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Editor’s Note: This proposal would reveal what really happened during the lead-up to the mortgage meltdown. The receiver would first take an objective inventory of what AIG (with taxpayer dollars) paid and track the actual transactions instead of REPORTS of the transactions.

It would reveal the theme for this week, which is that the loans were never securitized, which means that the “losses” attributed to failing mortgage bonds were fabricated losses, entitling the receiver to claw back the money given to the investment houses.

It would also result in clarification of title: who owns the property that has already been “sold” at auction pursuant to foreclosure and who is the legal owner of the loan. It should become apparent that only the originating lender really owns those loans as they are the only entity entity on record. By dismantling the illusion of securitization, it would also reveal that the investment banks did NOT sell the loans but only pretended to do so by clever manipulation of the wording in the prospectus.

And it would head off the worst title disaster in the nation’s history which so far has not been addressed — the inability of anyone to sell property (i.e.,m deliver clear title) that has been the subject property in what was an illegal table-funded loan that was later claimed to be part of fictitious pools whose “assets” were used to sell worthless bonds to investors in the form of mortgage “bonds” that were never actually issued.

A.I.G.: The First Test of Financial Reform?

July 21, 2010, 2:00 pm

<!– — Updated: 1:20 am –>

Do the sweeping financial regulations that just became law give the government another tool to deal with the American International Group? If so, what if anything should the Treasury Department do with its new power?

More specifically, now that the government has obtained the authority to place systemically important financial companies into receivership, should the government use this procedure with A.I.G.? After all, former Treasury Secretary Henry M. Paulson Jr. has said that if he had been able to use that process in fall 2008, he would have used it. If not then, why shouldn’t the government act now?

The government appears to have this power with respect to A.I.G., although it would require some procedural hurdles and a determination that A.I.G. is technically insolvent.

First, A.I.G. would have to be put under the supervision of the Federal Reserve as a systemically important nonbank financial company. This can be done by a declaration of two-thirds of the members of the newly created Financial Stability Oversight Council upon their determination that A.I.G. could pose a threat the financial stability of the United States. Check. We have already found that to be true, to our regret.

A.I.G. would next have to be put into the resolution process. Because the largest subsidiary of A.I.G. is almost certainly an insurance company, the new financial regulations would require that two-thirds of the members of the Federal Reserve Board and the newly appointed director of the newly created Federal Insurance Office, in consultation with the Federal Deposit Insurance Corporation, agree to recommend this action to the Treasury secretary.

The Treasury secretary would then decide whether to put A.I.G. into receivership based on a seven-factor test that requires him to determine whether A.I.G. “is in default or in danger of default” on its obligations and “no viable private sector alternative is available.” Importantly, the definition of default here is quite wide and includes a situation in which “the assets of the financial company are, or are likely to be, less than its obligations to creditors and others” or A.I.G. has depleted all or substantially all of its capital.

Recent reports by the Government Accountability Office and the Congressional Oversight Panel have stressed that it is very unclear what exactly A.I.G. is worth, and it may be the case that A.I.G.’s assets are less than what the company owes the United States government for billions of dollars in bailouts. But this is a moving figure and the stock market currently assigns A.I.G.’s equity billions of dollars in value, mitigating against these assessments.

If A.I.G. were to be put into receivership, it would be unwound according to the process set forth in the bill. There is an expedited claims process and the government has the power to terminate all of A.I.G.’s derivatives contracts. (The holders would then be entitled to cash damages as creditors of the company.)

The assets of A.I.G. would first go to pay the United States government, then to wages up to $11,725 per employee and thereafter to pay senior and unsecured creditors, the senior executives and directors and finally A.I.G. shareholders.

If there is a shortfall of funds, the bill appears to provide authority for the government to recover any such shortfall through an assessment on the financial sector, although it is not entirely clear that this provision would apply to the government’s prior financial assistance since it was provided before A.I.G.’s entry into receivership.

The advantages of the resolution process is that it sets a clear path for ending A.I.G.’s plight. The company would be liquidated in an orderly manner and the United States government repaid from A.I.G.’s assets or, if the bill is interpreted that way, the financial sector.

In addition, this type of resolution would penalize those creditors of A.I.G. that remain from the time before the bailout. In particular, it would ensure that the government is paid ahead of the $43.9 billion in A.I.G. private debt that was estimated to be outstanding by the Congressional Oversight Panel in its recent report on A.I.G. It would also stop the bleeding at A.I.G.

Only last week, three Ohio state pension funds reached a $725 million settlement with A.I.G. related to prior allegations of securities fraud. Only $175 million was actually paid in cash by A.I.G. (the rest will depend on an unlikely-to-occur stock offering), but this is money that comes out of the ability of A.I.G. to repay the government for its bailout.

The disadvantages of this resolution process are at least threefold.

First, there is a problem that Prof. Jeff Gordon at Columbia Law School has highlighted with the entire resolution process. Placing a company into the resolution process may itself scare the entire market and throw the financial system into panic. This may be addressed in part by only putting the main part of A.I.G. and its subsidiary AIG Financial Products (the division that wrote the derivatives that destroyed A.I.G.) into receivership, leaving the main insurance companies out of the process. But still, this would be an undeniable blow to market confidence.

Second, a resolution process may not provide the greatest return to the United States without a financial assessment. In other words, putting A.I.G. into the receivership process may diminish its value and require yet further government support. In particular, if A.I.G. is put into the resolution process, it may render worthless the billions of dollars in equity currently attributable to A.I.G.’s common stock (although that may be in part attributable to market expectations that the government would willingly take a haircut on its debt) and cut off A.I.G.’s healthier subsidiaries from any access to private-sector capital markets.

The third disadvantage lies in the political ramifications. Does the Obama administration really want the headache of taking full control of A.I.G. and the charges of socialism that would come with it?

In the end, I admit that this is a bit of a thought experiment and that the government is unlikely to (or should) take these steps, because the process of dealing with the company appears to be working on an acceptable, if not optimal, level. But plotting an A.I.G. receivership also reflects some of the problems and advantages of the new resolution process.

At a minimum, the government should likely acknowledge reality and designate A.I.G. as a systemically significant nonbank financial company under the new financial regulations. But even here, I acknowledge that such a designation may make the market increasingly leery of A.I.G. and foreclose its ability to effectively recover.

Still, as the process with A.I.G. unfolds, this designation and resolution option is one that government regulators should keep in mind if the company’s financial situation significantly deteriorates. At least, it is an option that should be debated as to its merits and deficits. The government owes it to the taxpayers to keep all of its options open.

– Steven M. Davidoff

Filed under: foreclosure | Tagged: A.I.G., financial reform, receivership, Steven M. Davidoff, University of Connecticut School of Law |