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American International Group (AIG) broke the customary code of silence around financial transactions when it published a detailed accounting of its financial counterparties on Mar. 15. The pressure to do so had come from Congress, insistent upon learning the companies to which U.S. taxpayer aid had flowed. AIG explained its disclosure as a bid for "transparency," but the data were just as much an opportunity to demonstrate the systemic risk AIG had long claimed its demise would pose.
If releasing the list was a surprise, the names on it were anything but. A Who's Who of global financial behemoths, the list included several European banks as well as U.S.-based giants like Goldman Sachs Group (GS) and Merrill Lynch (BAC).
Of course, financial ties between Europe and the U.S. have been growing in recent years, and the flow of funds has hardly been a one-way street from the U.S. taxpayer to banks abroad. Brad Setser, a fellow at The Council on Foreign Relations, notes that the Bank for International Settlements has reported that European banks had an $8 trillion balance sheet going into the crisis, with a large share of that invested in U.S. corporate bonds and asset-backed securities. If the European banks dumped those holdings, it would exact a severe, negative effect on the price of U.S. banks and their balance sheets.
Kentucky's Bunning Leads the Charge
Further, if the government had not backed AIG, those who had borrowed securities from AIG and collateralized them with the company's debt surely would have sold the debt to cover their losses and brought more pressure on the insurer just as it was struggling most, notes one Wall Street source.
Congress' demands for the names came to a head earlier in the month with the very public dressing-down of Fed Vice-Chairman Donald Kohn by Senator Jim Bunning (R-Ky.), after Kohn refused to name names. The prominence of foreign firms like Barclays (BCS), Deutsche Bank (DB), and BNP Paribas, once the list was released, stirred chat room debate over the logic of American taxpayers helping foreign banks. "In a world where financial institutions operate globally, bailouts are still financed domestically, and do ultimately rely on a backstop from the taxpayers," says Setser, of the Council on Foreign Relations. "There's a complicated set of issues around burden sharing. It's not just AIG."
The transactions at the core of AIG's disclosure have little to do with its central insurance business. The counterparties named on this list were part of far more complicated financial dealings. Some were customers of its collateralized default swaps, in which AIG insured transactions between other parties, something those parties would pay to gain, due to AIG's then-sterling AAA credit rating. But when AIG's ratings were cut, the company had to come up with collateral to back those deals.
Bonus Payments Spark Outrage
According to its filing, AIG has directly posted over $22 billion in collateral on these deals, and Maiden Lane III, an entity set up by the Treasury, has posted an additional $27 billion. Of that, $11 billion has gone to France's SociÉtÉ GÉnÉrale, $5.4 billion to Deutsche Bank, and $8.1 billion to Goldman Sachs. These deals are vestiges of the financial ingenuity of AIG's Financial Products Group. Some $165 million in bonus payments to executives from this division has drawn outrage from the White House to Congress and New York State Attorney General Andrew Cuomo since they were revealed on Mar. 14.
The second big block of AIG payouts stems from a business its insurance units did in lending out securities in which they had invested to customers for fees. When the borrowers returned those securities and demanded back the collateral that they'd put up, it cost AIG another $43.7 billion. Of that, England's Barclays got $7 billion, Deutsche Bank $6.4 billion, BNP Paribas $4.9 billion, and Goldman $4.8 billion. It's worth noting, however, that these names would arise in any large financial institutions' dealings, because they are the major players in these markets.
Adam Lerrick, a fellow at the American Enterprise Institute, argues that viewing AIG's counterparties as the final beneficiaries of the government bailout is overly simplistic and probably not correct. It would not be unusual for the banks named in the report to have turned around, Lerrick says, and written a second round of contracts with yet other banks, quite possibly different U.S. players such as Merrill Lynch. In today's financial system, Lerrick argues, it would be impossible to be certain that the taxpayer bailout didn't eventually come largely back to supporting other U.S. firms.
Fear of a Cascading Effect
"The issue in Treasury's mind is if AIG defaults…then there would be a whole cascading effect. It's not just Deutsche Bank, for example, on the other side. Deutsche Bank probably hasn't kept that contract. They've written another with Merrill Lynch, who has written one with Morgan Stanley, who's written one with SociÉtÉ GÉnÉrale," says Lerrick, who is also an economics professor at Carnegie Mellon University. "It would be a very bad policy to say 'O.K., AIG, you can take this taxpayer aid and use it to make Merrill Lynch whole, but not Deutsche Bank.'"
Byrnes is a senior writer for BusinessWeek in New York.