Sometimes you can understand why business people have such fear of government. This morning's incredibly myopic comments and narrow minded recollection of history by former New York Insurance Commissioner Eric Dinallo and Treasury Secretary Tim Geithner gave clear examples of grounds for this fear.
First Dinallo crowed about how effective his and Geithner's illegal taking of AIG by declaring it insolvent had been. It was truly scary to listen to Dinallo self-absorbed remarks, never allowing for the possibility, as several observers described at the time, that AIG's troubled financial products unit could have been separated from the solvent insurance operations, and separately taken through a Chapter 11 process, with all derivatives creditors taking proportional haircuts to resolve the unit's problems.
To hear Dinallo tell it, he crafted the best of all possible solutions, irrespective of the capricious nature of the seizing, or the general sense that, due to former NY AG Eliot Spitzer's animus toward AIG's former CEO, Hank Greenberg, the giant insurer was in for some truly 'special' treatment at the hands of New York and the feds.
Sadly, the co-anchors on the set let Dinallo spin his fairy tale of the soundness of the AIG seizure without a single probing question.
Then Tim Geithner appeared from Washington to easily hit some softball questions from the networks hapless senior economic reporter. Once again, the government official was allowed to go on and on without any interruptions for probing questions or serious challenges to his fairy tale.
In Geithner's case, the fairy tale is that yesterday's S&P warning on US debt is misplaced. That we haven't created too much debt which will be bequeathed to our children, and that extra spending on infrastructure and education is perfectly fine. Yes, the debt needs to be reduced, but certainly not at the cost of reining in special spending. Make sense? Not to me, either.
Both Dinallo's and Geithner's nearly robotic, surreal views that ignore reality ought to put fear into business people throughout the US. This is the attitude that causes investment to remain on the sidelines and hiring to be delayed. With government officials like these two inventing their own reality to justify power grabs and fiscal imprudence, there's no telling what overreach could come next from Washington or your own state capital.
At this point, in the interest of truth in packaging, CNBC should just relabel itself as a government public relations agency.
Showing posts with label AIG. Show all posts
Showing posts with label AIG. Show all posts
Tuesday, April 19, 2011
Friday, October 01, 2010
What If AIG Had Been Allowed To File A Conventional Chapter 11 Bankruptcy?
Yesterday's faux-repayment announcement by AIG rivaled GM's various announcements of debt repayment and an IPO for trying to disguise reality.
If you read the details, all that's really occurred is that Treasury has taken common shares to swap out the TARP's preferred shares in AIG. Hardly earth-shaking, is it?
The cognoscenti on CNBC yesterday morning were all a twitter about this development, with at least one co-anchor or guest host gushing that the TARP fund won't lose money, that AIG will ultimately not be a loss for the taxpayer, etc.
This got me thinking about the closest comparison to AIG- GM. Yesterday, I wrote this post about Paul Ingrassia's review of auto czar Steve Rattner's book on the administration's takeover of GM. In it, I observed, quoting from a prior post,
"Maybe if GM were allowed to go through a normal bankruptcy, and another firm had bought and reorganized various divisions of the old GM, all that borrowed Canadian and US money may have stayed in the private sector and funded other, better jobs with new firms."
What if AIG had also been allowed to proceed through a conventional, orderly Chapter 11 reorganization? As I wrote in one of many posts on this topic, found under the label "AIG,"
"I think Jenkins' idea is sound, but he omitted one very credible alternative that Geithner & Co. have never discussed.
That is, a simple carving out of AIG's financial products unit for placement into bankruptcy. Such a move would have isolated the troubled portion of the insurer from the heavily-regulated insurance operations.
Once in bankruptcy, AIG's counterparties would no longer have a right to 100% payments for positions. But an orderly disposition could have occurred, again avoiding needless losses to US taxpayers.
It continues to mystify me why only one Journal contributor has ever raised this option. It's the default path for failing companies, and should have been the preferred option for AIG.
Geithner may or may not have been guilty of various malfeasances or neglectful inactions in the AIG situation. But one thing is sure. He and his team were surely guilty of a lack of creativity and perspective on the situation."
In other posts, I suggested, as have others, that AIG could have been easily broken into three pieces: a group of conventional, state-regulated, solvent insurance units; a collection of asset management businesses which held, in trust, other peoples' money, and, finally; the problematic financial engineering and swaps-writing business units. Only the third was insolvent. As one Journal editorialist noted, a court could simply have assigned uniform haircuts to all counterparties and reduced the excess liabilities of the third unit.
That done, it could have been either closed or sold to the highest bidder.
But, like GM, our government chose to use taxpayer dollars to 'rescue' a firm which could have more efficiently and effectively been reorganized under existing Chapter 11 protections, with investors paying a market-determined value for any surviving operations and shareholders taking appropriate losses in bankruptcy.
So taxpayers footed the bill to keep dubious operations afloat and essentially prop up questionable asset values.
Why?
Wouldn't it have been a much better use of capital to allow investors and a bankruptcy court to determine asset values and use private money to reorganize, sell and/or liquidate various elements of both GM and AIG?
Then we wouldn't have this unholy entanglement of government and private sectors. Or the questionable use of taxpayer money to favor a few companies over others which went bust.
Then there's the question of opportunity costs. It's debatable that taxpayer funds will ever earn an appropriate, risk-adjusted return for the money pumped into either GM or AIG.
There was always an existing, appropriate path for handling GM and AIG- conventional Chapter 11 reorganization and, where necessary, bankruptcy.
What we see now is many government, GM and AIG officials, and selected pundits, misleading taxpayers about just what risks their money incurred for these bailouts, and what the appropriate return should have been or be in the future.
A classic example of a magician's misdirection and diversion from the real action, which, in this case, is that these companies should have been consigned to bankruptcy court where private investors could risk their own capital.
If you read the details, all that's really occurred is that Treasury has taken common shares to swap out the TARP's preferred shares in AIG. Hardly earth-shaking, is it?
The cognoscenti on CNBC yesterday morning were all a twitter about this development, with at least one co-anchor or guest host gushing that the TARP fund won't lose money, that AIG will ultimately not be a loss for the taxpayer, etc.
This got me thinking about the closest comparison to AIG- GM. Yesterday, I wrote this post about Paul Ingrassia's review of auto czar Steve Rattner's book on the administration's takeover of GM. In it, I observed, quoting from a prior post,
"Maybe if GM were allowed to go through a normal bankruptcy, and another firm had bought and reorganized various divisions of the old GM, all that borrowed Canadian and US money may have stayed in the private sector and funded other, better jobs with new firms."
What if AIG had also been allowed to proceed through a conventional, orderly Chapter 11 reorganization? As I wrote in one of many posts on this topic, found under the label "AIG,"
"I think Jenkins' idea is sound, but he omitted one very credible alternative that Geithner & Co. have never discussed.
That is, a simple carving out of AIG's financial products unit for placement into bankruptcy. Such a move would have isolated the troubled portion of the insurer from the heavily-regulated insurance operations.
Once in bankruptcy, AIG's counterparties would no longer have a right to 100% payments for positions. But an orderly disposition could have occurred, again avoiding needless losses to US taxpayers.
It continues to mystify me why only one Journal contributor has ever raised this option. It's the default path for failing companies, and should have been the preferred option for AIG.
Geithner may or may not have been guilty of various malfeasances or neglectful inactions in the AIG situation. But one thing is sure. He and his team were surely guilty of a lack of creativity and perspective on the situation."
In other posts, I suggested, as have others, that AIG could have been easily broken into three pieces: a group of conventional, state-regulated, solvent insurance units; a collection of asset management businesses which held, in trust, other peoples' money, and, finally; the problematic financial engineering and swaps-writing business units. Only the third was insolvent. As one Journal editorialist noted, a court could simply have assigned uniform haircuts to all counterparties and reduced the excess liabilities of the third unit.
That done, it could have been either closed or sold to the highest bidder.
But, like GM, our government chose to use taxpayer dollars to 'rescue' a firm which could have more efficiently and effectively been reorganized under existing Chapter 11 protections, with investors paying a market-determined value for any surviving operations and shareholders taking appropriate losses in bankruptcy.
So taxpayers footed the bill to keep dubious operations afloat and essentially prop up questionable asset values.
Why?
Wouldn't it have been a much better use of capital to allow investors and a bankruptcy court to determine asset values and use private money to reorganize, sell and/or liquidate various elements of both GM and AIG?
Then we wouldn't have this unholy entanglement of government and private sectors. Or the questionable use of taxpayer money to favor a few companies over others which went bust.
Then there's the question of opportunity costs. It's debatable that taxpayer funds will ever earn an appropriate, risk-adjusted return for the money pumped into either GM or AIG.
There was always an existing, appropriate path for handling GM and AIG- conventional Chapter 11 reorganization and, where necessary, bankruptcy.
What we see now is many government, GM and AIG officials, and selected pundits, misleading taxpayers about just what risks their money incurred for these bailouts, and what the appropriate return should have been or be in the future.
A classic example of a magician's misdirection and diversion from the real action, which, in this case, is that these companies should have been consigned to bankruptcy court where private investors could risk their own capital.
Monday, March 08, 2010
Hank Greenberg's Rx For Financial Sector Reform
Last Friday's Wall Street Journal featured an editorial by Hank Greenberg, former CEO of AIG, entitled "Six Steps Toward Financial Reform."
His six steps include:
-Improve regulation and regulators
-Tie compensation to long-term performance
-Make rating agencies independent
-Allow our financial institutions to remain competitive
-Institute responsible risk-management systems
-Use stimulus money strategically
Like these sorts of recommendations by other well-known CEOs, public office-holders or academics, Greenberg's list contains some gold and some dross.
His first suggestion is rather tautological, but enduringly debatable. It's a desirable-sounding goal, but seems always to be over the horizon. One could argue, and I do, that the Fed was responsible and well-armed to have identified and stopped much of the irresponsible behavior which contributed, but did not directly, solely cause, the recent financial sector meltdown. For example, Greenberg does not mention, by name, Fannie Mae, Freddie Mac, nor the public officials responsible for fueling the unwise growth of those two agencies. Yet, that growth in low-quality, risky mortgages was the spark that touched off the fuse which caused the financial services sector explosion.
I like Greenberg's second recommendation. As long ago as the late 1990s, I wrote public pieces endorsing such policy. But which CEO or senior manager, in the heat of the moment, faced with a talented trader, or desk, will deny them short-term compensation in some new, clever, regulation-evading manner, in order to book current profits and gain market share in selected markets?
Isn't that, indeed, how we arrived at the current third-party payer health care mess? By causing businesses to evade Congressional restrictions on cash compensation during WWII?
Does any thinking person honestly believe this can be legislated and enforced?
In fact, it's debatable that Greenberg's contention,
"No one is worth a $60 million cash payment a year,"
is true.
If a talented trader or deal-maker at some financial services company is given capital to deploy, and, either through trading or astute M&A activity, engages in activities which bring cash profits to the firm, through closed trades or advice on corporate actions, in the range of hundreds of millions of dollars, who is to say that person isn't worth 5% of that value?
Greenberg's third suggestion is also problematic. Who would judge whether the employees at rating agencies have "the appropriate background and abilities?"
From my discussions with executives at one agency, it became clear that the issue was not one of competence, but opportunity and the market share power of clients.
For someone so hounded by a "government institution," I am shocked that Greenberg would offer this option to ostensibly make rating agencies non-profit in nature.
That said, the very model of client-paid ratings ought to simply cause users to beware. I remain convinced that ratings, in this era, are simply less valuable than they once were. Any investment committee relying solely, or largely, on ratings is probably already in trouble.
Perhaps the most tenuous suggestion is Greenberg's third one, implying allowing "too big to fail" institutions to continue to exist in their current forms, with current government backing. He specifically rejects the Volcker Rule. In that linked post about Volcker's recommendation, I wrote,
"The solution we need isn't more complex regulation, so much as a reasoned return to a past regulation, and better, permanent severing of the riskier finance activities from the federally-insured, mainstays of deposit-taking and basic consumer and commercial lending. "
Greenberg continues to mouth the fallacy that integrated, universal banks are somehow better, and more competitively advantaged in the marketplace.
Which integrated, globe-girding bank didn't experience trouble in 2008? Which major US financial institution didn't risk its shareholder's equity and require taxpayers to provide ultimate backstopping? The only two that come to mind, Wells Fargo and Chase, are sufficiently lackluster to begin with that they were simply too late to the risk party of 2003-2007.
What Greenberg truthfully acknowledges in his comment is that this issue ultimately leads to regulator domicile shopping. In effect, any constraints applied by the US will result in the flight of those companies wishing to be integrated banks.
I say, good riddance. Is the price I pay not having to bail them out? I'm so worried.
Because if it's financial services competitiveness you want, integrated banks aren't where you find that. Typically, that comes, initially, from privately-held monoline financial entities. Trading, asset management, underwriting, can and are all performed in non-publicly-held companies. Often by far more talented people than are left out in the poorer-paying, regulated, publicly-held part of the sector.
Greenberg's views on risk management, while laudable, are equally unenforceable as are his notions about regulation and compensation. It's well and good to call for "responsible risk-management systems."
Just what would one look like? Will ten of the same still be considered 'responsible?'
Because, according to Scott Patterson's recently-published book, The Quants, that's pretty much what happened in 2008. So much for cutting-edge risk management.
By the way, where does leverage factor into this, Hank?
Greenberg's final thought concerning government stimulus money. To me, it's unrelated to the other issues as Greenberg treats it. If he had simply railed against using it as a bailout fund, that would make sense. Instead, he wanders out of the financial sector to make unsupported assertions about economic policy.
Hank Greenberg is a very smart, tough cookie. He has unique and vast experience in the financial services sector. If someone of his stature, intellect and experience can't get this topic right, who can?
Perhaps this, alone, suggests that the solution is not more regulation, but less. End government subsidies to risk-taking entities in the form of deposit insurance. Let rating agencies be who and what they are, with users of their information aware of the conflicts and history of their ratings.
Then, ultimately, let investors bear the risk of assessing their own selections, with no recourse to the political sector for bailouts, do-overs and insurance.
That might be reform which actually brings individual responsibility in line with financial services choices.
His six steps include:
-Improve regulation and regulators
-Tie compensation to long-term performance
-Make rating agencies independent
-Allow our financial institutions to remain competitive
-Institute responsible risk-management systems
-Use stimulus money strategically
Like these sorts of recommendations by other well-known CEOs, public office-holders or academics, Greenberg's list contains some gold and some dross.
His first suggestion is rather tautological, but enduringly debatable. It's a desirable-sounding goal, but seems always to be over the horizon. One could argue, and I do, that the Fed was responsible and well-armed to have identified and stopped much of the irresponsible behavior which contributed, but did not directly, solely cause, the recent financial sector meltdown. For example, Greenberg does not mention, by name, Fannie Mae, Freddie Mac, nor the public officials responsible for fueling the unwise growth of those two agencies. Yet, that growth in low-quality, risky mortgages was the spark that touched off the fuse which caused the financial services sector explosion.
I like Greenberg's second recommendation. As long ago as the late 1990s, I wrote public pieces endorsing such policy. But which CEO or senior manager, in the heat of the moment, faced with a talented trader, or desk, will deny them short-term compensation in some new, clever, regulation-evading manner, in order to book current profits and gain market share in selected markets?
Isn't that, indeed, how we arrived at the current third-party payer health care mess? By causing businesses to evade Congressional restrictions on cash compensation during WWII?
Does any thinking person honestly believe this can be legislated and enforced?
In fact, it's debatable that Greenberg's contention,
"No one is worth a $60 million cash payment a year,"
is true.
If a talented trader or deal-maker at some financial services company is given capital to deploy, and, either through trading or astute M&A activity, engages in activities which bring cash profits to the firm, through closed trades or advice on corporate actions, in the range of hundreds of millions of dollars, who is to say that person isn't worth 5% of that value?
Greenberg's third suggestion is also problematic. Who would judge whether the employees at rating agencies have "the appropriate background and abilities?"
From my discussions with executives at one agency, it became clear that the issue was not one of competence, but opportunity and the market share power of clients.
For someone so hounded by a "government institution," I am shocked that Greenberg would offer this option to ostensibly make rating agencies non-profit in nature.
That said, the very model of client-paid ratings ought to simply cause users to beware. I remain convinced that ratings, in this era, are simply less valuable than they once were. Any investment committee relying solely, or largely, on ratings is probably already in trouble.
Perhaps the most tenuous suggestion is Greenberg's third one, implying allowing "too big to fail" institutions to continue to exist in their current forms, with current government backing. He specifically rejects the Volcker Rule. In that linked post about Volcker's recommendation, I wrote,
"The solution we need isn't more complex regulation, so much as a reasoned return to a past regulation, and better, permanent severing of the riskier finance activities from the federally-insured, mainstays of deposit-taking and basic consumer and commercial lending. "
Greenberg continues to mouth the fallacy that integrated, universal banks are somehow better, and more competitively advantaged in the marketplace.
Which integrated, globe-girding bank didn't experience trouble in 2008? Which major US financial institution didn't risk its shareholder's equity and require taxpayers to provide ultimate backstopping? The only two that come to mind, Wells Fargo and Chase, are sufficiently lackluster to begin with that they were simply too late to the risk party of 2003-2007.
What Greenberg truthfully acknowledges in his comment is that this issue ultimately leads to regulator domicile shopping. In effect, any constraints applied by the US will result in the flight of those companies wishing to be integrated banks.
I say, good riddance. Is the price I pay not having to bail them out? I'm so worried.
Because if it's financial services competitiveness you want, integrated banks aren't where you find that. Typically, that comes, initially, from privately-held monoline financial entities. Trading, asset management, underwriting, can and are all performed in non-publicly-held companies. Often by far more talented people than are left out in the poorer-paying, regulated, publicly-held part of the sector.
Greenberg's views on risk management, while laudable, are equally unenforceable as are his notions about regulation and compensation. It's well and good to call for "responsible risk-management systems."
Just what would one look like? Will ten of the same still be considered 'responsible?'
Because, according to Scott Patterson's recently-published book, The Quants, that's pretty much what happened in 2008. So much for cutting-edge risk management.
By the way, where does leverage factor into this, Hank?
Greenberg's final thought concerning government stimulus money. To me, it's unrelated to the other issues as Greenberg treats it. If he had simply railed against using it as a bailout fund, that would make sense. Instead, he wanders out of the financial sector to make unsupported assertions about economic policy.
Hank Greenberg is a very smart, tough cookie. He has unique and vast experience in the financial services sector. If someone of his stature, intellect and experience can't get this topic right, who can?
Perhaps this, alone, suggests that the solution is not more regulation, but less. End government subsidies to risk-taking entities in the form of deposit insurance. Let rating agencies be who and what they are, with users of their information aware of the conflicts and history of their ratings.
Then, ultimately, let investors bear the risk of assessing their own selections, with no recourse to the political sector for bailouts, do-overs and insurance.
That might be reform which actually brings individual responsibility in line with financial services choices.
Monday, February 01, 2010
Yet Another Excuse From Geithner For AIG's Rough Treatment
Thursday's Wall Street Journal's staff editorial reminded us of yet another excuse being offered by then-NY Fed president, now Treasury Secretary, for directing AIG to pay 100% on its credit default swap obligations. Prior posts, here, here and here, have addressed this puzzling aspect of the AIG affair, and earlier Geithner attempts to evade criticism for this action.
First, we were told it was to prevent a systemic meltdown of the US financial sector due to swaps failing to settle.
Then, it was explained that all counterparties had to be treated equally, and some French executives would be imprisoned if forced to accept less than a 100% payout on their swaps. So Geithner blinked and agreed to the full payments.
Somewhere in the confusion since last fall, Geithner suggested that AIG was "too big to fail."
Now, the Journal reports Geithner's latest excuse. He was concerned about AIG's credit rating!
The Treasury Secretary testified that the state-supervised insurance businesses of AIG were, in fact, subject to failure from the effects of the financial products unit's swaps troubles. Further, Geithner said,
"the people responsible" for AIG's insurance unit regulation "had no idea" of the risks the company was facing.
The Journal editorial correctly notes that this is essentially the complete opposite of what state regulators, including Eric Dinallo, former NY state insurance regulator, believed. And that it's a very different story to explain the AIG swap payments as necessary to maintain AIG's credit rating, for the benefit of its many insurance businesses.
This latest excuse rings false. As the editorial observes, when the US government owns 80% of you, nobody will worry about your credit lines.
The real concern arising from Geithner's ever-shifting reasons for the AIG full swaps payments is that each one portends different problems in the US financial services sector, different regulatory issues and potential solutions.
If Geithner can't keep his excuses straight, how can Congress possibly author a responsible, effective reform of regulation for the sector?
It's neither an academic question, nor a funny one. This is serious. We can't even learn what the primary actors in the sad story of AIG's takeover truly thought was the major risk, and why.
The editorial points out the very major question Geithner's latest excuse implies. That is, is our entire state-based regulatory approach to insurance flawed? Or is Geithner simply grasping at excuses in order to evade responsibility for a bone-headed, expensive, unnecessary and ill-advised action?
How can there be productive forward movement for the financial sector from the recent financial crisis if we can't even pin down simple things, like why the Fed behaved toward and with AIG as it did?
First, we were told it was to prevent a systemic meltdown of the US financial sector due to swaps failing to settle.
Then, it was explained that all counterparties had to be treated equally, and some French executives would be imprisoned if forced to accept less than a 100% payout on their swaps. So Geithner blinked and agreed to the full payments.
Somewhere in the confusion since last fall, Geithner suggested that AIG was "too big to fail."
Now, the Journal reports Geithner's latest excuse. He was concerned about AIG's credit rating!
The Treasury Secretary testified that the state-supervised insurance businesses of AIG were, in fact, subject to failure from the effects of the financial products unit's swaps troubles. Further, Geithner said,
"the people responsible" for AIG's insurance unit regulation "had no idea" of the risks the company was facing.
The Journal editorial correctly notes that this is essentially the complete opposite of what state regulators, including Eric Dinallo, former NY state insurance regulator, believed. And that it's a very different story to explain the AIG swap payments as necessary to maintain AIG's credit rating, for the benefit of its many insurance businesses.
This latest excuse rings false. As the editorial observes, when the US government owns 80% of you, nobody will worry about your credit lines.
The real concern arising from Geithner's ever-shifting reasons for the AIG full swaps payments is that each one portends different problems in the US financial services sector, different regulatory issues and potential solutions.
If Geithner can't keep his excuses straight, how can Congress possibly author a responsible, effective reform of regulation for the sector?
It's neither an academic question, nor a funny one. This is serious. We can't even learn what the primary actors in the sad story of AIG's takeover truly thought was the major risk, and why.
The editorial points out the very major question Geithner's latest excuse implies. That is, is our entire state-based regulatory approach to insurance flawed? Or is Geithner simply grasping at excuses in order to evade responsibility for a bone-headed, expensive, unnecessary and ill-advised action?
How can there be productive forward movement for the financial sector from the recent financial crisis if we can't even pin down simple things, like why the Fed behaved toward and with AIG as it did?
Thursday, January 28, 2010
The Continuing Blindness In the AIG Matter
Yesterday's Wall Street Journal carried Holman Jenkins' weekly column. This week's topic was Geithner, Goldman and AIG.
Jenkins engaged in some very humorous role play, contending that Geithner didn't really have much leverage over Goldman et. al. He articulated two options: total nuclear annihilation via an AIG-triggered systemic meltdown, or; explicit exchange of political favors for accepting a haircut on AIG positions.
After discussing the two options, Jenkins offered that a simple government guarantee of AIG's positions would have restored order to the market, probably without costing anything. Certainly less than a complete takeover and payouts to counterparties.
I think Jenkins' idea is sound, but he omitted one very credible alternative that Geithner & Co. have never discussed.
That is, a simple carving out of AIG's financial products unit for placement into bankruptcy. Such a move would have isolated the troubled portion of the insurer from the heavily-regulated insurance operations.
Once in bankruptcy, AIG's counterparties would no longer have a right to 100% payments for positions. But an orderly disposition could have occurred, again avoiding needless losses to US taxpayers.
It continues to mystify me why only one Journal contributor has ever raised this option. It's the default path for failing companies, and should have been the preferred option for AIG.
Geithner may or may not have been guilty of various malfeasances or neglectful inactions in the AIG situation. But one thing is sure. He and his team were surely guilty of a lack of creativity and perspective on the situation.
Jenkins engaged in some very humorous role play, contending that Geithner didn't really have much leverage over Goldman et. al. He articulated two options: total nuclear annihilation via an AIG-triggered systemic meltdown, or; explicit exchange of political favors for accepting a haircut on AIG positions.
After discussing the two options, Jenkins offered that a simple government guarantee of AIG's positions would have restored order to the market, probably without costing anything. Certainly less than a complete takeover and payouts to counterparties.
I think Jenkins' idea is sound, but he omitted one very credible alternative that Geithner & Co. have never discussed.
That is, a simple carving out of AIG's financial products unit for placement into bankruptcy. Such a move would have isolated the troubled portion of the insurer from the heavily-regulated insurance operations.
Once in bankruptcy, AIG's counterparties would no longer have a right to 100% payments for positions. But an orderly disposition could have occurred, again avoiding needless losses to US taxpayers.
It continues to mystify me why only one Journal contributor has ever raised this option. It's the default path for failing companies, and should have been the preferred option for AIG.
Geithner may or may not have been guilty of various malfeasances or neglectful inactions in the AIG situation. But one thing is sure. He and his team were surely guilty of a lack of creativity and perspective on the situation.
Tuesday, January 19, 2010
Geithner Played For a Sap By The French In 2008
This morning's Wall Street Journal contains perhaps the most damning evidence yet of how badly current Treasury Secretary Tim (tax scofflaw) Geithner bungled the AIG situation back in 2008.
We now learn, courtesy of the Journal piece, that the two french banks owed significant amounts of money on AIG swaps claimed that their executive would be imprisoned if they took less than the contractually-obligated full payment due.
Amazingly, Geithner, played by a sap by bankers not even domiciled in his own country, collapsed and acceded to their demands. Then, to complete the travesty, decided that, since all AIG creditors must be treated equally, everybody else would get full payment, too.
Guess who footed that bill? Yep, you and me, if you are an American reading this.
Of course, this whole mess is why we have bankruptcy law. It prevents ill-equipped, inexperienced officials from making bad policy decisions. In this case, atrociously bad monetary policy.
As I, and others, have argued for over a year, were AIG to simply have been put into bankruptcy, if not aided, like the other major US financial institutions, then none of this would have happened. Instead, a bankruptcy court would almost certainly have proportionally allocated assets available to the financial products group among its creditors. Period.
This sort of uncertainty is what erodes the confidence of business people. Geithner's actions, both as NY Fed president and Treasury Secretary, have been nothing, if not erratic and inexplicable.
I suspect that, with continued mis-leadership like this in the financial sector, it will be some time before a genuine, non-government-money-stoked recovery takes hold in the US.
We now learn, courtesy of the Journal piece, that the two french banks owed significant amounts of money on AIG swaps claimed that their executive would be imprisoned if they took less than the contractually-obligated full payment due.
Amazingly, Geithner, played by a sap by bankers not even domiciled in his own country, collapsed and acceded to their demands. Then, to complete the travesty, decided that, since all AIG creditors must be treated equally, everybody else would get full payment, too.
Guess who footed that bill? Yep, you and me, if you are an American reading this.
Of course, this whole mess is why we have bankruptcy law. It prevents ill-equipped, inexperienced officials from making bad policy decisions. In this case, atrociously bad monetary policy.
As I, and others, have argued for over a year, were AIG to simply have been put into bankruptcy, if not aided, like the other major US financial institutions, then none of this would have happened. Instead, a bankruptcy court would almost certainly have proportionally allocated assets available to the financial products group among its creditors. Period.
This sort of uncertainty is what erodes the confidence of business people. Geithner's actions, both as NY Fed president and Treasury Secretary, have been nothing, if not erratic and inexplicable.
I suspect that, with continued mis-leadership like this in the financial sector, it will be some time before a genuine, non-government-money-stoked recovery takes hold in the US.
Sunday, January 10, 2010
The Fed's Behavior Re: AIG Disclosures
The Wall Street Journal published two very damning articles concerning the federal government's handling of AIG in 2008.
The first, on Friday, concerned emails from Fed personnel addressing the filing of detailed information regarding AIG's payments to counterparties. The Fed directed AIG to conceal details which AIG personnel indicated the SEC would prefer reported.
Aside from the obvious issue of one hand not knowing what the other is doing, or there being conflicts between federal entities on what they demand/require of companies, there's the issue of transparency.
The Fed's position smacks of concern that the actions it directed AIG to take were ones it would be unable, or unwilling, to explain and defend in public.
This sort of clandestine action by government, with a major once-private, then questionably "taken" by government, ought to be very worrisome to the business community.
A day later, in the weekend edition, the Journal published, as its customary single, long interview with a prominent business person, a piece by Holman Jenkins regarding his recent conversation with former AIG CEO Hank Greenberg.
I won't reprint major portions of Jenkins' piece. Suffice to say, Greenberg made his major theme that the business press needs to ferret out why Goldman Sachs, Morgan Stanley, Citigroup, et. al., were saved by federal cash, while AIG was, instead, marked for takeover and eradication.
Greenberg mentions something about which I was unaware, and I'm sure I'm not alone. He explained a 2005 change in the operation of credit default swaps by ISDA, the International Swaps and Derivatives Association. The change essentially changed such swaps from having value changes settled once, at maturity, to being ongoing 'mark to market' payments. He doesn't allege, but asks, whether or not Goldman Sachs, which bought large amounts of such swaps from AIG, was behind this change?
He also bluntly challenges the press to discover why AIG was treated so differently by Paulson and Bernanke than were the commercial and investment banks?
One passage really does deserve to be quoted,
If you see unholy alliances between Goldman and the Treasury and/or Fed, made in the shadows, then you find yourself agreeing with Greenberg's demand that somebody force explanations.
Even if you don't see such alliances, it still makes sense that, over a year later, the major players explain exactly why such differential treatment was demanded for AIG, than the commercial and investment banks which the government elected to save.
The first, on Friday, concerned emails from Fed personnel addressing the filing of detailed information regarding AIG's payments to counterparties. The Fed directed AIG to conceal details which AIG personnel indicated the SEC would prefer reported.
Aside from the obvious issue of one hand not knowing what the other is doing, or there being conflicts between federal entities on what they demand/require of companies, there's the issue of transparency.
The Fed's position smacks of concern that the actions it directed AIG to take were ones it would be unable, or unwilling, to explain and defend in public.
This sort of clandestine action by government, with a major once-private, then questionably "taken" by government, ought to be very worrisome to the business community.
A day later, in the weekend edition, the Journal published, as its customary single, long interview with a prominent business person, a piece by Holman Jenkins regarding his recent conversation with former AIG CEO Hank Greenberg.
I won't reprint major portions of Jenkins' piece. Suffice to say, Greenberg made his major theme that the business press needs to ferret out why Goldman Sachs, Morgan Stanley, Citigroup, et. al., were saved by federal cash, while AIG was, instead, marked for takeover and eradication.
Greenberg mentions something about which I was unaware, and I'm sure I'm not alone. He explained a 2005 change in the operation of credit default swaps by ISDA, the International Swaps and Derivatives Association. The change essentially changed such swaps from having value changes settled once, at maturity, to being ongoing 'mark to market' payments. He doesn't allege, but asks, whether or not Goldman Sachs, which bought large amounts of such swaps from AIG, was behind this change?
He also bluntly challenges the press to discover why AIG was treated so differently by Paulson and Bernanke than were the commercial and investment banks?
One passage really does deserve to be quoted,
"Most of all, he cannot fathom why Treasury and the Federal Reserve let billions of dollars fly out the backdoor to Goldman and other firms. Washington could have simply ordained that AIG's debts were the government's debts and so no collateral was due given Uncle Sam's bulletproof credit rating."It's a more than fair point. And Greenberg, never a fool, is clever to call for objective press investigations into this mess.
If you see unholy alliances between Goldman and the Treasury and/or Fed, made in the shadows, then you find yourself agreeing with Greenberg's demand that somebody force explanations.
Even if you don't see such alliances, it still makes sense that, over a year later, the major players explain exactly why such differential treatment was demanded for AIG, than the commercial and investment banks which the government elected to save.
Thursday, December 24, 2009
AIG, The Fed, & Financial Collapse
Almost a month ago, in the November 27/28th weekend edition of the Wall Street Journal, Peter J. Wallison of the American Enterprise Institute wrote a thought-provoking piece regarding the "lack of candor" surrounding the federal government's reasons for bailing out AIG.
He wrote,
"Since last September, the government's case for bailing out AIG has rested on the notion that the company was too big to fail.
Last week's news that this was not in fact the motive for AIG's rescue has implications that go well beyond the Obama administration's efforts to regulate CDSs and other derivatives."
According to the TARP's inspector general, Neil Barofsky, Geithner did not, in fact, believe AIG's credit default swap exposures were "a relevant factor" in the rescue.
Wallison's point is that, based upon the government's initial reasons for bailing out the insurer, Congress has rushed through some bad new regulatory legislation promulgated on the theory of unsupervised interconnectedness of large financial institutions.
If this weren't the reason for AIG's "rescue," then what was? And why are we so worried about something that Geithner contends wasn't the reason for taking over privately-owned AIG?
This sort of quasi-Constitutional, quasi-political question has somehow escaped notice in all the furor over private sector companies- insurers, commercial and investment banks- which were simply distributing the government's own flawed, low-quality mortgage-backed securities.
Perhaps that fact that the two major architects of Fannie Mae's and Freddie Mac's demise, Barney Frank and Chris Dodd, are in charge of all things financial in Congress, has a lot to do with why there has been no in-depth investigation of a Republican administration's concerns over interconnectedness that, upon closer inspection, was actually nowhere to be found.
Considering Congress' headlong rush to another piece of bad legislation, this time redrafting financial sector regulations, it would be a good time to pause and go through the AIG debacle slowly, with a fine-toothed comb, to learn exactly who was worried about the insurer, and why.
He wrote,
"Since last September, the government's case for bailing out AIG has rested on the notion that the company was too big to fail.
Last week's news that this was not in fact the motive for AIG's rescue has implications that go well beyond the Obama administration's efforts to regulate CDSs and other derivatives."
According to the TARP's inspector general, Neil Barofsky, Geithner did not, in fact, believe AIG's credit default swap exposures were "a relevant factor" in the rescue.
Wallison's point is that, based upon the government's initial reasons for bailing out the insurer, Congress has rushed through some bad new regulatory legislation promulgated on the theory of unsupervised interconnectedness of large financial institutions.
If this weren't the reason for AIG's "rescue," then what was? And why are we so worried about something that Geithner contends wasn't the reason for taking over privately-owned AIG?
This sort of quasi-Constitutional, quasi-political question has somehow escaped notice in all the furor over private sector companies- insurers, commercial and investment banks- which were simply distributing the government's own flawed, low-quality mortgage-backed securities.
Perhaps that fact that the two major architects of Fannie Mae's and Freddie Mac's demise, Barney Frank and Chris Dodd, are in charge of all things financial in Congress, has a lot to do with why there has been no in-depth investigation of a Republican administration's concerns over interconnectedness that, upon closer inspection, was actually nowhere to be found.
Considering Congress' headlong rush to another piece of bad legislation, this time redrafting financial sector regulations, it would be a good time to pause and go through the AIG debacle slowly, with a fine-toothed comb, to learn exactly who was worried about the insurer, and why.
Monday, December 14, 2009
On Conservation of Risk, Poor Risk Management & Government Intervention- Part 1
Over the weekend, I had an extensive discussion with my business partner on the topics of financial risk, Goldman Sachs, AIG, and the federal government and Federal Reserve's payment of AIG's credit derivatives obligations amidst its takeover of the insurer.
The reason for our renewed discussion was a Wall Street Journal piece over the weekend which cited several new sources that again called into question Goldman's management's assertions, which continue to this day, that it was adequately hedged and in possession of sufficient collateral, which would not have lost value, such that they were really indifferent to AIG's survival or bankruptcy.
The Journal's own staffers, the TARP's inspector general, and a private risk analyst from Chicago, retained by CBS to review and comment on an internal AIG memo, all have disputed Goldman's assertions.
The details contained in the Journal's weekend story, entitled "Goldman Fueled AIG Gambles," were somewhat shocking. At least, to me.
The investment bank, according to the Journal piece, was ultimately repaid for "trades with AIG covering a total of $22 billion in assets."
Elsewhere in the article, it is stated that Goldman intermediated $14B of CDO deals, to Merrill's $6B, and that AIG ultimately insured some $80B of CDOs with credit derivatives.
As my partner and I talked about Goldman's strong-arming of the Fed and Treasury to repay 100% of AIG's credit derivatives obligations, despite being effectively, but, thanks to government intervention, not technically bankrupt, he contended that one should credit Goldman for its cleverness and alacrity.
I disagreed, and continue to do so. Here's why.
First, Goldman's insistence on being repaid in full, rather than accept an AIG bankruptcy, and, indeed, argue for it, has fatally undermined the Constitutionally-enshrined, normal bankruptcy process. I believe the unintended consequences of this act will reverberate globally, to the ultimate detriment of faith in the US dollar and Treasury obligations.
Second, given that the preponderance of evidence points to Goldman now misrepresenting how vulnerable it was to bankruptcy from the losses it would have taken on its AIG transactions, it doesn't actually appear to be the same Goldman Sachs of, say, John Whitehead's reign as CEO.
In fact, the AIG debacle exposes Goldman for being just another financial services firm which mismanaged risk to a degree that should have caused its failure. A failure that is vital to terminating the control of assets by inept management.
True, Goldman Sachs weathered 2007 and part of 2008 by betting against the residential finance boom. But, in the end, it was undone by the simplest of risk management mistakes.
Goldman Sachs' management forgot that, until an actual financial loss, total risk in the financial system cannot be eliminated. It is conserved, and transferred via transactions such as credit derivatives.
But that does not eliminate it from the financial system. In fact, to the contrary, due to a hoary technical term known as "counterparty risk," a firm can sell its risk to another party, perhaps even at what seems to be an attractive price, only to find, later, it still owns the risk, when the counterparty fails.
Thus, when you examine the details of AIG's CDO credit derivatives book, you see that Goldman was in for about 25% of it.
Further, according to the Journal article, Goldman was securitizing mortgage pools that were no better in quality than others. They contained subprime mortgages, loans from Countrywide, known for pioneering low- and no-doc loans. In effect, Goldman's brand, in this case, carried no actual expectation of higher quality mortgages.
Nothing that Goldman did involving its underwriting of CDOs or trading credit derivatives on them with the intent of transferring the risk to AIG would seem to actually connote superior skills or value provided to its clients.
If anything, Goldman Sachs traded on its image by extracting value from everyone else in the deals in which it participated.
But it made one really big mistake. It's management overlooked the risk to its own firm of piling on too much risk with one other player, AIG. Goldman's risk managers apparently disregarded the likely outcome of one insurer, AIG, assuming far too much CDO valuation risk, for, as it turned out, prices which were much too low.
When all of that risk became concentrated in AIG, and then became realized with the bursting of the housing bubble, that risk went back to those firms which had attempted to sell it to AIG.
Unlike many other observers of last year's financial crisis, I have never believed that the government intervention embodied in the TARP and the Federal Reserve's liquidity creation was necessary to avert some sort of 'systemic meltdown,' or a 'plunge into a financial abyss.'
I continue to believe that Anna Kagan Schwartz was correct in her contentions in an interview with the Wall Street Journal last fall. She diagnosed the late 2008 financial crisis as one of institutional solvency, not liquidity.
As such, she opined, crippled, insolvent institutions should have been closed, with the excess financial capacity allowed to disappear. If the US financial system truly needed added capacity, there are plenty of private equity and hedge funds ready to move in and seize the opportunities thus presented.
The dirty little secret of US banking in the past two decades has not been a lack of capacity, but an overabundance. That's why so many exotic instruments were created. Because the basic equities and debt products became so marginally profitable.
Just when the US financial system had a chance to clean out poor financial risk management in a Schumpeterian wave of failures of credit providers, the government foolishly caved in to the affected, about-to-fail institutions and ran the monetary printing presses to bail them out.
How are the risk managers at Goldman Sachs and its ilk to learn from their mistakes if those gargantuan mistakes were simply erased?
Unfortunately, the damage has and will spread beyond just those institutions, as I'll discuss in the next post on this topic later this week.
to be continued.....
The reason for our renewed discussion was a Wall Street Journal piece over the weekend which cited several new sources that again called into question Goldman's management's assertions, which continue to this day, that it was adequately hedged and in possession of sufficient collateral, which would not have lost value, such that they were really indifferent to AIG's survival or bankruptcy.
The Journal's own staffers, the TARP's inspector general, and a private risk analyst from Chicago, retained by CBS to review and comment on an internal AIG memo, all have disputed Goldman's assertions.
The details contained in the Journal's weekend story, entitled "Goldman Fueled AIG Gambles," were somewhat shocking. At least, to me.
The investment bank, according to the Journal piece, was ultimately repaid for "trades with AIG covering a total of $22 billion in assets."
Elsewhere in the article, it is stated that Goldman intermediated $14B of CDO deals, to Merrill's $6B, and that AIG ultimately insured some $80B of CDOs with credit derivatives.
As my partner and I talked about Goldman's strong-arming of the Fed and Treasury to repay 100% of AIG's credit derivatives obligations, despite being effectively, but, thanks to government intervention, not technically bankrupt, he contended that one should credit Goldman for its cleverness and alacrity.
I disagreed, and continue to do so. Here's why.
First, Goldman's insistence on being repaid in full, rather than accept an AIG bankruptcy, and, indeed, argue for it, has fatally undermined the Constitutionally-enshrined, normal bankruptcy process. I believe the unintended consequences of this act will reverberate globally, to the ultimate detriment of faith in the US dollar and Treasury obligations.
Second, given that the preponderance of evidence points to Goldman now misrepresenting how vulnerable it was to bankruptcy from the losses it would have taken on its AIG transactions, it doesn't actually appear to be the same Goldman Sachs of, say, John Whitehead's reign as CEO.
In fact, the AIG debacle exposes Goldman for being just another financial services firm which mismanaged risk to a degree that should have caused its failure. A failure that is vital to terminating the control of assets by inept management.
True, Goldman Sachs weathered 2007 and part of 2008 by betting against the residential finance boom. But, in the end, it was undone by the simplest of risk management mistakes.
Goldman Sachs' management forgot that, until an actual financial loss, total risk in the financial system cannot be eliminated. It is conserved, and transferred via transactions such as credit derivatives.
But that does not eliminate it from the financial system. In fact, to the contrary, due to a hoary technical term known as "counterparty risk," a firm can sell its risk to another party, perhaps even at what seems to be an attractive price, only to find, later, it still owns the risk, when the counterparty fails.
Thus, when you examine the details of AIG's CDO credit derivatives book, you see that Goldman was in for about 25% of it.
Further, according to the Journal article, Goldman was securitizing mortgage pools that were no better in quality than others. They contained subprime mortgages, loans from Countrywide, known for pioneering low- and no-doc loans. In effect, Goldman's brand, in this case, carried no actual expectation of higher quality mortgages.
Nothing that Goldman did involving its underwriting of CDOs or trading credit derivatives on them with the intent of transferring the risk to AIG would seem to actually connote superior skills or value provided to its clients.
If anything, Goldman Sachs traded on its image by extracting value from everyone else in the deals in which it participated.
But it made one really big mistake. It's management overlooked the risk to its own firm of piling on too much risk with one other player, AIG. Goldman's risk managers apparently disregarded the likely outcome of one insurer, AIG, assuming far too much CDO valuation risk, for, as it turned out, prices which were much too low.
When all of that risk became concentrated in AIG, and then became realized with the bursting of the housing bubble, that risk went back to those firms which had attempted to sell it to AIG.
Unlike many other observers of last year's financial crisis, I have never believed that the government intervention embodied in the TARP and the Federal Reserve's liquidity creation was necessary to avert some sort of 'systemic meltdown,' or a 'plunge into a financial abyss.'
I continue to believe that Anna Kagan Schwartz was correct in her contentions in an interview with the Wall Street Journal last fall. She diagnosed the late 2008 financial crisis as one of institutional solvency, not liquidity.
As such, she opined, crippled, insolvent institutions should have been closed, with the excess financial capacity allowed to disappear. If the US financial system truly needed added capacity, there are plenty of private equity and hedge funds ready to move in and seize the opportunities thus presented.
The dirty little secret of US banking in the past two decades has not been a lack of capacity, but an overabundance. That's why so many exotic instruments were created. Because the basic equities and debt products became so marginally profitable.
Just when the US financial system had a chance to clean out poor financial risk management in a Schumpeterian wave of failures of credit providers, the government foolishly caved in to the affected, about-to-fail institutions and ran the monetary printing presses to bail them out.
How are the risk managers at Goldman Sachs and its ilk to learn from their mistakes if those gargantuan mistakes were simply erased?
Unfortunately, the damage has and will spread beyond just those institutions, as I'll discuss in the next post on this topic later this week.
to be continued.....
Thursday, October 15, 2009
Holman Jenkins' Rare Mistake
I finally got around to reading Holman Jenkins' interview with Goldman Sachs CEO Lloyd Blankfein in the weekend edition of the Wall Street Journal. The colleague who urged me to read it was correct- it's primarly a public relations piece by Blankfein to try to smooth over the bank's image prior to news that it will be again paying stratospheric bonuses after being rescued by the Fed and Treasury last fall.
Of course, now, Blankfein will have none of that, as conveyed in the interview. Note, for example, these passages,
"Then there's the matter of AIG, source of snarling recriminations even among Goldman's Wall Street brethren. If AIG, a huge player in all kinds of markets, had gone down, the impact on the economy would have been incalculable. Mr. Paulson and Fed Chief Ben Bernanke wouldn't risk it. They reversed course after Lehman and bailed out the insurance giant to a tune that now has reached $180 billion. To this day, charges fly that the AIG bailout was a backdoor bailout of Goldman.
AIG had been a big issuer of guarantees on subprime-backed paper; Goldman had been a big buyer of those guarantees. Nonetheless, when government officials rang up to ask what would be the potential impact of an AIG bankruptcy on Goldman, Mr. Blankfein says his answer was: "negligible." He did not, he says, ask Washington to save AIG: "It never occurred to me, having lived through Lehman Brothers weekend, that there was government money for anything. People wanted to know how we were going to do when AIG went down. I was telling them we were fine."
Mr. Blankfein points to what he calls a fundamental aspect of Goldman culture—its risk-management discipline. AIG had been regarded on Wall Street as a gold-plated client, not just a "Street" counterparty. But Goldman had nonetheless taken the usual step of requiring AIG to post collateral nightly against any deterioration in the market value of the guaranteed assets.
Mr. Blankfein placed some of the phone calls himself. "AIG was being beastly, difficult to deal with, not responding well to our calls for collateral. And I called them up and fought with them, and it was always because they were disagreeing with our 'marks.' They never said, and I never had reason to suspect, 'We're illiquid. We don't have the money.' It never occurred to me."
Goldman, in its rigor, reinsured any shortfall with other counterparties, who were also required to post collateral nightly. "We had one day of exposure with them. It doesn't mean I can't lose $300 million if they don't pay because that's how much a market can move in a day, but basically I'm not worried about it."
These estimates, of course, have a theoretical element. The underlying assets would certainly have collapsed even further in value if Wall Street firms and AIG began dropping like nine-pins. We'll never know. In the event, AIG was rescued—though that now meant that taxpayer money, in a sense, was being shipped to Goldman to meet AIG's collateral obligations.
Some say today the government should have spurned Goldman's collateral demands. Some say it should even have forced Goldman to settle the outstanding positions at a discount.
Realistically, though, AIG faced hundreds of counterparties; and short of bankruptcy, which Washington had ruled out for AIG, no obvious formula presented itself for rewriting thousands of AIG contracts without risking the market panic Washington was trying to forestall. For its part, Goldman would have been on thin ice with its own shareholders if it had voluntarily relinquished valuable contract rights to make nice with Washington."
There's just one problem with that last paragraph. Mr. Jenkins is wrong.
In an article that appeared in the Wall Street Journal within a few months of the financial sector meltdown of last fall, one astute observer noted that there was, in fact, an existing process by which AIG's numerous counterparties could have been fairly and equally treated.
That option, of course, was bankruptcy. And it's rather curious to me that Jenkins glosses over this with a simple "Washington had ruled (that) out for AIG."
As that editorial writer noted several months ago in the Journal, putting AIG's swaps through bankruptcy, quickly, would have resulted in all counterparties taking a known, equal percentage haircut on the value of their positions. This is no different than learning that the value of your swap declined for some market reason. Swaps gain, and lose value all the time.
The source really is somewhat immaterial.
I'm surprised Jenkins gave Blankfein, Goldman and Washington all passes on this rather monumental corruption of capitalism.
AIG's takeover by the federal government is precisely the sort of unnecessary appropriation of private property, followed by draconian, confusing Congressional and administration rules impositions, that begs for more use of bankruptcy and less entanglement of Washington with private enterprise.
Of course, now, Blankfein will have none of that, as conveyed in the interview. Note, for example, these passages,
"Then there's the matter of AIG, source of snarling recriminations even among Goldman's Wall Street brethren. If AIG, a huge player in all kinds of markets, had gone down, the impact on the economy would have been incalculable. Mr. Paulson and Fed Chief Ben Bernanke wouldn't risk it. They reversed course after Lehman and bailed out the insurance giant to a tune that now has reached $180 billion. To this day, charges fly that the AIG bailout was a backdoor bailout of Goldman.
AIG had been a big issuer of guarantees on subprime-backed paper; Goldman had been a big buyer of those guarantees. Nonetheless, when government officials rang up to ask what would be the potential impact of an AIG bankruptcy on Goldman, Mr. Blankfein says his answer was: "negligible." He did not, he says, ask Washington to save AIG: "It never occurred to me, having lived through Lehman Brothers weekend, that there was government money for anything. People wanted to know how we were going to do when AIG went down. I was telling them we were fine."
Mr. Blankfein points to what he calls a fundamental aspect of Goldman culture—its risk-management discipline. AIG had been regarded on Wall Street as a gold-plated client, not just a "Street" counterparty. But Goldman had nonetheless taken the usual step of requiring AIG to post collateral nightly against any deterioration in the market value of the guaranteed assets.
Mr. Blankfein placed some of the phone calls himself. "AIG was being beastly, difficult to deal with, not responding well to our calls for collateral. And I called them up and fought with them, and it was always because they were disagreeing with our 'marks.' They never said, and I never had reason to suspect, 'We're illiquid. We don't have the money.' It never occurred to me."
Goldman, in its rigor, reinsured any shortfall with other counterparties, who were also required to post collateral nightly. "We had one day of exposure with them. It doesn't mean I can't lose $300 million if they don't pay because that's how much a market can move in a day, but basically I'm not worried about it."
These estimates, of course, have a theoretical element. The underlying assets would certainly have collapsed even further in value if Wall Street firms and AIG began dropping like nine-pins. We'll never know. In the event, AIG was rescued—though that now meant that taxpayer money, in a sense, was being shipped to Goldman to meet AIG's collateral obligations.
Some say today the government should have spurned Goldman's collateral demands. Some say it should even have forced Goldman to settle the outstanding positions at a discount.
Realistically, though, AIG faced hundreds of counterparties; and short of bankruptcy, which Washington had ruled out for AIG, no obvious formula presented itself for rewriting thousands of AIG contracts without risking the market panic Washington was trying to forestall. For its part, Goldman would have been on thin ice with its own shareholders if it had voluntarily relinquished valuable contract rights to make nice with Washington."
There's just one problem with that last paragraph. Mr. Jenkins is wrong.
In an article that appeared in the Wall Street Journal within a few months of the financial sector meltdown of last fall, one astute observer noted that there was, in fact, an existing process by which AIG's numerous counterparties could have been fairly and equally treated.
That option, of course, was bankruptcy. And it's rather curious to me that Jenkins glosses over this with a simple "Washington had ruled (that) out for AIG."
As that editorial writer noted several months ago in the Journal, putting AIG's swaps through bankruptcy, quickly, would have resulted in all counterparties taking a known, equal percentage haircut on the value of their positions. This is no different than learning that the value of your swap declined for some market reason. Swaps gain, and lose value all the time.
The source really is somewhat immaterial.
I'm surprised Jenkins gave Blankfein, Goldman and Washington all passes on this rather monumental corruption of capitalism.
AIG's takeover by the federal government is precisely the sort of unnecessary appropriation of private property, followed by draconian, confusing Congressional and administration rules impositions, that begs for more use of bankruptcy and less entanglement of Washington with private enterprise.
Tuesday, March 17, 2009
On The AIG Bonuses
Yesterday's Wall Street Journal's headline article focused on the apparent fury caused by the payment of contractually-required bonuses to AIG personnel in the unit which triggered its near-insolvency and subsequent purchase by the Federal government.
Everybody from US Senators and Representatives of both parties, to talk show hosts such as Bill O'Reilly and Sean Hannity decried the payment of these bonuses. Iowa Republican Senator Chuck Grassley, in perhaps the worst excess, called for Ed Liddy and his executive team to publicly apologize, then either resign or "commit suicide."
This sort of demagoguery is precisely why government intrusion into private companies, whether they be publicly- or privately-held, is to be avoided at all costs.
The clearest, most illuminating explanation of the situation was provided yesterday by former federal judge Andrew Napolitano on Fox News. The judge, a Fox News contributor, laid the blame on the very same federal government whose senior members are now outraged at what they have wrought.
Napolitano noted that the Fed, in its rush to save AIG, twice, simply took over the firm, fired its CEO and board, asked Ed Liddy to head the firm, filled the board with its own slate of directors, and put no effective constraints on the arrangement. In short, as Napolitano explained, the government did no due diligence, did not become aware of the contractually-required bonus payments, and, therefore, did not take necessary steps to void them.
By the way, this is yet another instance in which a proper Chapter 11 filing would have allowed AIG to continue operating, but given a court-appointed referee the power to void or alter contracts such as the ones requiring the recent payments of several hundred million dollars of bonuses.
It's all well and good for various pundits to declare that without the federal intervention, these bonuses wouldn't even be payable. But that is precisely the point. Bankruptcy would have precluded this embarrassing example of federal ineptitude.
Now that taxpayers own AIG, we are being subjected to the rantings of the third-rate, relatively-unintelligent people we elected to Congress and the executive branch. Having just spent more than a trillion dollars of our money, between the so-called stimulus bill and the 'regular' budget, these public trough-feeders now express outrage- outrage!- at the requirement that their hasty actions have necessitated, i.e., paying a few comparatively measly hundred million dollars to employees of AIG.
But, if spending a trillion dollars on largely pork barrel projects is a good thing, isn't putting a few hundred million dollars into the pockets of AIG employees good, too?
Where's the consistency in the logic that certain spending waste is okay, but other spending that goes directly to consumers is not?
But, as judge Napolitano noted, the feds have only themselves to blame. They rushed in and unwisely seized AIG. Now, their hasty and ill-conceived action is generating unwanted consequences.
Is it too much to hope that maybe government officials will use existing means for processing insolvent companies in the future, i.e., Chapter 11, and refrain from ham-handedly seizing private property without due process?
Everybody from US Senators and Representatives of both parties, to talk show hosts such as Bill O'Reilly and Sean Hannity decried the payment of these bonuses. Iowa Republican Senator Chuck Grassley, in perhaps the worst excess, called for Ed Liddy and his executive team to publicly apologize, then either resign or "commit suicide."
This sort of demagoguery is precisely why government intrusion into private companies, whether they be publicly- or privately-held, is to be avoided at all costs.
The clearest, most illuminating explanation of the situation was provided yesterday by former federal judge Andrew Napolitano on Fox News. The judge, a Fox News contributor, laid the blame on the very same federal government whose senior members are now outraged at what they have wrought.
Napolitano noted that the Fed, in its rush to save AIG, twice, simply took over the firm, fired its CEO and board, asked Ed Liddy to head the firm, filled the board with its own slate of directors, and put no effective constraints on the arrangement. In short, as Napolitano explained, the government did no due diligence, did not become aware of the contractually-required bonus payments, and, therefore, did not take necessary steps to void them.
By the way, this is yet another instance in which a proper Chapter 11 filing would have allowed AIG to continue operating, but given a court-appointed referee the power to void or alter contracts such as the ones requiring the recent payments of several hundred million dollars of bonuses.
It's all well and good for various pundits to declare that without the federal intervention, these bonuses wouldn't even be payable. But that is precisely the point. Bankruptcy would have precluded this embarrassing example of federal ineptitude.
Now that taxpayers own AIG, we are being subjected to the rantings of the third-rate, relatively-unintelligent people we elected to Congress and the executive branch. Having just spent more than a trillion dollars of our money, between the so-called stimulus bill and the 'regular' budget, these public trough-feeders now express outrage- outrage!- at the requirement that their hasty actions have necessitated, i.e., paying a few comparatively measly hundred million dollars to employees of AIG.
But, if spending a trillion dollars on largely pork barrel projects is a good thing, isn't putting a few hundred million dollars into the pockets of AIG employees good, too?
Where's the consistency in the logic that certain spending waste is okay, but other spending that goes directly to consumers is not?
But, as judge Napolitano noted, the feds have only themselves to blame. They rushed in and unwisely seized AIG. Now, their hasty and ill-conceived action is generating unwanted consequences.
Is it too much to hope that maybe government officials will use existing means for processing insolvent companies in the future, i.e., Chapter 11, and refrain from ham-handedly seizing private property without due process?
Monday, November 10, 2008
AIG's Failed Quantitative Risk Models
Last Monday's Wall Street Journal featured a page one piece on the failure of AIG's risk management models.
It definitely caught my attention, because I had written recently on the fallacy of composition in risk management on Wall Street in this post just over a month ago.
"Here we have an unintended consequence affect the situation, due to the fallacy of composition.
Such a downgrade leads each counterparty of such an affected, downgraded firm to require more collateral on each position held with that firm as a counterparty. Thus, in the blink of an eye, or the stroke of a pen at a rating agency, the financial collateral requirements for a firm's book of positions with other trading partners rises significantly.
This is what actually drove AIG into ownership by the US Treasury. Its downgrading by a credit rating agency caused AIG's counterparties to require more collateral for swaps and other insurance arrangements it had sold than the firm had capital available to provide for such needs.
Do you suppose any of the quantitative, computer-based risk management systems of any of AIG's counterparties had the capability to model, forecast and integrate into their risk estimations such an occurrence? Did any of AIG's counterparties have enough knowledge of AIG's exposures to allow it to reasonably estimate the effects on that firm's capital position, and, thus, its risk as a counterparty, if it were downgraded?
I doubt it.
Thus, in yet another perverse way, the individual, similar actions of many financial service players, collectively, lead to a result which causes more risk and uncertainty in the system, even as each individual party seems to act to reduce its own risk to its positions and its counterparties."
Well, the Journal's AIG piece basically confirms my suspicions. Specifically, the article begins by describing how AIG's risk modeling was dependent upon the work of an outside consultant, Gary Gorton, who teaches at Yale's management school. It notes,
"Mr. Gorton, who teaches at Yale School of Management, is best known for his influential academic papers, which have been cited in speeches by Federal Reserve Chairman Ben Bernanke. But he also has a lucrative part-time gig: devising computer models used by the giant insurer to gauge risk in more than $400 billion of devilishly complicated deals called credit-default swaps.
AIG relied on those models to help figure out which swap deals were safe. But AIG didn't anticipate how market forces and contract terms not weighed by the models would turn the swaps, over the short term, into huge financial liabilities. AIG didn't assign Mr. Gorton to assess those threats, and knew that his models didn't consider them. Those risks have cost AIG tens of billions of dollars and pushed the federal government to rescue the company in September.
The swaps expose AIG to three types of financial pain. If the debt securities default, AIG has to pay up. But there are two other financial risks as well. The buyers of the swaps -- AIG's "counterparties" or trading partners on the deals -- typically have the right to demand collateral from AIG if the securities being insured by the swaps decline in value, or if AIG's own corporate-debt rating is cut. In addition, AIG is obliged to account for the contracts on its own books based on their market values. If those values fall, AIG has to take write-downs.
Mr. Gorton's models harnessed mounds of historical data to focus on the likelihood of default, and his work may indeed prove accurate on that front. But as AIG was aware, his models didn't attempt to measure the risk of future collateral calls or write-downs, which have devastated AIG's finances."
Thus, AIG used a fairly simple set of assumptions which neglected to consider both the effects of actions by other investors in similar assets, and the resulting changes in collateral, should those investors' actions lead to downward price spirals.
It should give you pause to realize that there has been a fairly widespread knowledge of the cascading effect of position liquidation ever since the failure of 'portfolio insurance' in the 1987 Crash. That's over twenty years ago.
Where have Mr. Gorton and AIG's senior and risk management executives been during that time? How could they have possibly believed that a quantitative risk management system which deliberately omitted effects of panic selling and attendant collateral increases due to other position value declines would have much relevance to the real world facing AIG and its trading and investment books?
Yet, even with such glaring holes in its approach to risk measurement and management, AIG paid Mr. Gorton a small fortune to do an inadequate job. Nice work, indeed, if you can get it. You can bet that Mr. Gorton will not be liable for any damages to AIG.
To understand how out of touch with real market behavior Gorton is, the article quotes his comments to one of his classes at Yale recently,
"On a rainy morning last week, Mr. Gorton briefly discussed with his Yale students how perplexing the struggles of the financial world have become. About 30 graduate students listened as Mr. Gorton lamented how problems in one sector caused investors to question value all across the board. Said Mr. Gorton: "There doesn't seem to be a fundamental reason why." "
Of course there is a fundamental reason why. That 'one sector' just happened to be one involving sophisticated investors and traders valuing structured and arcane financial instruments. When the CDOs, MBSs and swaps all went untradeable due to real, identifiable underlying trends, e.g., the cooling of the mortgage origination market and the observable rise in alt-a and subprime mortgage defaults and delinquencies, the broader markets began to realize that the so-called 'sophisticated' investors had gotten valuations terribly wrong.
In effect, the fact that many institutional investors who were presumed to be so astute were seen either holding untradeable paper, worth little in a 'mark-to-market' world, or dumping that paper at large losses, when possible, caused bystanding investors to wonder what the value of anything now was. Especially the equity and debt of the publicly-held institutions visibly undergoing value evaporation due to having misunderstood the values of these exotic structured instruments.
This whole mess didn't start because your grandmother worried about the value of Google's equity.
It began because sharp-elbowed asset managers and traders at opportunistic investment banks and hedge funds, such as Bear Stearns, Lehman, Goldman Sachs, and Citadel, began to react, logically, to the news of economic trends in mortgage markets which had all-too-obvious implications for holders of structured finance instruments and swaps.
That's why it only took one sector's actions to cause the resulting cascade of value destruction and, eventually, AIG's demise amidst a sea of poorly-understood risks on its balance sheet.
It definitely caught my attention, because I had written recently on the fallacy of composition in risk management on Wall Street in this post just over a month ago.
"Here we have an unintended consequence affect the situation, due to the fallacy of composition.
Such a downgrade leads each counterparty of such an affected, downgraded firm to require more collateral on each position held with that firm as a counterparty. Thus, in the blink of an eye, or the stroke of a pen at a rating agency, the financial collateral requirements for a firm's book of positions with other trading partners rises significantly.
This is what actually drove AIG into ownership by the US Treasury. Its downgrading by a credit rating agency caused AIG's counterparties to require more collateral for swaps and other insurance arrangements it had sold than the firm had capital available to provide for such needs.
Do you suppose any of the quantitative, computer-based risk management systems of any of AIG's counterparties had the capability to model, forecast and integrate into their risk estimations such an occurrence? Did any of AIG's counterparties have enough knowledge of AIG's exposures to allow it to reasonably estimate the effects on that firm's capital position, and, thus, its risk as a counterparty, if it were downgraded?
I doubt it.
Thus, in yet another perverse way, the individual, similar actions of many financial service players, collectively, lead to a result which causes more risk and uncertainty in the system, even as each individual party seems to act to reduce its own risk to its positions and its counterparties."
Well, the Journal's AIG piece basically confirms my suspicions. Specifically, the article begins by describing how AIG's risk modeling was dependent upon the work of an outside consultant, Gary Gorton, who teaches at Yale's management school. It notes,
"Mr. Gorton, who teaches at Yale School of Management, is best known for his influential academic papers, which have been cited in speeches by Federal Reserve Chairman Ben Bernanke. But he also has a lucrative part-time gig: devising computer models used by the giant insurer to gauge risk in more than $400 billion of devilishly complicated deals called credit-default swaps.
AIG relied on those models to help figure out which swap deals were safe. But AIG didn't anticipate how market forces and contract terms not weighed by the models would turn the swaps, over the short term, into huge financial liabilities. AIG didn't assign Mr. Gorton to assess those threats, and knew that his models didn't consider them. Those risks have cost AIG tens of billions of dollars and pushed the federal government to rescue the company in September.
The swaps expose AIG to three types of financial pain. If the debt securities default, AIG has to pay up. But there are two other financial risks as well. The buyers of the swaps -- AIG's "counterparties" or trading partners on the deals -- typically have the right to demand collateral from AIG if the securities being insured by the swaps decline in value, or if AIG's own corporate-debt rating is cut. In addition, AIG is obliged to account for the contracts on its own books based on their market values. If those values fall, AIG has to take write-downs.
Mr. Gorton's models harnessed mounds of historical data to focus on the likelihood of default, and his work may indeed prove accurate on that front. But as AIG was aware, his models didn't attempt to measure the risk of future collateral calls or write-downs, which have devastated AIG's finances."
Thus, AIG used a fairly simple set of assumptions which neglected to consider both the effects of actions by other investors in similar assets, and the resulting changes in collateral, should those investors' actions lead to downward price spirals.
It should give you pause to realize that there has been a fairly widespread knowledge of the cascading effect of position liquidation ever since the failure of 'portfolio insurance' in the 1987 Crash. That's over twenty years ago.
Where have Mr. Gorton and AIG's senior and risk management executives been during that time? How could they have possibly believed that a quantitative risk management system which deliberately omitted effects of panic selling and attendant collateral increases due to other position value declines would have much relevance to the real world facing AIG and its trading and investment books?
Yet, even with such glaring holes in its approach to risk measurement and management, AIG paid Mr. Gorton a small fortune to do an inadequate job. Nice work, indeed, if you can get it. You can bet that Mr. Gorton will not be liable for any damages to AIG.
To understand how out of touch with real market behavior Gorton is, the article quotes his comments to one of his classes at Yale recently,
"On a rainy morning last week, Mr. Gorton briefly discussed with his Yale students how perplexing the struggles of the financial world have become. About 30 graduate students listened as Mr. Gorton lamented how problems in one sector caused investors to question value all across the board. Said Mr. Gorton: "There doesn't seem to be a fundamental reason why." "
Of course there is a fundamental reason why. That 'one sector' just happened to be one involving sophisticated investors and traders valuing structured and arcane financial instruments. When the CDOs, MBSs and swaps all went untradeable due to real, identifiable underlying trends, e.g., the cooling of the mortgage origination market and the observable rise in alt-a and subprime mortgage defaults and delinquencies, the broader markets began to realize that the so-called 'sophisticated' investors had gotten valuations terribly wrong.
In effect, the fact that many institutional investors who were presumed to be so astute were seen either holding untradeable paper, worth little in a 'mark-to-market' world, or dumping that paper at large losses, when possible, caused bystanding investors to wonder what the value of anything now was. Especially the equity and debt of the publicly-held institutions visibly undergoing value evaporation due to having misunderstood the values of these exotic structured instruments.
This whole mess didn't start because your grandmother worried about the value of Google's equity.
It began because sharp-elbowed asset managers and traders at opportunistic investment banks and hedge funds, such as Bear Stearns, Lehman, Goldman Sachs, and Citadel, began to react, logically, to the news of economic trends in mortgage markets which had all-too-obvious implications for holders of structured finance instruments and swaps.
That's why it only took one sector's actions to cause the resulting cascade of value destruction and, eventually, AIG's demise amidst a sea of poorly-understood risks on its balance sheet.
Wednesday, September 17, 2008
About AIG
I wrote the prior two posts appearing today before the close of the market yesterday. Thus, the AIG loan package from the Federal government was not yet finalized.
How could I not write a few words about the AIG debacle today?
At first, it seemed to me a reasonable solution that AIG should be induced to file Chapter 11, with the Treasury or Fed as trustee. In short order, three companies would be created, one being the collection of pure insurance firms which are registered in various US states and foreign countries, the second being those units which functioned as mutual fund managers, and the third being 'all other,' including proprietary risk-taking businesses of AIG.
In discussing this last night with a friend who works at Fitch, we agreed that such a solution would make sense and be reasonably pragmatic.
Thus, my initial reaction to the loan extended to Willumstad's AIG was that it is a needless and further corruption of the doctrine of moral hazard. One look at the nearby Yahoo-sourced chart of AIG's equity price for the past twelve months clearly illustrates that AIG's management had fair warning that investors were not going to be receptive to providing new capital at reasonable prices.From January of this year, the company's share price decline began accelerating, hitting a sharper decline after May. But that was over three months ago.
Like Lehman, one may fairly argue that Martin Sullivan, Willumstad's predecessor, had plenty of time to see danger ahead and do something about it.
As I said to my business partner, and the friend with whom I spoke last night, Hank Greenberg was to AIG what Jack Welch was to GE. Both presided over corporate structures and performance in ways that effectively sprinkled pixie dust over analysts and investors. As soon as each was gone, both of the latter groups suddenly declared the companies 'complex,' 'difficult to understand,' and the value of both firms plunged.
One can question, in both cases, but especially AIG, why anyone let such a complex financial grabbag of businesses be so highly rated for so long.
In that sense, I disagree with the Federal loan arrangement, which seems to reward building impenetrable financial corporation structures, then waiting too long to shore up capital.
On the other hand, panic among consumers holding life and other insurance policies from AIG, as well as investors in its mutual funds, would create needless and unwarranted upheaval.
Perhaps the warrants that the US government holds, which have value, should AIG not effectively dismantle itself, creating sufficient value to pay off the $85B loan, is sufficient price to dissuade other financial service entities from taking prudent action before needing to fall on the mercy of the US taxpayer.
Perhaps not.
If the loan truly only buys breathing room for the dismantling of AIG into an insurance firm, an asset manager, and the rest of the mess which comprised it, and the values of the good parts repay the loan, with the US government as senior creditor, then it might make sense.
I just question whether the larger signal that CEOs can continue blithely ignoring capital inadequacy and clear weakness, knowing that the more complex, entangled and diversified the firm is, the more likely a regulator will ultimately take it over, is a net benefit.
I don't think it is.
Subscribe to:
Posts (Atom)
