The AIG-Maiden Lane III Controversy

As everyone knows by now, Neil Barofsky, special inspector general for TARP, has a new report out on the decision by the Federal Reserve Bank of New York last Fall to make various AIG counterparties (primarily some very big banks with names you know) whole on the the CDS protection they had bought from AIG to cover their risk on some CDOs. The potentially juicy bit has to do with the Maiden Lane III transaction (New York Fed summary here).

There are a couple of details I can’t quite reconcile (for example, the Fed balance sheet shows initial funding of $29.3 billion, but everyone says Maiden Lane III paid $29.6 billion for the CDOs), but essentially it went like this. The banks had bought CDS protection on $62.1 billion of CDOs (some of those CDOs they owned — some they did not, meaning those were “naked” CDS*). As of November, the market value of those CDOs was $29.6 billion. At that point, the banks already held $35.0 billion in cash collateral from AIG to cover the difference. (If you have a derivatives contract with someone under which your counterparty may have to pay you a huge amount of money, you generally negotiate a term under which the counterparty has to give you money as the trade moves against him, to protect you from default. In this case, a lot of the collateral came from the $85 billion credit line the Fed gave to AIG in September — otherwise AIG would have gone bankrupt because of collateral calls.)

In the transaction (I’m working off the New York Fed summary), first AIG contributed $5 billion to Maiden Lane III and the New York Fed gave it a $24.3 billion loan. Then Maiden Lane III gave all $26.8 billion to the banks in exchange for the CDOs. (The banks accepted $26.8 billion because  they already held $35.0 billion in collateral; together that makes $61.8 billion — as I said, I can’t get $300 million to reconcile.) Then Maiden Lane III gave $2.5 billion right back to AIG (this is the amount by which AIG had overcollateralized). As part of the deal, the banks agreed to tear up the original CDS on the CDOs, so AIG couldn’t lose any more on the CDS (which, remember, are separate from the CDOs).

The controversy is not over paying $29.3 (or $29.6) billion for the CDOs, since that was the market price. The controversy is over whether AIG should have agreed to settle the CDS at 100 cents on the dollar (meaning that the banks get the difference between the face value of the CDOs and their current market value). Bloomberg reported a while back that prior to the government bailout, AIG had been trying to negotiate a settlement at 60-70 cents on the dollar, but that that portion of the term sheet was crossed out in the final agreement. The implication is that paying the swaps off in full was a back-door, off-the-books way of funneling cash to banks that we didn’t want to fail.

The argument for the NY Fed is that the banks had legal contracts that entitled them to the money. AIG might have been able to negotiate a haircut because it was going bankrupt and counterparties will take less money up front rather than risk getting even less in bankruptcy. However, once the government stepped in, it had no way to abrogate the contracts. The Agonist has a long post with much more detail than I have provided, arguing in conclusion that Federal Reserve Bank presidents are technocrats, and technocrats abide by the advice of their lawyers, which was almost certainly that AIG had to pay off the swaps in full. (He says the mistake was bailing out AIG in the first place back in September.)

Various people have argued, however, that the Fed could have negotiated a better deal. The Epicurean Dealmaker argues that, given the considerable powers of the Federal Reserve and the federal government in general, the banks could have been intimidated into accepting a modest haircut.

Robert Pozen, in his very worth reading book Too Big to Save?, says (p. 79) that AIGFP could have been forced into bankruptcy without putting the rest of AIG into bankruptcy; threatening to put AIGFP into bankruptcy would have provided the leverage to induce the banks to take a haircut. Lucian Bebchuk, a Harvard law professor, argued back in March that because AIG had guaranteed the obligations of AIGFP, this would constitute a default by AIG — but that wouldn’t affect AIG’s insurance subsidiaries, which could stand alone quite nicely (insurance companies get most of their money from customer premiums, not from debt).

I think that given the state of the world in November 2008, paying the banks off in full was definitely the easy choice — it’s always easier to abide by the contract and pay up, especially when you have very deep pockets. And the fact that it helped out the banks as well was probably seen as another argument for it, given the perceived need within the government to bolster the banks’ balance sheets by any means necessary.

* Apparently there is some controversy about this. In an interview, Representative Peter DeFazio said the following:

“Geithner would not answer my question when I said, ‘Were those naked credit default swaps by Goldman or were they a counter party?’ He said, ‘I will not answer that question.'”

From the New York Fed web site:

“AIGFP, the LLC and the New York Fed have entered into agreements with AIGFP’s credit derivative counterparties to terminate approximately $53.5 billion notional amount of credit derivatives and purchase the related multi-sector CDOs. Of these, CDOs with a principal amount of approximately $46.1 billion settled on November 25, 2008. Settlement on the remaining $7.4 billion is contingent upon the ability of the related counterparty to obtain the related multi-sector CDOs and thereby settle with the LLC and terminate the related credit derivative contracts with AIGFP” (emphasis added).

By James Kwak

38 responses to “The AIG-Maiden Lane III Controversy

  1. A better deal was not negotiated because even the, um, French can push around our current Treasury Secretary.

    Strong reforms are coming. Really.

  2. Taxpayers paying off naked default swaps by shadow bankers? A $600 trillion derivative market in dark pools?

  3. James,

    You write: “The implication is that paying the swaps off in full was a back-door, off-the-books way of funneling cash to banks that we didn’t want to fail.”

    This is not just an implication. It was clearly stated by Edward Liddy, the head of AIG, in March: “He said A.I.G. was acting as a sort of conduit to funnel money from the government to dozens of financial institutions around the world.”

    http://dealbook.blogs.nytimes.com/2009/03/02/aig-chief-calls-new-aid-a-backup/?ref=business

    There should be no controversy about this point.

    From the very beginning, the AIG bailout was a way of bailing out banks to the tune of tens of billions of dollars without any accountability or oversight or demand in return. Free money from taxpayer to banks.

    There isn’t much point in recounting the story here, I think. Most readers of your blog probably agree about the contempt Wall Street banks have for the rest of us, even as they cash their bonus checks made possible by our largesse. P.T. Barnum had a word for what we are.

  4. A better deal wasn’t gotten because the only quality one must have to be head of the Ny federal reserve is to be a total slave to wall street interests. These banks pick the head of the NY Fed and does anyone think for a second they would put somone above them thay had any worries about. Hence, being head of the NY Fed should be an automatic disqualifacation to be treasury secretary.

  5. The point you miss Mr. Kwak is that the legal advice Timmy was getting was mostly coming from Wachtell, Lipton and Sullivan & Cromwell. Both Ed Herlihy and Rodgin Cohen, respectively, had vested interests in protecting their clients – the financial institutions at risk – and were in no mood to offer creative solutions to an overwhelmed and overmatched NY Fed president. Bail out the big guys or else. It was the same tactics used by Paulson and Bernanke with Congress. You didn’t have any other voices in the room arguing that maybe there is another way out here.

    Don’t let the lawyers off the hook. They are the secret sauce that allowed the stew to simmer to perfection. We are starting to see that in the Merrill/BofA investigations. Use the lawyers as cover for a larger conspiracy to save Wall St.’s ass at the expense of the rest of the nation.

  6. It’s absurd on its face that the government couldn’t use “moral” suasion to accomplish whatever it wanted. It does so all the time. Isn’t that what happened with various GM stakeholders? Didn’t they get rough with Ken Lewis when he wanted to back out of the Merrill deal? (Or do these same people not believe that? I know it hasn’t been proven yet, but I haven’t heard anyone say it’s implausible.)

    For that matter, wasn’t the story supposed to be that the TARP was “forced” on some of the recipients? Not that I believe that, but again I don’t recall anybody calling it laughable on its face.

    The point is, everybody seems to take it for granted in principle that the government has all sorts of leverage beyond strict legality to broker desired outcomes.

    Those denying it in this particular case are simply doing so for ideological reasons, because they want to defend the Bush admin or Geithner or whomever.

    However, given the bailout premise, which was simply to shovel as much loot as possible as fast as possible to these crooks, it certainly would have been inconsistent for the Fed to turn around and get stingy regarding any particular deal. So if I had been in Goldman’s position, I would’ve taken it for granted that any haircut request was just for show, and that it was perfectly OK if I said No. And I would’ve been right.

    So it is inconsistent for someone who supported the bailout in the first place to then complain about a detail like this. The outcome here was along the trend line of the bailout premise itself.

    Why support the bailout in principle and then oppose its implications in detail?

  7. “The argument for the NY Fed is that the banks had legal contracts that entitled them to the money.”
    —————————-
    Haha. Tell that to the Indiana Teachers.

  8. Corrupt Treasury

    The last year of bailouts was basically a coup by Wall St and its well-connected lawyers called the
    shots every step of the way. There wasn’t one single independent voice in any of those conference rooms who didn’t have a vested interest in seeing the system that caused this financial crisis being
    bailed out and perpetuated at taxpayer expense. The government never really had independent counsel.

    http://www.law.com/jsp/article.jsp?id=1202428508090&thepage=1

    http://www.law.com/jsp/cc/PubArticleCC.jsp?id=1202424720012

    The NYTimes profile of Rodgin Cohen from last week was the best. It was a total reporting handjob until the very end when the reporter had the audacity to ask Cohen whether he might not have been able to balance the competing interests of the taxpayer and his Wall St. clients during all the furious bailout negotiations.

    Cohen’s response? Indignation and denial and ultimately a non-response.

    There is zero accountability amongst the legal community for its role in the bailouts. Legal ethics are a useless screen for criminal conspiracy.

  9. Orthogonal Vision

    “The argument for the NY Fed is that the banks had legal contracts that entitled them to the money.”

    What type of contracts is there other than legal? The alternative was not voiding a “legal” contract, but having AIG enter bankruptcy. What would have happened during bankruptcy proceedings with those “legal” contracts? Would a judge have required them to be paid in full?

    The backdoor bailout to TBTF entities essentially created a stream of taxpayer funds with no requirements for accountability or future return. Free money with no strings attached and a promise of secrecy.

    If this action is allowed to stand (there’s also the issue of insider trading by the NY Fed Chairman Steven Friedman who purchased GS stock and sat on their Board while the whole deal was being negotiated), there’s no reason to expect that this scam won’t be repeated over and over again. One TBTF “insures” the other TBTF entities and earns lots of money for that activity. When the fecal matter hits the circulating blade, the USG makes whole the other TBTFs while propping up first. Lather. Rinse. Repeat.

    What Geithner calls saving Wall Street and hoping to save Main Street, I call moral hazard.

  10. Organized Crime

    http://www.nytimes.com/2009/11/15/nyregion/15cohen.html?scp=1&sq=rodgin%20cohen&st=cse

    I love how David Nason, the Treasury official in charge of financial institutions during the bailout, willingly admits to using Rodgin Cohen as part of his kitchen cabinet. But if we actually want to know what Mr. Cohen actually said, that would breach attorney-client privilege. I love it.

    Oh – by the way, here is what David Nason is up to after saving America from financial disaster:

    http://www.reuters.com/article/pressRelease/idUS98971+30-Mar-2009+BW20090330

    I love the revolving door in DC. I wish we were back in the 19th Century when wheelbarrows of money were openingly sent to government officials. I’d rather we be honest about this than pretend these guys were actually representing the public interest.

  11. markets.aurelius

    That was truly hilarious — the French govt negotiating with the NY Fed on behalf of the French banks, who asserted they could not and would not settle for less than 100 cents on the dollar. And Geithner caved! Mon dieu! Would that such resolve was shown by the French in the 1940s …

  12. Goldman indicated that they were fully hedged and had very little value at risk. While this is truly hard to believe, what would GS negotiating position be if they thought their hedges were good? Would GS consent to take a haircut if they thought they would get paid either by a government backed CDS on their original CDOs or collateral + CDS on AIG Bonds? I think not.

    So the US government is now in a corner. The government wants to bury these instruments as quickly as possible and GS expects to be payed in full. The terms of this transaction are going to be leaked / released at some point. We would have a great discussion if GS received 100% while everybody else took a discount. So everybody had to be payed in full, even the players who were not so well hedged and would have taken a significant haircut.

    If you like irony, avoiding the appearance of favoritism toward GS could have cost the US taxpayer billions.

  13. This transaction has a result not often discussed. The Federal Reserve Bank of NY acquired $29.6 bn of various accounts receivable with a face value greater than what the paid in all likelihood. The FRBNY has been collecting the cash flow passed through from MLIII. The FRBNY/ MlIII will be in a position to run off these receivables with the cash flows including interest hopefully offsetting any losses during
    the run off period. FRBNY will carry these receivables at cost. They are earning retail interest so the net cash flows to the bank will be considerably more than than what is normal interest to the FRBNY. Since virtually all of the profits of the bank effectively escheat to the Treasury it is the Treasury that will lose their profit distribution from all FRBNY activities as a worse case. In the worst case of all, the Maiden Lane Three asset can be written off against future profits.

    Maiden Lane III is a pass through entity. MLIII naturally gets the cash flows here and passes them on to the FRBNY. As such, these assets can be carried at cost and written off as bad debts occur net of recoveries. But in the end, MLIII will generate a lot of cash flows. Keep in mind MLIII is a closed end trust receiving cash flow in only.

    In the grand scheme of things the real question is what will the total cash flow of MLII. Will it total 29 .6 bn including interest? If so, the whole problem will be quite subsumable by the FRBNY over time.

    I took the $300 mn difference as being the cash flow paid over to FRBNY. The net shrinkage of the asset on their books. That or a combination of cash flow and write offs of bad debt portions. But the retail debtors owe MLII and MLIII owes the FRBNY.

    I would really like to see some asset details of MLIII. We will see them if they are audited for 2009. That way an entire year of activity is reflected. Of course, only the minimum required will be disclosed.

    Will the FRBNY get back its money and 1 % interest over time?

  14. Legal contracts can be changed:

    • G.M. pressed union leaders in a meeting in Detroit for a deal on financing what was the centerpiece of the 2007 U.A.W. contract — a perpetual, G.M.-financed trust to cover health care costs of hundreds of thousands of retired hourly workers and their surviving spouses.

    • It has also announced a 14 percent reduction in salaried workers around the world

    • The plan will also probably include revisions in executive compensation

    • The president designated the Treasury secretary, Timothy F. Geithner, and the chairman of the National Economic Council, Lawrence H. Summers, to oversee the task force on the auto industry.

    http://www.nytimes.com/2009/02/17/business/economy/17auto.html

    If Geithner could negotiate these contracts, he could negotiate the AIG contracts.

  15. Yeah, but one is “blue collar” workers and the other is guys just like us. We can’t cut the salaries of guys just like us! I mean, they’ll go to another bank! They’ll run to the Caymen Islands!

  16. Well when you get down to it that 70 cents on the dollar vs the $1 was (is) the snafu wasn’t it?? Is Geithner a bad dude?? The jury is still out on that one. But I think we can see from this he has VERY little backbone. Brings new meaning to the phrase “You need to get a haircut” doesn’t it?? Whether or not this is the result from lack of backbone or sabotage, the result is the same huh??? Time for some Beastie Boys “Sabotage”(EMI Music).

  17. Sorry for the lame ads. It’s youtube, what can you do?

  18. Another aspect of the Maiden Lane III deal is that the retail assets are contained within a pass through entity. I assume here for illustrative purposes that the internal tax basis of the retail assets is the value they are carried at on the MLIII books. Since these assets were very likely bought by Goldman at a discount the retail face values of the receivables is somewhat higher but unknown.

    A great deal of tax free money and guaranteed capital gains from cash flow could be made by someone buying the MLIII entity at say $15 bn and the FRBNY recognizing a loss that simply reduces its own profit to near zero for any given year. MLIII is gone and slips through the cracks. All that happens is that the Treasury payout is gone for awhile.

    The internal tax losses on bad debts would offset the interest income. The bad debt losses would be internal or inside basis determined losses at nearly twice the outside basis of the investment of the investor in MLIII of $15 bn. I assume here that the internal tax profit of MLIII is zero or a loss. The cash flow could be distributed tax free as a return of capital until the owner of MLIII has the entire $15 bn recovered.

    Thereafter, MLIII could then acquire other effective tax shelters to insure that all profits when repatriated wind up as capital gains.

    I could readily see where the retail assets within MLIII carry a face value of perhaps $40 bn and a 20 year runnoff period at 6 % with a $29bn inside basis and an outside basis of the final owner of MLIII of $15 bn. If the net cash flow of principle and interest totaled $40 bn in a runoff the final owner would make a killing.

    Someone will provide a premium to the FRBNY to get MLIII if the tax potential is anywhere near my admittedly rough speculation of values. Just an example. But MLIII is quite likely some elite’s future goldmine.

    If not and MLIII is a gross loss, by extrapolation, the entire banking system is simply a pile of unrecoverable promises to pay.

    Technocrats would not look at the MLIII asset this way, but the financial pirates would be greatly interested.

  19. I like to oversimplify this transaction like this:

    The Fed, via MLIII bought the CDS at (distressed, hopefully) market prices, and therefore may be made whole.
    AIG, funded partly through loans from the FED at Treasury’s direction (this conflation confuses things immensely), paid collateral to the counterparties equal to 100c less MLII price.

    Therefore the losses on the decision to pay counterparties 100c sit on AIGs books.

    For me the question is, who should have absorbed the losses from these deals, AIG creditors/shareholders or swap counterparties?

    In my view AIG creditors/shareholders should, and will, bear the losses, not the swap counterparties. Containing the losses at AIG was paramount at the time. Contagion was too big a risk.

    At the end of the day the AIG creditors/shareholders will take a haircut, which doesn’t sound unjust to me. If there is enough value left in AIG to repay the Treasury/Fed loans/equity at liquidation then I can hold my nose and rationalize the bailout decision and the 100c payout as unfair, but not indefensible.

    In bankruptcy the creditors might have been able to negotiate 70c or something less, but the AIG creditors forfeited that right when Treasury usurped the bankruptcy process.

    Since Paulson as the super senior creditor didn’t force the Fed to negotiate, I read the Feds decision to pay 100c as enactment of Paulson’s decision , as the de facto bankruptcy court, to F** the AIG creditors/shareholders for dragging everyone into this fiasco. Treasury was the gov’t arm that should have been demanding the haircut on behalf of AIG creditors, not the Fed. The Fed was indiferent, since they were merely vacuming the crap off the banks BSs at market prices, effectively providing lender of last resort liquidity to its constituents.
    Paulson went radio silent, which I think is significant and overlooked. The silence indicated to me that protecting AIGs counterparties was the only critical objective at the time. AIG’s damage needed to be contained, and it was.

  20. According to the September 30, 2009 Financial Statement disclosures of Maiden Lane III, LLC, the face value of the securities they hold is $62.1 billion.

    AIG has the equity contribution and the FRBNY portion is a Senior Loan. Since FRBNY is the Managing Member they also have a nominal undisclosed equity position.

    During the quarter cash flow applied to repayment of the FRBNY Senior Loan was $2.845 bn. That annualizes out at $ $11.380 bn.

    What the interest collected in $62.1 bn of face value at the end of the quarter was is not disclosed. But it certainly had to be around $3 bn including proceeds from selling security properties.

    It would be very interesting to see the full nine month financial statements in enough detail to be meaningful.

    But the gross receipts of interest collected and passed through must be a very substantial portion of the funds passed on to FRBNY.

    Even with a paucity of information one can get the sense that the entire investment will be repaid plus a great deal more if half of the face values carry to maturity and the other half realize a security recovery of half the face value. The foreclosure receipts will be very early on in the cash flow period and the value of the contracts that are sound will be worth close to face value.

    If someone bought Maiden Lane III at below FRB and AIG carrying values they would likely make a superb profit assuming the LLC itself stands for tax purposes.

    I assumed from the start of these LLC transactions that an LLC was chosen to achieve the values on sale of all potential tax benefits.

    However the transactions came about MLIII bought the assets at half off. Done competently, MLIII should wind up with inside basis tax deductions of $62 billion plus against whatever proceeds they actually collect.

    Someone is going to wind up with MLIII before the point where tax deductions really start adding up.

    Might it just turn out that AIG collapse was contained in so far as the FRBNY transaction is concerned at no cost or even profit to the FRBNY?

  21. The big problem is: this is not their money. The money that Congress authorizes or the Fed puts out, or Geithner speaks about, is not their money. They not only don’t care whether they pay 10 cents or 100 cents on the dollar, but they would prefer to pay the highest amount, because they are helping their plutarch allies, and allowing THEIR SYSTEM to function as it should (they get richer and we get poorer).

    This may sound cynical, and it’s nice to work through the details and pretend that they will abide or should care (about us), but just get over it. Until the world changes (maybe by an alien invasion but probably not befor), we can count on this kind of treatment. I’m not as bitter as it seems, after all, this has been true since the time of the Pharaohs, and is just the same now. It just looks much worse in a crisis.

  22. I would like to know where on the website to find the list of names and amounts due to receive. Thanks

  23. I am ready for a new rules.

    If the fed loses $ on loans then the member banks have to pay for the loss.

    Maybe they will be a little more careful.

  24. And what was Obama’s response? Reward that skinny man who forgot to pay his taxes and caved to the French with a promotion to Treasury Secretary. Because he’s got the goods that will lead us out of crisis back into growth.

    NOT!

  25. What the SIGTARP report proves beyond doubt is that when our economy crashed headfirst into the iceberg, the bankers driving the boat used their power, might and connections with people in power to make sure they got all the lifeboats.

    Wall Street cares only for its bonus packages. That’s it. That’s their contribution to the economy – sucking out whatever pennies they can from whatever pound of flesh the economy offers them.

  26. I went into details of the Maiden Lane III deal and the FRBNY site provided all the data to forensically construct an opening balance sheet for MLIII on both a tax and GAAP basis. The consideration for buying the CDO assets was a cash payment of $$26.8 bn plus retention by the sellers of deposits made by AIG. Thus , the deposits by AIG are a capital contribution to MLIII by AIG. By back off, these deposits aggregated $35.3 bn. Thus , tax basis for the purchased assets was around $62.1 bn. Later on FRBNY paid AIG $2.5 bn because the deposits exceeded a correction to GAAP carrying values. Thus, the FRB loaned $24.3 bn and put in another $2.5 bn. AIG Put in $2.5 bn plus the corrected deposits of $32.8 bn.

    The capital account of AIG is carried with a starting capital of $5.0 bn. Thus the deposit correction must have been rolled through the FRBNY loan to the AIG capital account. Thus AIG put in there own $2.5 bn sourced from the deposit payments refund and via an FRBNY loan for the other $2.5 bn. With this explanation the opening balances of MLIII work out.

    That $2.5 bn payment might also have been directly to AIG as a loan to AIG by FRBNY entirely outside MLIII . The above corrects for that unknown.

    Later on, MLIII established a market reserve to bring down the carrying value of the purchased CDO’s to $29.6 bn. This is not a tax deductible reserve and is entirely ignored in tax basis accounting.

    So, it is established that MLIII is a veritable tax savings goldmine if MLIII itself were sold to others for enough money pay off the FRBNY and give AIG it’s $5.0 bn

    FRBNY as managing member hired Blackrock to administer the assets on a long term run off basis.

    That will a massive cash flow even if half the loans collapse but some return of capital is achieved.

    All in all, FRBNY should recover its investment and interest at LIBOR plus 100 basis points.

  27. Jerry J’s post is quite inaccurate and shows a lack of understanding of tax issues. There is no possible way for the FRB loan to be made whole assuming a 50% cut on the assets – the losses cannot be passed through in such a way that actually generates more value than the original transaction.

    The total investment by the Fed in the 3 maiden lane funds was 72 billion. MLIII was 60 billion. The current market value of all three funds ( which of course includes any possible tax benefits to the purchaser as well as expected future cash flows) is under 27 billion.

  28. Secretary Geithner himself testifying to Congress. I don’t know if the Congressmen (who seem to be too busy making political lectures to ask questions) asked why he didn’t stick to his guns on the 70cents on the dollar settlement with the bankers. Geithner makes some good points. I hope next time Geithner dicusses terms with banks on how Uncle Sam will save banks from failure do to executive negligence, he shows this side of himself more.

  29. I am looking only into Maiden LaneIII. THE FRB NY discloses their investment at $24.339 bn plus $2.500 bn for a total of $26.839 bn. The balance of the loan was $19.385 bn as of September, 30 2009. The loan had been amortized during the third quarter 2009 $2.825 bn.

    The issue of total cash flow generation over time will be the basis for ability of Maiden Lane III to pay off the FRB loans. Just being rough here. If 50 % of the CDO’s performed in full and the other 50 % of the loans failed, there would be three segments of cash flows. First, the proceeds from liquidation of collateral on the failed loans. Second, the repayments of principal on the 50 % that go to term. The third segment is interest income collected to term.

    That is a huge cash flow where according to the FRBNY summary of transaction terms the FRBNY Senior Loan gets first cash after expenses in real terms. Expenses will be relatively nominal.

    We get some indication of loan amortization from the first nine months of operation where the loan was reduced $4.84 bn in nine months.

    As to the tax issues. I spoke of it being a goldmine to others buying out MLIII. It would need to be done in such a way as to preserve MLIII as a tax entity while taking out the FRBNY and AIG as members. I have accomplished that task a number of times. For one keeping AIG as a member at a very nominal level to avoid change of ownership problems would help. The more than 50 % change of ownership rules require some ingenuity timing and planning.

    The collection of principal would apply to the inside hard basis of some $62 bn. These being CDO’s it is not known if losses of principle wind up ” squeezed down” until what is left is worthless. there is not enough data to know how losses would be treated. That is carved out as each mortgage loss inside the CDO occurs or a mass squeeze down methodology. Either way, principle is sheltered by inside basis. On the basis of a squeeze down there would be net tax basis income stepping up member capital accounts. My supposition was that the new owners took out the FRBNY loan and thus would have a high outside basis in MLIII to cover cash withdrawls. Then , at some point just leave the cash flow inside MLIII to build outside basis in MLIII.

    The tax mine issue is very complex but with the billions involved here quite doable.

    Back to the FRBNY winding up being paid off. The total cash flow potential of MLIII over time seems quite adequate to paying off the FRBNY loan in full including interest.

    The 2009 principle reduction alone is on target for a reduction of around $6 bn. If 2009 cash generation is maintained, the FRB Loan will be fully amortized sometime in 2014.

  30. As long as you have a Federal Reserve with enormous powers to bailout financial institutions ,both domestic and foreign, these problems will continue.

  31. Eliot Spitzer wrote an article at Salon.com about 8 months ago criticizing the AIG bailout for it’s over generous treatment of counterparties. Mainly Goldman. 8 months ago.

    http://www.slate.com/id/2213942/

    Say what you will about moral lapses, the public would undoubtedly be better off if he were still working for us.

  32. I checked out the FRBNY carrying value of FRBNY of Maiden Lane III as of last Wednesday night. The total value was $22.951 bn. This indicates a slight run up of lendings. It would be interesting to find out why.

    The September 30, 2009 combined values were as follows plus the increment post third quarter 2009 through November 18th.

    Loan $19.855bn, the pesky $2.5 bn that went to AIG and an increment of $.596 bn. This must be interest added to the Senior Loan balance. The September 30, 2009 data indicated that the Senior Loan balance included accrued and capitalized interest.

  33. The AIG deal is addressed in this interview on the ‘New Australian School’ of economic thought:

    http://outsidethe-cardboard-box.tumblr.com/post/249074091/the-new-australian-school-of-economics-wonkish

    The latest silliness from Outside the (Cardboard) Box

  34. As a non-finance professional, my takeaway from this is that Obama showed naivete, Getitner showed subservience and the larger financial interests that by and large caused this problem showed us all who really runs the Treasury.

    Never again. I think in time, this wholesale subordination of the country’s interests to the interests of the financial elite of the nation will be what Obama is most faulted for.

    Certainly, I would see every financial firm in the country bankrupt and every financial services employee making more than $1,000,000 a year destitute long before I would approve spending even a single thin dime of taxpayer money on the elites that have well and thoroughly screwed us all.

  35. A great link from Barry Ritholtz’s blog discussing the huge mistake of repealing Glass-Steagall. Click the link below, then scroll down a little until you see the video box on the left and play. Pearls of wisdom here people. Great pearls of wisdom.

    http://www.ritholtz.com/blog/2009/11/why-jamie-dimon-wants-to-silence-paul-volcker/

  36. Time was of the essence in the AIG fiasco. Most commentary is about what was done before the crisis which is utterly irrelevant in a crisis. The question of
    the importance to a financial system of AIG operations was the key question. How do you stop adding to the panic mindset and reverse the mindset is most important.

    The Federal Reserve did what it thought it was empowered to do under the statutes.

    Looking at AIG by itself was there any other option than what was not done after the question of immediate importance of the moment was decided?

    For example , and only as an example, AIG the parent and AIG Financial Products might have sought Chapter 11 bankruptcy. At that moment the insurance subsidiaries were viable in the context of a microcosm. That would have really added fuel to the panic due to the inability to provide the instant solution via bankruptcy that was provided by the course of action taken.

    In the run up to the AIG bankruptcy AIG sought permission from the NY Insurance Regulators to substitute insurance subsidiary reserve assets for collateral owned by AIGFP. That is the point where regulatory authority should have stepped in . Regulatory authority in NY understanding the problem granted the AIG request.

    Did we not here have the problem of divided regulatory authority in a highly complex financial system. Too complex for survival? The over all objective of containing the panic was the problem , not AIG.

    As it stands now, AIG is a state owned business and the success of AIG surviving as such is the paramount concern. Like it or not, AIG success is on the head of the state itself.

    It has taken decades for the present Wall Street arrogance to bloom as it did. Prior to the eighties, the White Shoes ruled and they were terrified by their experiences in the 1930’s. Of course, the White Shoes exclusively operated by the general partnership. Most of the structural elimination of personal risk had it’s effect. No risk in the game itself for the use of other peoples money makes one brave on the cheap. As kid and in college I was taught by White Shoes . I was a town kid of their town.

    In short, the present problem is the people in big finance. White Shoes abhorred stock jobbers and plungers and made no secret about it either.

    So, finance does have a problem with current generational mindset. I do not think these people have learned a thing. Go back to partnerships and assessable shares and similar structures that were universal until after the First World War. Banks once held reserve assets of up to 25 %. The corollary to that is that the banks pay a low interest and there can be no money market funds where reserve assets are not required to be the same as banks. Both concepts suffer from the enormous change brought about by electronics. The lack of noblesse oblige for lack of a better word plus the structural changes wrought by electronics I suspect will eventually prove to be the core explanation of what has happened. But that is a vast subject.

  37. So Barofsky is saying that GS and the other counterparties received what they were owed, nothing more and nothing less, correct? This should put to rest the rather prevalent meme last summer that GS had gotten a $12 bn windfall.

    Paulson, Bernanke and Geithner were doing what economists like Krugman were suggesting at the time – shovelling a massive amount of money into the system in a variety of ways to prevent global financial collapse. Could they and should they have gotten better deals for the taxpayers? Without a doubt. But asking for a haircut from the foreign and domestic counterparties was probably the least effective strategem. On the other hand, the G-Men had a superior overall negotiating position with the banks that could have been used to impose significant curbs on compensation and other regulatory reforms. That was a failure of significant proportions.