That’s right, vindicated. Read the whole report. It makes clear that the NY Fed did try to negotiation haircuts with AIG’s counterparties, but not at all surprisingly, the counterparties (and the French regulators) refused, and the NY Fed was left with no choice but to pay par value. Geithner, contrary to popular belief, didn’t have the powers of a bankruptcy court. It’s funny how quickly the Immaculate Negotiation argument breaks down in the real world. (I will be accepting apologies in the form of cash or personal checks.)
Despite the overtly political “conclusions” and “lessons learned” sections (sadly, the only sections journalists read), the SIGTARP report (finally) gets a lot of the real facts out in the public domain, so we can finally talk about them now. The SIGTARP report confirms that:
1. First, AIG tried to negotiate haircuts on its CDS contracts, but counterparties refused (as was their right):
AIG was attempting to resolve its liquidity crisis caused by the collateral posting requirements by negotiating a cash payment to the counterparties in return for terminating the credit default swaps. … While FRBNY was conducting analysis on alternative solutions, AIG's attempts to negotiate the termination of its multi-sector credit default swap book with its counterparties were failing. AIG requested FRBNY's assistance in securing these terminations.
2. Contrary to the constant claims of ill-informed pundits, the NY Fed did try to negotiate haircuts with AIG’s counterparties:
On November 6 and 7, 2008, FRBNY assistant vice presidents, vice presidents, senior vice presidents, and executive vice presidents contacted eight of AIGFP's largest counterparties (Société Générale, Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, Calyon, Barclays and Bank of America) by telephone. They described a proposal under which each counterparty was asked to accept a haircut from par. Seven of the eight counterparties told FRBNY officials that they would not voluntarily agree to a haircut. The eighth counterparty, UBS, said that it would accept a haircut of 2 percent as long as the other counterparties also granted a similar concession to FRBNY. FRBNY officials told SIGTARP that their concerns about credit rating downgrades limited the time available for negotiation about reductions in payments.
3. The NY Fed tried to get the French bank regulators to help them negotiate haircuts with SocGen and Calyon—two of AIG’s biggest counterparties—but not only did the French regulators refuse to help, they specifically instructed SocGen and Calyon not to agree to any haircuts (rendering UBS’s conditional acceptance of a 2% haircut moot). From the report:
During these negotiations, an FRBNY executive vice president and senior vice president contacted the Commission Bancaire to inform them that the FRBNY was conducting negotiations with Société Générale and Calyon, two of the counterparties with the largest credit default swap contracts with AIG, and was requesting their support. The Commission Bancaire then contacted the firms. The Commission Bancaire spoke again with FRBNY and forcefully asserted that, under French law, absent an AIG bankruptcy, the banks could not voluntarily agree to less than par value for the underlying securities in exchange for terminating the swap contracts. Thus, the French banks claimed they were precluded by law from making concessions and could face potential criminal liability for failing to comply with their duties to shareholders.
4. Like I said before, the counterparties refused to accept haircuts because (a) they were contractually entitled to par value, and (b) the government’s bailout of AIG had removed the threat of bankruptcy, without which there was no mechanism whatsoever for forcing the counterparties to agree to workouts:
According to an FRBNY senior vice president, the counterparties that FRBNY approached that resisted being paid anything less than the equivalent of par in exchange for terminating their credit default swap contracts cited several reasons for this, including:
- They had collateral already posted by AIG to protect against the risk of AIG default. The combination of collateral in their possession plus the fair market value of the underlying CDOs also in their possession equaled the par value of the credit default swaps. Thus, from the counterparty's perspective, offering a concession would mean giving away value and voluntarily taking a loss, in contravention of their fiduciary duty to their shareholders.
- In addition to the collateral, they had a reasonable expectation that AIG would not default on any further obligations under the credit default swaps because the U.S. government had already demonstrated that it would not allow AIG to go bankrupt.
- They had already incurred costs to mitigate the risk of an AIG default on its obligations that would be exacerbated if they were paid less than par value.
- They were contractually entitled to the par value of the credit default swap contracts.
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I also want to knock down one of the more specious—and frankly shocking—arguments that Barofsky makes in the report. He criticizes the NY Fed for “refus[ing] to use its considerable leverage as the regulator of several of these institutions to compel haircuts.” Think about what this means: Barofsky is criticizing the NY Fed for not threatening to misuse its regulatory authority for purposes of retaliation. First of all, there would be serious questions about the legality of any such regulatory action, since the Fed would be using one of its regulatory tools for something other than its intended purpose. What’s more, this criticism for not misusing regulatory authority is coming from, amazingly, an inspector general. (You think Barofsky is accepting campaign contributions yet?)
It takes real chutzpah for an inspector general to criticize a regulator for not threatening to misuse its regulatory authority.
Maybe we need an inspector general for TARP’s inspector general. The SIGSIGTARP.
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