The Beginning of the End for Geithner?

When the top story on Bloomberg is "Geithner's New York Fed Told AIG to Limit Swaps Disclosure," it does not bode well for the Treasury Secretary's future.

"Jan. 7 (Bloomberg) -- The Federal Reserve Bank of New York, then led by Timothy Geithner, told American International Group Inc. to withhold details from the public about the bailed-out insurer’s payments to banks during the depths of the financial crisis, e-mails between the company and its regulator show.

AIG said in a draft of a regulatory filing that the insurer paid banks, which included Goldman Sachs Group Inc. and Societe Generale SA, 100 cents on the dollar for credit-default swaps they bought from the firm. The New York Fed crossed out the reference, according to the e-mails, and AIG excluded the language when the filing was made public on Dec. 24, 2008. The e-mails were obtained by Representative Darrell Issa, ranking member of the House Oversight and Government Reform Committee."

The fact that the banks were paid out 100c on the dollar on the CDS trades is not news - it's been a source of outrage for a few months now.  There is actually logic behind it, although I'm certainly not defending the decision.  The basic thought process was that GS, for example, had hedged exposure by buying credit default swaps from AIG.  Of course, this leaves GS with exposure to AIG in case AIG runs into trouble, so they bought CDS on AIG from a third counterparty (they insured against AIG's collapse).  Thus, if AIG defaults on its obligations, GS, in theory, still gets the same amount of money, because  if AIG can't pay GS the money it "owes" them, GS collects on the AIG CDS it bought from someone else.  (This may sound complicated, but it's not.  Let's just say that GS bought insurance on some assets from AIG, and then bought insurance on AIG from someone else, in case AIG couldn't pay of on that insurance.  Sounds like another Ponzi scheme right?)

Obviously, this means that the "someone else" will have huge liabilities and then be in trouble, and perhaps the entire daisy chain of  Firm A writing  protection on Firm B who wrote protection on Firm C who in turn wrote protection on Firm A would have imploded.  That's why the decision was made to prevent such an implosion, by just giving the AIG CDS customers payments they otherwise "would have collected anyway."  I put that last part in quotes because no one knows if they would have been able to collect on such a recursive chain of CDS obligations if everything blew up.  Although GS claims to have been hedged (in theory) against troubles at AIG, it's almost impossible to believe that all the banks were - after all, we know that AIG's CDS obligations (promises made by AIG to provide insurance) could not be paid off - and transferring the end risk around to other banks doesn't eliminate it.

Today's story, however, hints that Geithner knew that this decision would, at the minimum, generate some furor.  The attempt to cover up the disclosures will result in another tidal wave of (deserved) scrutiny on Geithner and the Treasury/Fed's handling of the crisis.

Bones wrote me a George Costanza quote perfect for the story:

"George Costanza: [pause] Was that wrong? Should I not have done that? I tell you, I gotta plead ignorance on this thing, because if anyone had said anything to me at all when I first started here that that sort of thing is frowned upon... you know, cause I've worked in a lot of offices, and I tell you, people do that all the time."

-KD