Now, many people have suggested that the counterparties should have taken a haircut. But keep in mind, AIG did get to liquefy its risk outside the scope of the contract, and it isn't like a total gift was bestowed upon the counterparties, either.
The counterparties had to deliver the actual bonds to AIG/Maiden Lane and tear up the contracts. If the counterparty did not hold the bond, it had to go out in the open market and buy that bond. The tearing up of the contract could have had actual costs to the counterparties.
Let's say I owned bond ABC as the result of facilitating a customer trade, but couldn't find protection or a market on ABC. But I could buy protection on bond XYZ that looks very similar to bond ABC, so I used the XYZ protection as my hedge. Now, by entering into the Maiden Lane deal, I have lost my XYZ protection. Yes, I may have been paid for some of the mark-to-market deterioration, but what if it gets worse? I no longer have my hedge. Now I need to go out and find a replacement hedge, and there are friction costs there, or I need to bear the risk of further market weakness.
Liquidity in the fixed-income markets relies on the ability of dealers to take principal risk. They are enabled to take principal risk by being able to hedge risk. When the ability to hedge is diminished, liquidity dries up. While some people may think Maiden Lane was a one-way street, in actuality there was give and take on both sides.So could we have allowed AIG to fail? Not without a price -- a price we got an inkling of when Lehman failed. That was the whole purpose of the AIG intervention to begin with: to ensure the (semi) orderly functioning of markets, and to prevent an already vulnerable system from suffering a massive shock. This was the defusing of a bomb so that no further damage was done. We did so by having AIG be a viable, but unwinding, entity. You have seen the roughly $13 billion Goldman received from AIG. Bucket one was return of collateral for return of cash lent. Bucket two was collateral posted based on market values. Bucket three was a transaction that unwound trades -- at a cost to both parties. Two of the buckets were unwinds of trades where bonds were exchanged for cash, and the third was posting of collateral that may very well be returned, depending on the future course of asset performance. None of this should be controversial; this was not a gift of money from the taxpayer to the counterparty -- in fact, it allowed for the unwind of AIG in an orderly manner, a manner which protected the taxpayer's 80% stake in AIG. Maybe now we can drop the showboating witch hunt and perhaps focus on issues that have some validity.
Know What You Own: In midday trading on Thursday, the most active stocks included Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), the Financial Bull 3X (FAS), the SPY Depositary Receipts (SPY), the Financial Select SPDR (NYSE) and Ford Motor (F).
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