The AIG Bailout Bargain

Last week, one of the very smart guys we know on Wall Street sent us this note from the inimitable Joan McCullough, at East Shore Partners, analysing the AIG bailout, and making the very simple point that the deal now looks more like money laundering than anything else.

“Clearly, the more heinous chapter in the AIG story is the fact that AIG was effectively turned into a Treasury-NY FED-sponsored money-laundering operation which not only kept Goldman Sachs and others afloat, but has the distinct honour of having seen about 60% of what has flowed thru there so far…doled out to foreign banks.  To me, that was the obvious outrage, not the bonuses.  Yes, the defence of the bonies that originally came from DC was totally overboard and deserved hammering. But how can $165 mil even begin to compare with $105 bil of our money that was laundered thru AIG?  So Goldman, for example, only has to pay back $10 bil which they got in plain view from the TARP… before they can shake off the feds from their yoke, right?  Well, what about the do-re-mi that they got thru AIG which is suggested to be in the neighbourhood of $13 bil, noting that Blankfein himself was part of the NY FED/Treasury/AIG negotiations?

Now, if you buy this argument, maybe there’s a further case to be made that the AIG bailout has served exactly the purpose the government wanted it to. Maybe it even has been a great bargain to American investors—both psychologically and financially.

(Now, beyond the money laundering aspect, McCullough doesn’t make this case, just to be clear. The following mini-theory is purely our own.)

Here’s how:

•First, go back in time to the weekend Lehman failed. Let AIG crumble that weekend, too and the words “massive” and “insurance” and “failure” together would have shown up in headlines around the world. Soon after, the words “massive” and “losses” would have been attached to Goldman Sachs, Bank of America, Wachovia, Citigroup and every other financial giant that was a counterparty to AIG contracts.

So, instead of another couple Wall Street giants in their graves and another dozen or so billion of shareholder equity down the tubes, the damage was centralized in one firm, AIG, for reasons far too complicated for most Americans to understand (and thus not need to explain beyond generalities).

•Today, the New York Post reports AIG had “written into its $1.6 trillion book of derivatives a clause that would have put most every one of its mortgage-backed securities and CDS in technical default if the company reneged on making any payout greater than $25 million, according a white paper AIG filed with Washington on March 13.”

Even the $165 million bonus package qualified as part of that book, the paper says.

“The document went on to lay out: “A cross default in many of these transactions is defined as a failure by AIGFP to make one or more payments in an amount that exceeds a threshold of $25 million.”

So, maybe the bonuses and bailout stream saved that default trigger from being hit.

•And finally, for our brave men and women on Capitol Hill, the public disclosure and subsequent flogging of AIG bonus provides another chance to duck responsibility for not having the nerve to fight the tape during the housing and easy credit booms.

Instead of giving their constituents a chance to ponder a stimulus plan larded with partisan pork and panic-stricken bank rescues plagued with cronyism and incompetence, politicians get to shift blame to AIG traders. Those traders make ideal fodder for middle class outrage, of course, because they have big houses in Connecticut.

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