| |||||||||||||||||||||||
| |||||||||||||||||||||||
 What do you do with a bunch of of bad collateralized debt obligations when the economy is tanking and there is a real threat that national banks are going to go under? That's the question Treasury Secretary Timothy Geithner, the Federal Reserve and the New York Fed faced when they held secret negotiations with the
banks that bought $62 billion of
credit default swaps from American International Group Inc. (NYSE:AIG).Bloomberg reports that the New York Fed and Federal Reserve made the decision to pay the banks 100 cents on the dollar even after AIG spent months trying to negotiate lower payments of 40 cents on the dollar. Those banks included Goldman Sachs Group Inc. (NYSE:GS), Societe Generale SA, Deutsche Bank AG (NYSE:DB) and Merrill Lynch & Co. According to Bloomberg the decision cost taxpayers $13 billion: 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. There are several theories as to why the Fed made the decision to pay the par value instead of the market value, as The Atlantic points out.
But the Federal Reserve Bank of New York has another reason. It says it had no choice, according to The Washington Post: "In its negotiations with its counterparties, AIG just didn't have the same bargaining power that it did with the Federal Reserve standing in the background," said Thomas C. Baxter, New York Fed's general counsel. "The only sensible outcome was to give them what they were legally entitled to." This is the same excuse the Fed gave when it bailed out AIG. Granted, it was an extreme time that called for extreme measures. As Donn Vikery of financial research firm Gradient Analytics Inc. points out to Bloomberg, the Fed did not want to negotiate with the banks separately, and in cases of bankruptcy the case to pay out swaps is usually 50, 60 or 70 cents on the dollar. This leads to many questions. If this decision had not been made, what were other possible outcomes could? Would the banks have been worse off if they had not received that backyard bailout? Merrill Lynch may have, as it received $6.2 billion. Later on it may have caused Bank of America Corp. (NYSE:BAC) to lose even more money after taking over Merrill. Goldman received the most, $14 billion, and certainly its press might be better now if not for the AIG credit default swap fiasco. Naked Capitalism said last September that an AIG failure would have created a hole as big as $20 billion in Goldman's balance sheet (Goldman had $45 billion of equity on its balance sheet as of last September), so this kind of loss would have sent shares into a black hole. Would another large institution have failed if that money wasn't paid in full as the Bloomberg article suggests? Would the failure of another large financial institution have killed the economy? The government may have been too hasty in bailing out AIG and in its payoffs to the bank because it feared the worst, but there is always a choice. The chance that a better outcome could have resulted from a decision is always nice to contemplate, isn't it? - Maria Woehr
 Deal Video
    Community
 Elsewhere on The Deal.comDealwatch
The Deal MagazineCorporate Dealmaker
The Deal VideoCategories
Blog roll
Archives
| |||||||||||||||||||||||
|
|
|
|
|
©Copyright 2009, The Deal, LLC. All rights reserved. Please send all technical questions, comments or concerns to the Webmaster.
I get the sense the Fed did not even think about this at the time. What's another $13 billion or so when the sky is falling? Now they are backfilling excuses to cover their derrieres.
And yet, if someone had paid attention, and negotiated with the counterparties like a man instead of a mouse, we might have saved several billion dollars of taxpayers' money.
Aargh.
http://epicureandealmaker.blogspot.com/2009/10/never-send-boy-to-do-mans-job.html