The Ransom of AIG

Posted Nov. 30, 2009, at 6:51 p.m.

On the face of it, $182 billion was a lot to pay for the “rescue” last year of the American International Group, even though the mammoth global insurance company was judged too big to fail and even though American taxpayers may get some of it back.

A report on the bailout by Neil M. Barofsky, special inspector general for the Troubled Asset Relief Program blames Federal Reserve Bank of New York and Treasury Secretary Timothy F. Geithner, who headed it at the time. Mr. Barofsky also targeted Mr. Geithner’s Treasury Department and the Federal Reserve Board in October for their failure to prevent and even know about the $165 million in bonuses AIG planned to pay some of its employees next year.

The government watchdog’s report was published just as Congress is taking up the questions of whether the federal regulation of big financial institutions needs improving and whether or not the Fed is the right agency to take the lead in regulation.

Mr. Barofsky accused the Fed of failure to develop a workable rescue plan when AIG looked unable to meet demands that it pay off big insurance contracts to American and foreign banks. Instead of bargaining with these “counterparties” and forcing them to take a loss on these toxic assets, the New York Fed paid top dollar, far above their market value at the time. The report said that the effect of the federal assistance to AIG was “tens of billions of government money was funneled inexorably and directly to AIG’s counterparties.” Wall Street firms including Goldman Sachs, Merrill Lynch and Wachovia, as well as foreign banks like Societe Géneral and Deutsche Bank got full value for their soured derivatives contracts and American taxpayers got the bill for $27.1 billion.

The Barofsky report dismissed the excuse that Treasury and Fed officials lacked legal power to exert leverage and strike a better bargain. After all, they weren’t shy about using leverage to force nine big banking firms to accept TARP loans whether they needed them or not, and they used plenty of leverage in negotiating federal aid to General Motors and Chrysler.

The report went on to remind us that Mr. Geithner and the Fed stalled for four months in revealing the names of the firms that got the 100 percent payout on their devalued contracts. They said the disclosure would undermine AIG’s stability. But Barofsky noted that when they finally put out the details, “the sky did not fall.”

A rejoinder by the Fed and the New York Fed acknowledged the need for better regulation of the huge financial institutions: “More effective supervision might have identified and blocked the extraordinarily reckless risk-taking at AIG.”

They could well have added that while big financial firms may be too big to fail, they should never be considered too big to accept losses resulting from reckless risk-taking or restrictions on giving out big bonuses for poor performance.

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