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Posted by: Matthew Goldstein on March 19
American International Group (AIG) is supposed to be gradually winding down its now infamous structured finance division., which was responsible for the near collapse of the once giant insurer and the world economy as well. But sometimes it’s hard to tell if that’s really the plan at AIG.
First, there was the controversy over those lavish retention bonuses the company approved for dozens of employees at AIG Financial Products, which sold hundreds of billions of dollars in insurance-like products on now ailing securities. Now there’s an allegation that the troubled Connecticut-based operation is blocking at least one longtime customer from moving its business elsewhere. The allegation, made in a recently filed federal lawsuit, suggests that AIG may not be so eager to wind down all of its far-flung derivatives deals.
A large Los Angeles-based asset management firm claims AIG Financial Products is playing hardball and preventing it from terminating a series of derivatives contracts. TCW Asset Management claims the AIG division is “interfering’’ with the asset manager’s efforts to find another trading partner—even threatening to file “suit against the new counterparty for tortious interference with AIG-FP’s purported contractual rights.’’
The legal dispute centers around seven collateralized debt obligations—complex securities that include slices of other asset-backed bonds. Beginning in 2003, the asset manager entered into a series of derivatives deals with AIG to minimize the impact of interest rate fluctuations and inconsistent interest payments on the underlying investments that make-up the seven CDOs. The lawsuit filed in New York federal court alleges the derivatives deals are valued at more than $100 million.
Things started getting testy between TCW and AIG in September when the ratings agencies downgraded the insurer’s debt rating—right around the time the Federal Reserve came in with the first round of bailout money. The lawsuit claims a so-called trigger in the derivatives contracts required AIG Financial Products to find a substitute trading party to takeover the transactions if the giant insurer’s credit rating was downgraded. AIG failed to do that and the asset manager moved to terminate the relationship.
As CDOs go, the deals managed by TCW—most of which bear the name Davis Square Funding—are in relatively good shape and haven’t yet fallen into default. So it’s perfectly understandable why the asset manager would like to get as far away from AIG as possible. After all, AIG is an effective ward of the federal government after taking on one taxpayer bailout after another.
But it’s less clear what’s motivating AIG Financial Products, which is obligated to make periodic payments to the asset manager under the transactions. The division’s 400 or so employees are supposed to be extricating the division from its remaining derivatives deals, presently valued at $1.7 trillion. It would seem that any opportunity for AIG to rid itself of a derivatives contract would be welcome news—even if its a contract that’s not fallen in value.
A lawyer for AIG Financial Products declined to comment before getting permission from his client. We’re still waiting to hear back from him.
But here’s a theory: may be AIG is trying to keep a goodly number of its outstanding derivatives transactions in place, so it can sell them en masse to another financial firm. Such a move may help AIG pay back some of the $170 billion in bailout money it’s getting from the federal government.
But that strategy of keeping sound derivatives contracts in place, means AIG Financial Products may be around a lot longer than many of us imagined. And, of course, the longer AIG Financial Products is around, the longer those bankers who got us in this mess will keep drawing paychecks
BusinessWeek's Adrienne Carter, Jessica Silver-Greenberg, and David Henry deconstruct the mysteries of high finance, Wall Street, and hedge funds for pros and ordinary investors. E-mail them directly if you've got tips about big deals, a hedge fund, or even securities industry gossip.