The New York Fed, which extended AIG an $85 billion loan in September 2008, made only “limited efforts to negotiate concessions” from AIG’s counterparties, companies that had insured complex securities with AIG. In the end, the New York Fed agreed to pay the counterparties 100 cents on the dollar to tear up the contracts, thus easing liquidity pressures on the vulnerable AIG.
The audit by the TARP watchdog faults the Fed for not persuading the counterparties to accept lower prices, known as ‘haircuts,’ on some $60 billion in contracts. Just days before the Fed agreed to pay the full value, one counterparty, UBS, agreed to a 2 percent discount if other counterparties agreed to the same deal.
But the Fed refused to treat the counterparties – both domestic and foreign banks – differently. It also declined to use any leverage to compel concessions, according to the audit. “These policy decisions,” according to the audit,”…led directly to a negotiating strategy with the counterparties that even then-FRBNY President [Tim] Geithner acknowledged had little likelihood of success.”
Critics have called the resulting payments “backdoor bailouts” to AIG’s creditors, which included some of the world’s largest banks, such as Goldman Sachs, Merrill Lynch, Deutsche Bank, Barclays, and Bank of America.
Geithner, now Treasury Secretary, and the New York Fed have denied that a bailout of counterparties was the intent of the payments. In a letter to the special inspector general for the Troubled Asset Relief Fund, Treasury’s assistant secretary for financial stability, Herbert Allison, defended the Fed’s actions, writing that “the circumstances that forced the government to act developed extremely quickly.”
The letter also stressed the limited regulatory power of the government at the time. “The government could not unilaterally impose haircuts on creditors, and it would not have been appropriate for the government to pressure counterparties to accept haircuts by threatening to retaliate in some way through its regulatory power.”
The TARP watchdog, however, seems to have little patience for such a defense. “Irrespective of their stated intent…there is no question that the effect of FRBNY’s decisions…was that tens of billions of dollars of government money was funneled inexorably and directly to AIG’s counterparties,” according to the report.
The audit also takes issue with the Fed’s contention that it could not interfere with the sanctity of contracts, pointing out that the government actively negotiated for concessions from creditors for General Motors and Chrysler.
The report does acknowledge that the Fed faced particular challenges, including the fact that a top French banking regulator “forcibly” argued that two of AIG’s French creditors, Societe Generale and Calyon, could not by law accept anything below full value on their contracts, unless AIG went into bankruptcy. Around the same time, seven of eight creditors contacted by the Fed about concessions refused to accept them.
As a result, according to the audit, “the counterparties were effectively paid full face (or par) value of the credit default swaps, an amount far above their market value at the time.”
Politico reported Tuesday that a senior Treasury official said the audit amounts to nothing more than “20-20 hindsight” and “second guessing,” of decisions made at the height of the financial crisis. “This is a classic case of a guy telling you that you could have gotten a better deal after the fact,” the official reportedly told Politico. “But it’s a little hard to refinance when your house is on fire.”