In September 2008, the Federal Reserve bailed out AIG, and ever since then, controversy has swirled around the motivation and terms of the bailout. A major part of the bailout funds went directly to three banks: Goldman Sachs, Merrill Lynch, and the French bank Société Générale (SocGen). These banks were holding CDS insurance from AIG on toxic assets, and the bailout saved them from the damage they would have suffered if AIG had gone bankrupt and that insurance had become worthless. The assets in question were then stuffed into a financial vehicle called Maiden Lane III, where they remain to this day, administered by BlackRock on behalf of the government.
The bailout has raised enduring questions about the propriety of US financial system governance. A recent article in France's leading newspaper Le Monde highlighted the two main theories currently circulating on why the bailout was so generous to a small group of banks. One idea holds that the political connections of Goldman Sachs were a key reason for the bailout. At the same time, it appears that the French regulatory authorities intervened on behalf of the French banks SocGen and Calyon by claiming (speciously) to the Fed that those bank directors would face prison time if they accepted anything less than a 100% bailout.
Attempts to investigate have slammed into a wall of secrecy. The Fed is still fighting Freedom of Information Act requests to disclose the beneficiaries of its various emergency rescue programs The central bank has refused to release details about how the banks benefited from the AIG bailout, even taking the impressively circuitous route of getting AIG itself to beg the SEC for permission to strike key information about Maiden Lane III from its regulatory filings.
The SEC agreed to let AIG keep Maiden Lane III information secret until 2018, since it "qualifies as confidential commercial or financial information." The Fed argued earlier this week that "If such information were to become available to traders in such securities, traders would be able to use such information to their advantage, and undercut the ability of Maiden Lane III to sell those assets for the maximum total return, to the detriment of taxpayers and AIG."
We now show that this argument is worthless. Nearly all of the deleted information can be reassembled from sources that are publicly available. The traders whom the Fed professes to find worrisome have access to far more information.
In June 2009, CBS News publicized a memo by AIG Financial Products Vice President Andrew Forster dated November 27, 2007. It listed various assets (to be specific, collateralized debt obligations - CDOs), almost entirely residential real-estate related, on which AIG had received collateral calls and was negotiating with counterparties. Most, perhaps all, of those deals, presumably the weaker ones, wound up in Maiden Lane III, along with a comparatively small amount of commercial real estate CDOs.
Between this memo and information provided on the Fed's website about individual commercial real estate CDOs in Maiden Lane III, the very same transaction details that the Fed pushed AIG to omit are already in the public domain: the names and par amounts of virtually all of assets sold to Maiden Lane. And from that information, someone who understands these sorts of deals can fill in even more details, still using only publicly available sources.
We have done this work. A professional at valuing CDOs reviewed the methodology and results. We discuss the construction of the model in greater detail today at Naked Capitalism and provide a link to sections of the most recent model run.
The ease with which we were able to carry out this analysis shows that keeping information away from predatory traders cannot have anything to do with the Fed's anxiety to keep the Maiden Lane III data hidden. There must be other reasons for secrecy.
An examination of our data raises troubling questions about how the Fed is valuing the Maiden Lane III assets. The Fed claims that in the second and third quarters of 2009, the CDOs in Maiden Lane III rose in value. But our data shows that most of the portfolio is rated junk, and some of the part that is not junk has been downgraded significantly during this period. Moreover, the Fed's disclosures show that paydowns on these assets accelerated sharply in Q2 and Q3. As discussed at greater length earlier this week at Naked Capitalism, all likely explanations for increasing paydowns imply further reductions for the value of the Maiden Lane III assets. With a weak and worsening portfolio, little to no improvement in the prices of severely distressed mortgage assets, and paydown figures implying additional decreases in asset values, how can Maiden Lane III possibly be reporting rising asset values?
Our analysis raises further questions about the bailout. The data shows that many of the CDOs were packaged by one bank and then the insured portion ended up with another bank. For instance, Goldman had insurance not only on deals it created, but also CDOs from seven other banks.
Many commentators have commended Goldman on the cleverness with which the bank successfully shorted the mortgage market. But why, then, does it seem from the data as if Goldman was systematically trying to increase its exposure to AIG?
And why is there such a pronounced connection between Goldman and the French bank SocGen, the two biggest AIG counterparties and two institutions which have in the past been associated (separately) to the decision to bail out AIG?
Probably the only way to resolve these questions and, incidentally, restore some measure of credibility to US financial governance is to press for additional information.
When the Swiss bank UBS was bailed out by its government, it was forced by its regulators to release a detailed report on how it had blown itself up. What great service for the country have our banks performed that justifies letting them shroud their actions in obscurity?
After the Great Crash of 1929, the Senate created a commission to investigate the causes of the meltdown. The commission was completely ineffective at first, and was widely viewed as a whitewash. It was only after the commission had run through three chief counsels and had been energized by the contributions of Ferdinand Pecora that it started to make waves. The discoveries of the Pecora Commission led to a financial regulatory system that was admired around the world for the next forty years.
The Financial Crisis Inquiry Commission needs to use its subpoena powers to compel the banks in question to dump emails and documents into the public domain. At that point, it will be possible for independent observers to work with that information and come to their own conclusions about how the global economy went into cardiac arrest. If there are bodies buried, exhume them. Having a functional financial system is more important than helping powerfully placed, undeserving parties avoid embarrassment.
Andrew Dittmer and Richard Smith contributed to this article.