Excerpt from zerohedge
Federal Reserve Moral Hazard Smoking Gun: In August 2008 Goldman Was Willing To Tear Up AIG Derivative Contracts, Offered To Take Haircut
As observant readers will recall, a week ago we pointed out a letter in which the New York Fed's Steven Manzari instructed AIG to stand down on all discussions with counterparties on "tearing up/unwinding CDS trades on the CDO portfolio." At the time we focused on the word "stand down" as an indication of the Fed's lead role in the process. At this point there is no doubt that the FRBNY, together with its law firm, Davis Polk, were in the pilot's seat during the entire AIG negotiation, and while Tim Geithner may not have been the responsible man for this, someone must have been - and for the record, our money is a double or nothing on recently promoted FRBNY Senior Vice President Sarah Dahlgren, who as of January 21st is in charge of the Fed's Special Investments [AIG] Management Group. We sure hope Sarah gets the chance to recall her memories beginning in the fateful month of September 2008 when she became the person in charge of the FRBNY's AIG relationship. But back to the letter - little did we know that our focus was on the right sentence... but on the wrong word. What should have struck us front and center, was Habayeb's admission that contract "tear downs" had been evaluated. This means that someone, aside from AIG, must have expressed an interest in a tear down, which if true would have dramatic consequences for the entire AIG debacle. Today, the WSJ presented the missing piece of the puzzle.
In tonight's Heard On The Street section, the WSJ notes:
As everybody knows, AIG got a huge government bailout in September 2008 to help make payments on derivatives contracts with banks, including Goldman. Yet in the previous month, Goldman approached AIG about "tearing up" its contracts, according to a November 2008 analysis by BlackRock, then an adviser to the New York Fed. So was Goldman prepared to offer AIG a haircut in the month before its rescue? A legitimate question, given that Goldman refused to accept such a cut when the New York Fed raised the idea after it bailed out AIG.
The implications of this discovery are huge as they essentially destroy all the arguments presented by the FRBNY about an inability to extract concession out of Goldman (which being the largest AIG CDO counterparty, was the critical negotiating factor). It also casts doubt on the veracity of any arguments presented in Congress by Goldman representatives discussing the potential to take a haircut on their AIG exposure. What this means in plain English is that, in the month before the Fed entered the scene, GOLDMAN SACHS ITSELF OFFERED TO TEAR DOWN THE CDS ON AIG'S CDO PORTFOLIO (we don't use caps lock lightly). This is basically a smoking gun on the moral hazard issue perpetrated by the FRBNY when it got involved, and indicates that through their involvement, Tim Geithner, Sarah Dahlgren or whoever, not only did not save US taxpayers' money, but in fact ended up costing money, when they funded the marginal difference between par (the make whole price given to all AIG counterparties after AIG was told to back off in its negotiations) and whatever discount would have been applicable to the contract tear down that had been proposed by Goldman a mere month earlier. This, more so than anything presented up to now, is the true scandal behind the New York Fed's involvement.
If this November Blackrock report indeed exists, and if Goldman did in fact offer to tear down contracts, this is an act of near criminal implications and heads at the FRBNY must roll immediately.
We hope this is the number one question asked by Chairman Towns of Mr. Geithner. But as the latter will plead the fifth due to his lack of involvement, we kindly suggest that the correct person, the person who can not claim lack of knowledge on the AIG situation due to a prior recusal, and is therefore the right person to grill before a live studio audience, is the FRBNY's Sarah Dahlgren: as it stands, Wednesday will merely be yet another spectacle, in which Geithner will claim stupidity, and this time very likely get away with it: is there any wonder why he agreed to provide testimony so promptly after his "invitation." What about Goldman's Stephen Friedman - did he accept the invitiation yet? How about Goldman's Hank Paulson? It sure must be nice to have the luxury to kindly decline the privilege of providing sworn testimony, and avoid perjury.
Goldman representatives, Lloyd Blankfein among them preferably, have to be on the stand next to Geithner, as they are the people who have bee at the core of this whole problem from the start till bitter end.
Last but not least, was it not Mr. Blankfein who just two weeks ago, before the FCIC committee, noted he had never gotten a request to take less than 100 cents on the dollar on AIG CDS? So what happens if it was he who offered less than 100 cents? Should that maybe have been at least mentioned in passing? Is that some equivalent of perjury, or will the semantics lawyers come out in force?
Ambac to Settle a CDO Exposure
Monday, August 4, 2008
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ReprintsAmbac Financial Group Inc. has agreed to pay Citi $850 million to settle one of its largest collateralized debt obligation exposures, improving the excess capital position of insurer subsidiary Ambac Assurance Corp., the companies announced Friday.
The agreement terminates the guarantee on a $1.4 billion collateralized debt obligation squared transaction, a CDO of a double-A rated CDO of asset-backed security tranches - most of which have now fallen below investment grade. Ambac Financial nevertheless expects to record a pre-tax $150 million gain on the settlement, because it had already recorded approximately $1.0 billion of mark-to-market losses on the instrument. It reports its second-quarter earnings Wednesday.
The "primary benefit" of the transaction is a reduction in uncertainty, Ambac chairman and chief executive officer Michael Callen said in a statement.
"We view the final outcome as favorable in light of the numerous widely circulated models that assumed a 100% write off for this transaction," Callen said in a statement. "This settlement also confirms our view that transaction mark-to-market adjustments are not indicative of ultimate credit impairment. This is an important milestone in our efforts to work with counterparties as we evaluate settlement as well as other restructuring opportunities related to our CDO exposures."
Ambac still has exposure to three other CDO squared transactions, although AA-Bespoke, as the terminated one is known, is by far the largest, according to quarterly filings as of March 31. Two other 2007 transactions of approximately $500 million each have also fallen below investment grade. The third outstanding CDO squared is a 2005 transaction of $79 million.
In a research note, Goldman, Sachs & Co. analysts Monica Gabel and Daniel Zimmerman called the move "a positive" for Ambac as it settled the debt at 61% of par value, compared to Goldman's estimate of potential losses on CDO-squared transactions of between 75% and 95%. Wisconsin insurance commissioner Sean Dilweg said his office viewed the deal "favorably."
Ambac's stock jumped 50.4% on the news to close at $3.79. Credit-default swaps on Ambac Assurance fell to 16 points upfront on Friday, down from 20 points on Thursday, according to Markit, reflecting the market's lower perceived threat of default.
The deal follows another announced last Monday night in which Security Capital Assurance Ltd. agreed to pay Merrill Lynch & Co. $500 million to commute eight credit-default swaps. Along with a separate agreement between SCA and its former parent XL Capital Ltd., the termination helped SCA avoid insolvency, New York insurance regulators said.
New York insurance superintendent Eric Dinallo said that pact between SCA and Merrill could serve as "template" for others between insurers and counterparties. Merrill has said it is negotiating settlements on CDO hedges with MBIA Inc. and other lower-rated bond insurers.
Analysts said other bond insurers and counterparties will likely strike more deals to terminate guarantees. Shares of other insurers rose in Friday's trading, with MBIA Inc. up 29.34% to close at $7.67, Assured Guaranty Ltd. up 8.9% to $12.48, and SCA up 12.63% to finish at $2.14.
"While the SCA/ML agreement to commute certain CDS contracts relating to ABS CDOs doesn't mark the beginning or the end of the mortgage saga for the bond insurers, it is a good indication that we have entered a new chapter," wrote Bank of America Securities LLC analysts Michael Barry, Seth Levine, and Brian Turner in a report last week.
The deals will further "tarnish" the reputations of bond insurers, because they set a precedent of them settling, rather than paying out full claims, said Richard Larkin, director of research at Herbert J. Sims & Co. But for existing bondholders the deals are "generally positive because it's going to assure that somewhere down the road maybe some money will be left to pay existing claims," Larkin said.
For bond insurers facing insolvency, though, some deals may actually hurt existing policyholders, according to Rob Haines, a senior analyst at CreditSights.
New York insurance law says that credit default swaps are not considered insurance, and, in the event of regulatory takeover, the claims of CDS holders would be subordinate to insured policyholders, even if the CDS contracts say otherwise, Haines wrote in a recent report. This gives the counterparties an incentive to get capital now - essentially jumping municipal policyholders - rather than wait for regulatory intervention, which could make their holdings "worthless".
"We think [commuting CDS exposure] will backfire and erode capital at an accelerated rate since both the cash used to commute contracts and the installment premiums associated with those canceled policies will head out the door," Haines wrote. "Ultimately, we believe that structured contract holder will crowd out their municipal book as they race to get as much capital as they can before a potential rehab event."
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