The AIG Counterparty Negotiations

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"The AIG Counterparty Negotiations"


A lot of the coverage of the new SIGTARP report on the handling of the AIG payouts—and, indeed, the report itself to an extent—seems a bit misleading.

Stepping back, this all began when banks made various risky loans. In order to reduce the risks, they essentially bought insurance from AIG. But AIG itself didn’t manage its own risk-profile well. So when the loans started going bad, it turned out that AIG couldn’t cover its contracts. Consequently, AIG’s poor risk-management was going to undermine the risk-management at every firm that managed risk through contracts with AIG. That would have led to a wave of bank failures. So the government stepped in and took over AIG. At which point it paid out the contracts in full.

The accusation of the report is basically that the government could and should have gotten a better deal than that for taxpayers. Paying out 80 cents on the dollar or whatever. But one big question is how would that have worked. If AIG were a firm going bankrupt, what you would do is call everyone up and say “uh…we screwed up…we can pay everyone 80% of what we owe you or else we can declare bankruptcy and you guys can roll the dice and see what you get in the end.” That’s a good strategy. But once AIG had been taken over by the government, the government couldn’t really threaten to default on AIG’s contracts. The government could have threatened to use its regulatory authority in a punitive way unless AIG counterparties agreed to a quasi-voluntary haircut. I can see the case for doing that, but I can also see the case for not doing it.

The crux of the matter is that once AIG goes from being an on-the-verge-of-bankruptcy company to a government-owned company, there’s really no more leverage that’s 100 percent legitimate. You could have said, pre-takeover, “hey guys, we’ll take over AIG but only if you all promise to take a haircut on your obligations.” But then you’re setting up a game of chicken. Are you really going to cause an economy-killing wave of bank failures unless the banksters agree to take a haircut? Well, no you’re not. So even when you seem to have leverage you actually don’t.

What’s really wanted here is for the United States to be a different kind of country with a more public-spirited business class wherein the bank executives could be persuaded to “do the right thing” in light of all the crap that taxpayers were doing on their behalf. But we live in the United States of America.

Fundamentally, though, as with a lot of this stuff I think what’s being implicated is much less America’s financial crisis emergency response policies than our background conditions of social justice. The very rich people in the top 0.5 percent of the income distribution who’ve garnered such a large share of the economic gains of the past thirty years should pay higher taxes, and in return there should be more and better public services. The Federal Reserve shouldn’t be so complacent about ten percent unemployment.

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