Despite the many options it had, the team led by current Treasury Secretary Timothy Geithner chose to bail out ailing insurer American International Group Inc. and its Wall Street counterparties to the eventual tune of more than $182 billion, a decision that continues to have a "poisonous effect on the marketplace," according to a new Congressional report.
The move to pay firms like Goldman Sachs Group Inc., Deutsche Bank AG, and Societe Generale SA 100 cents on the dollar to extinguish contracts on sophisticated financial products with AIG, "transforming highly risky derivative bets into fully guaranteed payment obligations," is unlikely to be repeated when it comes time to repay taxpayers for their generous investment, according to the report.
"Even at this late stage, it remains unclear whether taxpayers will ever be repaid in full," the Congressional Oversight Panel [COP] noted in its Thursday report on AIG and the extraordinary taxpayer support it received from the fall of 2008 through March 2009. While top officials from AIG, the Treasury Department, and the Federal Reserve Bank of New York have either outright said or expressed confidence that AIG will repay taxpayers in full with a profit, the Congressional Budget Office estimates that taxpayers will lose $36 billion, the report noted. Federal Reserve Chairman Ben Bernanke told lawmakers Wednesday that AIG will "repay" taxpayers. The government owns nearly 80 percent of the company.
Among the bailout watchdog's findings:
- Policymakers had several options to resolve the firm's troubles, rather than a "binary" choice of bailout or failure;
- Federal regulators could have acted earlier, potentially saving taxpayers from a $182 billion investment in the giant insurer;
- The government-led private-sector effort to save the firm primarily relied on just two financial firms and a small group of law firms rife with conflicts of interest;
- Policymakers involved in the rescue continue to change their public rationale for rescuing AIG with taxpayer cash, perhaps for political considerations;
- Even more foreign banks than previously disclosed were direct beneficiaries of the taxpayer bailout;
- It was "unlikely" a more muscular regulatory agency would have caught the insurer's problems given that the firm's own management didn't know what was going on;
- And despite the panel's mission of auditing how the government responded to its biggest intrusion in the financial markets since the Great Depression, some firms, including Goldman Sachs, which taxpayers bailed out with $10 billion in cash and nearly $21 billion in debt guarantees, continue to refuse to turn over key documents, the panel said in its report. Goldman faces a multitude of investigations regarding its subprime-era practices.
In short, the panel led by Harvard Law professor Elizabeth Warren issued the latest in a series of government reports to criticize the actions taken in the fall of 2008 to stabilize the collapsing financial system, a period marked by missed opportunities, inadequate measures, lax accountability, little transparency, and a perception that policymakers acted to save Wall Street with taxpayer cash while Main Street played second fiddle.
Booming profits on Wall Street versus nearly 10 percent unemployment, half-measures to stem the rising tide of foreclosures and the precipitous drop in bank lending have only reinforced these perceptions.
"The rescue of AIG dramatically added to the public's sense of a double standard -- where some businesses and their creditors suffer the consequences of failure, and other, larger, better connected businesses do not," the report notes.
"In retrospect, it is easy to speculate about how things might have been done differently, had there been more time," Treasury spokesman Andrew Williams, who worked for Geithner at the New York Fed, said in an e-mailed statement. "But the fact is that the Treasury has spent more time in meetings with COP answering questions about the decisions made on September 15 than the government had to make those decisions.
"After months of study, the COP has concluded that the government should have explored other options. But the laundry list of ideas, however creative, overlooks the basic fact that the global economy was on the brink of collapse and there were only hours in which to make critical decisions.
"The choices and tools available to the government were extremely limited and the potential outcomes were deeply uncertain.
"At that perilous moment, we took the actions that were most likely to protect American families and businesses from a catastrophic failure of another financial firm and an accelerating panic.
"We have learned from that experience and have been fighting for more than a year to give the government authority to put firms, like AIG, out of existence when their failure poses a danger to our economic system."
A Federal Reserve spokesman wrote in an e-mailed statement that the central bank "continues to believe that...the actions we took were necessary to protect American families and businesses from the catastrophic consequences of a disorderly failure of AIG."
A review of Fed officials' speeches and news releases by the Fed's headquarters in Washington reveals that this rationale for the AIG bailout -- protecting families -- was never used during the period the Fed was pumping taxpayer cash into the troubled insurer.
"We respectfully disagree with the view that there were any better alternatives that were workable in the extreme circumstances of the time -- in the middle of the worst financial panic in modern history," the Fed said in its statement.
Warren, one of the nation's foremost bankruptcy experts, and the panel she chairs attacked that reasoning in their report.
"[T]he Federal Reserve and Treasury repeatedly stated that they faced a binary choice: either allow AIG to fail or rescue the entire institution, including payment in full to all of its business partners," it noted. "The Panel rejects this all-or-nothing reasoning. The government had additional options at its disposal leading into the crisis."
For example, the government "could have acted earlier and more aggressively to secure a private rescue of AIG," as opposed to waiting until the weekend before its near-collapse," according to the report. AIG's chief executive approached Geithner in July 2008 with concerns -- two months before the firm was bailed out -- but was rebuffed, the panel noted.
Also, policymakers "then put the efforts to organize a private AIG rescue in the hands of only two banks, JPMorgan Chase and Goldman Sachs, institutions that had severe conflicts of interest as they would have been among the largest beneficiaries of a taxpayer rescue," according to the report. Goldman got nearly $13 billion from AIG after the insurer was bailed out.
"When that effort failed, the Federal Reserve decided not to press major lenders to participate in a private deal or to propose a rescue that combined public and private funds," the report said. "Nor did the government offer to extend credit to AIG only on the condition that AIG negotiate discounts with its financial counterparties.
"In short, the government chose not to exercise its substantial negotiating leverage to protect taxpayers or to maintain basic market discipline," COP noted, echoing a theme also expressed by the Special Inspector General for TARP in a November report on AIG.
"[T]he government could have used its leverage to attempt to negotiate concessions, but it failed to do so," according to the report. "The potential impact of [Treasury] Secretary [Hank] Paulson, then-President Geithner, and Chairman Bernanke (individually or in tandem) discussing the advantages of shared sacrifice with the counterparties, and, if necessary, speaking to the rating agencies, seems to have been overlooked by the government. If such powerful overtures had been rejected, the names of the non-complying counterparties could have been disclosed to the public. [The New York Fed] and Treasury had powerful non-financial tools at their disposal; they did not use them."
While the panel noted that there is "no doubt that orchestrating a private rescue in whole or in part would have been a difficult -- perhaps impossible -- task, and the effort might have met great resistance from other financial institutions that would have been called on to participate," Warren told reporters Wednesday evening that such a plan was "so superior to the cost of a complete government bailout that [federal officials] should have been pursued it as vigorously as humanely possible."
As the panel noted in its report, had such an alternative succeeded, "the impact on market confidence would have been extraordinary and the savings to taxpayers would have been immense. Asking for shared sacrifice among AIG's counterparties might also have provoked substantial opposition from Wall Street. Nonetheless, more aggressive efforts to protect taxpayers and to maintain market discipline, even if such efforts had failed, might have increased the government's credibility and persuaded the public that the extraordinary actions that followed were undertaken to protect them."
Instead, "the government failed to exhaust all options" before committing the first of nearly $182 billion in taxpayer funds, a decision that, coupled with its full payments to AIG's counterparties, "fundamentally changed the relationship between the government and the country's most sophisticated financial players.
"Even more significantly, markets have interpreted the government's willingness to rescue AIG as a sign of a broader implicit guarantee of -- too big to fail firms. That is, the AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America's largest financial institutions and to assure repayment to the creditors doing business with them. So long as this remains the case, the worst effects of AIG's rescue on the marketplace will linger," according to the report.
Geithner's team "failed to recognize the AIG problem and get involved at a time when it could have had more options," the panel noted. "While the reasons for [the New York Fed's] failure are not clear, it is clear that when [it] finally realized AIG was failing and that there would be no private sector solution, Chairman Bernanke and Mr. Geithner failed to consider any options other than a full rescue.
"To have the government step in with a full rescue was not the approach used in prior crises, including Bear Stearns and Long-Term Capital Management. It is also clear that by the time [the New York Fed] focused on the problem, time was and the breadth and scope of legal counsel sought were narrow. [It] chose lawyers from a limited pool and did not seek legal advice from a debtor's counsel (such as AIG's bankruptcy counsel or independent bankruptcy counsel).
"As a result, there were many options [New York Fed] evidently did not consider, including a combined private/public rescue (which would have maintained some market discipline), a loan conditioned on counterparties granting concessions, and a short-term bridge loan from [the New York Fed] to provide AIG time for longer-term restructuring.
"Providing a full government rescue with no shared sacrifice among the creditors who dealt with AIG fundamentally changed the relationship between the government and the markets, reinforcing moral hazard and undermining the basic tenets of capitalism.
In addition, the watchdog criticized the potential conflicts of interest embedded in the deal.
"Throughout its rescue of AIG, the government failed to address perceived conflicts of interest. People from the same small group of law firms, investment banks, and regulators appeared in the AIG saga in many roles, sometimes representing conflicting interests," according to the report.
"The lawyers who represented banks trying to put together a rescue package for AIG became the lawyers to the Federal Reserve, shifting sides within a matter of minutes. Those same banks appeared first as advisors, then potential rescuers, then as counterparties to several different kinds of agreements with AIG, and ultimately as the direct and indirect beneficiaries of the government rescue. The composition of this tightly intertwined group meant that everyone involved in AIG's rescue had the perspective of either a banker or a banking regulator. These entanglements created the perception that the government was quietly helping banking insiders at the expense of accountability and transparency."
The panel's J. Mark McWatters said the small group of firms involved in the bailout is indicative of the current makeup of the global financial system.
"[I]t is critical to note that the global financial system does not consist of a single monolithic institution but, instead, is comprised of an array of too-big-to-fail financial institutions many of which were, interestingly, also counterparties on AIG credit default swaps (CDS) and securities lending transactions (SL)," he wrote in a concurring opinion.
"In other words, the concept of a -- global financial systemis really just another term for the biggest-of-the-big financial institutions and, as such, there remains little doubt that the principle purpose in bailing out AIG was by definition to save these institutions as well as AIG's insurance business from bankruptcy or liquidation.
"It is troublesome that the plan implemented by the [New York Fed] and Treasury to save AIG along with the global financial system was without cost to those too-big-to-fail members of the global financial system who were rescued.
Current officials in the Federal Reserve and the Obama administration argue that one way to help deal with Too Big To Fail is to expand regulators' legal authority to dissolve ailing financial firms whose failure could threaten the system.
Both sets of officials have argued recently that had they had this power in the fall of 2008, policymakers wouldn't have had to bail out AIG.
Congress is poised to pass a bill in the coming weeks that would give regulators the power they say they lacked in 2008. President Barack Obama hopes to sign it into law by July 4.
Warren, though, pushed back against this claim.
"The government didn't need resolution authority to try other options to deal with AIG," the bankruptcy expert said. "It needed to exercise more of the leverage that it had."
Instead, more than $27 billion of taxpayer money went into the coffers of firms like Goldman Sachs and Deutsche Bank. The firms were also allowed to keep $35 billion in collateral previously posted by AIG.
Since AIG was under the control of taxpayers, it's been argued that more than $62 billion in taxpayer funds went to rescue Goldman and its peers in a series of transactions members of Congress have termed a "backdoor bailout."
Asked in April about the firm's $12.9 billion payout via AIG and taxpayers, Goldman's chief financial officer David Viniar told a Senate panel that the firm simply accepted the deal that was offered. Pressed further, he revealed there were no negotiations over the terms.
The feds gave Goldman a deal, and Wall Street's most profitable firm took it.
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