Special Inspector General To Describe New York Fed Investigations

- Estimate that the AIG CDS contracts in questions had a market value of 40 cents to 71 cents on the dollar.

Banks that paid AIG to insure the value of financial assets had a contractual right to demand that AIG provide more collateral when its credit ratings fell. When the New York Fed stepped in to help AIG handle the escalating demands for collateral, AIG met 100% of the demands, without getting any reductions, or "haircuts."

One investigation that Barofsky is undertaking concerns Treasury Department assertions that the CDS collateral assistance will help taxpayers get the money the government has invested in AIG back.

In fact, the Treasury Department believes it will lose $30 billion on the AIG deal, according to the draft testimony.

The second investigation relates to a series of documents that concern efforts by the New York Fed to buy CDS arrangements from AIG and put them a facility called Maiden Lane III.

Additional documents and facts have come to light, causing Barofsky to review the "extent of the Federal Reserve's cooperation with SIGTARP during the course of the audit," according to the draft testimony.

Barofsky also will criticize the role that credit rating agencies played in the events that led to the government's decision to bail out AIG, according to the draft testimony.

"AIG stands as a stark example of the tremendous influence of credit rating agencies upon financial institutions and upon government decision making in response to financial crises," Barofsky will say, according to the draft testimony.

Barofsky says the rating agencies over-rated the collateralized debt obligations underlying the CDS entered into by the AIG Financial Products unit.

Once the financial crisis came to a head, the credit rating agencies' downgrades of AIG and of the underlying securities played a significant role in creating and aggravating AIG's liquidity crisis, by triggering contract provisions requiring the company to post billions of dollars in additional collateral, Barofsky says, according to the draft testimony.

The "threat of further rating agency downgrades due to the onerous terms of the initial FRBNY financing, among other things, led to further Government intervention, including the TARP investment in AIG and the necessity to do something with the swap portfolio," Barofsky says, according to the draft testimony.

Concerns about the reaction of the credit rating agencies "played a role in FRBNY's decision not to pursue a more aggressive negotiating policy to seek concessions from counterparties," Barofsky will assert, according to the draft testimony.

Barofsky will testify that New York Fed executives told him that Timothy Geithner, then president of the New York Fed and now Treasury secretary, "acquiesced" to the proposal by other New York Fed executives to pay off the CDS at par.

"When asked by SIGTARP if the executives felt they had received their marching orders' from then-FRBNY President Geithner to pay the counterparties par, one FRBNY official responded, 'yes, absolutely,'" Barofsky says in the draft testimony.

The draft testimony also includes some details about the value of the AIG arrangements involved in the transactions.

Each arrangement that the New York Fed unwound had a different value, and some banks benefited more than others, Barofsky says in the draft testimony.

Goldman Sachs Group Inc., New York, for example, held arrangements with an estimated market value of 40 cents on the dollar.

UBS A.G., Zurich, held arrangements with an estimated market value of 71 cents on the dollar.

Before New York Fed broke off efforts to persuade 8 major AIG trading partners to take haircuts, it was estimated that all of the arrangements involved in the talks had a market value of about 40 cents to 48 cents on the dollar.