The Man You Don’t Want in the Foxhole Next to You

The SIGTARP’s latest audit report is out, the New York Times article is here.  Reaction has been swift, and definitely one-sided – against Treasury Secretary Geithner.

But I’m not going to rehash that.  I’m going to take a look at the report and the assets the New York Fed got in the bargain from AIG – a big slug of CDOs that are practically worthless or soon will be.

First, it’s clear our government officials panicked.  From the SIG TARP report:

Mr. Geithner mobilized a consortium of banks led by representatives from JPMorgan Chase & Co. and Goldman Sachs to arrange private financing for a $75 billion loan to address AIG’s liquidity crisis. The Federal Reserve believed that the bank consortium would provide the liquidity AIG needed.  A JPMorgan Chase vice chairman noted that participants felt a sense of urgency to find an immediate solution to avert a potential downgrade by the credit rating agencies.  The group developed a loan term sheet, but an analysis of AIG’s financial condition revealed that liquidity needs exceeded the valuation of the company’s assets, thus making the private participants unwilling to fund the transaction.  FRBNY officials told SIGTARP that, in their view, the private participants declined to provide funding not because AIG’s assets were insufficient to meet its needs, but because AIG’s liquidity needs quickly mounted in the wake of the Lehman bankruptcy and the other major banks decided they needed to conserve capital to deal with adverse market conditions.

First sign they panicked: that “sense of urgency” to come up with $75 billion to float AIG, even though the assets – which would’ve been pledged as collateral – were insufficient.  When you panic, you still try and do things that you know you shouldn’t do, but you still do them because you’re not prepared to do what you need to do.  The Fed & Treasury needed to be prepared to let AIG go.  But they weren’t.

Second sign from the SIGTARP report:

FRBNY did not develop a contingency plan in the event that the private financing did not go through and did not conduct an independent analysis regarding the appropriate terms for Government assistance to AIG; instead it used in substantial part the economic terms of the private sector deal, albeit for $85 billion instead of the $75 billion prepared by JPMorgan Chase for the unsuccessful private sector solution.

No contingency plan?  They just upped the loan amount by $10 billion, because it’s, well, just another $10 billion.  I saw all of the different asset classes that they got themselves (and us) into, and I can only come away with the thought that they could’ve spun off stuff they weren’t going to support into a subsidiary and let that subsidiary blow up while still backing the commercial paper and other obligations that were attached to the stable value funds and corporate 401k plans.  At least that way you’d do something to ensure employees of Wal-Mart, AT&T, etc. didn’t get wrapped up in this mess but at the same time you didn’t do something stupid.

But that’s what you do when you panic.  You do stupid things.

People have written ad-nauseum about the Fed’s decision to pay par on the CDS contracts when they shouldn’t have, so I won’t spend a lot of time on it.  They could’ve taken door #2 instead of door #3 (p. 12 of the SIGTARP report).  The wind-down process would’ve taken longer but there would’ve been less money at risk & the counterparties would still have to hold on to the CDOs with the NY Fed paying in the event of a CDO default.  The NY Fed would’ve gotten that money from the dismantling of the rest of AIG.

So what are we left with in the Maiden Lane III SPV the NY Fed set up?

Yeah.  That’s a solid portfolio <sarcasm off>.  If you wanted to know what a crap sandwich looked like at somebody else’s expense (that somebody else is the taxpayer), this is it.  There’s no way on Earth this CDO – with these underlying assets – will ever realize face value.  $29.6 billion right there.  We may be lucky to see $14 billion returned to the taxpayer.

At this point, there’s nothing we can do.  Tim Geithner committed our collective butts to this thing.

And he did it in a moment of panic.

So when the bullets are flying, people are dazed and confused, and the battle is being fiercely waged out there on the front, would you want him in the foxhole next to you based on how he handled this?



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Filed under finance, Markets, Timmay, You're kidding

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