There is a bizarre article in the WSJ today. It claims that the French “masterfully outmaneuvered” the Fed to get 100 cents on the dollar for their counter-part banks to AIG’s Financial Products division.

Quelle stupidité!

I have many reasons to doubt the judgment of former Treasury Secretary Hank Paulson, and Fed Chief Ben Bernanke, but this is not one of them. I am unconvinced that a legal maneuver by the French is why AIG-FP counter-parties were paid 100 cents on the dollar.

There are two reasons why I think this argument fails.

First, both SocGen and Goldman Sachs each managed to squeeze 100 cents on the dollar on $5.9 billion a piece days before AIG collapsed. In a bankruptcy hearing, that would have been deemed a fraudulent conveyance and clawed back. Why that was allowed to stand implies that the Fed wanted other financials to have the money.

The second reason was more explicit. Paulson’s successor, Treasury Secretary Tim Geithner, explicitly stated that if the pass thrus were not permitted, the system might have collapsed. Thus, the NY Fed, and now the Treasury, wanted the 100% payouts to help liquify the system.

Here’s the Journal:

“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 creditors, 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 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. Their refusal was crucial, as it helped set the tone for U.S. banks, including Goldman and Merrill, to resist negotiation.

The French 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.”

I fail to see how a counter-party could win an arm’s length negotiation with that tactic:

French: “We cannot take anything less than 100 cents on the dollar.”

Fed Response:  “OK, then you’ll leave empty handed. Go back and tell your shareholders you were offered less than 100%, and you rejected it. Come by in 2 years and pick up whatever is left over –3 cents. 4 cents? –and its yours! Have a safe flight now . . . Buh bye”

Besides, as University of Luxembourg law professor Pierre-Henri Conac noted in the article, “their argument was very overstated. Banks give haircuts every day.”

‘Nuff said. This was an outright gift done on purpose, and not the result of some obscure French bank law.

>
Source:
How French Outplayed AIG and Fed
DENNIS K. BERMAN
WSJ, JANUARY 19, 2010

http://online.wsj.com/article/SB20001424052748703626604575011321802336844.html

Category: Bailouts, Derivatives

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

41 Responses to “Why AIG Counter-Parties Recieved 100% on Derivatives”

  1. Scott F says:

    Megan McCardle said Goldman could have just seized the money even if AIG filed for bankruptcy:

    “Seriously, what could AIG have threatened Goldman with? If they didn’t accept a haircut, AIG would file for bankruptcy? Fine, Goldman would’ve just seized the $7.5 billion in cash collateral, and collected the remaining $2.5 billion from its counterparties on the now-triggered CDS on AIG (on which more below), covering Goldman’s full bilateral exposure to AIG. That’s what it means to be “hedged. ”

    ~~~

    BR: Its not my job to defend McCardle, but I believe she is quoting someone else (Economics of Contempt) there

  2. Legal Beagle says:

    Why do you guys even bother with Megan McCardle?

    She is a dimwit disguised as an intellectual. I stopped reading her when it finally dawned on me that she is rhetorically retarded.

    When will you people stop wasting your time on morons and idiots wankers?

  3. OK, for the record:

    No, you cannot simply make a smash and grab and think a bankruptcy court will allow it.

    Indeed, in some cases, transfers made as much as 6 months earlier to some creditors over others are deemed “Fraudulent Conveyances” and taken back by courts.

    To suggest that you need only take what you want before a bankruptcy and you are home free is beyond silly — it is legal malpractice.

    But that does not seem to be the argument Tavakoli is making — its that the Fed lacked the authority to do more. I disagree with that — half of what the Fed did — including the $29B Bear Stearns bailout — they lacked the authority for.

  4. dead hobo says:

    Barry Ritholtz Says:
    January 19th, 2010 at 7:09 am

    half of what the Fed did — including the $29B Bear Stearns bailout — they lacked the authority for.

    reply:
    ————-
    But noooo! The Fed could NEVER have pumped the stock market, directly or indirectly, in secret (hence the lack of evidence until the Fed is audited). It’s all ZIRP (of course ZIRP is having an influence, it’s just not high octane enough to see the markets go straight up over such a short time for so long). Anyone who claims the Fed would do something illegal is whacked.

  5. Don’tmiss the main point here:

    Paying 100 cents on the dollar bailouts were ridiculous.

    It is not the taxpayers resposibility to make good bets gone bad by speculators, hedge funds or banks.

    Choose your counter parties well, don’t lend to insolvent institutions, dont invest in bad managements.

  6. dead hobo says:

    Per current industry talking points:

    Our investment advisers can read a track and tout sheet better than anyone. Our market calls are legendary and anyone who claims otherwise is barking daft. We have a system and it works. We even have a $2 window. It’s called the 401k deduction. For larger amounts, we’ll provide personal calls based on the current tout.

  7. dead hobo says:

    Barry Ritholtz Says:
    January 19th, 2010 at 7:25 am

    Don’tmiss the main point here:

    Paying 100 cents on the dollar bailouts were ridiculous.

    reply:
    ———
    Very much in agreement. I’m just saying the stupidity and fraud didn’t end there. The Fed pump might have even been considered a good idea if the market wasn’t so overvalued and so sticky due to HFT algos, and it about half of it didn’t end up in the bonus pool.

  8. sfharris81 says:

    Quelle stupide!

  9. call me ahab says:

    “This was an outright gift done on purpose”

    exactly-

    the simplest excuse is usually the best- the Treserve (thanks ZH) was just trying to keep money flowing to where it needed to go to minimize as much damage as possible-

    pretty poor bankers though- because normally a banker would cut your heart out if it saved him a dime

  10. Tarkus says:

    Another question is: why is the WSJ even bothering to print that – to float a trial-balloon on excuses and try to lay the seed for a plausible explanation? There is none, other than to shove more money to the bailout, keeping TBTF alive and well.
    Companies that contribute to the economy provide goods and services to their client base (i.e., Microsoft provided a real growth to the economy, thought they were tough on competitors). “Banks” (with their hedge-funds ensconced safely within their walls) now function as Predators on their client-base, because TBTF is allowed to exist. Why make loans when you can play the casino and offload your losses onto the public? That Bernanke advocates continuing that model raises serious questions. It implies the belief that healthy banks supersede a healthy economy, when the association is not necessarily valid when banks are predatory.

  11. Transor Z says:

    Swaps must be resolved pre-bankruptcy. We talked about this a long time ago. That’s why the AIG counterparties had so much leverage.

    Bankruptcy law has favored swaps for 30 years, but that favoritism was further strengthened in the 2005 BACPA “reforms.”

    This is all part of the creeping legislative capture over decades that is discussed here all the time.

    In my view, this does not rule out counterparties taking a serious haircut, but it does provide a legal figleaf against fraudulent conveyance claims in bk.

  12. dead hobo says:

    Transor Z Says:
    January 19th, 2010 at 8:40 am

    Swaps must be resolved pre-bankruptcy. We talked about this a long time ago. That’s why the AIG counterparties had so much leverage.

    reply:
    ————–
    Good points. Given my limited understanding of bankruptcy law, someone with a perfected security interest is outside the bankruptcy unless the asset is sold and the claim is not covered in full. The deficit becomes a part of the bankruptcy estate. Any excess on sale becomes available for distribution to others making claims. Thus, in theory, anyone with a perfected security interest (probably everyone who was hedged) stood pretty well.

    Preferential transfers made before a bankruptcy can be set aside if they meet certain broad criteria that basically give one claimant an artificial preference over another.

    That being said, the securitized assets were financial in nature and subject to changing market valuation. Any delays may have caused them to fall in value. Just stalling a little would have provided massive leverage in any negotiation.

    Also, like most people, I really don’t know what was hedged. Were they financial assets with as much substance as side bets on which bird would fly off first; the one on the left or the one on the right or were they derivatives with real value. I suspect they were more related to the former than the latter.

    Uncle Stupid has shown time and time again he either doesn’t understand the concept of negotiation or won’t negotiate. He is the perfect sucker or perfect inside man.

  13. clawback says:

    TRansor, et al.,

    Anyone remember what happened with Lehman? Were swaps settled beforehand? I thought there was beaucoup confusion on this at the time and, if memory serves, some of the CDS Lehman had written were simply torn up by the court. This is a key issue. I simply don’t know the answers on this.

    Also, since AIG had no way to cover its CDS obligations, it would have gone into BK, but the insurance units would have gone into statutory receivership at the state level. Thus leaving the AIG parent holding the flaming sack of CDS merd — oui, no? In any case, any BK court is going to give AIG FP’s CDS a good examination for evidence of fraud.

    Further, as Marshall Aurback has pointed out, what kind of leverage did AIG counterparties have when some of them would have been toast without the backdoor bailout?

  14. clawback says:

    Also, let’s not forget Steve Friedman’s role here. Looks like a clear case of insider trading. See here: http://dailybail.com/home/is-stephen-friedman-guilty-of-insider-trading.html

  15. FrancoisT says:

    @Tranzor Z:

    “Bankruptcy law has favored swaps for 30 years, but that favoritism was further strengthened in the 2005 BACPA “reforms.”

    Bingo! And that is why we shall never see any change to this legalized fraud in the so-called Financial Reform going through CONgress.

    This “reform” looks more and more like a sex slave used as a pet in the hands of a bunch of depraved perverts. Battered, abused, bullshited beyond recognition, while told time and again that it is for her/his own good.

    Alas, this is nothing new; this is how elites in countries in financial troubles behave:

    1) Above all, preserve the status quo for themselves and their cronies/friends.
    2) Make sure you stick it to the “little people”.
    3) Deny, obfuscate and BS everything that reveal the truth.
    4) Only when reality hit hard enough shall anything meaningful get done.

    Apparently, reality hasn’t hit hard enough on our shores. I wonder what will it takes?

  16. call me ahab says:

    clawback-

    no doubt re Stephen Friedman-

    must be nice having friends in high places- they smack Martha Stewart around for a less egregious offense-

    dude should be tried and convicted for insider trading-

    scam of scams

  17. cognos says:

    You guys seem to ALL miss the whole point:

    - The Fed could not allow AIG to enter out-right bankruptcy.
    - The Fed really should not have allowed Lehman to enter out-right bankruptcy.

    Did Q4 2008 not teach you that much?

    p.s. this is not really a big deal. the FDIC does not allow small banks to even enter bankruptcy. it declares them “insolvent” and winds them down in an orderly fashion. counterparties of small banks are paid at par.

    p.s. 2 shouldnt the focus be on the problems at AIG, not on cp payments? AIG will not really be a major source of losses in 2yrs. they had $200B in equity. they have reasonably valuable businesses. relax. deep breath. this is what a crisis is – ugly. lets get past it.

  18. jdillonnyc says:

    As Sister Patrick Mary taught me: i before e except after c.

  19. Transor Z says:

    Cognos you magnificently ignorant slut. Here’s how it works with FDIC receivership of insolvent banks (AIG still isn’t a bank, by the way):

    Individual swap agreements with the same counterparty are provided special treatment as ‘qualified financial contracts’ (QFCs) in the bank resolution code and, unlike other accounts, are permitted to be netted. Individual contracts with a single counterparty are typically netted by incorporation in a standardised single master swap agreement developed by the International Swap and Derivative Association (ISDA), so that only the net rather than the gross position is at risk. An insolvent bank may have net swap positions that are either or both in-the-money — so that they are assets to the bank — or out-of-the-money — so that they are in-the-money to the bank’s counterparties and a liability to the bank. If the net positions of the insolvent bank are in-the-money, they provide no special problem to the FDIC in resolution. Similar to other assets, the FDIC can sell the net positions to other (third party) solvent counterparties at market value. But, if the positions are out-of-the-money, the solvent counterparties have claims on the bank and the FDIC needs to consider how to treat these claims in resolution. And this may not be independent of the way the FDIC disposes of the positions.

    The FDIC may currently pursue one of two options in resolving the counterparties’ net in-the-money swap positions of insolvent large banks. It receives an automatic one business day stay after its appointment as receiver to make a determination of its actions. On the one hand, the FDIC can repudiate the net contracts, effectively terminating and closing them out at current market value. If the net positions are not collateralised, the in-the-money claimants are treated as general creditors of the insolvent bank, who since the Depositor Preference Act of 1993, have lower legal priority than domestic depositors and are subject to potential prorata losses (haircuts) on their claim based on the recovery value of the bank’s assets. They receive no special treatment.

    From George G. Kaufman, “A proposal for efficiently resolving out-of-the-money swap positions at large insolvent banks” (Journal of Banking Regulation, 2007)
    http://www.palgrave-journals.com/jbr/journal/v9/n1/full/2350058a.html

    Note also that bank insolvency is not resolved through the Bankruptcy Code but through FDIC receivership process. AIG (not a bank) would not go through the FDIC. This was a resolution of in-the-money swap obligations held by banks (i.e., a liability to AIG (still not a bank).

  20. call me ahab says:

    cognos-

    quite the apologist-

    it was great the way the TBTF’s were wound down . . .oh . . .my bad . . .they weren’t . . .

    so . . .what’s your point again?

  21. call me ahab says:

    damn TZ-

    you “outshined” my little post-

    so cognos is Jane Curtain to your Dan Akroyd?

  22. Mannwich says:

    cognos is a Wall Street plant. My mental “ignore” button is on for him now.

  23. cognos says:

    Transor Z –

    Nothing in what you posted contradicted what I wrote. And you certainly did not deal with the main basic point — which is that avoiding an AIG bankruptcy was of paramount importance. Why is that not obvious?

  24. Transor Z says:

    @cognos:
    You’re entitled to your own opinions but not your own facts. Your statement about bank counterparties being paid at par value in FDIC receivership shows you don’t know wtf you are talking about. Not only did you make an inapt analogy since bank receivership is its own animal, but you were wrong. So I should give weight to your opinions here because … ?

  25. cognos says:

    TransorZ — Again, nothing you posted stated some unique “fact” that was in stark disagreement from what I wrote. The key end point of the long copied section said, “IF they are not collateralized” (I bet most of the AIG swaps were collateralized, “then swaps MAY be subject to haircuts”.

    Yet somehow these “facts” are clearly on your side. Hmm… I dont see it. Again, not my main point. Agree fully that “bank receivership is its own animal”… dont get caught up in silly details. “Orderly wind down” is the key driver… and in both cases sacrifices are made. Get it?

  26. cognos says:

    Ahab – I think its more like TZ is playing the Sarah Palin to my Katie Couric.

  27. HoldYourHorses says:

    Don’t forget who owns the WSJ nowadays. Mr. Murdoch’s wordlview might be playing the narratives of the “news” at yet another megaphone. “France got us” is too juicy to be left alone. When there are easily reported issues to be legitimately furious at the current regime about, its dissapointing to see articles such as this make their way to press.

  28. FrancoisT says:

    “Murdoch’s wordlview might be playing the narratives of the “news” at yet another megaphone.”

    Might?

  29. clawback says:

    cognos, I’ll grant you Katie Couric. LOL.

    also, cognos wrote:

    You guys seem to ALL miss the whole point:

    - The Fed could not allow AIG to enter out-right bankruptcy.
    - The Fed really should not have allowed Lehman to enter out-right bankruptcy.

    Did Q4 2008 not teach you that much?
    —————————————————-

    The Fed had no business doing anything with AIG. YOU miss the point on this. It’s not about Timmy’s “judgment” as to which actions would have which effects on GDP, etc. We’re talking about the rule of law. Real Americans respect that, desire it, and demand it. Short-run GDP be damned. The bailout apologists have no answer for this except vague metaphors and fear-mongering.

    Lehman, furthermore, is the model for how things should have been handled. Did the sun not come up on September 18th and every day thereafter. Yes, I believe it did. Did the CP market for industrials ever freeze up as the bailout apologists keep saying it did? Nope. Check the data for yourself at the Minneapolis Fed. CP for certain *financials* was a bit of a problem, but considering the situation this makes perfect economic sense. The suggestion from Paulson, et al. that the entire economy would grind to a halt because Goldman, Morgan Stanley and AIG imploded is preposterous. Still not explained. All we get are metaphors and fear-mongering.

    Geithner, especially, but all of the bailout apologists believe that because their minds are unable to see how the world would co-ordinate itself in the event of a few BK’s, that the world would therefore be unable to co-ordinate itself. The notion is that the chips couldn’t be allowed to fall where they may, but that, as one writer put it, if only Geithner and his friends could catch those chips as they fall and arrange them neatly, then all would be well. This amounts to pretense of epic proportions. Geithner doesn’t even have a background in finance, never mind in economic and financial central planning.

    Finally, even granting that all of the bailouts were 100%, 100-cents-on-the-dollar necessary, why haven’t any of the executives been held responsible, why do they all still have jobs and enormous paychecks, and why have no bondholders been asked, even at this late date, to take a haircut? The bailout apologists can’t have it both ways. If all of this was completely necessary, then they should be fired and their pay from recent years clawed back. If it wasn’t necessary, then some heads need to roll and money clawed back.

    Regardless, I want to see heads roll. I want to see them on sticks.

  30. Transor Z says:

    Okay, Cognos. I’ll bite.

    First, I highly recommend the entire Kaufman article. It was written in 2007 and outlined a crisis resolution scenario involving systemic risk virtually identical to what we faced in 2008.

    However, the key difference between Kaufman’s theses and AIG is that, instead of FDIC, it was the NY Fed that intervened in the bailout of counterparties. The FDIC backstops bank insolvencies and absorbs losses as needed in order to make good on an insolvent bank’s depositor insurance and creditor obligations. However, the FDIC has some unique powers, notably the authority to place not-wound-down contractual obligations (like swaps) with other solvent banks.

    Yes, orderly wind down is key. Thus the Lehman disaster. And yes, the goal was to avoid bk for AIG with all of the inherent systemic risk — not only on the banking side, but on the insurance side as well…

    But the fact remains that this was a FED intervention, not FDIC. Where in the Fed statute are they authorized to act as they did? The best you can offer is to say that “crises are ugly.” WTF kind of anti-intellectual bilge is that? So the Fed gets to make things up as they go along? No, because if you’re going to ascribe to them free-ranging FDIC-like powers, they still have an obligation to balance the needs of all parties during wind-down — notably the US taxpayers. Kaufman’s point is that imposing haircuts are a viable and desirable form of resolution to avoid explosive decompression (Lehman) and acknowledge the equity of making counterparties accountable for moral hazard.

  31. Transor Z says:

    New York Fed ‘Very Sensitive’ on AIG, E-Mail Says, by Hugh Son (Bloomberg) 1/19/2010
    http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aX4pBpXXkoOU

    The New York Fed asked Habayeb to “stand down” from negotiating with counterparties, according to an Oct. 31, 2008, e-mail he wrote to AIG CFO David Herzog. Herzog replied that AIG should “get back with Goldman” about the change in plans.

    Before the New York Fed took over the talks, AIG tried to persuade banks to accept so-called haircuts of as much as 40 cents on the dollar, according to people familiar with the matter. The regulator made “limited efforts” to secure discounts over two days in November 2008, according to a report from Neil Barofsky, the special inspector charged with policing the U.S. Troubled Asset Relief Program.

  32. Mannwich says:

    @Transor: Saw that one too. Well, we know who the Fed works for, don’t we? Hint: It’s not the American taxpayer, so it’s pretty easy for them to dole out 100 cents on the dollar to their real masters.

  33. Transor Z says:

    ‘Nuff said. This was an outright gift done on purpose, and not the result of some obscure French bank law.

    Gee, Barry, would it surprise you that Davis Polk & Wardwell (the firm hired by the NY Fed that vetted the AIG disclosure to AIG) has a Paris office?

  34. Transor Z says:

    s/b “the AIG disclosure to SEC”

  35. cognos says:

    So according to Tranzor –
    – they shouldnt have paid swaps amounts to GS in Full
    – they should’ve bankrupted AIG
    – no wait, they shouldn’t have bankrupt’d AIG
    – no wait, the Fed has no power to intervene and is evil
    – no wait, Kaufman wrote a paper, ergo they do have the right to haircut counterparties

    hmm… sounds like a good full-circle plan.

  36. Transor Z says:

    So according to Tranzor –
    – they shouldnt have paid swaps amounts to GS in Full [Admits]
    – they should’ve bankrupted AIG [Denies, mischaracterization of position relying on fallacy of false alternatives]
    – no wait, they shouldn’t have bankrupt’d AIG[Denies, mischaracterizes stated position]
    – no wait, the Fed has no power to intervene and is evil[Admits as to NY Fed not having statutory power to intervene in resolution of out-of-the-money swap obligations of a non-banking entity to detriment of United States for the sole benefit of foreign and domestic financial institutions, insufficient knowledge as to Fed evil, denies as to "no wait"]
    – no wait, Kaufman wrote a paper, ergo they do have the right to haircut counterparties [Denies as to “no wait,” Admits as to Kaufman authoring a paper on FDIC powers, Denies Cog assertion that NY Fed is the same thing as FDIC, Denies as to Kaufman paper arguing that the NY Fed is authorized to do anything, Admits to possibly wasting time countering the disingenuous/moronic arguments of a tool/cog/troll/shill.

  37. Mannwich says:

    @Transor: LOL.

  38. Transor Z says:

    @Manny:
    Whatever. ;-)

    Bigger news: 52-47 Brown with 18% reporting.

    If Obama doesn’t get the message that people are feeling betrayed by him and turn things around, he’s a one-termer/failed presidency.

  39. emmanuel117 says:

    A dramatic recreation of Tranzor Z’s vise on cognos.

  40. Transor Z says:

    Awesome. Tappin’ out is for bitches.

  41. foxmuldar says:

    clawback says:

    Finally, even granting that all of the bailouts were 100%, 100-cents-on-the-dollar necessary, why haven’t any of the executives been held responsible, why do they all still have jobs and enormous paychecks, and why have no bondholders been asked, even at this late date, to take a haircut? The bailout apologists can’t have it both ways. If all of this was completely necessary, then they should be fired and their pay from recent years clawed back. If it wasn’t necessary, then some heads need to roll and money clawed back.

    Regardless, I want to see heads roll. I want to see them on sticks.

    I fully agree, head should roll. AIG was just another sweetheart deal to buddies of Paulson, Geithner and Bernanke. Seems quite similar to what took place with Goldman Sachs. These guy all hang out at the same bars and spas. Besides its the taxpayers money they were throwing around, so they really didn’t care much at the time about what and who they paid off. As for Lehman Bros, I expect Geithner and Paulson decided it would be good to let them go under so their pals at Goldman could clean up once the dust settled. Sure seems like thats whats happened the past year. GS showing record profits simple by having a better and quicker moving software then their competitors. And with Lehman out of the way, its one less competitor to fight for those pennies on each trade.