Tuesday, January 19, 2010

Vive les Grandes Ecoles (AIG-Goldman edition)

Did negotiators from French banks save Goldman from a haircut on its AIG CDS contracts? Or did Goldman save the French banks with its, um, connections to Paulson and other high places?

WSJ: The Federal Reserve's decision to pay billions of dollars to Goldman Sachs Group Inc. and other big banks as part of its bailout of American International Group Inc. has spawned criticism and conspiracy theories. Treasury Secretary Timothy Geithner, who presided over the New York Fed at the time, was summoned to Congress to explain why AIG paid off the $62.1 billion in soured derivatives in full, far more than they were worth in the market.

One element of the decision hasn't been well explored—how the Fed agreed to the full-payment demands of France's bank regulator and two of AIG's largest creditors, Société Générale SA and Calyon Securities, a unit of Crédit Agricole SA. The French banks and their regulator, it now appears, masterfully outmaneuvered the Americans to avoid discounts, or "haircuts," on their securities.

The French won the day by using a legal argument that some leading French scholars and corporate attorneys variously described in interviews as highly dubious and lacking real legal ground.

The banks and the regulator, known as the Commission Bancaire, said bank executives could be criminally liable for accepting a discount on their contracts, according to a November report of the inspector general of the Troubled Asset Relief Program.

While true in the abstract, "their argument was very overstated," said Pierre-Henri Conac, a University of Luxembourg law professor and a director of France's oldest corporate-law review. "Banks give haircuts every day."

French banks aren't always the best negotiators, Mr. Conac added, but this time "the French were very good."


The Fed and AIG finally seized on a plan, according to the inspector general's report. Step one: Let the banks keep $35 billion of collateral already posted by AIG. Two: Purchase the banks' underlying securities, which were derivatives tied to low-grade mortgages. Three: Cancel the contracts. Over one frenzied weekend in early November, Fed and AIG officials struggled with the final step: What should they pay for those securities? By contract, the banks were guaranteed full payment.

There were some factors to suggest a lower, negotiated price was in order. The securities' market value had fallen significantly. And absent the extraordinary U.S. bailout, AIG would have been in bankruptcy, potentially leaving counterparties with zero.


"To say that these people would have gone to jail if they cut a deal and signed the same agreement as Goldman Sachs is really pushing beyond what goes on in France," said Christopher Mesnooh, a partner at Paris's Fields Fisher Waterhouse who has authored a book on French corporate law.

"There is no clear-cut provision that would have prevented SocGen or Calyon" from negotiating a discount, said one of Paris' top lawyers, who asked not to be named because he works for the banks.

More information may shake loose as Congress continues its study of AIG. At the upcoming hearings, one can only hope the French role is carefully examined. There may well have been compelling reasons for making good on the $20.8 billion owed the French banks. But —as is now clear—not for the legal reason that the Fed and the French banks claim.

Related links: AIG bailout , Societe Generale , Les Moines-Soldats , Les Grandes Ecoles


Unknown said...

"French banks aren't always the best negotiators, Mr. Conac added, but this time "the French were very good."

Has anyone, anyone, ever been on the other side of a negotiation with Geithner and not come out on top?

Steve Hsu said...

In the end, Geithner comes out on top.

I predict his net worth will be easily north of $10M within 5 years of leaving office. Quid pro quo. (See: Bill Clinton, Rahm Emanuel, etc.)

In a system like that, how could government *not* be captured by financial interests?

Seth said...

Why only $10M? Rubin collected something like $125M for his help in destroying Citigroup. Maybe you dropped a zero?

Unknown said...

One would have imagined that the negotiators were very well versed with both contract law and legal precedents. The seem to have got the first part right, but messed up while looking at the second part. The incompetence here is breath-taking. Some meritocracy, huh? :)

Steve Hsu said...

I was being conservative with the Geithner number, but he's not in the same category as Rubin who was co-head of Goldman before leading Treasury. Geithner (like Emanuel) has little or no actual business experience. His main value is the ability to open doors and get meetings, along with having insight into what Fed and Treasury policies/reactions are likely to be.

LondonYoung said...

So, I have noticed that the President of the U.S. and his predecessor both attended Harvard. And I also gather that Harvard graduates (and Fellows) are doing much better than the median college grad. So, are connections to the White House allowing kids from this school to do much better than the rest?

This is what I think when I see suggestions that Paulson was somehow helping out GS. Hank is a very moral guy (check out the work around his confirmation as Tsy Secy) and this is ye olde "correlation confused with causation" problem. For a long time GS has been the premier financial institution so, like Harvard, you'll find GS alumni in a lot of key places. But the main reason kids from Harvard are getting good jobs is not their connection to fellow alum Barry Obama.

Also, as I've said before, according to GS, they had nothing to "negotiate" (the word used in the article) over AIG - AIG bankrupt, AIG bailed out, no difference to GS.

It is amusing, however, to see the President suggest a bank tax to recover the money he looted from the TARP by bailing out automobile companies that invested heavily in making gas-guzzling SUV's. This is about as brilliant as trying to enact a health-care entitlement in the middle of a recession.

The smart kids are moving to China ...

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