Proposal to Place AIG Into Receivership Would Lead to Disclosure of Inner Workings

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 –>

[The Deal Professor by Steven M. Davidoff]

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?

About The Deal Professor

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate lawyer at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. He is the author of “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion,” which explores modern-day deals and deal-making.

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

A.I.G. to Pay $725 Million in Ohio Case

July 16, 2010

A.I.G. to Pay $725 Million in Ohio Case

By MICHAEL POWELL and MARY WILLIAMS WALSH

The American International Group, once the nation’s largest insurance group before it nearly collapsed in 2008, has agreed to pay $725 million to three Ohio pension funds to settle six-year-old claims of accounting fraud, stock manipulation and bid-rigging.

Taken together with earlier settlements, A.I.G. will ladle out more than $1 billion to Ohio investors, money that will go to firefighters, teachers, librarians and other pensioners. The state’s attorney general, Richard Cordray, said Friday, that it was the 10th largest securities class-action settlement in United States history.

“No privileged few are entitled to play by different rules than the rest of us,” Mr. Cordray said during a news conference. “Ohio is determined to send a strong message to the marketplace that companies who don’t play by the rules will pay a steep price.”

A.I.G. disclosed the terms of the settlement in a filing with the Securities and Exchange Commission.

How A.I.G. will pay for this settlement is an open question. It has agreed to a two-step payment, in no small part to give it time to figure out how to raise the money.

Executives are well aware that taxpayers and legislators would cry foul if it paid the lawsuit with any portion of the $22 billion in federal rescue money still available from the United States Treasury.

Instead, the company intends to pay $175 million within 10 days of court approval of its settlement. It plans to raise $550 million through a stock offering in the spring of 2011. That prospect struck some market analysts as a long shot.

“There’s still a lot of question marks hanging over A.I.G.,” said Chris Whalen, a co-founder of Institutional Risk Analytics, a research firm. “How would you write a prospectus for it?

“The document,” he said, “would be quite appalling when it described the risks.”

A.I.G.’s former chief executive, Maurice R. Greenberg, and other executives agreed to pay $115 million in an earlier settlement with Ohio, which filed its lawsuit in 2004.

State attorneys general often have proved more aggressive than federal regulators in going after financial houses in the wake of the 2008 crisis. And A.I.G. could face new legal headaches. For instance New York’s attorney general, Andrew M. Cuomo, has stepped up his investigation of the company in the last few weeks, according to a person with direct knowledge of the case.

The Ohio settlement allows “A.I.G. to continue to focus its efforts on paying back taxpayers and restoring the value of our franchise,” Mark Herr, a company spokesman, said in a news release.

The Ohio case was filed on behalf of pension funds in the state that had suffered significant losses in their holdings of A.I.G. when its share price plummeted after it restated results for years before 2004. Those restatements followed an investigation by Eliot L. Spitzer, Mr. Cuomo’s predecessor, into accounting irregularities at the company and the subsequent resignation of Mr. Greenberg.

But the company faces a long and uncertain road, say Wall Street analysts.

Its stock, after adjusting for a reverse split, once traded at $1,446.80 a share; it stands now at $35.64.

A.I.G. has become the definition of turmoil. Its chairman resigned this week after a fierce feud with the chief executive, who has referred dismissively to “all those crazies down in Washington.”

Those crazies presumably include the federal government, which over the last two years gave A.I.G. the largest bailout in United States history, making $182 billion available to the company.

And the company’s proposed stock offering next year is rife with uncertainties. Such an offering would by definition dilute the value of the government’s holdings.

A.I.G. has struggled of late to sell off subsidiaries to repay the Federal Reserve Bank of New York. This year the company failed in its attempts to turn its Asian life insurance subsidiary over to Prudential of Britain. This week the company’s directors voted to proceed with an initial public offering of the same subsidiary, with the proceeds intended for the Federal Reserve.

Should the company fail to raise the $550 million, Ohio has the right to resume its litigation.

The fall of the world’s largest insurance company began in the autumn of 2008, when a sudden downgrade in its credit worthiness set off something like a bank run. It turned out that the company had sold questionable derivatives that were used to prop up the portfolios of other financial institutions.

Federal officials moved quickly to bail out the company, fearing that if A.I.G. toppled, dozens of financial institutions would quickly fall as well. Havoc seemed in the offing.

Federal investigators have since examined many aspects of the company’s behavior, even convening a grand jury in New York. But they have never brought charges against the company or its top officials.

“The states are too often the only ones to watch out for this misconduct,” Mr. Cordray said Friday. “For years, people have been asleep at the switch.”

Louise Story contributed reporting.

This article has been revised to reflect the following correction:

Correction: July 17, 2010

An earlier version of this article misidentified the New York attorney general who began the investigation into A.I.G.’s accounting irregularities. It was Eliot L. Spitzer, not Andrew M. Cuomo.

GRETCHEN MORGENSON Takes the Lead in Media Coverage of Mortgage Meltdown in NY Times

NOW AVAILABLE ON KINDLE/AMAZON
Gretchen Gets It. The entire article is worth reading and even studying. If you get what she is saying, you can understand just how false this Waltz has been.

“The very design of the federal assistance to A.I.G. was that tens of billions of dollars of government money was funneled inexorably and directly to A.I.G.’s counterparties.” The report noted that this was money the banks might not otherwise have received had A.I.G. gone belly-up.

Goldman Sachs, Merrill Lynch, Société Générale and other banks were in the group that got full value for their contracts when many others were accepting fire-sale prices.

Ms. Tavakoli argues that Goldman should refund the money it received in the bailout and take back the toxic C.D.O.’s now residing on the Fed’s books — and to do so before it begins showering bonuses on its taxpayer-protected employees.

According to an e-mail message that Goldman sent to the New York Fed at the time, Mr. Geithner talked about the article with Mr. Viniar, Goldman’s chief financial officer, before calling me. When Mr. Geithner called, he said that Goldman had no exposure to an A.I.G. collapse and that the article had left an incorrect impression about that. When I asked Mr. Geithner if he, as head of the regulatory agency overseeing Goldman, had closely examined the firm’s hedges, he said he had not.

Probing, in-depth analyses of regulatory responses to the financial meltdown are worth their weight in gold. Mr. Barofsky’s certainly is. Yet in its rush to put financial reforms into effect, Congress seems uninterested in investigating or grappling with truths contained in such reports — and until it does, our country’s economic and financial system will continue to be at risk.

November 22, 2009
Fair Game

Revisiting a Fed Waltz With A.I.G.

A RAY of sunlight broke through the Washington fog last week when Neil M. Barofsky, special inspector general for the Troubled Asset Relief Program, published his office’s report on the government bailout last year of the American International Group.

It’s must reading for any taxpayer hoping to understand why the $182 billion “rescue” of what was once the world’s largest insurer still ranks as the most troubling episode of the financial disaster. And it couldn’t have come at a more pivotal moment.

Many in Washington want to give more regulatory power to the Federal Reserve Board, the banking regulator that orchestrated the A.I.G. bailout. Through this prism, the actions taken in the deal by Treasury Secretary Timothy F. Geithner, who was president of the Federal Reserve Bank of New York at the time, grow curiouser and curiouser.

Of special note in the report: the Fed failed to develop a workable rescue plan when A.I.G., swamped by demands that it pay off huge insurance contracts that it couldn’t make good on as the economy tanked, began to sink. The report takes the Fed to task as refusing to use its power and prestige to wrestle concessions from A.I.G.’s big, sophisticated and well-heeled trading partners when the government itself had to pay off the contracts.

The Fed, under Mr. Geithner’s direction, caved in to A.I.G.’s counterparties, giving them 100 cents on the dollar for positions that would have been worth far less if A.I.G. had defaulted. Goldman Sachs, Merrill Lynch, Société Générale and other banks were in the group that got full value for their contracts when many others were accepting fire-sale prices.

On the question of whether this payout was what the report describes as a “backdoor bailout” of A.I.G.’s counterparties, Mr. Barofsky concluded: “The very design of the federal assistance to A.I.G. was that tens of billions of dollars of government money was funneled inexorably and directly to A.I.G.’s counterparties.” The report noted that this was money the banks might not otherwise have received had A.I.G. gone belly-up.

The report zaps Fed claims that identifying banks that benefited from taxpayer largess would have dire consequences. Fed officials had refused to disclose the identities of the counterparties or details of the payments, warning “that disclosure of the names would undermine A.I.G.’s stability, the privacy and business interests of the counterparties, and the stability of the markets,” the report said.

When the parties were named, “the sky did not fall,” the report said.

Finally, Mr. Barofsky pokes holes in arguments made repeatedly over the past 14 months by Goldman Sachs, A.I.G.’s largest trading partner and recipient of $12.9 billion in taxpayer money in the bailout, that it had faced no material risk in an A.I.G. default — that, in effect, had A.I.G. cratered, Goldman wouldn’t have suffered damage.

In short, there’s an awful lot jammed into this 36-page report.

Even before publishing this analysis, Mr. Barofsky had made a name for himself as one of the few truth tellers in Washington. While others estimate how much the taxpayer will make on various bailout programs, Mr. Barofsky has said that returns are extremely unlikely.

His office has also opened 65 cases to investigate potential fraud in various bailout programs. “When I first took office, I can’t tell you how many times I’d be having a sit-down and warning about potential fraud in the program and I would hear a response basically saying, ‘Oh, they’re bankers, and they wouldn’t put their reputations at risk by committing fraud,’ ” Mr. Barofsky told Bloomberg News a little over a week ago, adding: “I think we’ve done a good job of instilling a greater degree of skepticism that what comes from Wall Street isn’t necessarily the holy grail.”

Mr. Barofsky says the Fed failed to strong-arm the banks when it was negotiating payouts on the A.I.G. contracts. Rather than forcing the banks to accept a steep discount, or “haircut,” the Fed gave the banks $27 billion in taxpayer cash and allowed them to keep an additional $35 billion in collateral already posted by A.I.G. That amounted to about $62 billion for the contracts, which the report describes as “far above their market value at the time.”

Mr. Geithner, who oversaw those negotiations, said in an interview on Friday that the terms of the A.I.G. deal were the best he could get for taxpayers. He considered bailing out A.I.G. to be “offensive,’ he said, but deemed it necessary because a collapse would have undermined the financial system.

“We prevented A.I.G. from defaulting because our judgment was that the damage caused by failure would have been much more costly for the economy and the taxpayer,” Mr. Geithner said. “To most Americans, this looked like a deeply unfair outcome and they find it hard to see any direct benefit. But in fact, their savings are more valuable and secure today.”

The report said that while bailing out Goldman and other investment banks might not have been the intent behind the Fed’s A.I.G. rescue, it certainly was its effect. “By providing A.I.G. with the capital to make these payments, Federal Reserve officials provided A.I.G.’s counterparties with tens of billions of dollars they likely would have not otherwise received had A.I.G. gone into bankruptcy,” the report stated.

As Goldman prepares to pay out nearly $17 billion in bonuses to its employees in one of its most profitable years ever, it is important that an authoritative, independent voice like Mr. Barofsky’s reminds us how the taxpayer bailout of A.I.G. benefited Goldman.

A Goldman spokesman, Lucas van Praag, said that Goldman believed “that a collapse of A.I.G. would have had a very disruptive effect on the financial system and that everyone benefited from the rescue of A.I.G.” Regarding his firm’s own dealings with A.I.G., Mr. van Praag said that Goldman believed that its “exposure was close to zero” because it insulated itself from a downturn in A.I.G.’s fortunes through hedges and collateral it had already received. (Goldman’s complete response is here.)

The inspector noted in his report that Goldman made several arguments for why it believed it was not materially at risk in an A.I.G. default, but he is skeptical of the firm’s reasoning.

So is Janet Tavakoli, an expert in derivatives at Tavakoli Structured Finance, a consulting firm. “On Sept. 16, 2008, David Viniar, Goldman’s chief financial officer, said that whatever the outcome at A.I.G., the direct impact of Goldman’s credit exposure would be immaterial,” she said. “That was false. The report states that if the New York Fed had negotiated concessions, Goldman would have suffered a loss.”

The report says that Goldman would have had difficulty collecting on the hedges it used to insulate itself from an A.I.G. default because everyone’s wallets would have been closing in a panic.

“The prices of the collateralized debt obligations against which Goldman bought protection from A.I.G. were in sickening free fall, and the cost of replacing A.I.G.’s protection would have been sky-high,” she said. “Goldman must have known this, because it underwrote some of those value-destroying C.D.O.’s.”

Ms. Tavakoli argues that Goldman should refund the money it received in the bailout and take back the toxic C.D.O.’s now residing on the Fed’s books — and to do so before it begins showering bonuses on its taxpayer-protected employees.

“A.I.G., a sophisticated investor, foolishly took this risk,” she said. “But the U.S. taxpayer never agreed to be a victim of investments that should undergo a rigorous audit.”

Perhaps Mr. Barofsky will do that audit, and closely examine the securities that A.I.G. insured and that Wall Street titans like Goldman underwrote.

Goldman contends that it had a contractual right to the funds it received in the A.I.G. bailout and that the securities it returned to the government in the deal have increased in value.

For his part, Mr. Geithner disputed much of the inspector general’s findings. He also took issue with the conclusion that the Fed failed to develop a contingency plan for an A.I.G. rescue and largely depended on plans proffered by the banks themselves.

He said the report’s view that the Fed didn’t use its might to get better terms in the rescue was unfair. “This idea that we were unwilling to use leverage to get better terms misses the central reality of the situation — the choice we had was to let A.I.G. default or to prevent default,” he said. “We could not enforce haircuts without causing selective defaults and selective defaults would have brought down the company.”

Mr. Geithner also said that the “perception that this decision by the government, not my decision alone, was made to protect any individual investment bank is unfounded.”

Less than two weeks after the A.I.G. bailout, Mr. Geithner took the firm’s side when he criticized a Sept. 28, 2008, article in The New York Times that I wrote about the A.I.G. bailout. That article included Goldman’s statement that it wouldn’t have been affected by an A.I.G. collapse. Among other things, the article, like Mr. Barofsky’s report, questioned Goldman’s assertion.

According to an e-mail message that Goldman sent to the New York Fed at the time, Mr. Geithner talked about the article with Mr. Viniar, Goldman’s chief financial officer, before calling me. When Mr. Geithner called, he said that Goldman had no exposure to an A.I.G. collapse and that the article had left an incorrect impression about that. When I asked Mr. Geithner if he, as head of the regulatory agency overseeing Goldman, had closely examined the firm’s hedges, he said he had not.

Mr. Geithner told me on Friday that he spoke with Mr. Viniar that day to ensure that Goldman’s hedges were adequate. And, notwithstanding the inspector general’s findings, he said he still believes Goldman was hedged.

Probing, in-depth analyses of regulatory responses to the financial meltdown are worth their weight in gold. Mr. Barofsky’s certainly is. Yet in its rush to put financial reforms into effect, Congress seems uninterested in investigating or grappling with truths contained in such reports — and until it does, our country’s economic and financial system will continue to be at risk.

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