SIGTARP Explains AIG Fail
The big takeaway from the SIGTARP report on the bailout is the discussion of the failure of the Fed to force AIG’s credit default swap counterparties to take a haircut. I join with others in saying that Timothy Geithner, then president of the New York Fed, acting for the benefit of the Financial Elite, failed miserably at protecting taxpayers and citizens. The report shows that the entire strategy adopted by Paulson and Geithner was doomed from the beginning.
Their first step was to buy common stock of AIG for $85bn, giving the Treasury control of the company. Why? If AIG failed, the common stock would be worthless. That only made sense if the problem was to replace management and run the company, which wasn’t going to happen. Treasury did the same thing with CIT Group, Inc. , buying preferred stock. CIT filed bankruptcy, and the preferred stock will almost certainly be a total loss.
Geithner says the reason he couldn’t bargain was that there was no credible threat of bankruptcy. Now why was that? Because it would have meant that the Treasury would lose a huge chunk of that $85bn. That would not have been the case if Treasury had made a loan, secured by the common stock of the insurance subsidiaries and any other profitable subs and other assets. Then, when the whiny losers with their CDSs demanded collateral, Geithner and Paulson would have the credible threat of bankruptcy or foreclosure on all the valuable assets. That would have been leverage. It would have been perfectly legal, and well within the powers of the government.
SIGTARP tells us what we got instead:
Merrill Lynch: A managing director told SIGTARP that, on November 7, an FRBNY Vice President and Assistant Vice President called senior Merrill Lynch officials and asked if Merrill Lynch would consider accepting a discounted price to tear up the contracts. Senior Merrill Lynch officials told FRBNY that FRBNY would need to contact directly John Thain, Merrill Lynch’s then-CEO, to discuss any potential discount. FRBNY stated that an executive vice president called Mr. Thain at the outset of the negotiations to request his cooperation. Later that night, FRBNY spoke by phone to a Merrill Lynch managing director and proposed a transaction in which Merrill Lynch would receive par for the contracts. The managing director told SIGTARP that Merrill Lynch was not receptive to FRBNY’s request for concessions for reasons similar to those described above by Goldmans [sic] Sachs and because Merrill Lynch had already paid approximately $40 million in fees and to obtain credit protection and anticipated that it would have to pay an additional approximately $36 million in fees and costs to resolve the Maiden Lane III CDOs.
“Pretty please” isn’t a negotiating strategy. Even Geithner admits that it had little chance of success. P. 29
He denies that his decision was based on risks to the financial condition of the counterparties (page 15); which amounts to a denial that the transactions were a backdoor bailout, or were intended to maintain liquidity in the banking system as a whole. That might have made sense, but it’s not the case.
One of Geithner’s fears was that a “disorderly failure of AIG risked deepening and prolonging the current recession.” Page 10. He claims he lacked power to set up an orderly resolution of the AIG problem. After the initial thoughtless error, the risks were greater, especially the risks of loss to the Treasury. But, all of the problems Geithner identifies have cheaper solutions. For example, he says he was worried that default on AIG commercial paper would cause money funds to break the buck, that is, their asset value per share would fall below $1. That risk, if it were so important, could have been dealt with more cheaply by doing what the Treasury eventually did, guarantee the money market funds for a fee.
Compare AIG with the handling of the GM disaster. There was a loan, with conditions. GM was required to put together a plan that would work. When it didn’t, the CEO was fired, and the new guy came up with a possible plan, under the lash from Car Czar Steven Rattner and the Obama White House. When stakeholders didn’t consent, the plan was turned into a prepackaged bankruptcy and it was rammed through. That plan worked (we hope). It worked because instead of a chaotic filing, there was a plan, and an orderly resolution.
If Paulson, Geithner and company ever thought a couple of steps down the road, they might have come up with the Obama strategy. After the disastrous decision to buy stock, it really was impossible to put the loss where it belonged: on the shareholders and AIG’s credulous creditors.