Why the Goldman Sachs-AIG story wont go away

Written by Bloomberg | Updated: Oct 31 2009, 04:14am hrs
Jonathan Weil

How did so much taxpayer money end up in the coffers of American International Group Incs too- big-to-fail customers The more we find out, the more it becomes obvious we still dont know the half of it.

To believe AIGs disclosures, youd have thought its executives decided on their own last year to pay 100 cents on the dollar to the various banks that had bought $62 billion of credit-default swaps from the company. Now, it turns out the decision to make the banks whole wasnt AIGs. It was made by the Federal Reserve Bank of New York, back when its president was the current US treasury secretary, Timothy Geithner, and its chairman was Goldman Sachs director Stephen Friedman. (Friedman resigned in May, after WSJ reported he had bought more than 50,000 shares of Goldman stock following AIGs takeover.)

Before AIG was seized, its executives had been negotiating for months with the banks, trying to get them to accept discounts of as much as 40 cents on the dollar, Bloomberg reported, citing people familiar with the matter.

Then, late in the week of November 3, the New York Fed took over the negotiations with the banks from AIG, together with the Treasury Department (at the time run by former Goldman boss Henry Paulson) and Chairman Ben Bernankes Federal Reserve Board. Less than a week later, the New York Fed instructed AIG to pay the counterparties in full.

Judging by the result, you might think Geithners team was on the banks side, rather than AIGs.

AIG wound up paying $32.5 billion to retire the swaps, $13 billion more than if it had paid, say, 60 cents on the dollar. The New York Fed also arranged to pay the banks $29.6 billion for collateralised-debt obligations backed by subprime mortgages and other loans, a tad less than half their face value. (The swaps were side bets by the banks that rose in value as the CDOs fell.) It probably made sense for the counterparties to reject AIGs initial settlement offers. They had their own investors to look after. And once the government took control of AIG, it couldnt credibly threaten to force the company into bankruptcy proceedings. The premise of the governments seizure, after all, was that AIG was too big to fail. But why the rush to pay the banks in full once Geithners team took over the talks The public has never gotten satisfactory answers, notwithstanding that the governments commitment to AIG now stands at about $182 billion.

The New York Feds general counsel, Thomas Baxter, told the Washington Post that officials were racing to prevent AIGs collapse and didnt have time for protracted negotiations with each creditor. That wont put to rest suspicions that regulators used AIG as a slush fund to shield some of the banks from losses, using taxpayer money.

Nor has anyone from AIG or the government explained why there was such a hurry to buy the CDOs. While the banks supposedly received market prices, that deal has since turned sour for taxpayers. The value of the securities, now held by a Fed-run entity called Maiden Lane III, was down by about $7 billion as of June 30, according to the New York Fed.

The public might get some answers soon. Next month, the inspector general for the governments Troubled Asset Relief Programme, Neil Barofsky, is scheduled to release a report on whether AIG overpaid the banks, and the extent to which the counterparties own financial problems may have been at issue.

Goldman, for one, has long said it wouldnt have incurred any material losses even if AIG had gone under.

We limited our overall credit exposure to AIG through a combination of collateral and market hedges, Goldmans chief financial officer, David Viniar, said in March. There would have been no credit losses if AIG had failed.

Then again, Viniar is the same guy who this month made the ridiculous claim that Goldman doesnt have a too-big-to-fail guarantee from the government. Goldman has refused to identify who the counterparties were on the other side of its hedges, rendering Viniars statement in March unverifiable.

Even if Goldman was fully hedged, its reasonable to assume that not all the other banks were. We shouldnt have to guess anymore, though. Its long past time for the government to start telling us the whole truth about what happened at AIG. Weve had too many secrets in this financial crisis already.