Timothy Geithner, I Call Your Bluff
TSF (to view at Huffington Post - click above link) - January 7, 2010
By Janet Tavakoli

The Treasury responded to reports that the New York Fed asked AIG to suppress and delay facts about the bailout. Meg Reilly, a Treasury spokesperson claimed: “In the transaction at the heart of this dispute…the FRBNY [Federal Reserve Bank of New York] made a loan of $25 billion which is on track to be paid back in full with interest.” She claims the loan is currently “above water.”

In the first place, that loan is not the heart of the dispute. Nonetheless, the FRBNY should immediately release the details of all of the Maiden Lane III assets backing that loan and show the current prices BlackRock has placed on them. Based on the current market, it is extremely likely that the loan is underwater.

The assets backing the loan are so-called super senior and AAA rated collateralized debt obligations (CDOs). Similar CDOs trade for under ten cents on the dollar, not close to the average price of 35 cents for the loan’s assets shown in a recent Fed report. The Fed claims prices climbed 4.5%. Yet in the secondary market, prices have dropped.

The Fed awarded no-bid contracts to Blackrock to manage and price these assets (among other things). Given BlackRock’s track record as a CDO manager*, I have no reason to believe its prices are reliable. As I mention above, I have reason to question the prices.

[JT Note: The loan/asset value argument is a red herring. The average price may or may not be 35 cents, but secondary market trades suggest otherwise. We should see a list of the CDOs, the underwriter, the manager, the list of portfolio assets, and the prices for each. Some CDOs will be worth more than others. If any CDOs were liquidated or sold, we should know who bought the collateral and at what price. Click here to see a January 2008 snapshot of the inner portfolios of two of the CDOs. That said, the real issue is the settlement of the credit default swap contracts for 100 cents on the dollar when ten cents would have been appropriate. Asset values are not directly related to where the CDSs should have settled. If the "super senior" and "AAA" CDOs weren't worth anywhere near 100 cents on the dollar, then there is an issue with the way the deals were marketed and the way in which "sophisticated" investor participated. Now that unsophisticated public money is involved, and given AIG's near collapse, the CDSs should have settled at a bit more than the capital that would have been reserved if these CDOs had been worth their ratings, or around ten cents on the dollar as MBIA, Ambac, and FGIC have done. The circumstances surrounding this settlement were extraordinary and unprecedented. We should revisit this settlement, since public money was involved.]

If the Treasury wants to publicly claim the loan is not underwater, now is the time to prove it, even though this particular loan is not the key issue.

As Representative Darrell Issa explained in his letter to the Fed, at the heart of this dispute is my assertion that Treasury Secretary Timothy Geithner, in his former role as President of the FRBNY, paid 100 cents on the dollar to settle AIG’s credit default swap contracts, and he wildly overpaid. Other bond insurers including Ambac, MBIA, and FGIC have settled similar contracts for as little as ten cents on the dollar.

The general public was kept unaware of several politically explosive facts. Risky subprime loans partly backed CDOs that AIG insured. Goldman Sachs played a key role in AIG’s distress with both credit default swap transactions and CDOs that Goldman underwrote. The identities of the banks—including some foreign banks—that received payments were not revealed until five months after the bailout. The November 2009 TARP Inspector General’s report failed to mention that Goldman originated or bought protection from AIG on about $33 billion of the problematic $80 billion of U.S. mortgage assets that AIG "insured" with credit derivatives, about twice as much as the next two largest banks involved.

The TARP report also failed to highlight the synthetic CDOs underwritten by Goldman Sachs that remain on AIG’s books. There is nothing wrong with hedging or taking the opposite view to one's customers. There is nothing wrong with using credit derivatives to accomplish this goal. But there are serious questions about whether residential mortgage backed securities and downstream CDOs were value-destroying and misrated.

Wall Street was chiefly responsible for the “financial innovation” that did massive damage to the U.S. economy. I assert there should be fraud audits of Wall Street’s securitization activities.

Given the extraordinary circumstances surrounding AIGs trades, the global financial crisis, and the AIG bailout, it is time to reopen this issue. AIG’s counterparties can repurchase the approximately $62 billion in CDOs from Maiden Lane III at full price**. If the Fed really believes they are worth 35 cents on the dollar, then these counterparties will be getting a windfall versus ten cents on the dollar. As for Goldman Sachs’s approximately $8.2 billion in CDOs (including synthetic CDOs) that are still on AIG’s books, they can be settled at ten cents on the dollar, and excess collateral currently held by Goldman can be returned. This is the value at which other bond insurers have settled similar deals. The return of payments to AIG can be used to pay down its public debt, before banks pay tax-payer subsidized bonuses to their employees.

* BlackRock managed Pacific Pinnacle CDO ($1 billion; closed 1/1/07; event of default 2/4/08); Pinnacle Point Funding ($2B closed 6/7/07; acceleration 12/13/07); Tenorite CDO I ($1 B closed 5/11/07; liquidation 2/7/08); and Tourmaline CDO III ($1.5 billion closed 4/5/07; event of default 3/31/08). (Earlier I wrote a post that included a 2005 Tourmaline deal managed by BlackRock that ended up being part of a CDO bailed out by the Fed.) I highlight BlackRock’s 2007 CDOs similar to those in it now manages for the Fed, because in 2007 mainstream media was already reporting on the potential for these CDOs of this type to blow up. I wrote an article for the precursor to Risk Professional in early 2007 warning about the type of value-destroying CDOs that AIG insured. I had also issued earlier warnings on other types of value-destroying CDOs.

**The price can be adjusted for interim principal and interest payments, as applicable.



* Residential Mortgage Backed Securities (RMBS), Collateralized Debt Obligations (CDOs and CDO-squared), Structured Investment Vehicles (SIVs), Real Estate Mortgage Investment Conduits (REMICs and Re-REMICs), Asset Backed Commercial Paper (ABCP), and related credit derivatives. Wall Street also engaged in suspect securitizations of some credit card receivables, auto loans, bank trust preferred securities, commercial real estate loans, and a variety of corporate loans.

**When asked whether or not certain individuals had done anything illegal, I responded that I did “not think anyone did anything illegal, because Congress did not pass laws to make it so,” because I did not want to scapegoat individuals. I should have said: "That is up to the Department of Justice to determine.”


JT Note: Earlier I said we are at greater risk for deflationary collapse than before our last crisis. Washington is trying to stave off a massive deflationary collapse by temporarily reinflating it with more inflationary wild cards. Whether we get deflationary collapse followed by inflation or just move straight to inflation, the economy is guaranteed more pain.


Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008).

Janet Tavakoli's book on the global financial meltdown is Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley 2009)


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