Starr vs US regarding AIG

Article in the NYT about the Starr suit against the federal government.

It would truly be wonderful if we saw some evenhanded coverage that showed exactly what the government did and did wrong when it used AIG's value to bail-out much of wall street.  Even if the actions were necessary to preserve the financial system, it doesn't mean that AIG shareholders should have uniquely borne so much of the burden of those actions.

The use of AIG as a conduit to make other parts of the financial system whole was a panicked reaction by the government to the crisis.  Taking the government at face value that there was no malice does not justify the use of government powers to act so inequitably.  Some recompense is appropriate.

The following statement from the NYT article captures what I have been writing for years: 

The decision to use taxpayer and A.I.G. money to repurchase soured mortgage deals that the company insured for big banks in the form of credit-default swaps amounted to a “backdoor bailout” of Wall Street, the lawsuit says.

Geithner

He seems like a nice enough guy but he is being disingenuous when he says the government lacked the powers it needed to handle the collapse of a company like AIG and that, "Coming into AIG we had, basically, duct tape and string."  Setting aside the method (meaning tools), it was the PRICE that was wrong.  The tools at hand (using AIG as a conduit to cover banks exposed to CDS losses) were used poorly.  The Fed could have poured less cash into AIG rather than paying out on CDSs at 100 cents on the dollar.  Also, the subtext seems to be that the CDS counterparties used economic collapse as a playing card ("we will bring the financial system down by demanding that AIG make good on its CDS obligations") and that the Fed caved in.  Crazy both in the recklessness of the counterparties and if the Fed bought the argument.  Put simply, the Fed should simply have said: "we can pay you some amount on the CDSs or you can take your chances in bankruptcy court with AIG."  As bankruptcy court for AIG would have meant bankruptcy for the counterparties (as the financial system collapsed), they would have accepted the "some amount".  Separately, why is Goldman's hedged position with AIG relevant?  Either they were hedged (in which case there was no need to bail GS out because there was no system risk from failure to satisfy the CDS obligations to GS) or they weren't (in which case they weren't in a position to demand 100 cents on the dollar).

The Fed should ask for its money back.

AIG CDS Collateral

We are starting to get some clearer coverage on the collateral calls that sunk AIG and, more importantly, made its CDS counterparties whole.  Unfortunately, that coverage is buried inches below the lead.  From today's Wall Street Journal:

"That [Maiden Lane] was a boon to the banks, which were effectively made whole. The banks pocketed $35 billion in collateral AIG already had paid them, and collected another $26.8 billion in cash for selling the investments at roughly their lowered values. Goldman Sachs got to keep billions in collateral and got paid $5.6 billion for the investments.

Whether that was the best strategy for AIG remains a subject of debate.

At the time, the move eliminated the risk that AIG would have to post still more collateral on the canceled swaps if the investments continued to decline. Last November, AIG's then-chief executive, Edward Liddy, told investors that the company was hemorrhaging cash because it had to post collateral on the swaps and problems with other deals. "We need to stop that and that's what this is designed to do," Mr. Liddy said.
The advantage of that approach was illustrated in the first quarter. Markets continued to fall but AIG didn't have to keep handing over more cash on closed-out deals. But AIG also surrendered any chance of getting some of the collateral back on the canceled swaps.

AIG's former longtime CEO, Maurice R. "Hank" Greenberg, argued publicly at the time that the government should have guaranteed the swap contracts, eliminating the need for AIG to post more collateral. Others have contended that AIG's trading partners should have been forced to accept less money for tearing up the contracts."

I'm pretty sure I've heard this story

Gold, stocks, etc. have been rising recently.  Isn't most of this simply a function of a declining dollar?  In other words, inflation?  An asset bubble?  Much of the government's stimulus efforts seem to have been translated into increased holdings of financial assets rather than increased spending.  Which isn't great for TIPS (CPI flat, asset prices way up).

Oh well.

Wall Street problems

This is generally right, especially adding in my pet theory of sales guys rising a little further than they ought to.

New York Times has difficulty with private equity

I don't get it.  The article says that private equity portfolios are being sold at between 29.3 cents on the dollar and 51.58 cents on the dollar, measured at net asset value.  I believe some discount so I would accept these numbers and trust the article. 

Except for the baffling sentence two paragraphs later:  "But what happens if Stanford is able to sell its stake at only 50 cents on the dollar, for example, when K.K.R. is listing it at 80 cents? If other endowments hold similar stakes, what happens to their value?"

Huh?  Isn't KKR's listed stake the net asset value?  Perhaps the article means 29.3 cents on the invested capital?  But who in their right mind is applying a discount off of entry price rather than their judgment of current value?  What is this "dollar" referring to?  In the KKR context, I think it is of invested capital.  In Stanford's case, I think off of KKR's reported value (which is lower than entry value).  But, of course, I have no idea because the article is sloppy.

Notwithstanding private equity's larger mindshare and increased column inches, the press still has a long way to go before it understands even the basics, I think.

Is it clear something went wrong?

The leader in the Economist this week is "What Went Wrong With Economics". The alliteration notwithstanding, is it really clear that something went wrong? I thought there were many calls for pricking the asset bubble over the prior years (including from the Economist). Also, doesn't standard economic theory predict that where incentives are not properly designed (for example, mortgage originators are seeking one-time initial fees rather than a reliable stream of income payments; bond raters are paid by the issuer rather than the purchaser; etc.) that you will have poor results?

Freddie - what is going on here?

Something must be horribly wrong at Freddie.

Semantics

We should really stop calling the AIG payments a bailout of AIG - more honest (and perhaps actually more politically palatable) to describe it as the CDS bailout. AIG, as the largest seller of CDSs, was simply a conduit for the payments to the purchasers of CDS protection - that money did not stay with AIG or go to its executives or shareholders.

AIG CDS scandal

Again, when will the counterparties to AIG's CDS contracts be named? I believe they were paid out at face with the bailout money. We should know to whom this direct transfer of taxpayer money was sent.

It would have been fair for those counterparties to be stuck (they could sue, there would have been some compensation) or, to cut to the chase, they could have agreed to a negotiated amount equal to their expected litigation proceeds. And, perhaps if there truly was systemic risk, the government could have funded some of that negotiated amount as an advance to AIG.

For the government to have bailed out the counterparties (I'm guess GS for a lot of it) at FACE is wrong wrong wrong.

telecoms x1000?

I vaguely recall during the telecom/dotcom bubble that many hardware companies were reporting huge sales but most were financed by the manufacturer and so there were crushing losses when buyers evaporated (doubly so because the equipment was often outdated by that time). Today's crisis feels like a giant version of that: manufacturing centered economies financed purchases by debtor/consumer economies. And gains from those purchases built up the capital to provide more financed purchases. Until the purchasing stopped...

CS no FB?

Had no idea that there were even rumors that CS would get out of investment banking altogether. I thought CS was doing relatively well and so would be able to preserve an investment banking platform.

A hope

Price variations are generally a function of liquidity needs rather than changes in underlying value. I hope.

Malus

Awesome word. As a potential deduction from a bonus, UBS executives may get a "malus". But, of course, I don't think it can result in a number lower than zero. http://dealbook.blogs.nytimes.com/2008/11/17/no-bonuses-for-top-ubs-executives/

Break The Glass

According to this Bloomberg article, Goldman seems to have been aware of the break-the-glass plan from at least the beginning of 2008 as they already had Federal Reserve representatives on the premises in March 2008. I guess it wasn't so secret after all? And how was it shocking news when Goldman and Morgan became bank holding companies at the end of September. And, finally, why wasn't Lehman given permission when asked a few weeks earlier?

"The contingency planning to become a commercial bank had been under way since March, after the collapse of Bear Stearns Cos. sent shivers through Wall Street. That's when Federal Reserve inspectors set up camp at the firm's 85 Broad St. headquarters, a sign of things to come."

new model?

I wonder if the more gradual declines (relatively speaking) and absence of a capitulation day is due to investors being (somewhat) better educated and, in any event, indoctrinated with the view that a crash is the wrong time to sell?

Holy Mackerel

I think the Fed has just signed on to bail out all large commercial enterprises in the U.S. Because no one is financing, the Fed will now buy commercial paper.

Citi seeks $60b

Based on absolutely nothing as I haven't bothered to read the court filings - doesn't seeking $60b ($20b for compensatory damages) confirm that Citi was getting Wachovia for almost nothing ($2b)? Which is the strongest policy case for finding for Wells Fargo? And thus Citi's request indirectly supports Wells Fargo?

Developed and Emerging Markets Banks Convergence?

I think that the business model of emerging market banks has historically been collecting deposits and investing them in foreign sovereign debt (and not lending to local business except large and/or politically connected enterprises). Are we moving to the same structure in the rest of the world? At the same time the emerging markets are moving towards actual commercial lending? And, if so, does this suggest that investments as substitution for debt will become possible in the U.S.?

Spitzer's Fault?

Only half tongue in cheek, was Eliot Spitzer a proximate cause of the current economic turmoil?

Consider his weakening of the investment banks (leading them to take on riskier strategies to maintain earnings), targeting of AIG (leading to the ouster of its CEO – the one man who could keep Financial Products in line), and failure to limit mortgage lending fraud and abuses (items more appropriately with a state AG’s mandate).

And then the consequences: Lehman’s bankruptcy, Bear’s bailout, Merrill’s merger, AIG’s nationalization, and today’s frozen credit markets.