Why did Tim Geithner and the New York Fed undermine AIG’s negotiations with banks over haircuts on credit default, costing tax-payers tens of billions of dollars and delivering a windfall to the banks?
The general counsel of the NY Fed has explained that once the Federal Reserve agreed to rescue AIG, the firm lost all ability to negotiate a better deal with its counterparties. (By the way, kudos to Bloomberg for their excellent work reporting the NY Fed’s screw-up and for forcing the Fed to make a rare public response to criticism.)
From the Washington Post:
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 favouring 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.
In other words, the bailout of AIG was screwed up right from the start. By stepping in and rescuing the giant insurer, the government triggered a host of unintended consequences. Taking away the possibility of an AIG bankruptcy didn’t prevent economic chaos–it created an opportunity for looting.
Great job, Tim!