AIG and Greece: A Comparison of Bankruptcies

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- In the midst of the Greek crisis, a report was issued last week by a watchdog government agency assessing how the Federal Reserve handled the AIG crisis. Remember that one? At one point, the Feds had ponied up $182.3 billion to save AIG ( AIG). And let's put this in perspective: so far, the ECB/IMF has only agreed to a $151.5 billion bailout for Greece. But it is interesting. The European governments convinced the banks to settle for 50 cents on the dollar. AIG? The U.S. government insisted that AIG pay its creditors in full. Let's take a moment to refresh our memories on AIG.

AIG Revisited

The following comes from an article I wrote in April 2010:

1. On July 10, 2006, Henry Paulson left his job as CEO of Goldman Sachs ( GS) to become Secretary of the U.S. Treasury. Keep in mind that Goldman Sachs was a major client of AIG.

2. In mid-Sept. 2008, Treasury Secretary Paulson and Timothy Geithner, then head of the Federal Reserve Bank of New York (FRBNY), met with senior executives of AIG in the Bank's headquarters in New York. The only outsider in that meeting was Lloyd Blankfein. Blankfein replaced Paulson as CEO of Goldman Sachs.

3. As I reported in a March 2010 article, Goldman had a large stake in AIG's survival: an insurance claim for guaranteed asset-backed securities of almost $13 billion. That meeting resulted in an $85 billion credit line from the FRBNY later in Sept. 2008.

4. Why the FRBNY and not TARP? TARP was not enacted until Oct. 3, 2008.

AIG was effectively insolvent without the FRBNY credit. But with it, the AIG staff believed it could settle claims at 60 cents on the dollar and was prepared to start negotiating on that basis.

But then, two things happened:

1. The FRBNY instructed AIG to pay off claims in full;

2. The FRBNY did everything it could to keep the names of who was getting paid off out of the AIG reports to the SEC. It hoped the SEC would accept a total amount paid without the names of who got paid. But the SEC was insistent. Details were finally released on March 15, 2009. The following table details who got paid what from AIG (billions of US$):

At 60 cents on the dollar, the payout would have been $56 billion, a savings of $37 billion.

The New GAO Report

The new report adds useful detail to what we already know. Consider first the tone of the Fed's request for concessions (statements in quotes below are taken from the GAO report. The following is the script of a phone call that was made to one creditor:

"We have asked to meet with you in order to give you an opportunity to substantially reduce your counterparty exposure to AIG and assist in promoting the long-term viability of the company...."

More on the Fed's attempts to obtain concessions:"Our review found that FRBNY made varying attempts to obtain concessions and halted efforts before some of the counterparties responded to the Bank's request for the discounts. The counterparties opposed concessions...."

Counterparties opposed discounts? Well, what did the Feds expect? I quote again from the report:

"...the analysis identified one counterparty as resistant to deep concessions because a significant portion of its portfolio was high quality with little expectation of losses."

Oh. I see. Well then, never mind.

Back to what the report says about attempts to obtain concessions:

"FRBNY officials told us that in seeking concessions, they contacted 8 of the 16 counterparties.... FRBNY officials said that counterparties' initial reactions to these requests were negative....According to our interviews with 14 of the 16 counterparties, FRBNY appears to have started the process of seeking discounts with attempts of varying degrees of assertiveness to obtain concessions from five counterparties. In particular, according to our interviews, FRBNY requested a discount from two counterparties, which said they needed to consult internally before replying....However, FRBNY made contact soon afterward seeking to execute an ML III agreement without a discount, and FRBNY officials did not provide any explanation for their change in position, according to the counterparties we interviewed. Our interviews also indicated that FRBNY requested "best offer" of a discount from two other counterparties, and briefly referenced seeking a discount from another counterparty, before similarly withdrawing its request with little or no explanation...."

This is most certainly not the approach to use when attempting to obtain concessions.

The GAO attempts to defend the Feds:

"FRBNY had little or no bargaining power given the circumstances. The attempts at concessions took place less than two months after the Federal Reserve System had rescued AIG, and the counterparties expected that the government would not be willing to put the credit it had extended to the company in jeopardy."

How about if the Feds said something like the following to AIG creditors?

"Take 50% now or you can get in line for a U.S.-government-managed AIG bankruptcy."

My Conclusions: The European governments were able to extract 50% concessions from banks holding Greek debt. Had Paulson really wanted to obtain significant concessions from AIG creditors, do you think he could have gotten them? I do.

Elliott Morss is an economic consultant and an individual investor in developing countries. He has taught at the University of Michigan, Harvard University, Boston University, among other schools. Morss worked at the International Monetary Fund and helped establish Development Alternatives Inc. He has co-written six books and published more than four dozen articles in professional journals.

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