Fear and Trembling vs. Laughter and Forgetting
During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent – these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were “we have never done as big or as profitable trades – ever“.
As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks – effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities – run a chart from say last September to current of say S&P 500 and Itraxx – credit has underperformed massively. This is largely due to AIG-FP unwinds.
I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period.“
For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman’s terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.
In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).
What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were 1) one-time in nature due to wholesale unwinds of AIG portfolios, 2) entirely at the expense of AIG, and thus taxpayers, 3) executed with Tim Geithner’s (and thus the administration’s) full knowledge and intent, 4) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.
Further down the page, the International Swaps and Derivatives Association (ISDA, the only real supervisor of the over-the-counter CDS market) is allowing fiction to rule once again.
That this and inevitable further ‘unwinds’ chased by taxpayer money can be explained away as ‘normal’ fluctuations in a turbulent market or the natural and obvious result of misguided government policy is a testament to the strength of recently outdated ideologies, the natural theology of the market and the atomization of choice. Their intellectual support is gone, but they linger as blinders, assumptions too well ingrained to be conscious. In the benighted universe they project, society becomes more of a wargame the further one travels from the site of middle class domesticity, more a bunch of pieces scattered arbitrarily around a board, unreadable to one another and bent on increasing their individual score, whatever the cost. One is too polite even to guess at what goes on behind closed doors.
In order to manage the first glimmerings of the awareness of teamwork, and its application to understanding social reality, official discourse must add a few enhancements.
MR. GREGORY: I want to turn to the issue of anger on Wall Street and those AIG bonuses. The president said a couple of weeks ago this:
(Videotape, March 18, 2009)
PRES. OBAMA: I don’t want to quell anger. I think people are right to be angry. I’m angry.
MR. GREGORY: You shared–you said in a letter, you shared the president’s outrage, and yet the reality is that these bonuses first came to light back in October of 2008. You were still at the New York Fed. They were also the subject of hundreds of e-mails between Treasury and the Fed and AIG during the transition and when you came into office. In fact, the Treasury Department even negotiated with Senator Dodd with regard to executive compensation when the Treasury Department said, “No, no, don’t have this deal with retroactive bonuses. We can’t abrogate those contracts.” So if you were so outraged about all of this, why didn’t you deal with this back when these first came up?
SEC’Y GEITHNER: David, how could people not be angry with this? With the challenges we’re facing now as a country in part because of risks our financial sector took on, how could people not be angry? But our obligation and our deep obligation responsibility is, again, to try to fix this problem so that the trauma in the financial system is not causing more damage to the lives and fortunes of Americans and businesses across the country. That’s the most important thing we do. Everything we do has to be judged by the test of whether we’re getting the economy going again and recover…
MR. GREGORY: Well, and that’s all fair. But if you were so outraged, why didn’t you say that then? Instead, you said, “I was outraged and we should try to get this money back.” The government knew about these bonuses several months ago.
SEC’Y GEITHNER: Look, we had no good choices in that context, David. These were contracts written before the government got involved, before Ed Liddy became CEO of AIG.
MR. GREGORY: Mm-hmm.
SEC’Y GEITHNER: We’re a nation of laws. We cannot get the economy going again if there’s an expectation the government’s going to come in and break contracts. Just not a tenable thing to do. But what we did is–and we had no good choices, David–was when, when I was informed about the details of those provisions, we moved very quickly to ask that they–those that could be renegotiated get renegotiated, the government get those–or reduce those payments going forward. And we’re going to use the authority we have to go recoup those payments where we have a good legal basis for doing that. And you’ve already–we’re seeing a lot of those payments returned. But the important thing is going forward that we establish clear conditions, clear rules of the game, prevent this kind of compensation practice in the future from coming back and putting our system at risk. And we want to make sure that where the government is putting up assistance for these, for these banks, that that assistance is going to get lending going again…
MR. GREGORY: Right.
SEC’Y GEITHNER: …not to enrich the people that helped get us in this mess.
MR. GREGORY: But, but my question is, is this: If you thought this was so outrageous at the time, why didn’t you put this on the agenda then? And if you felt that you didn’t have any good choices, that you really couldn’t dissolve those contracts, then when it came to light, why didn’t you and the president stand up and say, “This populist anger is understandable, but you have to understand it has to be put in context and it has to stop”?
SEC’Y GEITHNER: Well, that–but that’s what the president did say. And again, we’re trying to make sure that people understand…
MR. GREGORY: The president said, “We shouldn’t govern in anger,” and then he said, “Yes, I’m angry, too. I don’t want to quell the anger.” You said this was outrageous.
SEC’Y GEITHNER: But…
MR. GREGORY: Did anybody stand up and say, “Let’s put this in context. We didn’t have good choices. This is not worth getting so upset about”?
SEC’Y GEITHNER: But, but, as you’ve seen the president say over the course of the week, the most important thing is we recognize that of course we don’t want to reward failure and we don’t want the government assistance going to reward failure, but we need to make sure we get this economy on–back on track. That’s going to require the financial system getting fixed and repaired. Of course we’re going to put strong conditions on the compensation…(unintelligible). Remember, the first–the second week in office, the president put out very, very broad, ambitious standards on compensation practice. That was before the Congress acted. He was a–took early initiative in this area because we knew this was going to be a significant problem.
We’re angry too. Because, again, the primary fault here is to be a moral one, to be directed at individuals who made bad choices, who retain unfair benefits like the AIG chiefs, at allegedly individual rackets like Madoff’s, and finally at a ‘system’ that is morally compromised as a whole because of it. Obama and Geithner understand the cleansing effect of punishment, but also the mature public’s capacity for realism. A realism born of forgiveness, born of the public acknowledgement of personal sin. Progressives also get mad. But we will watch the chastisement and humiliation of a powerful few, and the mature assurances of accountability by our newly elected officials, with the knowledge that our punishment will be quieter, better distributed, longer lasting. For progressives also live off credit. And on this basis we will come to a reconciliation. We can all be forgiven. We are a nation of laws.
(GEITHNER:) Now, just, just one more thing. We’re not going to get through this unless we get a–willing to take risk again. You know, the financials took too much risk. The great danger for us now is they’re going to take too little risk, they’re not going to take a chance on a viable business or a family that wants to put their kids through college. So we need to get them working with us in this context. And of course, for them to take risk they’re going to need to have more confidence about what the rules of the game are going forward, that there’s clarity about conditions and they don’t face the risk of great uncertainty about those conditions going forward.
MR. GREGORY: And to that point, are you this morning providing a guarantee to those investors that the rules of the games will not change? If they make money in these transactions, that Congress won’t try to go get their gains and change the rules?
SEC’Y GEITHNER: We have to do that or they won’t come. And it’s a simple proposition. Again, for these, all these programs to work, all these programs to work…
MR. GREGORY: So the rules of this, of this program won’t change?
SEC’Y GEITHNER: No, they cannot change.
Laws. And meanwhile the possibility that the rules could really change passes us by, until one day we’ll look back on it as a childhood dream, magically absorbed into the same dream that brought us a black president:
The problem with the Geithner plan, as with all other varieties of bailout largesse, is that it depletes our limited resources with no particular likelihood of success. I would ask everyone to consider what our situation will be if the dollar spigot is exhausted before the financial system is back in approximate working order. My candidate adjective: dire.
The alternative continues to be the same: invest public money in a good, new public bank. Make sure the economy has a working, well-capitalized, unencumbered financial infrastructure; then, if you want, sort through the legacy institutions and assets.
— Peter Dorman at EconoSpeak
The truth appears as if behind a television screen, a bit of untranslatable common sense. But this simple truth that politicians and wall street are in bed with one another, popular and on the tips of all tongues, has a real referent, and there’s no use pretending this isn’t it. When a former IMF chief economist describes the handling of the financial crisis as “late night, back-room dealing, pure and simple” and (in the final paragraph) all but calls for revolution, it’s clearer than clear our troubles have come home.