Tuesday, April 7, 2009

AIG’s Bank Payments Probed by TARP Inspector General

Posted on Bloomberg by Hugh Son:

The Treasury’s chief watchdog for the U.S. financial rescue program is probing whether American International Group Inc. paid more than necessary to banks including Goldman Sachs Group Inc. after the insurer’s bailout.

Neil Barofsky, special inspector general for the Troubled Asset Relief Program, began an audit last week into whether there were attempts by New York-based AIG or the government to reduce the payments, according to an April 3 letter to Representative Elijah Cummings. The Maryland Democrat requested the probe last month along with 26 other members of Congress.

Lawmakers, frustrated with the cost of an AIG bailout that has expanded three times, have asked why about $50 billion was paid after the initial September rescue to banks that bought credit-default swaps from the firm. The audit will reveal who made “critical decisions” regarding the payments and provide an explanation for the actions, Barofsky said.

“To what extent did AIG pay counterparty claims at 100 percent of face value and was any attempt made to renegotiate and close out these claims with ‘haircuts?’” Barofsky wrote. “Questions concerning whether AIG paid more than necessary to counterparties and whether Treasury adequately monitored such payments are clearly relevant.”

AIG, under pressure to show how its $182.5 billion U.S. bailout was being spent, revealed on March 15 that banks including Goldman Sachs, Deutsche Bank AG and Societe Generale SA were top recipients.

Goldman Sachs

Barofsky will also examine if there was any review about the ability of banks “such as Goldman Sachs” to sustain losses on the swaps, he said in the letter.

Goldman Sachs had cash and liquid securities as collateral against its exposure to AIG and had bought credit-default swaps as protection where there was a difference in the collateral and what AIG owed, CEO Lloyd Blankfein said today at a conference sponsored by the Council of Institutional Investors.

“We spent over $100 million protecting our shareholders against a default by AIG,” Blankfein said in Washington. “So at the end of the day, we were sleeping very comfortably from a credit risk point of view with AIG.”

The lawmakers’ query concerns payments made to unwind some of AIG’s swaps, contracts similar to insurance that pay investors if bonds don’t pay as promised. AIG sold swaps to more than 20 U.S. and foreign banks. Christina Pretto, an AIG spokeswoman, didn’t immediately return a call for comment.

“We would like to know if the AIG counterparty payments, as made, were in the best interests of the taxpayers,” lawmakers led by Cummings said in a March 25 letter to Barofsky.

Ambac, Syncora

Competing insurers including Ambac Financial Group Inc. and the predecessor of Syncora Holdings Ltd. reached agreements with banks such as Citigroup Inc. and Merrill Lynch & Co. to cancel similar contracts at discounts to their expected losses.

Federal Reserve Chairman Ben S. Bernanke said in a March 24 congressional hearing that the systemic risk posed by an AIG failure went “well beyond” the insurers’ counterparties.

“More importantly than the specific losses associated with the counterparties would be the loss of confidence in the system as a whole and the likelihood we would have seen ‘a run on the banks’ given that markets did not know who ultimately was exposed to AIG,” Bernanke said.

GAO Report

The Government Accountability Office said last month that the Treasury should demand that AIG seek concessions from banks as a condition of the latest U.S. aid.

“If such concessions are not considered to be in the government’s interest, the reasons should be clearly articulated and explained,” the congressional auditors said.

Kristine Belisle, a spokeswoman for Barofsky, confirmed the authenticity of the April 3 letter. Results of the audit will be made public, she said, declining to comment further. Barofsky is a former New York-based federal prosecutor who was made inspector general for the $700 billion TARP plan in December.

The company’s rescue package includes as much as $70 billion from TARP, a $60 billion Federal Reserve credit line and $52.5 billion to buy mortgage-related securities it guaranteed or owned. AIG owes about $46 billion on its credit line as of last week.

After AIG was rescued by the U.S. from collapse last year, banks that bought credit-default swaps got $22.4 billion in collateral and $27.1 billion in payments to retire the contracts, the insurer said last month. The letter from Congress asked whether holders received 100 cents on the dollar for their securities, even if the holdings hadn’t defaulted.

Credit-Default Swaps

Credit-default swaps, conceived by bondholders, allow investors to buy protection against a possible default. As the market expanded, speculators started using them to bet on a borrower’s creditworthiness. The contracts pay the holder face value for the underlying securities or the cash equivalent should a company fail to repay its debt.

The $50 billion in payments made to banks for credit- default swaps after AIG’s bailout represent about half of the money that the insurer sent to financial firms and U.S. states from the middle of September to the end of 2008. Banks also got about $44 billion tied to securities lending, AIG said in a March 15 statement.

Cummings, 58, a member of the House Oversight and Government Reform Committee, was among the first lawmakers last year to question AIG’s plans to pay $1 billion in retention bonuses. A firestorm of criticism about the payments prompted President Barack Obama to demand that some bonuses be blocked or recovered.

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