THE STASH NOVEMBER 17, 2009
Today's big financial story is the TARP inspector general report criticizing the New York Fed for not negotiating a better deal with all the banks--like Goldman and Merrill Lynch--whose mortgage-backed securities AIG had effectively insured, and to whom it owed big money once the market melted down. The inspector general, Neil Barofsky, says the Fed should have used its leverage to persuade the banks to accept less than 100 cents on the dollar (aka, a haircut).
For what it's worth, I think Matt Ygelsias is right about why this would have been a lot trickier than it sounds:
[O]ne 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.
Exactly. Recall that the government takeover came in September, whereas the counterparty negotiations happened in November. At that point the Fed could have just lied and said it was going to let AIG slide into bankruptcy if the counterparties didn't take a haircut. But 1.) it's not a great policy for the government to get into the business of systematic, strategic lying, and 2.) almost no one would have believed it in any case, since most of the reasons for bailing AIG out in September also existed two months later.