AIG Hearing Witnesses: We Had No Time To Get Haircuts

Instead of making the CDS counterparties accept a haircut, or payment reduction, the New York Fed ended up unwinding the CDS by paying 100 cents on the dollars for the collateralized debt obligations that the CDS were hedging. At that time, the CDOs had an estimated market value of less than 50 cents on the dollar, according to Neil Barofsky, the special inspector general for the Troubled Asset Relief Program.

Rep. Cliff Stearns, R-Fla., recalled at the hearing that Michael McRaith, the Illinois insurance commissioner, had testified about the possibility of AIG going bankrupt.

If AIG had gone bankrupt, state regulators would have simply unwound the insurance companies, according to Stearns' summary of McRaith's testimony.

"I respectfully disagree with him," Paulson said. "This company was a huge problem. There was no single regulator that had a line of sight over the whole company."

In response to another lawmaker, who said the AIG insurance companies would have been fine without the parent company, Geithner disagreed.

"No, that's not true," Geithner said.

"The actions we took to prevent the default of the firm protected those companies from the risk of failure," Geithner said. "You could not separate these companies from the companies that took the risk. The tragic thing in the structure was that these companies were so closely connected that we could not separate them."

The insurance regulators themselves did not know how much the insurance companies were affected by holding company risk, Geithner said.

Geithner insisted that the New York Fed, which he headed at the time, the Board of Governors of the Federal Reserve System, and Paulson had acted appropriately when they agreed to pay large banks 100 cents on the dollar to unwind the AIG Financial Products CDS contracts.

While the New York Fed was unwinding the CDS, AIG was preparing to report its earnings Nov. 10, 2008.

The credit rating agencies had told those dealing with the AIG counterparty problem that any haircut, or "selective default," could have caused a rating ratings downgrade that would have wound up costing the taxpayer more than the decision to pay off dollar-for-dollar, Paulson and Geithner said.

Paulson and Geithner said they believed at the time that they had to come up with a solution before AIG announced its earnings.

In responding to heated questions by several congressmen as to why Goldman Sachs Group Inc., New York, and other large banks were paid in full, Geithner said, "If AIG had been a bank, we could have done many things."

But, "under the laws of the land, we could not have selectively defaulted without risk of downgrade and default," Geithner said.

Rep. Stephen Lynch, D-Mass., was particularly angry at the decision of federal regulators not to demand a haircut. He said that federal regulators had made shareholders of the failed investment bank Bear Stearns take just 2 cents on the dollar, but then failed to use their leverage to get AIG counterparties to accept any kind of haircut.

"I just think it was a terrible decision on your part," Lynch said. "It just stinks to the high heaven what happened here. … It makes me doubt your commitment to the American people."

If the government had not stepped in to shore up AIG, "millions of more Americans would have lost their jobs," Geithner told Rep. Edolphus Towns, D-N.Y., chairman of the committee. "People would have rushed to take their money out of the banks. There would have been utter collapse."

At the time the New York Fed was starting to talk to AIG, "I think you were seeing a full-scale run on the financial system," Geithner said. "We did not rescue AIG; we intervened so that we could dismantle it safely."

Geithner acknowledged that people think bailouts are unfair, but added, "you can't create jobs without a functioning financial system."

While highly critical of Geithner in opening remarks, after Geithner made his prepared remarks and answered several questions, Towns said, "I don't know what else you could have done."

Responding to questions about why the Fed and Treasury did not disclose all the details of what they were doing, Geithner said, "It is very hard to put yourself in shoes you did not occupy. … I do believe they [the Fed officials] acted with great integrity."

Paulson made similar arguments. In response to a question from Rep. John Tierney, D-Mass., he said the Fed and Treasury acted because "the markets were frozen."

Even blue chip industrial companies were having trouble getting financing, Paulson said.

If an implosion of AIG had added to the economic problems, "Main Street companies and industrial companies would not have been able to pay employees, the employees would be let go and stop paying their bills, and this would have rippled through the economy," Paulson said.

Geithner and Paulson asked members of Congress to give federal regulators the authority to unwind problems at giant financial institutions in a way that does not expose taxpayers directly to the cost of paying for bailouts.

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For earlier coverage of the hearing, please see House Panel Grills Witnesses Over Aid To AIG.