The Geithner AIG Story

Those emails and 'systemic risk.'

Timothy Geithner is back in piñata mode, with House Oversight Chairman Edolphus Towns asking him to testify next week about bailout giant AIG. By all means Members should swing away at the Treasury Secretary, but only if they focus on the right questions.
The trigger for the Towns hearing is the release of emails between the Federal Reserve Bank of New York and AIG in November and December 2008. The New York Fed urged AIG to limit disclosure of its deal to buy out derivative trading partners at 100 cents on the dollar. But since AIG went ahead and disclosed it anyway, this line of inquiry doesn't get to the heart of the taxpayer interest.
Likewise, asking if Mr. Geithner helped write the emails to AIG will simply allow him to continue avoiding the bigger questions: Why did he believe AIG could not fail? Why should he receive more authority to declare firms systemically important, when he will still not fully explain his previous multibillion-dollar judgments in the name of countering "systemic risk"?
Mr. Geithner was president of the New York Fed when it began sending what has become $182.3 billion in taxpayer assistance to AIG in September 2008. Much of this money was used to meet collateral calls from big banks that had bought AIG's credit default swaps. AIG had resisted handing over more collateral. But once Mr. Geithner was in charge of AIG, the cash flowed freely to these bank counterparties.

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Associated Press

Treasury Secretary Timothy Geithner

The Fed and AIG ultimately bought the underlying securities at par. This was not only much more than the counterparties might have received from a bankrupt AIG, but even a healthy AIG would never have handed over so much cash in the midst of a panic in which cash was king. Mr. Geithner's New York Fed demanded the 100-cents on the dollar deal for these counterparties, and it demanded that their identities be kept secret. The Journal nonetheless reported this sweet deal and the names of some beneficiaries, including Goldman Sachs, in early November 2008, but taxpayers had to wait months before AIG finally released the full story.

Given the sweet deal and the fact that Mr. Geithner sought to keep secret the identities of the beneficiaries, logic would suggest that the AIG intervention was intended as a bailout for these counterparties. Supporting this conclusion is the fact that Mr. Geithner has sold his plan to regulate derivatives as a way to prevent such problems in the future. Yet when asked directly by the inspector general for the Troubled Asset Relief Program why he opted to buy out the counterparties at par, Mr. Geithner said "the financial condition of the counterparties was not a relevant factor."

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Then last November, he suggested that the systemic risk was in AIG's traditional insurance business. "AIG was providing a range of insurance products to households across the country. And if AIG had defaulted, you would have seen a downgrade leading to the liquidation and failure of a set of insurance contracts that touched Americans across this country and, of course, savers around the world," he said. So which was it?
Taxpayers also still haven't been told why there couldn't have been any sunshine on Mr. Geithner's beloved AIG counterparties. If some of them really would have failed, with systemic consequences, why not announce that they were all getting a deal to bolster liquidity and allow them to resume lending? That is exactly what regulators had just done in October 2008 by naming recipients of TARP capital injections.
On the other hand, if the counterparties weren't the systemic risk, then what's the argument for regulating derivatives?
The evidence builds that AIG's "systemic risk" wasn't a mathematical answer to a rigorous and thoughtful review of data, but rather a seat-of-the-pants judgment by regulators in a panic. If that is the case, someone should ask Mr. Geithner why the American people should give him even more authority to make more such judgments from his hip pocket—with little public scrutiny.
Under the House regulatory reform, Mr. Geithner would chair a new Financial Services Oversight Council. The council could declare virtually any company in America a systemic risk, making them eligible for intervention on the taxpayer's dime. The law firm Davis Polk reports that since this council is not an agency, it will not be subject to the Administrative Procedure Act, the Freedom of Information Act or the Sunshine Act, among other laws intended to allow citizens to scrutinize government.
It's difficult to learn and apply the lessons of AIG because the New York Fed has done so much to conceal them. Mr. Towns appears to be getting closer to the truth, deciding yesterday to issue subpoenas focused on the New York Fed's decision-making, as opposed to whatever it told AIG to say in public. Let's hope lawmakers explore what the "systemic risk" actually was—and why Mr. Geithner should get nearly open-ended power to define it again.