The Big Picture, By Barry Ritholtz, March 7

Yesterday, in Backdoor Bailouts for Goldman Sachs?, we noted that GS, as well as Morgan Stanley, Merrill Lynch, and Deutsche Bank, were all made whole on their bad bets with AIG.

That’s right, what was misleadingly described as systemic risk turned out to be in large part little more than a counter-party bailout — money for the very same people who helped cause the problem.

Only the $25 billion figure I mentioned was off by 100% — the WSJ is reporting this morning it was $50 billion dollars, almost a third of $173 billion total AIG loot:

[WSJ Quote]

Now you know why the Fed was so reluctant to reveal who the coutnerparties were.

This is a giant FUCK YOU to the American taxpayer. Isn’t there some Congressmen (besides Ron Paul) who are morally offended by the Paulson plan, which is slowly becoming the Geithner plan? Isn’t there anything that can be done?

Naked Capitalism, By Yves Smith, March 6

Even though I often take on the Wall Street Journal's depiction of new stories, the flip side is that it does break significant news stories. Today is one of those days, although I wonder about an item this juicy hitting the wires on a Friday evening. [Taking out the trash? -Raja].

Gretchen Morgenson reported in September that Goldman was the only financial firm that had a seat at the table during the AIG rescue talks. We noted at the time:

This is special dealing, pure and simple. Even if AIG needed to be salvaged (there was considerable agreement on this point), having Goldman deeply involved in the process is cronyism. But that's been a staple of this Administration.

Another reason for the bailout was that AIG's guarantees allowed European banks to circumvent minimum capital requirements, which means the AIG salvage operation was a backstop to European financial firms.

[...]

Readers suffering from bailout fatigue are wondering why this is a biggie. By the time you are talking AIG level numbers, does it matter where the money went, really? Willem Buiter begs to differ (hat tip Ed Harrison). Bottom line: covert subsidies were given to bank via AIG. Remember, Henry Paulson, who had perilously few inhibitions about shoveling money at banks, even when the pretexts were often dubious and the checks non-existent, nevertheless was afraid to overpay openly for dud assets, which is why he retreated from his original conception of the TARP as as way to hoover up bad debt.

But AIG? No problem. CDS are arcane, and these were bi-lateral contracts (while the dud TARP asset were in most cases securities, so in many cases, third parties could formulate a rough view as to where they might trade).

Wake up and smell the coffee. The public purse is being looted and we the great unwashed are being fed pablum. Just because the perps work for once esteemed institutions and are typically treated with deference does not change the nature of the undertaking.

Remember that the reason for shoring up AIG was its credit default swaps portfolio, in which it had written lots of unhedged guarantees on the cheery assumption that there was tantamount to no risk. Insurers are state-regulated in the US, and subject to a host country requirements overseas (and AIG has substantial foreign operations). Uncle Sam has no regulatory responsibility for AIG, but was hit up nevertheless as the most logical deep pocket that could prevent a financial train wreck.

The payouts are in response to deterioration in AIG's credit rating, though some sizable payouts do relate to the growing subprime losses on mortgage-backed securities and derivatives (i.e., AIG is paying out on insurance claims as well).

Here's what I don't understand. If AIG is owned by the government, why are they not back to Aaa? Shouldn't the government tell Goldman Sachs, Calyon, Deutsche Bank and all these others that their obligations will be met, end of story, so forget demanding all this additional collateral. It seems to me that if the hangup is a legal one - AIG is not truly owned by the government - then it would be a considerable savings for the taxpayer if the Treasury wiped out all the shareholder interest and took 100% ownership of all common and preferred just to assure the market.

This whole episode remains so shrouded in secrecy that even basic questions like this cannot get answered.

March 8, 2009
Fair Game
A.I.G., Where Taxpayers’ Dollars Go to Die
By GRETCHEN MORGENSON

“DERIVATIVES are dangerous.”

That simple sentence, written by Warren Buffett, begins an enlightening discussion in Berkshire Hathaway’s most recent annual report. Mr. Buffett’s views on derivatives, gleaned from his own unhappy encounters with them, should be required reading for all United States taxpayers.

Why? Because we own almost 80 percent of the American International Group, the giant insurer whose collapse was a direct result of derivatives it sold during the late, great credit boom.

A.I.G. nearly barreled off the cliff last September, when it couldn’t meet its obligations to customers who had bought a version of derivatives called credit default swaps. Such swaps are like insurance policies; bondholders buy them to protect themselves from default on various forms of debt.

When A.I.G. couldn’t meet the wave of obligations it owed on the swaps last fall as Wall Street went into a tailspin, the Federal Reserve stepped in with an $85 billion loan to keep the hobbled insurer from going bankrupt; over all, the government has pledged a total of $160 billion to A.I.G. to help it meet its obligations and restructure operations.

So is A.I.G. the taxpayer gift that keeps on taking? Sure looks that way. And while no one can say with certainty whether more money will be needed, the sheer volume of derivatives engineered by a small London unit of A.I.G. suggests that taxpayers haven’t seen the bottom of this money pit.

Some $440 billion in credit default swaps sat on the company’s books before it collapsed. Its biggest customers, European banks and United States investment banks, bought the swaps to insure against defaults on a variety of debt holdings, including pools of mortgages and corporate loans.

Because of the way A.I.G. wrote its swaps, and because the company had a double-A credit rating at the time, it did not have to put up collateral to assure its customers that it would be able to pay on the insurance if necessary. Collateral would be required only if A.I.G.’s credit rating were cut or if the debt underlying the swaps declined.

Both of these “unthinkable” events occurred in 2008. Suddenly, A.I.G. had to cough up collateral it didn’t have.

SO, you see, the rescue of A.I.G. also involved a bailout of its many customers, none of whom the insurer or the government is willing to identify.

Nevertheless, Edward M. Liddy, the chief executive of A.I.G., explained to investors last week that “the vast majority” of taxpayer funds “have passed through A.I.G. to other financial institutions” as the company unwound deals with its customers.

On Wall Street, those customers are known as “counterparties,” and Mr. Liddy wouldn’t provide details on who the counterparties were or how much they received. But a person briefed on the deals said A.I.G.’s former customers include Goldman Sachs, Merrill Lynch and two large French banks, Société Générale and Calyon.

All the banks declined to comment.

How much money has gone to counterparties since the company’s collapse? The person briefed on the deals put the figure at around $50 billion.

Unfortunately, that is likely to rise.

According to its most recent financial statements, A.I.G. had $302 billion in credit insurance commitments at the end of 2008. Of course, the company is not going to have to make good on all that insurance: the underlying securities are not all going to zero.

But as the economy deteriorates, A.I.G.’s insurance bets certainly become more perilous. And because most of A.I.G.’s swaps are known as the “pay as you go type,” collateral must be supplied when the underlying debt declines in value. Swap arrangements made by other insurers require payments only if a default occurs.

So the meter is constantly running at A.I.G. Just as quickly as taxpayer funds flow into the firm, chunks of it go right out the door to settle derivatives claims.

A.I.G.’s insurance commitment stood at “only” $302 billion in part because the government has already voided $62 billion of the protection A.I.G. had written on pools of especially toxic securities. The underlying collateral on those contracts, valued at about $32 billion or so, now sits in a facility that the Federal Reserve Bank of New York oversees and which we, the taxpayers, own.

In order to rip up those contracts, the taxpayers had to make A.I.G.’s counterparties whole by buying the debt that A.I.G. had insured and paying out — in cash — the remaining amount owed to the counterparties.

Of the $302 billion in insurance outstanding at A.I.G., about $235 billion was sold to foreign banks and covers prime home mortgages and corporate loans. The banks that bought this insurance did so to reduce the money they must set aside for regulatory capital requirements.

A.I.G. also wrote $50 billion of insurance on pools of corporate loans. These contracts are performing O.K. for now, the company has said.

But there’s yet another complication that will probably force A.I.G. to cough up cash more quickly than it otherwise might have had to. That’s because it didn’t simply write insurance protection on debt; it also entered into yet another derivative contract — known as an interest rate swap — with counterparties buying the protection.

The reason A.I.G. entered into the second contract was that banks feared they were also exposed to interest rate risks on the loans bundled into debt pools. Presto! A.I.G. was happy to remove that risk by writing another complicated swap.

Now, however, A.I.G. not only has to meet collateral calls as the value of the debt it insured withers, but also has to post collateral related to the interest rate swaps.

Another troubling aspect of these deals is how long it takes to untangle them when they go awry. Back to Mr. Buffett’s recent shareholder letter: when Berkshire acquired the insurance company General Re in 1998, he wrote, General Re had 23,218 derivatives contracts that it had struck with 884 counterparties.

Mr. Buffett wanted out from under the contracts and he began unwinding them. “Though we were under no pressure and were operating in benign markets as we exited,” he said, “it took us five years and more than $400 million in losses to largely complete the task.”

When you look back with the benefit of hindsight, it is truly amazing how outsized A.I.G.’s insurance commitment was, at $440 billion. After all, in 2005, when A.I.G. put many of these swaps on its books, the market value of the entire company was around $200 billion.

That means the geniuses at A.I.G. who wrote the insurance were willing to bet more than double their company’s value that defaults would not become problematic.

That’s some throw of the dice. Too bad it came up snake eyes for taxpayers.

Josh Asks Why Geithner Doesn't Tell

Moon of Alabama, By "b", March 5

Josh Marshall wants to know why Secretary Geithner can not tell us who the beneficiaries of the AIG bailout are.

We are now several month into this and some people still do not 'get it'. I'll try to give a slow but simple answer to Josh's question.

AIG signed insurances against bond defaults in form of Credit Default Swaps in a notional value of more than $450 billion. Some insured bonds defaulted and AIG paid out for these insurances. As it did not have the money to do so, the Bush and Obama administrations decided that the taxpayer should pay.

Up to November $150 billion were given to AIG and on Monday another $30 billion. But AIG still has $300 billion of CDS exposure and will likely make more high losses on that.

[...]

...This is money moving from many persons at the bottom to very few at the top.

Geithner and his masters fear that if the public knew or understood that, they would probably only get the costs of the lottery slip disbursed - if at all.

They want the big one. AIG has still $300 billion at risk that you and your kids will have to pay for.

They want it. And they are getting it. And there is nothing you can do about that.

March 7 2009: Political Social Ethical Capital

There are two separate issues today in the US that occupy my mind. One is the Wall Street Journal revelation that at least $50 billion in taxpayer money ostensibly doled out to save AIG has gone straight to a consortium of the world's largest banks. That is worrisome because it should never have gone there. It also is because just a few days ago, Fed officials refused to tell Congress about these behemoth transfers of public funds. Yes, perhaps it’s also worrisome that the Journal found out regardless, and it certainly is that the banks' dealings with AIG consisted, purely and simply, of gambling wagers for which the once mighty insurer volunteered to be counterparty. The American taxpayer did not, and should never have been forced to pay a dime for the bets. The reason why (s)he was anyway leads to the by far most troubling part of the story. It shows that in the White House and on Capitol Hill, it's the bankers who have final control, not the people.

[...]

Both issues above give me the impression that it's not just the FDIC that’s losing it's grip, it's the government itself, and with it the entire political system. I started warning way before Obama was even elected that we were looking at something much bigger than a financial or an economic crisis, that the way Bear Stearns and Lehman Brothers and Paulson's TARP were handled pointed to a full-blown political crisis. I've seen very few comments since that reflect that realization, but that doesn't make it any less relevant. I’m hopeful that today more people will wake up to the flip side of the confidence issue, and the dark side of the change we can believe in.

[...]

After all, as I said, it's the bankers that control the government, as the AIG "rescue" abundantly and unequivocally shows. This government may well fall along with Citigroup, if only because it lacks the instruments to deal with a collapse of that order. Read my hips: all they can think of is to throw more billions and trillions at the issue, and hope some of it will stick. It's all still entirely one-dimensional. I see no answers, no ethics, no ideas that would help dig ordinary people out of the quicksand that rapidly drags them down. Well written and well-delivered speeches provide time and space to move, but real political capital comes from the proven ability to tackle issues. All I see is the image of "leaders" that draw people deeper into misery, pulling on their feet, not lifting them out by their shoulders. Political bankruptcy may be a novel term for many, but trust me, it does exist. In democracies.

A list obtained by Fortune includes the names of many foreign banks - as well as U.S. giants such as Goldman Sachs.

Fortune, By Carol J. Loomis, March 7

[According to Automatic Earth, the list is different (by 4 names) from the one published in the WSJ - Raja]

NEW YORK -- Donald Kohn, vice chairman of the Federal Reserve, learned this week about blackmail, Senate style, when he refused to disclose the names of financial institutions benefiting from the bailout of American International Group.

Testifying about AIG before the Senate Banking committee, Kohn respectfully resisted all of its attempts to extract the names. Several committee members grew frustrated and finally got to the point of threatening Kohn with no more dollars for the credit crisis - ever - if he didn't spill the information.

Said Sen. Jim Bunning, R-Ky., "You will get the biggest 'no' you ever got. I will do anything possible to stop you from wasting the taxpayers' money on a lost cause."

Why so much fuss over these names? While the government has maintained that saving AIG was necessary to prevent an even wider catastrophe, senators contend the move has also bailed out counterparties who took unwise risks, so the legislators want to know who those companies are.