A Rift at the Fed Over the Bailout of A.I.G.
By LOUISE STORY and GRETCHEN MORGENSON
New documents submitted to Congressional investigators examining the 2008 rescue of the American International Group show that officials at the Federal Reserve were deeply divided over the structure of the bailout and its long-term implications. At the same time, regulators had to contend with major banks that were A.I.G.’s trading partners and were unwilling to accept a discount from the government when closing out the contracts the banks had struck with the insurance giant.
Ultimately, the government decided to make the banks whole on the contracts, a decision that the documents say was approved by Timothy F. Geithner, the Treasury secretary who, at the time, was president of the Federal Reserve Bank of New York. The Fed’s decision to pay A.I.G.’s trading partners in full on tens of billions of dollars in contracts has been controversial because many analysts say they believe the government could have negotiated a price for a fraction of that amount, reducing taxpayer funds used in the rescue. Similar contracts were being settled at heavy discounts in other deals where the government was not involved.
Not good negotiating, for the most important deals. Such incidents increases one's skepticism of government involvement in anything important.
Last Thursday, Thomas C. Baxter Jr., the New York Fed’s general counsel, told Congressional investigators of his frustration with the banks, according to committee staff notes obtained by The New York Times. “We asked for concessions, and they said no,” he said, according to the notes. “I wonder why we even bothered.” Mr. Baxter also said that Mr. Geithner verbally approved the decision to pay full price to the banks. A spokesman for the Treasury Department noted that Mr. Geithner’s decision to give the banks 100 cents on the dollar in the A.I.G. bailout was previously discussed in a report that the Treasury’s inspector general released last fall.
Why bother? Why not push the banks to accept?
According to a 13-page slide show prepared by the asset management firm BlackRock that was submitted to the committee, Merrill Lynch and a French bank, Société Générale, were “resistant to deep concessions” on their A.I.G. contracts. Goldman Sachs, another major trading partner, was willing to accept only “a small concession” on its contracts. The slide show is among more than 250,000 pages of documents provided to the House Committee on Oversight and Government Reform in preparation for a hearing next week on the Fed’s role in the A.I.G. bailout. The committee, which is led by Edolphus Towns, Democrat of New York, has been interviewing some of the people who will testify, including Mr. Baxter.
In October 2008, one month after the A.I.G. rescue was initiated, the New York Fed encountered heavy objections to its plans for structuring the bailout from its overseers at the Federal Reserve Board in Washington. The New York Fed had recommended creating two vehicles — known as Maiden Lane 2 and Maiden Lane 3 — to house securities taken in as part of the A.I.G. rescue. A similar vehicle had been created to hold the assets guaranteed by the government in the Bear Stearns collapse.
In an Oct. 15 e-mail message to Mr. Geithner, Sarah Dahlgren, the New York Fed official leading the A.I.G. effort, wrote, “Board staff again reiterated that they didn’t think that the Governors (unnamed) would go for ML2 or ML3.” Later in the same e-mail message, Ms. Dahlgren noted, “The Governors have cited the Bear Stearns deal as a one-off deal that was done on the understanding it wouldn’t be done again (so ML2 and ML3 aren’t well-received...)”
The e-mail message also summarized the board’s questions about the bailout. Atop the list: “What does any of this buy us?” Plenty, said the Treasury Department in a statement on Friday evening. “Those investments have turned out to be very sensible, and the fund at the center of the controversy is on track to return every dollar to taxpayers, and may well yield a profit,” said Andrew Williams, a Treasury spokesman.
The Fed was advised that the banks had valued the contracts in question at severely depressed levels. The contracts were tied to bundles of mortgage bonds known as collateralized debt obligations, or C.D.O.’s. A senior New York Fed official wrote in an Oct. 22 e-mail message to Mr. Geithner that there was a “discrepancy” between “what our advisers are saying these C.D.O.’s are worth and where the firms have them marked.”
Some of the banks seemed to recognize that the mortgage bundles might wind up being worth more than they were claiming at the time. According to BlackRock’s slide show, Goldman and Société Générale were willing to tear up some of the contracts with A.I.G. if they were allowed to keep the underlying C.D.O.’s, indicating that both banks may have thought they could increase in value. The Fed instead decided to take those C.D.O.’s onto its own books and pay the banks to extinguish the contracts.