Felix Salmon

Understanding the AIG decision

By Felix Salmon
November 17, 2009

As Dean Baker notes, Neil Barofsky’s report on the 100% payments to AIG’s counterparties is the news of the day. It’s sexy stuff, revisiting the dramas of the week of Lehman’s collapse, and of course going into great detail about the way in which the crisis’s designated villain, Goldman Sachs, walked away with billions of dollars of taxpayer money despite saying they never asked for it nor particularly needed it.

I agree with Barofsky that, in hindsight, the payments should have been made at less than par; TED has a good explanation of how that could have happened, given sufficient aggression. After all, it’s not like Treasury wasn’t being run by a hard-charging former investment banker at the time.

But I’m maybe slightly more sympathetic to the Fed than most — or at least I understand how this happened. It shouldn’t have happened, that’s true: for the sake of putting a knife into the moral-hazard trade, some haircut — any haircut — should definitely have been imposed, even if it was only the 2% that UBS offered to accept.

But the government owned AIG, which created the situation that Germans call Anstaltslast: the fact that state-owned companies simply don’t default on their obligations. The government was also battling a major crisis using the only weapon at its disposal: enormous amounts of liquidity. When you’re putting out a fire, you don’t stop to worry that large amounts of liquidity are going to end up where you don’t particularly want them — the important thing is putting out the fire.

So yes, given a bit more aggression and foresight, the Fed could have tried to cram down a haircut onto AIG’s counterparties. But at the time, no one was particularly interested in being harsh to the global financial sector; instead, they were trying to rescue it. With hindsight, it now seems that companies like Goldman Sachs have turned out to be the biggest winners, paying out billions of dollars in bonuses even as the rest of the country struggles with an extremely nasty recession. But that wasn’t particularly foreseeable. And so although I agree with Barofsky that the Fed and Treasury should have been harsher on the counterparties, I do understand why they weren’t.

19 comments so far | RSS Comments RSS

Now, Felix, don’t go all soft on us.

I agree the most pressing problem Treasury faced was the stabilization of the financial system, and time pressure–and perhaps certain structural, legal, and regulatory constraint–limited their options. But the Treasury also holds a fiduciary obligation to the taxpayers, and I see no evidence whatsoever that they made any attempt to uphold or even pursue that.

And, given the low cost, low danger, and limited time a serious negotiation effort over the AIG CDSs would have entailed–investment bankers could have hammered out a price over the weekend–I find the Treasury’s feeble posturing simply appalling.


For a good example of what could have been done you only have to look at Chrysler. They called the bondholders bluff and threatened to tie them up in bankruptcy court which could have taken years to sort out.

I don’t see why AIG had to be any different.

Posted by schooner | Report as abusive

>>With hindsight, it now seems that companies like Goldman Sachs have turned out to be the biggest winners, paying out billions of dollars in bonuses even as the rest of the country struggles with an extremely nasty recession. But that wasn’t particularly foreseeable>>
It wasn’t foreseeable that if you give a lot of money to Goldman that it will do what it always does – pay a large percentage to employees as bonuses?

As Schooner said, see Chrysler.

Posted by foosion | Report as abusive

Goldman bluffed the Fed, and the Fed folded. If the government did nothing, Goldman would have been forced to negotiate with AIG, but they were sure the government, with the Treasury still being run by ex-Goldman CEO Paulson, would not risk a chain reaction that might occur with AIG’s bankruptcy. But really, if AIG said its 70 cents or bankruptcy, and Goldman’s choice was take the 70 cents (and still show a little profit for the year) or leave it and file for bankruptcy, they would have taken it.

So there was AIG, lying on the side of the road after it got drunk and crashed the car, and Goldman was going through its pockets. They wouldn’t even leave 2 cents there, they had to take all of it.


TED, you’re right about the fiduciary obligation. It just gets forgotten in times of crisis, or interpreted very broadly.

Posted by Felix Salmon | Report as abusive

Fiduciary obligation – do we have it these days anymore?


Herr Krugman got bit by the “German” bug again yesterday too with his extensions of Godwin’s law.


“When you’re putting out a fire, you don’t stop to worry that large amounts of liquidity are going to end up where you don’t particularly want them — the important thing is putting out the fire.”

Maintaining the beautiful simplicity of the analogy — you *do* stop to worry if the water you are using to put out the fire is from a small limited source of your only drinking water.


The only time he cinches up his tie in the last few years is here… in Israel? Israel? (Top botton undone, of course, though). Recession over? This guy is so full of balogna.


“It shouldn’t have happened, that’s true: for the sake of putting a knife into the moral-hazard trade, some haircut — any haircut — should definitely have been imposed, even if it was only the 2% that UBS offered to accept.”

That might make sense *IF* you are sure that the Fed could convince people that only evil investment banks doing mysterious credit derivative swaps would have their contracts with AIG dishonored.

If the perception had taken hold that a contract with AIG was subject to negotiation, the Fed might have been right back to dealing with the market panic they were trying to avoid. In which case, all sorts of people would be trying to liquidate all sorts of potentially mysterious and evil contracts, as described in the report.

Are municipal GICS politically acceptable? 401(k) wraps? AIG had lots of puzzling products that maybe could have been subjected to liquidation at a haircut.

My goodness – the NYC Fire Department could probably improve their budget picture if they negotiated a price for their services while standing at the front steps of a burning building, too. I don’t think that is what we expect, and I, for one, don’t expect the Fed and Treasury to be engaging in random, implausible contract-breaking just to make a belated point about moral hazard (LTCM in 1998 was the time for that – if a firm no one has heard of is too big to fail during an economic boom, then they are all too big to fail.)

As a bit of an aside – the linked article about the payoff to a more aggressive negotiating stance is self-contradictory.

The author says that firms must be threatened with a lifetime on “The List” of companies that will be forever in the government’s bad graces if they don’t take a haircut now.

He also says that companies must be forced to say “Yes” before they can mobilize their lobbyists and political allies.

Which is is? If they have all these allies, the threat of “The List” is not credible. Or maybe they don’t have allies (Yeah, right).

Posted by Tom Maguire | Report as abusive

The whole “sanctity of the contract” thing is nonsense. I may own a bond that says Nortel must pay me a set amount of interest but if they don’t have any money or enough money I’m out of luck.

AIG was no different and Goldman was getting more than enough aid by being allowed to become a bank holding company and virtually unlimited access to the Fed as LOLR.

They and all the rest should have taken a haircut.

Posted by schooner | Report as abusive

Tom Maguire says the deal with GS had to be done, because the govt had a contract with them. There was no such contract. The government was a shareholder in AIG, and shareholders aren’t responsible for the debts of the company they own shares in. The government didn’t sell any swaps to Goldman, it was AIG that had contracts with GS, and if they defaulted on those contracts, Goldman’s recourse would have been to stand in line at bankruptcy court, so they had plenty of incentive to negotiate.

And as far as his sarcastic comment about “only evil investment banks doing mysterious credit derivative swaps would have their contracts with AIG dishonored” – none of AIG’s other CDS customers were threatening to force them into bankruptcy, only Goldman and it’s friends. Nobody is talking about dishonoring any contracts, either – if the government let AIG go bankrupt, Goldman would have received a lot less than 100 cents.

The deal that the Fed made with AIG and its counterparties is defensible only if you say you had no idea what you were doing. It was an outright gift to Goldman and the others. When the fire department arrives on the scene of a fire, it doesn’t give out rewards to the arsonist, just because they are willing to sell them water.



Treasury ≠ NY Fed.

Notice that the word “Treasury” doesn’t appear once in the entire section called “NYFRB Decided to Compensate Counterparties Effectively at Par Value.” That’s because Treasury was not a party to the transaction. Last time I checked, ML III was a Fed vehicle.

Pointing out that Treasury has a fiduciary obligation to the taxpayers is totally irrelevant.


EoC — You are correct: The NY Fed was the principal actor in the AIG drama, not Treasury. My bad. Sloppy commenting.

However, it does you no credit to nitpick. The distinction between Fed and Treasury is not so concrete, meaningful, or durable in this context as you imply. 1) The then-head of the NY Fed is now the Secretary of the Treasury. 2) The Fed and the Treasury were in extremely close cahoots during the entire financial crisis. Do you think they did not talk hourly and coordinate obsessively? 3) The representatives of our government, whatever their department or function, do have a fiduciary obligation, in (at least) the broadest sense, to the citizens of this country. They work for us.

That the government has a fiduciary responsibility to its citizens is entirely the point. And, in my opinion, that fiduciary responsibility does indeed trump those of others in certain heightened circumstances. I maintain AIG was one of those circumstances.


I hope the next Treasury Secretary would be either Jewish or Chinese (I’m Chinese), because, at the risk of coming off a racist, I’d boldly claim, WE (Jews or Chinese) would never ever strike the kind of deal Geithner did, NEVER!!! It’s stupidity stinking to high heavens, and it’s total loss of common sense. The gov was in a strong position to DEMAND a haircut, because the alternative was the counter parties would get zero. How was that even a hard negotiation???

I would rush to judge that people like Geithner, although geeky smart, are entirely detached from reality on the ground, from everyday life, from common sense. Also, they are only so generous because, in their own mind, they were trying to rescue the world with taxpayer money. I challenge them to do the same, if it were their own money! I bet they’d have bargained a LOT harder then!!

As much as I believe gov has a larger role to play in this country, these incompetent gov bureaucrats’ actions so far have been discouraging indeed. How do we counter the tea-party goers’ arguments against more gov and more taxes, when blatant indifference and incompetence was shown in this dreadful AIG deal??

Posted by jian | Report as abusive

Let me also add, this whole AIG raw deal thing was no news at all! NPR’s Fresh Air (to my best recollection) did an excellent interview of some economist with a British accent (sorry forgot his name) only weeks (or was it days?) after that dreadful rescue, and the economist complained loudly that how come the gov didn’t demand a haircut? Obviously, he was, sadly, the only one who cared that tax payers got a rotten deal (and Terry Gross and her listeners).

Interestingly, he (the economist) went on to say he hoped the gov would find its balls with time and would NOT let the big banks pay back TARP money early, because when they did it would mean they would escape gov oversight on bonus payout and other matters. How silly of him (and of me to hold my breath)! Of course the government chickened out, again, and let Goldman and Co. pay back TARP, and went out to dole out billions in bonus. It was even trumpeted as a triumph for taxpayers back then!

So that’s the 2nd time in a roll (as far as I was counting) that Treasury played no ball. Can we honestly continue to trust Geithner and his likes to act assertively on OUR behalf?? Don’t hold your breath like I did, or you’d turn blue!!!

How can someone like that not be replaced? We need and we DEMAND someone who has taxpayers’ interests at heart, who remembers what fairness means, who does not think of Wall Street bankers as masters of the universe, and who has the courage to stand up for us against those masters! If you haven’t had enough of this nonsense of unquestioning deference to Wall Street, when will you???

Posted by jian | Report as abusive


OK, I suppose I was nitpicking. Sorry about that.

But I still don’t understand how you can seriously argue that the NY Fed breached some broad fiduciary duty to taxpayers because they didn’t persuade 8 large financial institutions to do something that they were under no obligation to do, and that the NY Fed had no legal authority to force them to do. (And I’d note that your speech, convincing though it was, was predicated on the French regulators being on board, which they were not.)

It’s one thing to argue that the NY Fed could have gotten the counterparties to agree to haircuts (anything is possible, I suppose), but it’s another to argue that the NY Fed breached it’s fiduciary duty because it didn’t get the counterparties to agree to haircuts.

This might be something we’ll have to agree to disagree on, because I just don’t see it.


the issue at the time that often goes overlooked is that MorgStan and GS were in midst of a run on their commmon equity in the stockmarket (which is why ML dealt themselves to BoA) and the TreasuryFed was attempting to allay some of that via the AIG mess (ie. payments from AIG to MorgSgtan,GS and others was then available for them for *funding* themselves which was key aspect)

another point – repayment of TARP funding may end that particular discrete part of the bailouts, but GS (and many others) still has/have large amts of usa-govt-guaranteed debt outstanding that they issued in late 2008 and in 2009 – i submit that until they retire *ALL* of that, they are still receiving massive subsidy from the usa govt, and therefore the latter can indeed intrude on a whole host of issues that were previously NOT in their bailiwick

just sayin’

Posted by frankl | Report as abusive

the fed had no legal authority to force a haircut …

just a matter of interpretation. what legal authority did the fed have to take over AIG in the first place?

Posted by whatever | Report as abusive

They have had no actual “legal authority” to force the haircut or maybe they did, it’s irrelevant.

They had plenty of leverage in any negotiations and they pissed it away. How hard would it have been to say “If you don’t want to take a haircut, you’re on your own and good luck with getting anything since you’ll have to wait in line with the rest”

Posted by schooner | Report as abusive

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