Geithner Deal With Wall Street Over AIG Swaps Cost Taxpayers $13 Billion

Last Updated Oct 27, 2009 2:58 PM EDT

Many people's discomfort with the U.S. government's handling of the financial crisis is that it has largely taken place behind a shroud of secrecy. The events of fall 2008, following the bankruptcy of Lehman Brothers and the injection of massive sums of taxpayer dollars into AIG, remain particularly murky.

Bloomberg today offers a troubling picture of the role of the Federal Reserve Bank of New York, then led by current Treasury Secretary Tim Geithner, in the bailout of AIG. The heart of the issue: Did Geithner and other government officials arrange a sweetheart deal for Wall Street banks seeking repayment for credit default swaps the companies had purchased from AIG?

By November of last year, the federal government owned roughly 78 percent of AIG as a result of bailing out the insurance company. In his role as the top local financial watchdog, Geithner was assigned to represent AIG in talks with the banks over the swaps. These institutions included Goldman Sachs, Merrill Lynch, Germany's Deutsche Bank and France's Société Générale.

Ordinarily, investors in the AIG swaps, which insure against losses on pools of loans called credit default obligations, would've been expected to take a "haircut" on what they were owed. That's what typically occurs in paying off default protection instruments sold by other insurers. Ordinarily, in representing AIG the New York Fed would've sought to minimize the cost to taxpayers by offering the market value of the swaps.

Extraordinarily, none of this happened.

In early November, Geithner, joined by Federal Reserve Chairman Ben Bernanke and Treasury officials, came up with a deal for the banks regarding the AIG swaps, according to the wire service:
After less than a week of private negotiations with the banks, the New York Fed instructed AIG to pay them par, or 100 cents on the dollar. The content of its deliberations has never been made public. The New York Fed's decision to pay the banks in full cost AIG -- and thus American taxpayers -- at least $13 billion.
The story offers a few possible theories for the New York Fed's unusual largess in repaying the banks. One is that certain banks 'insisted" on getting all their money back. Another is that New York Fed and government officials feared that one or more of AIG's counterparties could fail if they recouped only a fraction of the swap payments, dealing another serious blow to the financial system.

This remains a matter of conjecture. And that's because Geithner and New York Fed officials refuse to discuss it. Details may come to light when the inspector general for the Troubled Asset Relief Program weighs in next month on the AIG swap agreement.

Goldman Sachs has collected some $14 billion related to the AIG deal. Merrill Lynch received $6.2 billion; Société Générale, $16.5 billion; Deutsche Bank, $8.5 billion.

Through their ownership of AIG, taxpayers paid nearly $30 billion to buy the banks' credit default debt, which now sits in an entity overseen by the Federal Reserve. As of July, that investment had lost 24 percent of its value.

Over the course of the banking crisis, the Fed has loaned more than $2 trillion to bail out the financial industry. It continues to refuse to disclose exactly whom received the money and in what amount.
  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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