Most mainstream media reports on special inspector general Neil Barofsky's audit of the Fed bailout of AIG summarized the findings as an implicit remonstration: Tim Geithner's Fed looks bad because it was unable to get AIG's counterparties to agree to a deal in which they received less than what they were owed under the terms of the credit default swaps AIG had entered into. But in the econoblogosphere, it's Rashomon all over again.
Naked Capitalism's Yves Smith exploded in anger, calling the report "far too forgiving" of the Fed, accusing Barofsky of being just "as badly cognitively captured as the Fed is" and declaring that the "uncritical reportage of defenses by the officialdom is annoying."
You get the sense that at this point in the game, Smith would not be satisfied by anything less than a firing squad. What she sees as uncritical reportage others could interpret as "leaving the Fed hung out to dry." For example, the audit reports that Fed was worried about "violating the principle of the sanctity of contract." Come on! The financial world was falling apart and the U.S. government was on the hook for hundreds of billions of dollars in a frantic effort to stave off utter disaster. In that milieu, the supposed sanctity of contracts is a bogus excuse, mere cover for doing nothing. As Smith points out:
Companies that get into trouble renegotiate their obligations as a matter of course. You cannot get blood from a turnip. And the fact that the Feds stepped in to prevent the financial system from collapsing is NOT THE SAME as an open-ended commitment to honor the obligations of a dead company.
Meanwhile, Felix Salmon is feeling charitable today. The fact that the financial world was falling apart, he argues, is reason to cut Geithner and the Fed some slack.
It shouldn't have happened, that's true: for the sake of putting a knife into the moral-hazard trade, some haircut -- any haircut -- should definitely have been imposed, even if it was only the 2 percent that UBS offered to accept.
But the government owned AIG, which created the situation that Germans call Anstaltslast: the fact that state-owned companies simply don't default on their obligations. The government was also battling a major crisis using the only weapon at its disposal: enormous amounts of liquidity. When you're putting out a fire, you don't stop to worry that large amounts of liquidity are going to end up where you don't particularly want them -- the important thing is putting out the fire.
So yes, given a bit more aggression and foresight, the Fed could have tried to cram down a haircut onto AIG's counterparties. But at the time, no one was particularly interested in being harsh to the global financial sector; instead, they were trying to rescue it.
Regular HTWW readers will know that in the past I have been sympathetic to the view that in the mad rush to keep the global economy functioning, mistakes were going to be made. But after reading Barofsky's report, I feel much less inclined to go there. The sequence of events is too blatant: The Fed asked the companies to take a haircut, the companies said no, and there is no evidence that the Fed pushed back at all. What kind of negotiating stance is that? It looks like pusillanimous capitulation.
But not to everyone. To the structured finance lawyer who writes The Economics of Contempt blog, the report vindicates Geithner! (That sound you just heard was Yves Smith popping like an over-inflated balloon.)
[The report] makes clear that the NY Fed did try to negotiate haircuts with AIG's counterparties, but not at all surprisingly, the counterparties (and the French regulators) refused, and the NY Fed was left with no choice but to pay par value. Geithner, contrary to popular belief, didn't have the powers of a bankruptcy court.
Economics of Contempt is relying here on one of the crucial reasons why the Fed's bargaining position differed from, say, the Obama administration's stance with regard to the hedge funds who were refusing to take haircuts in the negotiations over the GM and Chrysler restructurings. In the case of the automakers, the government could say, you're going to get a worse deal from the bankruptcy judge, so you better take this one now. That was a threat with some juice to it. But the whole point of the government bailout of AIG was to avoid a Lehman-like bankruptcy that would take everyone down with it. So, it is true, the Fed's leverage was not terrific.
I am less sure what to make of Economics of Contempt's position that for the Fed to play hardball would be an abuse of "its regulatory authority for purposes of retaliation." I don't think anyone was considering the Fed's attempt to get a haircut as "retaliation." Instead, a more appropriate framing would be that the Fed should be attempting to get the best deal for its taxpayer money. The Fed had moral authority -- We're saving all of your asses, so play ball!
Just such a position is taken by The Epicurean Dealmaker, who imagines a scenario in which the Fed stared down the reluctant banks and shamed them into compliance.
A sample:
I have also been authorized to inform you that we are fully aware of the legal rights and fiduciary duties which constrain each of you to do what you think is best for your firms and your stakeholders. Under normal circumstances, we would be entirely supportive of these obligations. However, these are not normal times. Furthermore, and because these are not normal times, I would like to inform you that the government of the United States of America will take an extremely dim view of any individual or institution which chooses to pursue simply its own interest and its own duties without regard for the consequences to the broad economy, this country, and indeed the entire world. This government has a fiduciary duty too, gentlemen, and I am afraid that it trumps yours.
There's a lot more where that came from, and it makes for very entertaining reading. There's just one problem. For the speech to work in real life, one would have to imagine it being delivered by Tim Geithner.
And I just don't see the Secretary of Treasury as a guy who could deliver, in this or any other reality, a passage like this:
I am not your fucking friend. As far as you are concerned, you should view me as the Angel of Fucking Death. Because the time has come for each of you to do what is right for the greater good. It is time to think about survival, gentlemen -- your own and that of your institutions -- both now and in the future. For let me assure you that the decisions you make in this room today will be remembered. They will be remembered, gentlemen, as long as there is a United States of America. And if, God willing, we all come through this terrible crisis to a safer and more stable world, those people who helped us get there will be remembered. And, perhaps more importantly, those people and institutions in this room which did not help us, which put their own narrow personal and corporate interests before the interests of this nation and its people, will be remembered as well.
The funny thing: Although that speech never was given and never could have been given by the parties involved, it contains an essential truth -- the decisions made during that fateful week will always be remembered. For its role, Goldman Sachs is now widely reviled, and it's very difficult to see how that will change, any time soon.
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