Why AIG Counter-Parties Recieved 100% on Derivatives

There is a bizarre article in the WSJ today. It claims that the French “masterfully outmaneuvered” the Fed to get 100 cents on the dollar for their counter-part banks to AIG’s Financial Products division.

Quelle stupidité!

I have many reasons to doubt the judgment of former Treasury Secretary Hank Paulson, and Fed Chief Ben Bernanke, but this is not one of them. I am unconvinced that a legal maneuver by the French is why AIG-FP counter-parties were paid 100 cents on the dollar.

There are two reasons why I think this argument fails.

First, both SocGen and Goldman Sachs each managed to squeeze 100 cents on the dollar on $5.9 billion a piece days before AIG collapsed. In a bankruptcy hearing, that would have been deemed a fraudulent conveyance and clawed back. Why that was allowed to stand implies that the Fed wanted other financials to have the money.

The second reason was more explicit. Paulson’s successor, Treasury Secretary Tim Geithner, explicitly stated that if the pass thrus were not permitted, the system might have collapsed. Thus, the NY Fed, and now the Treasury, wanted the 100% payouts to help liquify the system.

Here’s the Journal:

“The Federal Reserve’s decision to pay billions of dollars to Goldman Sachs Group Inc. and other big banks as part of its bailout of American International Group Inc. has spawned criticism and conspiracy theories. Treasury Secretary Timothy Geithner, who presided over the New York Fed at the time, was summoned to Congress to explain why AIG paid off the $62.1 billion in soured derivatives in full, far more than they were worth in the market.

One element of the decision hasn’t been well explored—how the Fed agreed to the full-payment demands of France’s bank regulator and two of AIG’s largest creditors, Société Générale SA and Calyon Securities, a unit of Crédit Agricole SA. The French banks and their regulator, it now appears, masterfully outmaneuvered the Americans to avoid discounts, or “haircuts,” on their securities.

The French won the day by using a legal argument that some leading French scholars and corporate attorneys variously described in interviews as highly dubious and lacking real legal ground. Their refusal was crucial, as it helped set the tone for U.S. banks, including Goldman and Merrill, to resist negotiation.

The French banks and the regulator, known as the Commission Bancaire, said bank executives could be criminally liable for accepting a discount on their contracts, according to a November report of the inspector general of the Troubled Asset Relief Program.”

I fail to see how a counter-party could win an arm’s length negotiation with that tactic:

French: “We cannot take anything less than 100 cents on the dollar.”

Fed Response:  “OK, then you’ll leave empty handed. Go back and tell your shareholders you were offered less than 100%, and you rejected it. Come by in 2 years and pick up whatever is left over –3 cents. 4 cents? –and its yours! Have a safe flight now . . . Buh bye”

Besides, as University of Luxembourg law professor Pierre-Henri Conac noted in the article, “their argument was very overstated. Banks give haircuts every day.”

‘Nuff said. This was an outright gift done on purpose, and not the result of some obscure French bank law.

How French Outplayed AIG and Fed
WSJ, JANUARY 19, 2010

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