[Marxism] (BN) How New York Fed's Secret Decision on AIG Swaps Cost Americans $13 Billion

Red Arnie redarnie at gmail.com
Tue Oct 27 13:51:25 MDT 2009

Outrageous capitalist grab at the people's earnings exposed in twits

New York Fed’s Secret Choice to Pay for Swaps Hits Taxpayers

Oct. 27 (Bloomberg) -- In the months leading up to the September 2008  
collapse of giant insurer American International Group Inc., Elias  
Habayeb and his colleagues worked nights and weekends negotiating with  
banks that had bought $62 billion of credit-default swaps from AIG,  
according to a person who has worked with Habayeb.

Habayeb, 37, was chief financial officer for the AIG division that  
oversaw AIG Financial Products, the unit that had sold the swaps to  
the banks. One of his goals was to persuade the banks to accept  
discounts of as much as 40 cents on the dollar, according to people  
familiar with the matter.

Among AIG’s bank counterparties were New York-based Goldman Sachs  
Group Inc. and Merrill Lynch & Co., Paris-based Societe Generale SA  
and Frankfurt-based Deutsche Bank AG.

By Sept. 16, 2008, AIG, once the world’s largest insurer, was running  
out of cash, and the U.S. government stepped in with a rescue plan.  
The Federal Reserve Bank of New York, the regional Fed office with  
special responsibility for Wall Street, opened an $85 billion credit  
line for New York-based AIG. That bought it 77.9 percent of AIG and  
effective control of the insurer.

The government’s commitment to AIG through credit facilities and  
investments would eventually add up to $182.3 billion.

Beginning late in the week of Nov. 3, the New York Fed, led by  
President Timothy Geithner, took over negotiations with the banks from  
AIG, together with the Treasury Department and Chairman Ben S.  
Bernanke’s Federal Reserve. Geithner’s team circulated a draft term  
sheet outlining how the New York Fed wanted to deal with the swaps --  
insurance-like contracts that backed soured collateralized-debt  

Subprime Mortgages

CDOs are bundles of debt including subprime mortgages and corporate  
loans sold to investors by banks.

Part of a sentence in the document was crossed out. It contained a  
blank space that was intended to show the amount of the haircut the  
banks would take, according to people who saw the term sheet. After  
less than a week of private negotiations with the banks, the New York  
Fed instructed AIG to pay them par, or 100 cents on the dollar. The  
content of its deliberations has never been made public.

The New York Fed’s decision to pay the banks in full cost AIG -- and  
thus American taxpayers -- at least $13 billion. That’s 40 percent of  
the $32.5 billion AIG paid to retire the swaps. Under the agreement,  
the government and its taxpayers became owners of the dubious CDOs,  
whose face value was $62 billion and for which AIG paid the market  
price of $29.6 billion. The CDOs were shunted into a Fed-run entity  
called Maiden Lane III.

Habayeb, who left AIG in May, did not return phone calls and an e-mail.

Goldman Sachs

The deal contributed to the more than $14 billion that over 18 months  
was handed to Goldman Sachs, whose former chairman, Stephen Friedman,  
was chairman of the board of directors of the New York Fed when the  
decision was made. Friedman, 71, resigned in May, days after it was  
disclosed by the Wall Street Journal that he had bought more than  
50,000 shares of Goldman Sachs stock following the takeover of AIG. He  
declined to comment for this article.

In his resignation letter, Friedman said his continued role as  
chairman had been mischaracterized as improper. Goldman Sachs  
spokesman Michael DuVally declined to comment.

AIG paid Societe General $16.5 billion, Deutsche Bank $8.5 billion and  
Merrill Lynch $6.2 billion.

New York Fed

The New York Fed, one of the 12 regional Reserve Banks that are part  
of the Federal Reserve System, is unique in that it implements  
monetary policy through the buying and selling of Treasury securities  
in the secondary market. It also supervises financial institutions in  
the New York region.

The New York Fed board, which normally consists of nine directors, in  
November 2008 included Jamie Dimon, chief executive officer of  
JPMorgan Chase & Co., and Friedman. The directors have no direct role  
in bank supervision. They’re responsible for advising on regional  
economic conditions and electing the bank president.

Janet Tavakoli, founder of Chicago-based Tavakoli Structured Finance  
Inc., a financial consulting firm, says the government squandered  
billions in the AIG deal.

“There’s no way they should have paid at par,” she says. “AIG  
was basically bankrupt.”

Citigroup Inc. agreed last year to accept about 60 cents on the dollar  
from New York-based bond insurer Ambac Financial Group Inc. to retire  
protection on a $1.4 billion CDO.

Unwinding Derivatives

In March 2009, congressional hearings and public demonstrations  
targeted AIG after it was disclosed it had paid $165 million in  
bonuses that month to the employees of AIGFP, which is unwinding  
billions of dollars in derivatives under the supervision of Gerry  
Pasciucco, a former Morgan Stanley managing director who joined AIG  
after the CDS payments were mandated.

Far more money was wasted in paying the banks for their swaps, says  
Donn Vickrey of financial research firm Gradient Analytics Inc. “In  
cases like this, the outcome is always along the lines of 50, 60 or 70  
cents on the dollar,” Vickrey says.

A spokeswoman for Geithner, now secretary of the Treasury Department,  
declined to comment. Jack Gutt, a spokesman for the New York Fed, also  
had no comment.

One reason par was paid was because some counterparties insisted on  
being paid in full and the New York Fed did not want to negotiate  
separate deals, says a person close to the transaction. “Some of  
those banks needed 100 cents on the dollar or they risked failure,”  
Vickrey says.

A Range of Options

People familiar with the transaction say the New York Fed considered a  
range of options, including guaranteeing the banks’ CDOs. They say  
that by buying the securities, AIG got the best deal it could.

According to a quarterly New York Fed report on its holdings, the  
$29.6 billion in securities held by Maiden Lane III had declined in  
value by about $7 billion as of June 30.

Edward Grebeck, CEO of Stamford, Connecticut-based debt consulting  
firm Tempus Advisors, says the most serious breach by the government  
was to keep the process of approving the bank payments secret.

“It’s inexcusable,” says Grebeck, who teaches a course on CDSs at  
New York University. “Everybody should be privy to the negotiations  
that went on. We can’t have bailouts like this happening behind  
closed doors.”

Secret Deliberations

The deliberations of the New York Fed are not made public. In this  
case, even the identities of the AIG counterparties weren’t disclosed  
until March 2009, when U.S. Senator Christopher Dodd, head of the  
Senate Finance Committee, demanded they be made public.

Bloomberg News has filed a Freedom of Information Act request seeking  
copies of the term sheets related to AIG’s counterparty payments,  
along with e-mails and the logs of phone calls and meetings among  
Geithner, Friedman and other New York Fed and AIG officials. The  
request is pending.

The Federal Reserve has been reluctant to publish information on its  
efforts to stabilize the financial system since the crisis began. The  
Fed has loaned more than $2 trillion, yet it refuses to name the  
recipients of the loans, or cite the amount they borrowed, saying that  
doing so may set off a run by depositors and unsettle shareholders.

Bloomberg LP, the parent of Bloomberg News, sued in November 2008  
under the Freedom of Information Act for disclosure of details about  
11 Fed lending programs. In August, Manhattan Chief U.S. District  
Judge Loretta Preska ruled in Bloomberg’s favor, saying the central  
bank had to provide details of the loans.

The Fed has appealed to the Second Circuit Court of Appeals, and the  
data remain secret while the appeal proceeds.

‘Cataclysmic Financial Crisis’

Information on the borrowers is “central to understanding and  
assessing the government’s response to the most cataclysmic financial  
crisis in America since the Great Depression,” attorneys for  
Bloomberg said in the Nov. 7 suit.

Questions about the New York Fed transactions may be answered by Neil  
Barofsky, inspector general for the Troubled Asset Relief Program, or  
TARP. He is working on a report, which may be released next month, on  
whether AIG overpaid the banks. TARP is the vehicle through which the  
Treasury invested more than $200 billion in some 600 U.S. financial  

William Poole, a former president of the Federal Reserve Bank of St.  
Louis, defends the New York Fed’s action. The financial system had  
suffered through months of crisis at the time, he says. The investment  
bank Bear Stearns Cos. had been swallowed by JPMorgan; mortgage  
packagers Fannie Mae and Freddie Mac had been taken over by the  
government; and the day before AIG was rescued, Lehman Brothers  
Holdings Inc. had filed for bankruptcy.

‘Enough Trouble’

“I think the Federal Reserve was trying to stop the spread of fear in  
the market,” Poole says. “The market was having enough trouble  
dealing with Lehman. If you add, on top of that, AIG paying off some  
fraction of its liabilities, a system which is already substantially  
frozen would freeze rock-solid.”

Still, officials at AIG object to the secrecy that surrounded the  
transactions. One top AIG executive who asked not to be identified  
says he was pressured by New York Fed officials not to file documents  
with the U.S. Securities and Exchange Commission that would divulge  

“They’d tell us that they don’t think that this or that should be  
disclosed,” the executive says. “They’d say, ‘Don’t you think  
your counterparties will be concerned?’ It was much more about  
protecting the Fed.”

‘An Outrage’

Friedman’s role remains controversial. In December 2008, weeks after  
the payments to the banks were authorized in November, Friedman bought  
37,300 shares of Goldman stock at $80.78 a share, according to SEC  
filings. On Jan. 22, he bought 15,300 more at $66.61.

Both purchases took place before the payments to Goldman Sachs were  
publicly disclosed under pressure from Senator Dodd in March. On Oct.  
26, Goldman Sachs stock closed at $179.37 a share, meaning Friedman  
had paper profits of $5.4 million.

Jerry Jordan, former president of the Federal Reserve Bank of  
Cleveland, says Friedman should have resigned from the New York Fed as  
soon as it became clear that Goldman stood to benefit from its actions.

“It’s an outrage,” Jordan says. “He needed to either resign  
from the Fed board or from Goldman and proceed to sell his stock.”

98,600 Goldman Shares

Friedman remains a member of Goldman’s board and held a total of  
98,600 shares of the firm’s stock as of Jan. 22.

Vickrey says that one reason the New York Fed should have insisted on  
discounted payments for AIG’s CDSs is that the banks likely had  
hedges against their insured CDOs or had already written down their  
value. On March 20, Goldman Sachs CFO David Viniar said in a  
conference call with investors that Goldman was protected.

“We limited our overall credit exposure to AIG through a combination  
of collateral and market hedges,” Viniar said. “There would have  
been no credit losses if AIG had failed.”

In any event, former St. Louis Fed President Poole says the entire  
process should have been public and transparent. “There should be a  
high bar against not disclosing,” Poole says. “The taxpayer has  
every right to understand in detail what happened.”

To contact the reporters on this story: Richard Teitelbaum in New York  
at rteitelbaum1 at bloomberg.net . Hugh Son in New York at hson1 at bloomberg.net

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