Thursday, January 07, 2010

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."



Anonymous said...

GS took out umbrella insurance on top of home insurance, on the neighbor's house
which they'd already packed with explosives and a timer. GS undoubtably knew the insurance was mispriced (since it was based
on actuarial tables gleaned from normal
business behavior, not based on the criminal record of an explosives expert
living next door to the exposive-packed
insured house).

This is why insurance policies exclude
fraud from insurance payouts. An insurance system ultimately dies once fraudsters know you'll cut a (tax payer backed) insurance check despite the fact that the payee ACTUALLY burnt down the house themselves.

The guys who cut the check to GS are not ignorant country bumpkins. Humpty Dumpty
was pushed. Good luck getting moral hazard put back together...ain't gonna happen. Rule by law is apparently dead.

Kid Dynamite said...

anon, i understand what you're saying, but i think you have it partially backwards. here's what i mean - GS THOUGHT they were protecting themselves from their exposure to AIG by buying the "umbrella" policy on AIG - that was smart of them, BUT, in reality, if AIG blew up without a gov't bailout, none of the insurance would have been worth jack doo doo, because whomever they bought the AIG insurance from, let's just pretend it was MER or BAC, would have also blown up, and not been able to make good on it.

said differently, GS's answer "we were hedged against AIG's demise" is true in theory, on paper, but in the real world, that hedge would have blown up also had they not been gifted par payouts on the CDS purchased from AIG. i think you probably agree on that note.

Anonymous said...


GS didn't stop at umbrella insurance -- Who is Keyser Soze?

They knew that the umbrella insurance was
also mispriced and not sufficiently backed by assets to payout. They are not dumb.
They basically took some financial hostages.
But the ultimate insurance layer was having former GS executives present at the decision to "save AIG (save GS's gambit)" (like Paulson, for example). In The Sting,
this is equivalent to providing the prepaid policeman who take the mark from the scene. By capturing the very
government employees that decided
to cut the insurance check, they turned
this huge scam into a sure bet.

MSM can write excuses all day long.
Follow the doesn't lie.

Anonymous said...

Or are we all supposed to believe GS earns net profit almost every fucking day by being "lucky"?

Dark Helmet: The Ring! I can't believe you fell for the oldest trick in the book! What a goof! What's with you man? Come on! You know what? Here let me give it back to you.
[throws it down the grate]
Dark Helmet: Oh, look, you fell for that too! I can't believe it, man!

Kid Dynamite said...

i hear you - i thought you were saying that they thought the umbrella policy would be made good on (by someone other than the government!) - i KNOW they are smart, but i got the sense that they actually believed that.

GS claims exactly the opposite of what you're saying - they say they didn't care if AIG went down, cause they were "hedged." you're saying that was a total bs bluff and they knew it, right?

Hammer Player a.k.a Hoyazo said...

I would be thrilled to see that f*ck get removed from his post.

Then he can go back to avoiding paying taxes he owes.

What a crock.

Anonymous said...

Yep. They'll pretend they are lucky and smart...but no one makes money every fucking day by guess about the future...they only make money every fucking day by making the future.

And oh's only fraud unless the government tells you to lie:

Government cuts the fraud check.
Nobody goes to jail, because the government writes a law that says
it ain't fraud, if the government does it.

What, no flowers and chocolate?

Anonymous said...

What I cannot believe is that were here in 2010 arguing about who's to blame for
the "losses".

It was stolen.

Like any good con, the pigeon is too stupid
to anything but coo about their bad luck.

getyourselfconnected said...

Sorry for the dumb question, but does this not prove the uslessness of these instruments?

Steve said...

This may be a stretch, but...

Is it possible the Fed didn't want any of the recipient banks to be viewed as "needing" the 100 cent payout/bailout as it would suggest they were near failure?

Remember there was a lot of this going on where good banks were forced to go shoulder to shoulder with bad banks in receiving government investment and using the discount window, so the bad banks wouldn't be tainted by participating.

Sam said...

The fact that foreign banks were involved also complicated things a LOT and reduced the bargaining power the NY Fed had.

(Someone will always claim GS sold to foreign investors precisely to put the government in this quandary and force them to pay out, but I think that would be giving them way too much credit)

Anonymous said...

> ....but I think that would be giving
> them way too much credit

So having insurance (on the house packed with exposives and a timer), and insurance on insurance (i.e. insurance on the insurer, AIG, being unable to pay) AND having people present to make sure the government bails them out 100% was all luck, but taking a few foreign hostages is giving them too much credit?

[throws it down the grate]
Dark Helmet: Oh, look, you fell for that too! I can't believe it, man!