Counter-parties, black tie optional – but do you dance with the one that brung you

As we continue to address the issue of the bonuses, we cannot lose sight of another potential abuse of taxpayer funds – the counterparty payments.

Tuesday TPM reported Senator Cummings (MD) was circulating a letter to his colleagues asking them to sign on to his letter requesting an investigation of AIG payments to counter parties.

Further, Goldman Sachs claimed in September that they had no material exposure to AIG; however, after AIG released the counterparty information on March 15, we found out that Goldman Sachs received almost $13 billion in counterparty payments.

This letter proposes that the Special Inspector General examine the nature of the counterparty payments – including the recipients, the process by which they were made whole, and the justification, if any, for that level of payment.

Under intense pressure, AIG finally released a list of transaction counterparties on March 15. These releases showed that the investment banks around the world received billions in taxpayer dollars without apparently being required to take a discount; further, there is little evidence that a concerted strategy guided the payments.

The American people were told that they had to bail out the financial sector because of the great systemic risk from an AIG collapse, and $180 billion later, the people find themselves “involuntary investors.”

Investment in AIG may be necessary, but it deserves the utmost scrutiny and attention. (emphasis added)

TPM’s Zachery Roth stayed with the story and reported more in a follow-up yesterday.

Earlier this month, the Treasury Department announced it was rescuing the fallen insurance giant yet again, bringing the total amount of taxpayer assistance given to the firm since last September to $170 billion. It soon became clear that much of that money — over $49 billion, to be exact — was going right through AIG to the counter-parties on its credit default swaps, both American banks like Goldman Sachs, and foreign ones like DeutscheBank.

Defenders of the move have argued that not giving the counter-parties this indirect bailout would have risked a wider financial collapse.

But the level of analytic rigor that the government applied in coming to the conclusion that it had to bail out the counter-parties has never seemed particularly high. And over the weekend, Goldman Sachs — the biggest American counter-party to AIG’s CDS deals — undermined that argument, when it publicly announced that, because they hedged their CDS bets, they’d have been fine without that backdoor bailout. A Goldman exec bolstered that claim yesterday, telling (sub. req.) a conference hosted by the Wall Street Journal that “We would have been 100 percent fine,” had AIG been allowed to fail.

Slate’s Daniel Gross countered with Goldman Sachs, Welfare Queen.

While it was singed in the credit meltdown, Goldman Sachs, the alpha male of Wall Street, has emerged as a survivor. The cover of last week’s Barron’s heralded the resurrection of Goldman and Morgan Stanley—”the sole standouts,” as Andrew Bary called them. The company’s shares have rallied back above $100, and its market capitalization is nearly $47 billion. Goldman’s emergence from the wreckage could be seen as yet another glorious chapter for the firm. Charles Ellis, in his book about Goldman, The Partnership, lionized the firm as the only company “with such strengths that it operates with almost no external constraints in virtually any financial market it chooses, on the terms it chooses, on the scale it chooses, when it chooses, and with the partners it chooses.” For the paperback, Ellis might want to add the following proviso: so long as the government is willing to give it billions of dollars.tpm-graphic-2

People sometimes refer to the firm as Government Sachs because so many of its former employees wind up in high positions in Washington (Robert Rubin, Henry Paulson, etc.). But the sobriquet sticks today because the company is heavily reliant on the government for support. Tally up the various forms of direct and indirect taxpayer assistance Goldman has received in the last several months, and it turns out that you and I are providing billions of dollars to bail out the proud firm. The former undisputed heavyweight champion of the financial services sector has become one of New York’s biggest welfare queens.

Last fall, in the wake of the failure of Lehman Bros., Goldman transformed itself from an unregulated investment bank into a bank holding company so it could accept deposits. Like other banks, Goldman participated in the TARP program. On Oct. 28, Goldman sold $10 billion in preferred stock to the government, which bears an interest rate of 5 percent through 2013 (after which the rate bumps up to 9 percent). Like other TARP recipients, Goldman received capital on pretty easy terms. Just a month earlier, when Goldman raised $5 billion from investor Warren Buffett, it sold preferred shares that carried a 10 percent interest rate. (At the same time, Goldman also raised $10 billion in a public offering of stock.) The difference between borrowing $10 billion at 5 percent and borrowing $10 billion at 10 percent—in other words, the value of the government subsidy—is $500 million per year.

Back at TPM, Roth was quoting a column by Elliot Spitzer that appeared in Slate last Sunday.

The AIG scandal is getting ever-more disturbing. Goldman Sachs’ public conference call explaining its trading relationship and exposure with AIG established, once again, that Goldman knows how to protect itself. According to Goldman, even if AIG had failed, Goldman’s losses would have been minimal.

How did Goldman protect itself? Sensing AIG’s weakening capital position through 2006 and 2007, Goldman demanded more collateral from AIG and covered outstanding risk with instruments from other firms.

But this raises two critical questions. The first is why $12.9 billion of taxpayer money went from AIG to Goldman. What risk—systemic or otherwise—was being covered? If Goldman wasn’t going to suffer severe losses, why are taxpayers paying them off at 100 cents on the dollar? As I wrote earlier in the week, the real AIG scandal is that the company’s trading partners are getting fully paid rather than taking a haircut.

The week before, Spitzer had posed The Real AIG Scandal It’s not the bonuses. It’s that AIG’s counterparties are getting paid back in full.

Everybody is rushing to condemn AIG’s bonuses, but this simple scandal is obscuring the real disgrace at the insurance giant: Why are AIG’s counterparties getting paid back in full, to the tune of tens of billions of taxpayer dollars?

For the answer to this question, we need to go back to the very first decision to bail out AIG, made, we are told, by then-Treasury Secretary Henry Paulson, then-New York Fed official Timothy Geithner, Goldman Sachs CEO Lloyd Blankfein, and Fed Chairman Ben Bernanke last fall. Post-Lehman’s collapse, they feared a systemic failure could be triggered by AIG’s inability to pay the counterparties to all the sophisticated instruments AIG had sold. And who were AIG’s trading partners? No shock here: Goldman, Bank of America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche Bank, Barclays, and on it goes. So now we know for sure what we already surmised: The AIG bailout has been a way to hide an enormous second round of cash to the same group that had received TARP money already.

Today, TPM continued its focus on the counterparties with Bachus: AIG Stiffed Small U.S. Institutions, While Paying Off Foreign Banks in Full

Rep. Spencer Bachus (R-AL) just raised a new objection to the AIG counterparty payments–specifically that while AIG used government money to pay off their CDS obligations dollar-for-dollar to major (sometimes foreign) financial institutions, it repaid smaller U.S. institutions that made secured loans to AIG subsidiaries at a rate of only about 20 to 30 cents on the dollar.

So, when’s the party and will anyone be able to find “who brung” them and dance? Was AIG too big to fail or just too big to fail until it could be loaded with the losses of its counterparties and sink under the weight?

Out on Main Street, this same strategy is called paying off your Visa with your Master Card.

4 thoughts on “Counter-parties, black tie optional – but do you dance with the one that brung you”

  1. Very nice Nowdy. Cummings and Spitzer are the two guys which know what is going on who are not afraid to look into the mess. Lets hope they can get to the bottom of this mess. It seems every time someone gets close they meet an untimely departure from power and nobody is willing to follow in their footsteps.

  2. Are you sure there is a bottom? CLS said I was on track with “I am my own grandpa” – maybe so, but, who was grandpa when it started.

  3. CLS calls it the Ubiquitous illuminati. In Mississippi, we call them the good ole boys. Not Bo and Luke like our guys here in Hazzard County but Boss Hoggs and his crew. I thought you might enjoy this article about an offshore accounting firm and Boss Hoggs old lobbying firm. It seems playing games is what its all about on that level—

    Spies, Lies & KPMG
    An inside look at how the accounting giant was infiltrated by private intelligence firm Diligence

    In the spring of 2005, Guy Enright, an accountant at KPMG Financial Advisory Services Ltd. in Bermuda, got a call from a man identifying himself in a crisp British accent as Nick Hamilton. Hamilton said he needed to see Enright about matters of utmost importance.

    Over the course of two meetings, Hamilton led Enright to believe he was a British intelligence officer, according to a person familiar with the encounters. He told Enright he wanted information about a KPMG project that Hamilton said had national security implications for Britain. Soon, Enright, who was born in Britain, was depositing confidential audit documents in plastic containers at drop-off points designated by Hamilton.

    But Nick Hamilton was not an agent of Her Majesty’s secret service, and the documents never found their way to the British government.

    Nick Hamilton was in fact Nick Day, now 38, a onetime British agent and co-founder of Diligence Inc., a Washington private intelligence firm that counts William Webster, former director of the CIA and FBI, among its advisory board members. Diligence’s client was not Britain’s Queen, but Barbour Griffith & Rogers, one of the most formidable lobbying firms in Washington. Barbour Griffith represented a Russian conglomerate whose archrival, IPOC International Growth Fund Ltd., was being audited by KPMG’s Bermuda office.

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