By David Cho
Washington Post Staff Writer
Wednesday, October 28, 2009
The Federal Reserve Bank of New York said Tuesday that it had no choice but to instruct American International Group last November to reimburse the full amount of what it owed to big banks on derivatives contracts, a move that ended months of effort by the insurance giant to negotiate lower payments.
Fed officials offered the explanation in a rare response to a media report after Bloomberg News said that the New York Fed, led at the time by then-President Timothy F. Geithner, directed AIG to make the payments after it received a massive government bailout. The officials said AIG lost its leverage in demanding a better deal once the company had been saved from bankruptcy.
Lawmakers and financial analysts critical of the payouts say it amounted to a back-door bailout for big banks. AIG, the recipient of a $180 billion federal rescue package, ended up paying $14 billion to Goldman Sachs over months and $8.5 billion to Deutsche Bank, among others. Before the New York Fed intervened, AIG had been trying to persuade the firms to take discounts.
The precise cost to taxpayers of these decisions is difficult to determine. Bloomberg, quoting an industry source, reported Tuesday that AIG was aiming to pay just 40 percent of the $32.5 billion it owed to the banks. Using those figures, the report concluded that the government needlessly overpaid $13 billion.
But government and industry sources familiar with the matter questioned the 40 percent figure and said it was not proper to apply it across all the contracts. These sources spoke on the condition of anonymity because the discussions were private. Few of these sources disputed that the payments by AIG were expensive for taxpayers.
New York Fed officials explained that the main reason creditors were willing for a time to accept less than full reimbursement was their fear of an AIG bankruptcy. The government's rescue of the company removed that threat and left the company with virtually no way to wrestle concessions from the banks.
"In its negotiations with its counterparties, AIG just didn't have the same bargaining power that it did with the Federal Reserve standing in the background," said Thomas C. Baxter, New York Fed's general counsel. "The only sensible outcome was to give them what they were legally entitled to."
Moreover, AIG's foreign creditors told the Fed that they were barred by their governments from accepting partial reimbursement unless AIG faced bankruptcy, because doing so would amount to giving a gift to a U.S. company, according to officials at the New York Fed. Because the law prohibits the central bank from favoring some banks over others, New York Fed officials said they had determined that all of the creditors, foreign and domestic, had to be paid in full. They also decided it would be improper for the Fed to use its power as the banks' regulator to pressure them into taking less money.
Baxter said that the New York Fed "engaged a couple of institutions as to whether they would contemplate a discussion of taking a couple of points less than what they were entitled to." But he said officials were also racing to prevent AIG's collapse and did not have time to get involved in protracted negotiations with each creditor.
For years, AIG sold a type of insurance contract called a credit-default swap. In these transactions, AIG agreed in exchange for fees to cover losses if an investment went sour. During the credit crisis, when many investments collapsed, AIG didn't have enough money to cover all the promises it had made in its swap contracts.
The cash crunch at the firm nearly brought down the global financial system because so many banks and other investment firms had counted on AIG to cover losses. Facing this threat, government officials rescued the firm with one of the largest bailouts in history.
Now treasury secretary, Geithner did not respond Tuesday to a request for comments made with Treasury's public affairs office.
The Federal Reserve has declined to detail the terms of the deals and specifics about negotiations with creditors. The Bloomberg report quoted an unnamed AIG executive who said he was pressured by New York Fed officials to refrain from filing any documents with the Securities and Exchange Commission that would divulge the deals' details.
But Baxter said that was not true. "Our position has always been if your securities lawyer says it is necessary for AIG to make a particular filing, that's what AIG must do," he said.
Bloomberg and other news media organizations have sued to obtain records of the meetings and phone calls, including those made by Geithner. A U.S. District judge ruled in Bloomberg's favor in August, but the Fed has since appealed and won a ruling to keep the information sealed. The identities of the banks were made public when Sen. Christopher J. Dodd (D-Conn.) demanded the information in March.