Another Embarrassing Day for Geithner

 |  Includes: AIG, GS
by: Rolfe Winkler, CFA

Tim Geithner’s appearance in front of Congress Wednesday was another embarrassment, perhaps more for the people’s representatives than the Treasury Secretary. Still, Geithner offered a clumsy defense for paying out 100¢ on the dollar to AIG’s counterparties, which included more than Goldman Sachs (NYSE:GS).

What they lacked in knowledge and nuance, Congress made up for in volume and OUTRAGE. The worst moment I saw was the utterly bogus comparison by Rep. Stephen Lynch between AIG’s (NYSE:AIG) payout to Goldman (100¢ on the dollar!) and the bailout offer for Bear Stearns shareholders (only $2 per share). 100 is a bigger number than 2, you see.

Geithner was lucky to be doing battle with such an unprepared, unimpressive group.

His defense, such as it was, amounted to the following:

Had the Fed imposed haircuts on AIG counterparties, it would have led to AIG’s credit rating being downgraded and the company (and consequently the economy) would have collapsed.

But AIG had already been downgraded, that’s why the government stepped in with a bailout. At that point the firm’s liabilities were taxpayer backed, so it strains credulity to say that extinguishing certain CDS it had written would cause systemic fallout in and of itself. Essentially what was happening here was unused insurance contracts were being extinguished. (Imagine a pro-rata refund from your insurer for a homeowner’s policy it wants to cancel…)

And there was precedent for this kind of negotiation. Eric Dinallo, former Commissioner of the NYS Dept. of Insurance and current candidate for Eliot Spitzer’s old job, had previously negotiated haircuts on CDS written by the monoline bond insurers. They were never forced into a taxpayer bailout. Did anyone at the Fed pick up the phone to consult Dinallo? Why not?

At the hearing, Geithner said he took “great pride” in his judgment to pay out 100¢ on the dollar to AIG counterparties because, he claims, it saved us from economic catastrophe.

No doubt the system was on the verge of collapse. But the biggest threat was undercapitalized banks. The payout to AIG counterparties was just a backdoor bailout for them. As Dan Alpert of Westwood Capital points out:

Every dollar of [haircut] would…amount to a dollar less of capital on bank balance sheets today (actually more, because in the interim the affected banks made money with that capital). If the discount was more than a little, some of the institutions would have required “front door” bailouts, or would have failed.

That’s why everyone is still so angry about this, and Goldman’s ridiculous claims that it would have been fine even absent the $12.9 billion it received from taxpayers via AIG. Sure, they’ve paid back TARP. But here’s another $12.9 billion of your money that’s helping to fund their bonus pool.

Jim Rickards offers a good closing thought on the matter:

What was actually done [in the AIG bailout] shows a breathtaking lack of imagination and legal skill on the part of the people involved. The Fed and Treasury do have an obligation to save the system, but they have no obligation to save each and every member of the system. That’s a big difference. You may need to build a firewall but it’s important to build it in the right place. Makes sense to protect the little guy but where was the national security interest in protecting Goldman? This is why I am just speechless when I hear Geithner testify that though he was utterly surrounded by ex-Goldman people they somehow had NO IMPACT on his judgment to save Goldman. How blind and unaware can you be?

Not so blind that you can’t be Treasury Secretary…