Compassion Fatigue

November 18, 2009

272

The release of the Special Inspector General of the TARP’s (SIGTARP) report on the Federal Reserve’s bailout of AIG’s counterparties to the tune of 100 cents on the dollar has triggered some debate among commentators. It seems clear that the Fed had the leverage to negotiate a better deal on behalf of the taxpayers, but utterly failed to do so. But just how horrendous was the Fed’s failure? – Ilene

Compassion Fatigue

Courtesy of The Epicurean Dealmaker

"No matter how many times you save the world, it always manages to get back in jeopardy again. Sometimes I just want it to stay saved, you know? For a little bit? I feel like the maid: ‘I just cleaned up this mess! Can we keep it clean for … for ten minutes?!’"

— The Incredibles

I don’t know about you, Dear and Long-Suffering Readers, but I am beginning to worry about Yves Smith. [See Yves’s Very Abbreviated Takedown on SIGTARP Report on AIG CDS Payouts]

The indefatigable blogger and soon-to-be-published author is really showing the strain of commenting from the front lines of the global financial crisis, as she has done, admirably, from the very beginning. Today, she lit into Neil Barofsky’s SIGTARP post mortem on the New York Fed’s disbursement of billions of taxpayer dollars to cancel credit default swaps written by the pathetic boobs at AIG. AIG sold those swaps, you may remember, under the cheerfully naive assumption that, as long as you hold a AAA credit rating and employ a bunch of overpaid financial engineers in a fancy office on Curzon Street, you can write as many naked puts on as much toxic crap as you like with no consequences. Much as I would be delighted to learn otherwise, I believe we may safely consider that presumption to be dead, buried, decayed, mixed into topsoil, and completely absorbed into the Earth’s mantle via tectonic subduction by now.

In the meantime, however, the rest of us continue to live with the consequences of AIG’s tomfoolery, and Ms Smith remains understandably upset about this state of affairs. So much so, in fact, I think she rather unfairly pans Mr. Baroksky’s report as unacceptably timid and mealy-mouthed. I read her to say she would rather have the report blast the Fed’s mishandling of the AIG crisis in no uncertain terms, not sugarcoat its misdeeds in the bland and unoffensive coating of bureaucratese.

But this is unfair. From my perspective—known to most of you as distinctly unappreciative of the Fed’s spineless and inept handling of this imbroglio—I think Barofsky and pals did a rather bang-up job of blowing holes in both the government’s actions and their pathetic ex post rationalizations therefor. You just have to read between the dry, measured lines a little.

* * *

As witness, I offer for your reading pleasure select excerpts from the Conclusions and Lessons Learned section of the report, with a few helpful explanatory titles and glosses of my own design.

Page 28: "Plan B? What Plan B?"

— or —

The New York Fed Conclusively Demonstrates It Cannot Plan Its Way Out of a Paper Bag, Even with a Map and a Blowtorch

When first confronted with the liquidity crisis at AIG, the Federal Reserve Board and FRBNY, who were then contending with the demise of Lehman Brothers, turned to the private sector to arrange and provide funding to stave off AIG’s collapse. Confident that a private sector solution would be forthcoming, FRBNY did not develop a contingency plan; when private financing fell through, FRBNY was left with little time to decide whether to rescue AIG and, if so, on what terms. … Not preparing an alternative to private financing, however, left FRBNY with little opportunity to fashion appropriate terms for the support, and believing it had no time to do otherwise, it essentially adopted the term sheet that had been the subject of the aborted private financing discussions (an effective interest rate in excess of 11 percent and an approximate 80 percent ownership interest in AIG), albeit in return for $85 billion in FRBNY financing rather than the $75 billion that had been contemplated for the private deal. In other words, the decision to acquire a controlling interest in one of the world’s most complex and most troubled corporations was done with almost no independent consideration of the terms of the transaction or the impact that those terms might have on the future of AIG.

This bang-up example of tactical thinking and mental flexibility, of course, led directly to a threatened downgrade of AIG by the ever-helpful credit rating agencies, which in turn made it absolutely necessary for AIG to get out from under those nasty, collateral-sucking CDSs. This allowed the Fed staffers a stellar opportunity to affirm their collective membership in the phylum Platyhelminthes (spineless flatworms) by halfheartedly negotiating for haircuts on the CDOs underlying AIG’s swaps with its recalcitrant counterparties.

Apparently, the sum and substance of these negotiations was remarkably similar to that which my bloggish antagonist Economics of Contempt rather presciently proposed just recently:

AIG: "Would you be willing to accept, say, 70 cents on the dollar?"
Goldman: "No."

THE END

I kid you not.

Seven of AIG’s largest counterparties—including, for the two which were French, that beacon of unfettered capitalism and bastion against tortious interference in contract law, the Government of Fucking France—told the Fed to go pound sand. The eighth, UBS, showed a deplorable lack of principle by venturing to offer a 2% haircut to its position, as long as everyone else did. Nevertheless, the Fed decided that friends don’t let friends make insultingly small unilateral concessions where the US taxpayers’ dime is concerned, so they just told them to forget it.

Mr. Barofsky picks up the narrative from here:

Page 29: "Integrity Is Our Watchword"

— or —

For Some Unexplained Reason, Perhaps Having to Do with Sunspots or the Phase of the Moon, the Institution Which Presided Over the Botched Fire Sale of Bear Stearns and the Clusterfuck Incineration of Lehman Brothers Magically and Unexpectedly Decides to ~~Grow a Pair of Testicles~~ Adopt a Set of Principles

In pursuing these negotiations, FRBNY made several policy decisions that severely limited its ability to obtain concessions from the counterparties: it determined that it would not treat the counterparties differently, and, in particular, would not treat domestic banks differently from foreign banks — a decision with particular import in light of the reaction of the French bank regulator which refused to allow two French bank counterparties to make concessions; it refused to use its considerable leverage as the regulator of several of these institutions to compel haircuts because FRBNY was acting on behalf of AIG (as opposed to in its role as a regulator); it was uncomfortable interfering with the sanctity of the counterparties’ contractual rights with AIG, which entitled them to full par value; it felt ethically restrained from threatening an AIG bankruptcy because it had no actual plans to carry out such a threat; and it was concerned about the reaction of the credit rating agencies should imposed haircuts be viewed as FRBNY backing away from fully supporting AIG. Although these were certainly valid concerns, these policy decisions came with a cost — they led directly to a negotiating strategy with the counterparties that even then-FRBNY President Geithner acknowledged had little likelihood of success.

The first, of course, is my personal favorite, for there is absolutely no tactic more effective at gutting whatever leverage and flexibility you might have in a negotiation—other than shoving a fragmentation grenade up your ass and pulling the pin—than refusing to treat different counterparties differently. I remember hearing hints of this preposterous limitation in earlier accounts of the AIG fiasco, but the Fed always seemed to imply it was a legal restriction inherent in its charter. Now, perhaps, we learn differently:

FRBNY’s decision to treat all counterparties equally (which FRBNY officials described as a “core value” of their organization), for example, gave each of the major counterparties (including the French banks) effective veto power over the possibility of a concession from any other party. This approach left FRBNY with few options, even after one of the counterparties indicated a willingness to negotiate concessions. It also arguably did not account for significant differences among the counterparties, including that some of them had received very substantial benefits from FRBNY and other Government agencies through various other bailout programs (including billions of dollars of taxpayer funds through TARP), a benefit not available to some of the other counterparties (including the French banks). It further did not account for the benefits the counterparties received from FRBNY’s initial bailout of AIG, without which they would have likely suffered far reduced payments as well as the indirect consequences of a potential systemic collapse.

Oh, yeah, that was a real winner.

Also in the winner column was the Fed’s newly discovered squeamishness about playing hardball. Where the fuck did that come from? Mr. Barofsky needs no gloss on this topic (pp. 29–30):

Similarly, the refusal of FRBNY and the Federal Reserve to use their considerable leverage as the primary regulators for several of the counterparties, including the emphasis that their participation in the negotiations was purely “voluntary,” made the possibility of obtaining concessions from those counterparties extremely remote. While there can be no doubt that a regulators’ inherent leverage over a regulated entity must be used appropriately, and could in certain circumstances be abused, in other instances in this financial crisis regulators (including the Federal Reserve) have used overtly coercive language to convince financial institutions to take or forego certain actions. As SIGTARP reported in its audit of the initial Capital Purchase Program investments, for example, Treasury and the Federal Reserve were fully prepared to use their leverage as regulators to compel the nine largest financial institutions (including some of AIG’s counterparties) to accept $125 billion of TARP funding and to pressure Bank of America to conclude its merger with Merrill Lynch. Similarly, it has been widely reported that the Government, while arguably acting on behalf of General Motors and Chrysler, took an active role in negotiating substantial concessions from the creditors of those companies.

Gee, that sounds familiar.

* * *

Of course, then there is the whole "backdoor bailout" question, which arguably lies at the core of the persistent conspiracy theories percolating through our troubled polity.

Page 30: "No, No, No. I Didn’t Give You That Dollar, I Gave You This Dollar"

— or —

The Fed Attempts to Gauge Exactly How Stupid 310 Million Americans Really Are by Denying the Fungibility of US Currency

Questions have been raised as to whether the Federal Reserve intentionally structured the AIG counterparty payments to benefit AIG’s counterparties — in other words that the AIG assistance was in effect a “backdoor bailout” of AIG’s counterparties. Then-FRBNY President Geithner and FRBNY’s general counsel deny that this was a relevant consideration for the AIG transactions. Irrespective of their stated intent, however, there is no question that the effect of FRBNY’s decisions — indeed, the very design of the federal assistance to AIG — was that tens of billions of dollars of Government money was funneled inexorably and directly to AIG’s counterparties. Although the primary intent of the initial $85 billion loan to AIG may well have been to prevent the adverse systemic consequences of an AIG failure on the financial system and the economy as a whole, in carrying out that intent, it was fully contemplated that such funding would be used by AIG to make tens of billions of dollars of collateral payments to the AIG counterparties. The intent in creating Maiden Lane III may similarly have been the improvement of AIG’s liquidity position to avoid further rating agency downgrades, but the direct effect was further payments of nearly $30 billion to AIG counterparties, albeit in return for assets of the same market value. Stated another way, by providing AIG with the capital to make these payments, Federal Reserve officials provided AIG’s counterparties with tens of billions of dollars they likely would have not otherwise received had AIG gone into bankruptcy.

And, lastly, the SIGTARP report blasts the Fed’s continued ridiculous insistence on complete confidentiality for its actions, even in retrospect. Given the revelations we have been privileged with, I can only assume the Fed’s diffidence has far more to do with covering up its massive, multidimensional incompetence in dealing with AIG than with any other purpose.

Page 31: "Transparency? We Don’t Need No Fucking Transparency!"

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Sunlight Is the Best Disinfectant, But Only for Those Other Guys

Second, the now familiar argument from Government officials about the dire consequences of basic transparency, as advocated by the Federal Reserve in connection with Maiden Lane III, once again simply does not withstand scrutiny. Federal Reserve officials initially refused to disclose the identities of the counterparties or the details of the payments, warning that disclosure of the names would undermine AIG’s stability, the privacy and business interests of the counterparties, and the stability of the markets. After public and Congressional pressure, AIG disclosed the identities. Notwithstanding the Federal Reserve’s warnings, the sky did not fall; there is no indication that AIG’s disclosure undermined the stability of AIG or the market or damaged legitimate interests of the counterparties. The lesson that should be learned — one that has been made apparent time after time in the Government’s response to the financial crisis — is that the default position, whenever Government funds are deployed in a crisis to support markets or institutions, should be that the public is entitled to know what is being done with Government funds. While SIGTARP acknowledges that there might be circumstances in which the public’s right to know what its Government is doing should be circumscribed, those instances should be very few and very far between.

* * *

In fact, reading through this report, I find very little evidence that Barofsky et al. were even remotely swayed by the transparent nonsense the Fed used to justify its idiocy. Sure, they included it in their report, as they were no doubt required to do, but their conclusions seem remarkably impervious to the Fed’s perspective.

And, weasel words aside, I read the SIGTARP report and find complete confirmation of two important points. First, the New York Fed, led by our current Secretary of the Treasury, botched the rescue of AIG so completely and so pathetically that it does border, as Yves says, on criminal incompetence. Second, the Fed had enough negotiating leverage in the entire affair to have substantially lessened the amount of taxpayer funds it ending up paying to AIG’s counterparties, to the tune of billions and billions of dollars. A competent and motivated negotiator could have extracted billions of dollars in concessions with little else. But the Fed squandered that leverage, and it explicitly renounced several situational and structural advantages it possessed that contributed to that leverage, in the service of … what, exactly? Certainly not in the service of its fiduciary duty to the American people, which cannot and should not be limited simply to the ad hoc preservation of a bunch of systemically important financial institutions.

Sadly, the horse has left the barn, the barn has burned down, and the farmer’s wife has run off with the village idiot. I fear there is little upside in further speculation on what might have been. Suffice it to say, however, that I think Michael Moore should add a coda to his recent movie, Capitalism: A Love Story. In my vision, the chubby provocateur will pull his rented armored truck up to the steps of the Federal Reserve Bank and start chanting into his bullhorn: