Marketplace Scratch Pad

AIG and the long-haired banks

Scott Jagow Jan 19, 2010

One day, we may finally find out what happened with the AIG bailout. While the SEC has agreed to keep certain details mum until 2018, Fed Chairman Ben Bernanke said today that the Fed would welcome a “full review” of its actions by government watchdog groups.

From CNN Money:

“The Federal Reserve extended this credit (to AIG) to prevent the immediate disorderly failure of the company, an event that likely would have led to a significant intensification of an already severe financial crisis and a further worsening of global economic conditions,” Bernanke wrote in the letter to the Government Accountability Office..

Given the continuing questions about the AIG assistance, the Fed chairman said the Fed would welcome a full review by the GAO and will make available “all records and personnel necessary to conduct this review.”

Funny how Bernanke is okay with this but opposes a regular Congressional audit of the Fed.

Meanwhile, Treasury Secretary Tim Geithner has agreed to testify before Congress next week about his role in AIG’s affairs. Emails surfaced earlier this month that suggested the Geithner-led New York Federal Reserve pressed AIG to keep quiet details about AIG’s repayments to banks.

Today’s Wall Street Journal suggests one reason two major French banks got 100% of their money back was that the French were shrewd negotiators. Put another way, they seriously bent the truth:

The French banks and their regulator, it now appears, masterfully outmaneuvered the Americans to avoid discounts, or “haircuts,” on their securities.

The French won the day by using a legal argument that some leading French scholars and corporate attorneys variously described in interviews as highly dubious and lacking real legal ground. Their refusal was crucial, as it helped set the tone for U.S. banks, including Goldman and Merrill, to resist negotiation.

The French banks and the regulator, known as the Commission Bancaire, said bank executives could be criminally liable for accepting a discount on their contracts, according to a November report of the inspector general of the Troubled Asset Relief Program.

While true in the abstract, “their argument was very overstated,” said Pierre-Henri Conac, a University of Luxembourg law professor and a director of France’s oldest corporate-law review. “Banks give haircuts every day.”

At the Big Picture blog, Barry Ritholtz isn’t buying the idea that the French duped the Americans. He says the “no haircut” gesture was “an outright gift done on purpose.” Here’s how easy it would’ve been for the Fed to negotiate with the French:

French: “We cannot take anything less than 100 cents on the dollar.”

Fed Response: “OK, then you’ll leave empty handed. Go back and tell your shareholders you were offered less than 100%, and you rejected it. Come by in 2 years and pick up whatever is left over – 3 cents. 4 cents? -and its yours! Have a safe flight now . . . Buh bye”

I’ll suggest one alternative theory — not that the Fed was fooled by the French or that it eager to gift, but that it was just plain wimpy. At one point, the Fed said it was
“uncomfortable with violating the principle of sanctity of contract” in defending its decision to give banks 100% of their money back. But what happened with the carmakers? Those contracts weren’t as important? Some of the carmaker creditors got their heads shaved.

With AIG, the banks didn’t even have to set foot in the barber shop. Let’s take Bernanke up on his offer to investigate.

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