier in 2008, AIG's day of reckoning would have come sooner. Instead, that day coincided with Lehman's bankruptcy. The ratings agencies announced their major downgrades of AIG after the close of business on September 15, 2008. Those downgrades triggered cash collateral calls and on AIG on September 16, 2008, the same day that a money market fund, which wrote down Lehman paper, broke the buck and triggered widespread panic in the money markets.

As noted before, the timing of the CDO downgrades looks suspicious. Eric Kolchinsky, a former managing director at Moody's, has alleged that the ratings agency deliberately and deceitfully delayed the announcements of downgrades of various CDOs. The House Oversight Committee is still investigating the matter.

Why Goldman Pressured AIG to Hand Over Cash

The thrust of the front-page Times article was that Goldman aggressively pressured AIG to hand over cash collateral beginning in 2007, Goldman asserted, because, the CDOs "were deemed to have lost value." But negotiations were always at an impasse, for an obvious reason. There was no way to settle on agreed-upon "market value" for the CDOs. These securities weren't bought or sold, like Treasuries or shares of IBM. Nor was there any market benchmark upon which the CDOs could be valued. The only way to set a price, according to auditors for AIG and the Federal Reserve, was according to internal valuation models.

The Times reports:

[D]ocuments show there were unusual aspects to the deals with Goldman. The bank resisted, for example, letting third parties value the securities as its contracts with A.I.G. required. And Goldman based some payment demands on lower-rated bonds that A.I.G.'s insurance did not even cover. A November 2008 analysis by BlackRock, a leading asset management firm, noted that Goldman's valuations of the securities that A.I.G. insured were "consistently lower than third-party prices."

The Times reporting suggests that Goldman wanted to control the dispute by using a nominally independent third party, PricewaterhouseCoopers, which had shifted into Goldman's camp:

Adding to the pressure on A.I.G., [David] Viniar, Goldman's chief financial officer, advised the insurer in the fall of 2007 that because the two companies shared the same auditor, PricewaterhouseCoopers, A.I.G. should accept Goldman's valuations, according to a person with knowledge of the discussions. Goldman declined to comment on this exchange.

Pricewaterhouse had supported A.I.G.'s approach to valuing the securities throughout 2007, documents show. But at the end of 2007, the auditor began demanding that A.I.G. provide greater disclosure on the risks in the credit insurance it had written. Pricewaterhouse was expressing concern about the dispute.

The insurer disclosed in year-end regulatory filings that its auditor had found a "material weakness" in financial reporting related to valuations of the insurance, a troubling sign for investors.

Of course, a highly plausible explanation is that Pricewaterhouse, like AIG, had assumed that the CDOs' AAA ratings were credible, until Goldman set them straight. But again, this gets back to the issue of whether Goldman knew these deals were toxic from the start. Goldman opposed proposals that would have enabled it to make its case to others:

Litigation

x

IN RE AMERICAN INTERNATIONAL GROUP, : INC. 2008 SECURITIES LITIGATION

x

No. 08 CV 4772 (LTS) ORAL ARGUMENT REQUESTED

AIGFP to retain $500 billion CDS book

AIG has shelved plans to sell the whole of its derivatives portfolio, which nearly destroyed the insurer in 2008. It believes that keeping up to $500bn worth of complex positions could help it to survive as an independent entity and repay US taxpayers.

The decision underlines the management’s confidence in AIG’s future but could prove controversial in Washington, where officials have baulked at the cost of the US government bail-out of the insurer and scrutinised its use of derivatives.

Gerry Pasciucco, who joined AIG after it was rescued by the government in September 2008 to wind down AIG Financial Products, said the troubled unit would still be out of business by the end of this year. AIGFP caused a storm in Congress last year with plans to pay some of its 200-plus staff large bonuses.

The original plan, devised by then chief executive Edward Liddy and the government after the rescue, was to sell off all the positions and close down AIGFP as soon as possible. But Mr Pasciucco said that derivatives with a notional value of between $300bn and $500bn – or between 15 and 25 per cent of the derivatives portfolio’s original size – would not be sold. The assets could either be managed by AIG or outsourced to an external fund manager, he added.

AIG’s management, led by chief executive Robert Benmosche, believes that such a move reduce the need for fire sales and enable AIG to reap the benefits of rallying credit markets, Mr Pasciucco said. AIG recorded billions of dollars in paper profits on its derivatives in the third quarter of 2009.

AIG, which is majority-owned by the US authorities, has sold derivatives – and reduced the risk attached to them – since the bail-out. Its derivatives book, which had a notional value of $2,000bn in September 2008, stood at $940bn at the end of December 2009, the insurer is expected to announce with its fourth quarter results.

Mr Pasciucco said his team would continue to reduce the size and the risk of the portfolio until it reaches $300bn-$500bn. The number of derivatives positions has fallen from 44,000 in late 2008 to 16,100 at the end of December while the “gross vega” – a measure of risk – in the portfolio has gone from $1.3bn to $310m

AIG executives said the Treasury and the New York Federal Reserve, which took an 80 per cent stake in the insurer in return for more than $80bn in federal funds, had been consulted on the decision to keep the derivatives. Peter Hancock, the derivatives expert who has just been hired to oversee AIGFP, among other responsibilities, is also believed to back the move.

AIGFP winddown

Source: Bloomberg, June 30, 2009 "Unwinding at AIG Prompts Pasciucco to Ponder Systemic Failure"

CDS Tangle

AIG, more than any other institution, has thrown a spotlight on the tangled world of derivatives -- securities whose value is derived from underlying stocks, bonds, currencies or commodities -- and especially on credit-default swaps. CDSs are lightly regulated insurance-like contracts used to protect investors against the default or loss in market value of a security they hold.

The government rescued AIG to avert “systemic failure,” Federal Reserve Chairman Ben S. Bernanke said at the time. If AIG had collapsed, a dozen other big financial companies that were counterparties in its derivative trades and insurance contracts might have gone down along with it, Bernanke told Congress in March.

By the end of 2008, more than $60 billion was paid to AIG counterparties that had bought CDSs from AIG. In a May 2009 filing to the Securities and Exchange Commission, AIG disclosed for the first time the full extent of those payments, including cash that had flowed to banks before AIG’s bailout.

Big Payout

Paris-based Societe Generale got $16.5 billion in collateral and other payments from late 2007 through 2008; New York-based Goldman Sachs Group Inc. received $14 billion; Frankfurt-based Deutsche Bank AG, $8.5 billion; and Merrill Lynch & Co., $6.2 billion.

The payments were triggered by the credit-rating downgrades of AIG and declines in the market value of the assets protected by the swaps. The most volatile of those assets were collateralized-debt obligations, or CDOs, which are agglomerations of subprime mortgages and other debt that are divided up and sliced into tranches, each of which has a different risk and income stream.

The filing, which is heavily redacted and uses abbreviations for counterparty names, reveals the extent to which Goldman Sachs was the leader in demanding -- and receiving -- collateral on the problem CDOs that AIG had insured. It got $5.9 billion before the insurer was forced into the government’s arms on Sept. 16, more than any other counterparty. Goldman Sachs spokesman Michael DuVally declined to comment.

'No Reason to Pay’

“There was no reason to pay the contracts in full,” says Janet Tavakoli, founder of Tavakoli Structured Finance Inc. in Chicago and author of “Dear Mr. Buffett: What an Investor Learns 1,269 Miles From Wall Street” (Wiley, 2009). “We’ve run roughshod over the interests of the American taxpayer; we’ve bailed out the Wall Street creditors; we’ve used AIG as a huge slush fund.”

In September, Moody’s Investors Service, Standard & Poor’s and Fitch Ratings all downgraded AIG two or three grades in response to its accelerating cash crunch. The company was rated AAA from 1983 to March 2005, when it lost that designation after CEO Maurice “Hank” Greenberg was forced to resign.

The September downgrades sealed the firm’s fate by triggering the collateral calls by Goldman Sachs and the other banks to which AIGFP had sold swaps.


Sales of assets

AIG since September 2008 has marketed its assets to pay off its government loans. A global decline in the valuation of insurance businesses, and the weakening financial condition of potential bidders, has challenged its efforts. If the U.S. government decides to continue to protect the company from falling into bankruptcy, it may have to take the assets itself in exchange for the loans, or offer further direct financial support.[33]

Record losses

On March 2, 2009, AIG reported a fourth quarter loss of $61.7bn (£43bn) for the final three months of 2008. This was the largest quarterly loss in corporate history at that time. [34]

The announcement of the loss had an impact on morning trading in Europe and Asia, with the FTSE100, DAX and Nikkei all suffering sharp falls. In the US the Dow Jones Industrial Average fell to below 7000 points, a twelve-year low.[35] [36]

The news of the loss came the day after the US Treasury Department had confirmed that AIG was to get an additional $30 billion in aid, on top of the $150 billion it has already received.[37]

The Treasury Department suggested that the potential losses to the US and global economy would be 'extremely high' if it were to collapse[38] and has suggested that if in future there is no improvement, it will invest more money into the company, as it is unwilling to allow it to fail. [39]

The firm's position as not just a domestic insurer, but also one for small businesses and many listed firms, has prompted US officials to suggest its demise could be 'disastrous' and the Federal Reserve said that AIG posed a 'system risk' to the global economy.[40]

The fourth quarter result meant the company made a $99.29 billion loss for the whole of 2008, [41] with five consecutive quarters of losses costing the company well over $100 billion.[42]

In a testimony before the Senate Budget Committee on March 3, 2009, the Federal Reserve Chairman Ben Bernanke stated that "AIG exploited a huge gap in the regulatory system,” ... and "to nobody’s surprise, made irresponsible bets and took huge losses".[43]

2009 employee bonus payments

In March 2009, AIG announced that they were paying out $165 million in executive bonuses. Total bonuses for the financial unit could reach $450 million and bonuses for the entire company could reach $1.2 billion.[44] President Barack Obama, who voted for the AIG bailout as a Senator [45] responded to the planned payments by saying "[I]t’s hard to understand how derivative traders at A.I.G. warranted any bonuses, much less $165 million in extra pay. How do they justify this outrage to the taxpayers who are keeping the company afloat?" and "In the last six months, A.I.G. has received substantial sums from the U.S. Treasury. I’ve asked Secretary Geithner to use that leverage and pursue every legal avenue to block these bonuses and make the American taxpayers whole."[46]

Politicians on both sides of the Congressional aisle reacted with outrage to the planned bailouts. Senator Chuck Grassley (R-Iowa) said "I would suggest the first thing that would make me feel a little bit better toward them if they'd follow the Japanese example and come before the American people and take that deep bow and say, I'm sorry, and then either do one of two things: resign or go commit suicide."[47]

Senator Chuck Schumer (D-New York) accused AIG of "Alice in Wonderland business practices" and said "It boggles the mind." He has threatened to tax the bonuses at up to 100%. [48]

Senator Richard Shelby (R-Alabama) said "These people brought this on themselves. Now you're rewarding failure. A lot of these people should be fired, not awarded bonuses. This is horrible. It's outrageous." [49]

Senator Mitch McConnell (R-Kentucky) echoed his comments, saying "This is an outrage."[50]

Senator Jon Tester (D-Montana) said "This is ridiculous." and AIG executives "need to understand that the only reason they even have a job is because of the taxpayers." [51]

Senator Dick Durbin (D-Illinois) said "I've had it." and "The fact that they continue to do it while we pour in billions of dollars is undefensible."[52]

US president Obama, Congress call for blocking of executive bonuses at AIG insurance company. Representative Barney Frank (D-Massachusetts), Chairman of the House Financial Services Committee, said paying these bonuses would be "rewarding incompetence"[53] and "These people may have a right to their bonuses. They don't have a right to their jobs forever."[54]

Representative Mark Kirk (R-Illinois) said "AIG should not be on welfare from Uncle Sam, and yet paying bonuses and transferring a considerable amount of taxpayer funds to entities overseas."[55]

Federal Reserve Chairman Ben Bernanke said "It makes me angry. I slammed the phone more than a few times on discussing AIG."[56]

Lawrence Summers, Director of the National Economic Council, said "The easy thing would be to just say, you know, ‘Off with their heads,’ and violate the contracts."[57]

Austan Goolsbee, of the Council of Economic Advisers said "I don't know why they would follow a policy that's really not sensible, is obviously going to ignite the ire of millions of people." and "You worry about that backlash."[58]

Political commentators and journalists expressed an equally bipartisan outrage.[59][60][61][62] [63][64][65][66][67][68]

On March 24, 2009, The New York Times printed the resignation letter of Jake DeSantis, executive vice president of AIG’s financial products unit, to Edward M. Liddy, the chief executive of AIG. DeSantis stated he had nothing to do with the credit default swaps, he lost much of his life savings in the form of deferred compensation invested in the capital of AIG Financial Products; he had agreed to work for an annual salary of $1 out of a sense of duty, that he was assured many times the bonuses would be paid in March 2009, and that he believed he and others were let down by Liddy's lack of support. He also stated he was going to donate his bonus to those suffering from the global economic downturn. [69]

It was reported that Senator Christopher Dodd (D-Con) (who first denied, then admitted to amending the legislation to allow the AIG bonuses), received $160,000 from employees of AIG. [70][71] [72][73]

A memo issued in 2006 by Joseph Cassano, AIG Financial Products chief executive, urged AIG employees to donate to Dodd, saying that as "next in line to become chairman of the Senate Banking, Housing, and Urban Affairs Committe... Senator Dodd will now have the opportunity to set the committee's agenda on issues critical to the financial services industry."[74]

AIG breakup nets Wall Street $1 billion

Source: AIG breakup nets Wall Street $1 billion bonanza: report Reuters, August 6, 2009

"Wall Street banks and lawyers could collect nearly $1 billion in fees from the Federal Reserve Bank of New York and American International Group Inc to help manage and break apart the insurer, The Wall Street Journal said on Wednesday, citing its own analysis.

Morgan Stanley could collect as much as $250 million, the newspaper said, citing banking experts and documents released by the New York Fed.

Bank of America Corp, private equity firm Blackstone Group LP, law firm Davis Polk & Wardwell LLP, accounting firm Ernst & Young, Goldman Sachs Group Inc and JPMorgan Chase & Co are among others that have or could get big paydays for helping dismantle AIG, the newspaper said.

To calculate dollar amounts, the newspaper said it tallied estimated fees for transactions already announced and those AIG is considering, planning or may be forced to pursue. It said it obtained assistance from Freeman & Co, Thomson Reuters and documents provided by the New York Fed.

According to the newspaper, the situation creates potential conflicts of interest in oversight by causing the government to employ many companies it regulates.

The government owns nearly 80 percent of AIG, and has given the insurer a series of bailouts estimated at $180 billion.

AIG was felled by big bets on credit default swaps that left it on the hook for tens of billions of dollars of payouts it could not make.

Shares of AIG closed Wednesday up 62.7 percent at $22 on the New York Stock Exchange, as investors rushed to cover short positions. AIG has said it plans to report second-quarter results on Friday."

Speculators feast on AIG remains

"A year after the government sought to avert a market meltdown by rescuing some of the country's biggest financial firms, speculative traders are feasting on these companies' remains. Shares of two government wards, mortgage giants Fannie Mae and Freddie Mac, bounced between about 60 cents and $2 in August. Shares of Lehman Brothers, left to fail by the government and currently in bankruptcy proceedings, rose from five cents to 20 cents in recent weeks.

AIG, arguably, has been the biggest casino of all. In the past seven weeks, its common shares have careened between $13 and $55, surging past $54 on Tuesday before closing at $45.80.

The extraordinary price action is a dramatic display of an unintended consequence of the U.S. bailout of AIG. Last Sept. 16, the government propped up the faltering company by trading $85 billion in loans for an 80% stake in AIG in the form of preferred shares, which don't trade on the market. It allowed the other 20% of the company's equity -- its millions of common shares -- to continue to trade publicly.

Some analysts declared the deeply indebted company's common shares basically dead money. Many buy-and-hold investors bailed out. That has left AIG's common shares -- $6.2 billion worth, as of Tuesday -- trading most actively between short-term traders, who buy and sell based on market momentum and bet against each other in risky options trades. Often they use borrowed funds, amplifying their gains and losses.

Increasingly toxic pool of CDS

Source:AIG’s European Derivatives May Take Decades to Expire July 17, 2009, Bloomberg

"July 17 (Bloomberg) -- American International Group Inc.’s trading partners may force the insurer to bear the risk of losses on corporate loans and mortgages for years beyond the company’s expectations, complicating U.S. efforts to stabilize the firm, analysts said.

European banks including Societe Generale SA and BNP Paribas SA hold almost $200 billion in guarantees sold by New York-based AIG allowing the lenders to reduce the capital required for loss reserves. The firms may keep the contracts to hedge against declining assets rather than canceling them as AIG said it expects the banks to do, according to David Havens, managing director at investment bank Hexagon Securities LLC.

“For counterparties to voluntarily terminate those contracts makes no sense,” Havens said in an interview. “There’s no question that asset values have soured on a global basis. With the faith and credit of the U.S. government backing those guarantees, why would they give that up?”

The falling value of holdings backed by the swaps may force AIG to post more collateral, pressuring the insurer’s liquidity and credit ratings in a repeat of the cycle that caused the firm’s near collapse in September, Citigroup Inc. analyst Joshua Shanker said last week. The insurer needed a U.S. bailout valued at $182.5 billion after handing over collateral on a different book of swaps backing U.S. subprime mortgages.

The average weighted length of the European swaps protecting residential loans is more than 25 years, while the span tied to corporate loans is about 6 years, AIG said in a regulatory filing. Contracts covering corporate loans in the Netherlands extend almost 45 years, and the swaps on mortgages in Denmark, France and Germany mature in more than 30 years."


References


Retrieved from "http://freerisk.org/wiki/index.php/AIG"
Personal tools