“This ‘legally obligated’ stuff is a lot of nonsense,” says one expert on the Wall Street bailout.
To hear Treasury Secretary Tim Geithner tell the tale, the federal officials negotiating the taxpayer bailout of American Insurance Group had no choice but to provide full payment to the company’s trading partners, including Goldman Sachs.
“There was no way, financial, legal, or otherwise, we could have imposed haircuts, selectively default on any of those institutions, without the risk of downgrade and default,” Geithner told lawmakers on the House Oversight and Government Reform Committee last week.
[Economy1]Don’t tell that to Rep. Dennis Kucinich. The Ohio Democrat — who heads the committee’s domestic policy subpanel — says that federal officials had plenty of leverage to push Goldman for a lesser payout, but simply chose not to use it. Indeed, an investigation by his office, Kucinich says, found that Goldman was already preparing to take less than 100 cents on the dollar for the complex, AIG-backed securities it held at the time. He’s charging that Geithner — who headed the New York Federal Reserve when it funneled billions of dollars through AIG to other firms — simply put Goldman’s interests above those of taxpayers.
“There was only one way for Goldman Sachs to get all of the billions they claimed from AIG, and that was if the New York Fed voluntarily agreed to give it to them,” Kucinich, the populist former mayor of Cleveland, said in a little-noticed exchange with Geithner last week. “If the Fed had fought for taxpayers, Goldman would have had to take some losses and the cost to the people could have been minimized.”
Some legal experts agreed. “This ‘legally obligated’ stuff is a lot of nonsense,” said an expert on the Wall Street bailout who wasn’t authorized to speak on the record. “They [Fed officials] are only as legally obligated as they want to be.”
That Goldman is such a powerful player in Washington politics (then-Treasury Secretary Henry Paulson once headed of the firm) could only have contributed to the decision to pay on par, the expert noted. “The idea of imposing a haircut [on Goldman] just kind of wasn’t in the bloodstream of the people involved.”
The controversy stems from the $27 billion the Fed paid in late 2008 to settle roughly $62 billion in insurance contracts that AIG held with a number of large firms. As the mortgage market tanked, AIG had paid out billions to those companies — collateral based on the falling value of the securities. But the banks were all scrambling to cash out on the balance because they were allowed to make more collateral calls as AIG’s credit rating was being downgraded — and because the value of those mortgage bundles was still sinking fast.** **Effectively, the Fed scrapped the insurance contracts and bought the securities outright. “We paid the fair market value at that time for the assets,” Geithner said last week.
Critics of that arrangement have long wondered why the Fed agreed to pay the full amount, rather than negotiate a better deal for the taxpayers footing the bill. More recently, the scandal has surrounded news that the Fed, at the time, tried to hide those full payments from the public.
The gist of Kucinich’s beef, which focuses just on Goldman’s contract, is more nuanced: Because of a months-long disagreement with AIG over the value of the underlying securities, Goldman took out supplemental insurance policies on $2.5 billion it feared it would lose if AIG failed — much like seniors take out supplemental health policies to cover services that Medicare doesn’t. Goldman executives have said repeatedly that, aided by those policies, the firm was fully protected in the event that AIG went under.
“If AIG had defaulted on its obligations, our shareholders would have been protected against loss because we were fully hedged,” Goldman spokesman Michael DuVally said in an email Friday. “But, because AIG could meet its obligations, it avoided default.”
Left unmentioned, Kucinich says, is that Goldman’s supplementary policies were invalid in the case of a government takeover of AIG — which was the only way the insurance giant was ultimately able to meet its obligations. Translation: After the government stepped in to rescue AIG, Goldman was in a position to lose $2.5 billion, leaving the Fed with a good deal of leverage to negotiate lower payments on behalf of taxpayers.
“The New York Fed had a lot of leverage — a lot of leverage — to negotiate a reduction which would have saved taxpayers billions,” Kucinich told Geithner.
He wasn’t the only lawmaker making a stink about the deal. Rep. Stephen Lynch (D-Mass.) blasted Geithner over the Goldman payments, arguing that Fed officials had “every opportunity” to negotiate a better arrangement for taxpayers.
“The commitment to Goldman Sachs trumped the responsibility that our officials had to the American people,” Lynch said.
Geithner, for his part, fought back against all the critics. The Treasury secretary argued that — because current law doesn’t allow regulators to unwind troubled investment houses the way they can unwind failing commercial banks — officials were left will little choice but to prop up AIG and make good on all of its financial obligations. “We faced a very simple choice: Let AIG default or prevent it,” Geithner said. Allowing the former, he maintained, would have led to an economic collapse much worse than the one that occurred.
“Thousands of more factories would have closed their doors,” he testified. “Millions more Americans would have lost their jobs. The value of Americans’ houses and savings would have fallen even further than they did at that time. People would have rushed to take their money out of banks. It would have brought about utter collapse.”
A March 2009 report from the special inspector general of the Troubled Asset Relief Program indicates that AIG’s trading parties were well justified to fight for full payment on behalf of their shareholders. “[F]rom the counterparties perspective, offering a concession would mean giving away value and voluntarily taking a loss, in contravention of their fiduciary duty to their shareholders,” the report states. “They were contractually entitled to the par value of the [securities].”
But some critics of the Goldman payments have argued that, shareholders or none, the giants of Wall Street should have shown more willingness to absorb the consequences of a financial meltdown caused largely by them.
“Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won’t be laid off,” former New York governor Eliot Spitzer wrote last year. “Why can’t Wall Street royalty shoulder some of the burden?”
Instead, champagne-sipping Goldman employees are celebrating their bonuses this month.
Kucinich, representing a part of the country decimated by foreclosures in recent years, preferred to focus his criticisms not on the firms, but on the federal officials charged with protecting the public.
“The government gave Goldman Sachs more than Goldman Sachs had any right to expect while at the same time giving no financial relief whatever to millions of Americans facing a foreclosure crisis,” he told Geithner. “If that doesn’t illustrate what the New York Fed thought it was working for — or who it was working for — I don’t know what does.”
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