Bailout indignation: the case of AIG November 18, 2009 at 8:13 am

There has been a lot of discussion recently about the SIGTARP report on the AIG bailout. See for instance here for Krugman, here for Naked Capitalism, and here for the Big Picture. At first I shared this outrage: Geithner undoubtedly underplayed his hand, and showed his usual snivelling obeiscance to the banks. But does it, in this instance, matter much?

What did he really do? He loaned AIG money, at a penal rate, so that they could meet margin calls on CDS. Derivatives receivables are technically pari passu with senior debt (and in practice better than that, due to a wide definition of default in the CSA), so he did nothing worse than lend money to AIG’s counterparties. He did not recapitalise them covertly: these payments were debt, not equity. And many of the counterparties, Goldman included, could have borrowed directly from the FED at that point. By allowing AIG to make the payments, he injected liquidity, and prevented a potentially systemic failure of the CDS market. Moreover, AIG (and thus the taxpayer) is on the hook for the performance of the CDS it had written anyway, and in due course we will see how that goes: the collateral payments were merely based on the current mark to market. If conditions improve (as they have done), AIG and thus the taxpayer will get the money back, with interest.

In conclusion, then, there are many, many things that we can criticise about Timmy’s actions (and inactions) during the crisis. But the AIG margin payments are not on the top ten Timmy screwup list.

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