Geithner Testimony On AIG Maddening, But The TARP Cop Explains A Lot

Protagonists from the TARP drama testified for five hours today before a House committee, and the headliners -- Geithner and Paulson -- stuck to their old stories and waved the flag about the rescue of AIG, as irate, indignant congressmen accused the two of selling out the U.S taxpayer with a "backdoor bailout" for Wall Street. No news there, but late in the session the Special Investor General for TARP, Neil Barofsky, gave explanations of why events in fall 2008 went down as they did. It's not our government's finest hour, far from it, but his account does pop some of the conspiracy balloons.

The hearing started at 10 this morning, and for some reason I watched the whole thing on CSPAN. Much of the Q&A was spent quibbling on dates and jurisdictions: the agency behind the AIG bailout was the Fed, so Treasury Secretary Paulson was able to dodge many questions on the grounds that AIG wasn't his job. Congressmen picked at his potential conflicts of interest as the former chief executive of Goldman Sachs, one of the biggest winners from the AIG rescue, and we're sure to see some of that in sound bite form on TV.

Geithner had more to answer for, since he was the head of the New York Fed in fall 2008. He insisted that the Fed could not dither on AIG: it was the only fire station operating, as he put it, and since AIG had sold life and health insurance coverage to people, and small towns, they either had to support AIG, or let it fail with catastrophic results. Geithner told the story well, his volume rising and the tension building. "We extended them a line of credit, but given the massive storm, it wasn't enough. After November 10, we had to take steps to stabilize the situation."

But to the congressmen's questions Geithner, too, gave a fine run-around: after President-elect Obama named him as Treasury nominee, he excused himself from the AIG deal, so he was unable to answer the two key questions of the day -- (1) why the Fed did not negotiate with the AIG counterparties to accept a discount on their claims, and (2) how the details of the assets the Fed bought from AIG merit treatment as national security secrets.

Seeing Geithner and Paulson was obligatory, but I hung on in the afternoon to see Neil Barofsky, the eager SIGTARP, as a few congressmen called him. (His office issued a fresh audit report on the AIG bailout in November.)

Barofsky didn't try to convince anyone that massive rescue of AIG was anything other than blundered and wasteful, but he did illuminate some of the curious details enumerated above.

On why the asset details should not be publicized: the securities in question are very illiquid collateralized debt obligations (CDOs), and if the trading community knows what they are when it comes time to sell them, the taxpayers' profit would vanish. (Think of showing your hand in a poker game.) That's actually a reasonable explanation, at least to me as a finance geek, but the Fed and Treasury people have trouble putting it in simple terms.

The reason the Fed did not negotiate with the swap counterparties is much the same: AIG was about to report a huge loss for third quarter 2008, due to these swaps; the credit agencies in turn were about to cut AIG's ratings, which would have made the losses worse; and if the Fed had tried to negotiate for a discount of a few percent, AIG might have defaulted, and its insurance coverage to all sorts of people would have been worthless. (The AIG insurance operations are in OK shape; it's the top-level holding company that was and is the problem.)

So the Fed decided to pay full price. It sounds like lousy business practice, which it is, but the economy was really in a mess, and someone decided it was not time to fuss over a few billion dollars, seeing as the printing press was already warmed up.

Did Goldman Sachs and other banks get a sweet deal? Yes. Could those banks have said "Gee, we were supposed to get $32 billion, but the U.S. taxpayer has suffered enough, so we'll be happy with $25 billion"? Sure, but no one forced them to.

Our public servants are compromised, and they are lousy negotiators, but they had a lot to deal with. Remember that the problem started with bad mortgage lending, both on the part of banks and the people that took the loans.

To sum up, here is what financial writer James Stewart, one of my heroes, said about Barofsky's recent report:

There are legitimate issues about Wall Street compensation and incentives that need to be addressed. But the Goldman conspiracy theories are a distraction. They may satisfy a populist thirst for vengeance, but nothing in this latest report lends them any credence.