Posted by: Dirk | January 27, 2010

AIG and the “haircut” that did not happen

Here is an extract from Thomas C. Baxter, Executive Vice President and General Counsel at the testimony before the Committee on Government Oversight and Reform, U. S. House of Representatives:

IV. Negotiating Concessions from AIG’s Counterparties
The Federal Reserve has been criticized by some for not using its regulatory power to force the counterparties to accept less money for the CDOs. The critics overlook a number of key factors.

First, there was little time, and substantial execution risk and attendant harm of not getting the deal done by the deadline of November 10th. As noted above, AIG had attempted for some time to negotiate tear-ups of its CDS contracts with its counterparties under terms more favorable than Maiden Lane III. It did not succeed. When the Federal Reserve reached out to AIG’s counterparties, we believed, based on AIG’s own experience, that our probability of success of getting them timely to agree to concessions was slim. Even in a best-case scenario, we did not expect that the counterparties would offer anything more than a modest discount to par. In our judgment, taking additional time to press further for a discount was not justified in light of the overwhelming risk and catastrophic consequences of failing to complete the transaction by November 10. …

Second, the Federal Reserve had little or no bargaining power given the circumstances. This restructuring negotiation was taking place in November of 2008, less than two months after the decision to rescue AIG from insolvency and the infusion of tens of billions of dollars. The Federal Reserve had already acted to rescue AIG, and the counterparties fully expected that we would stand by that decision, especially because the economic situation had gotten worse, not better. So, the typical threat in such negotiations—we will stand down and watch AIG file for bankruptcy—would have been an idle threat had we made it. …

Finally, even if we had had bargaining power, the rating agencies, as discussed above, were closely examining AIG for signs that it would not be able to address its financial situation. If they saw the Federal Reserve take any action that seemed to suggest a lack of full support, in particular a bankruptcy threat, it might well have led to an immediate downgrade and the irreversible destruction of AIG, with the attendant consequences on the financial stability of our economy.

There was a time when financial sector players and the government went to look for a solution in a cooperative way:

The [1907] panic may have deepened if not for the intervention of financier J. P. Morgan, who pledged large sums of his own money, and convinced other New York bankers to do the same, to shore up the banking system. At the time, the United States did not have a central bank to inject liquidity back into the market.

It seems that this image is naïve when thinking about today’s world. It is the Fed against the financial sector. This is deeply disturbing, given the power the financial sector holds. It did not hesitate to use that power to bully the Fed and therefore tax payers into paying bills in full that they were not supposed to pay in the first place.



  1. Hey, there’s goin’ to be quite another haircut and there’s something in it for everyone unfortunately: Of Mortgage Brokers, ARMs, Attrition and Marathons

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