CONGRESSIONAL OVERSIGHT PANEL JUNE OVERSIGHT REPORT *

[JPRT, 111th Congress]
[From the U.S. Government Publishing Office]

CONGRESSIONAL OVERSIGHT PANEL

JUNE OVERSIGHT REPORT *

----------

THE AIG RESCUE, ITS IMPACT ON MARKETS, AND THE GOVERNMENT'S EXIT
STRATEGY

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

June 10, 2010.--Ordered to be printed

* Submitted under Section 125(b)(1) of Title 1 of the Emergency
Economic Stabilization Act of 2008, Pub. L. No. 110-343
CONGRESSIONAL OVERSIGHT PANEL JUNE OVERSIGHT REPORT
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CONGRESSIONAL OVERSIGHT PANEL

JUNE OVERSIGHT REPORT *

__________

THE AIG RESCUE, ITS IMPACT ON MARKETS, AND THE GOVERNMENT'S EXIT
STRATEGY

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

June 10, 2010.--Ordered to be printed

* Submitted under Section 125(b)(1) of Title 1 of the Emergency
Economic Stabilization Act of 2008, Pub. L. No. 110-343
CONGRESSIONAL OVERSIGHT PANEL
Panel Members
Elizabeth Warren, Chair
Richard H. Neiman
Damon Silvers
J. Mark McWatters
Kenneth Troske
C O N T E N T S

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Page
Glossary of Terms................................................ V
Executive Summary................................................ 1
Section One......................................................
A. Overview.................................................. 13
B. AIG Before the Government Rescue.......................... 14
1. AIG's History......................................... 14
2. AIG's Structure and Regulatory Scheme................. 15
3. The Causes of AIG's Problems.......................... 18
4. Other Problematic Aspects of AIG's Financial Position
and Performance........................................ 36
5. The Role of Credit Rating Agencies.................... 41
6. Were Regulators Aware of AIG's Position?.............. 42
C. The Rescue................................................ 46
1. Key Events Leading up to the Rescue................... 46
2. The Rescue Itself..................................... 55
3. The Key Players in the Rescue......................... 58
4. The Legal Options for Addressing AIG's Problems in
September 2008......................................... 61
D. Subsequent Government Actions............................. 68
1. Securities Borrowing Facility: October 2008........... 68
2. The TARP Investment and First Restructuring: November
2008................................................... 69
3. Maiden Lane II........................................ 71
4. Maiden Lane III....................................... 73
5. Additional Assistance and Reorganization of Terms of
Original Assistance: March and April 2009.............. 77
6. Government's Ongoing Involvement in AIG............... 79
E. The Impact of the Rescue: Where the Money Went............ 82
1. The Beneficiaries of the Rescue....................... 86
2. How the Beneficiaries Would Have Fared in Bankruptcy.. 95
F. Analysis of the Government's Decisions.................... 105
1. Initial Crisis: September 2008........................ 105
2. Securities Borrowing Facility: October 2008........... 137
3. The TARP Investment and First Restructuring: November
2008................................................... 138
4. Maiden Lane II........................................ 141
5. Maiden Lane III....................................... 141
6. Additional Assistance and Reorganization of Terms of
Original Assistance: March and April 2009.............. 148
7. Government's Ongoing Involvement in AIG............... 150
8. Differences between the Treatment of AIG and Other
Recipients of Exceptional Assistance................... 151
G. Assessment of the Role of Treasury and the Federal Reserve 154
H. Current Government Holdings and Their Value............... 156
1. Market's View of AIG's Equity......................... 157
2. Residual Value of AIG: the Parameters of Debate....... 162
3. Administration and CBO Subsidy Estimates.............. 164
I. Exit Strategies........................................... 165
1. Overview.............................................. 166
2. AIG's Plans for Return to Profitability............... 172
3. Treasury's Plan for Exit.............................. 186
J. Executive Compensation.................................... 189
1. General............................................... 189
2. Initial Government Involvement........................ 190
3. The AIGFP Retention Payments.......................... 190
4. The Special Master.................................... 191
5. Effect on AIG's Future................................ 195
K. Conclusion................................................ 195
1. AIG Changed a Fundamental Market Relationship......... 195
2. The Powerful Role of Credit Rating Agencies........... 196
3. The Options Available to the Government............... 196
4. The Government's Authorities in a Financial Crisis.... 198
5. Conflicts............................................. 199
Annexes:
Annex I: Where the Money Went................................ 202
Annex II: Detailed Timeline of Events Leading up to the
Rescue of AIG.............................................. 203
Annex III: What are Credit Default Swaps?.................... 213
Annex IV: Legal Authorities.................................. 221
Annex V: Securities Lending.................................. 231
Annex VI: Details of Maiden Lane II Holdings................. 232
Annex VII: Details of Maiden Lane III Holdings............... 234
Annex VIII: Comparison of Effect of Rescue and Bankruptcy.... 236
Section Two: Additional Views....................................
A. J. Mark McWatters........................................ 241
Section Three: Correspondence with Treasury Update............... 254
Section Four: TARP Updates Since Last Report..................... 255
Section Five: Oversight Activities............................... 272
Section Six: About the Congressional Oversight Panel............. 273
Appendices:
APPENDIX I: LETTER TO CHAIR ELIZABETH WARREN FROM ASSISTANT
SECRETARY HERB ALLISON RE: GM LOAN REPAYMENT, DATED MAY 18,
2010....................................................... 274
APPENDIX II: LETTER TO SENATOR CHARLES GRASSLEY FROM
SECRETARY TIMOTHY GEITHNER RE: GM LOAN REPAYMENT, DATED
APRIL 27, 2010............................................. 277
APPENDIX III: LETTER TO REPRESENTATIVES PAUL RYAN, JEB
HENSARLING, AND SCOTT GARRETT FROM SECRETARY TIMOTHY
GEITHNER RE: GM LOAN REPAYMENT, DATED APRIL 30, 2010....... 280

Glossary of Terms

ABS Asset-backed securities
AGF American General Finance
AGP Asset Guarantee Program
AIA American International Assurance
Company
AIG American International Group, Inc.
AIGCFG AIG Consumer Finance Group
AIGFP AIG Financial Products
AIGIP AIG Investment Program
AIG FSB AIG Federal Savings Bank
AIRCO American International Reinsurance
Co.
ALICO American Life Insurance Company
AMLF Asset-Backed Commercial Paper
Money Market Mutual Fund
Liquidity Facility
CBO Congressional Budget Office
CDO Collateralized debt obligation
CDS Credit default swap
CLO Collateralized loan obligation
CMBS Commercial mortgage-backed
securities
CP Counterparty
CPP Capital Purchase Program
CPFF Commercial Paper Funding Facility
DIP Debtor-in-possession
EESA Emergency Economic Stabilization
Act of 2008
EU European Union
FDIC Federal Deposit Insurance
Corporation
FRBNY Federal Reserve Bank of New York
GAO U.S. Government Accountability
Office
GIA Guaranteed Investment Agreements
ILFC International Lease Finance
Corporation
ISDA International Swaps and
Derivatives Association
LIBOR London Interbank Offered Rate
LTCM Long-Term Capital Management
ML2 Maiden Lane II
ML3 Maiden Lane III
NAIC National Association of Insurance
Commissioners
OIS Overnight Index Spread Rate
OMB Office of Management and Budget
OTS Office of Thrift Supervision
RCF Revolving Credit Facility
RMBS Residential mortgage-backed
securities
ROE Return on equity
S&P Standard & Poor's
SBF Securities Borrowing Facility
SEC U.S. Securities and Exchange
Commission
SIGTARP Special Inspector General for the
Troubled Asset Relief Program
SPA Securities purchase agreement
SPV Special purpose vehicle
SSFI Systemically Significant Failing
Institution Program
TARP Troubled Asset Relief Program
TIP Targeted Investment Program
TruPS Trust preferred securities
======================================================================

JUNE OVERSIGHT REPORT

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June 10, 2010.--Ordered to be printed

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EXECUTIVE SUMMARY *

At its peak, American International Group (AIG) was one of
the largest and most successful companies in the world,
boasting a AAA credit rating, over $1 trillion in assets, and
76 million customers in more than 130 countries. Yet the
sophistication of AIG's operations was not matched by an
equally sophisticated risk-management structure. This poor
management structure, combined with a lack of regulatory
oversight, led AIG to accumulate staggering amounts of risk,
especially in its Financial Products subsidiary, AIG Financial
Products (AIGFP). Among its other operations, AIGFP sold credit
default swaps (CDSs), instruments that would pay off if certain
financial securities, particularly those made up of subprime
mortgages, defaulted. So long as the mortgage market remained
sound and AIG's credit rating remained stellar, these
instruments did not threaten the company's financial stability.
---------------------------------------------------------------------------
* The Panel adopted this report with a 4-0 vote on June 9, 2010.
---------------------------------------------------------------------------
The financial crisis, however, fundamentally changed the
equation on Wall Street. As subprime mortgages began to
default, the complex securities based on those loans threatened
to topple both AIG and other long-established institutions.
During the summer of 2008, AIG faced increasing demands from
their CDS customers for cash security--known as collateral
calls--totaling tens of billions of dollars. These costs put
AIG's credit rating under pressure, which in turn led to even
greater collateral calls, creating even greater pressure on
AIG's credit.
By early September, the problems at AIG had reached a
crisis point. A sinkhole had opened up beneath the firm, and it
lacked the liquidity to meet collateral demands from its
customers. In only a matter of months AIG's worldwide empire
had collapsed, brought down by the company's insatiable
appetite for risk and blindness to its own liabilities.
AIG sought more capital in a desperate attempt to avoid
bankruptcy. When the company could not arrange its own funding,
Federal Reserve Bank of New York President Timothy Geithner,
who is now Secretary of the Treasury, told AIG that the
government would attempt to orchestrate a privately funded
solution in coordination with JPMorgan Chase and Goldman Sachs.
A day later, on September 16, 2008, FRBNY abandoned its effort
at a private solution and rescued AIG with an $85 billion,
taxpayer-backed Revolving Credit Facility (RCF). These funds
would later be supplemented by $49.1 billion from Treasury
under the Troubled Asset Relief Program (TARP), as well as
additional funds from the Federal Reserve, with $133.3 billion
outstanding in total. The total government assistance reached
$182 billion.
After reviewing the federal government's actions leading up
to the AIG rescue, the Panel has identified several major
concerns:
The government failed to exhaust all options before
committing $85 billion in taxpayer funds. In previous rescue
efforts, the federal government had placed a high priority on
avoiding direct taxpayer liability for the rescue of private
businesses. For example, in 1998, the Federal Reserve pressed
private parties to prevent the collapse of Long-Term Capital
Management, but no government money was used. In the spring of
2008, the Federal Reserve arranged for the sale of Bear Stearns
to JPMorgan Chase. Although the sale was backed by $28.2
billion of federal loans, much of the risk was borne by private
parties.
With AIG, the Federal Reserve and Treasury broke new
ground. They put U.S. taxpayers on the line for the full cost
and the full risk of rescuing a failing company.
During the Panel's meetings, the Federal Reserve and
Treasury repeatedly stated that they faced a ``binary choice'':
either allow AIG to fail or rescue the entire institution,
including payment in full to all of its business partners. The
government argues that AIG's failure would have resulted in
chaos, so that a wholesale rescue was the only viable choice.
The Panel rejects this all-or-nothing reasoning. The government
had additional options at its disposal leading into the crisis,
although those options narrowed sharply in the final hours
before it committed $85 billion in taxpayer dollars.
For example, the federal government could have acted
earlier and more aggressively to secure a private rescue of
AIG. Government officials, fully aware that both Lehman
Brothers and AIG were on the verge of collapse, prioritized
crafting a rescue for Lehman while they left AIG to attempt to
arrange its own funding. By the time the Federal Reserve Bank
reversed that approach, leaving Lehman to collapse into
bankruptcy without help and concluding that AIG posed a greater
threat to financial stability, time to explore other options
was short. The government then put the efforts to organize a
private AIG rescue in the hands of only two banks, JPMorgan
Chase and Goldman Sachs, institutions that had severe conflicts
of interest as they would have been among the largest
beneficiaries of a taxpayer rescue.
When that effort failed, the Federal Reserve decided not to
press major lenders to participate in a private deal or to
propose a rescue that combined public and private funds. As
Secretary Geithner later explained to the Panel it would have
been irresponsible and inappropriate in his view for a central
banker to press private parties to participate in deals to
which the parties were not otherwise attracted. Nor did the
government offer to extend credit to AIG only on the condition
that AIG negotiate discounts with its financial counterparties.
Secretary Geithner later testified that he believed that
payment in full to all AIG counterparties was necessary to stop
a panic. In short, the government chose not to exercise its
substantial negotiating leverage to protect taxpayers or to
maintain basic market discipline.
There is no doubt that orchestrating a private rescue in
whole or in part would have been a difficult--perhaps
impossible--task, and the effort might have met great
resistance from other financial institutions that would have
been called on to participate. But if the effort had succeeded,
the impact on market confidence would have been extraordinary,
and the savings to taxpayers would have been immense. Asking
for shared sacrifice among AIG's counterparties might also have
provoked substantial opposition from Wall Street. Nonetheless,
more aggressive efforts to protect taxpayers and to maintain
market discipline, even if such efforts had failed, might have
increased the government's credibility and persuaded the public
that the extraordinary actions that followed were undertaken to
protect them.
The rescue of AIG distorted the marketplace by transforming
highly risky derivative bets into fully guaranteed payment
obligations. In the ordinary course of business, the costs of
AIG's inability to meet its derivative obligations would have
been borne entirely by AIG's shareholders and creditors under
the well-established rules of bankruptcy. But rather than
sharing the pain among AIG's creditors--an outcome that would
have maintained the market discipline associated with credit
risks--the government instead shifted those costs in full onto
taxpayers out of a belief that demanding sacrifice from
creditors would have destabilized the markets. The result was
that the government backed up the entire derivatives market, as
if these trades deserved the same taxpayer backstop as savings
deposits and checking accounts.
One consequence of this approach was that every
counterparty received exactly the same deal: a complete rescue
at taxpayer expense. Among the beneficiaries of this rescue
were parties whom taxpayers might have been willing to support,
such as pension funds for retired workers and individual
insurance policy holders. But the across-the-board rescue also
benefitted far less sympathetic players, such as sophisticated
investors who had profited handsomely from playing a risky game
and who had no reason to expect that they would be paid in full
in the event of AIG's failure. Other beneficiaries included
foreign banks that were dependent on contracts with AIG to
maintain required regulatory capital reserves. Some of those
same banks were also counterparties to other AIG CDSs.
Throughout its rescue of AIG, the government failed to
address perceived conflicts of interest. People from the same
small group of law firms, investment banks, and regulators
appeared in the AIG saga in many roles, sometimes representing
conflicting interests. The lawyers who represented banks trying
to put together a rescue package for AIG became the lawyers to
the Federal Reserve, shifting sides within a matter of minutes.
Those same banks appeared first as advisors, then potential
rescuers, then as counterparties to several different kinds of
agreements with AIG, and ultimately as the direct and indirect
beneficiaries of the government rescue. The composition of this
tightly intertwined group meant that everyone involved in AIG's
rescue had the perspective of either a banker or a banking
regulator. These entanglements created the perception that the
government was quietly helping banking insiders at the expense
of accountability and transparency.
Even at this late stage, it remains unclear whether
taxpayers will ever be repaid in full. AIG and Treasury have
provided optimistic assessments of AIG's value. As current AIG
CEO Robert Benmosche told the Panel, ``I'm confident you'll get
your money, plus a profit.'' The Congressional Budget Office
(CBO), however, currently estimates that taxpayers will lose
$36 billion. A large portion of the funds needed to repay
taxpayers will be generated through the sale of assets bought
by the government to assist AIG, assets still held by AIG, and
units of AIG sold to third parties or to the public through
initial public offerings. The uncertainty lies in whether AIG's
remaining business units will generate sufficient new business
to create the necessary shareholder value to repay taxpayers in
full. AIG's management is unsurprisingly bullish on that
prospect, where the CBO does not attempt to forecast such
expansion in revenues and instead relies on a baseline
estimate. For now, the ultimate cost or profit to taxpayers is
unknowable, but it is clear that taxpayers remain at risk for
severe losses.
The government's actions in rescuing AIG continue to have a
poisonous effect on the marketplace. By providing a complete
rescue that called for no shared sacrifice among AIG's
creditors, the Federal Reserve and Treasury fundamentally
changed the relationship between the government and the
country's most sophisticated financial players. Today, AIG
enjoys a five-level improvement in its credit rating based
solely on its access to government funding on generous terms.
Even more significantly, markets have interpreted the
government's willingness to rescue AIG as a sign of a broader
implicit guarantee of ``too big to fail'' firms. That is, the
AIG rescue demonstrated that Treasury and the Federal Reserve
would commit taxpayers to pay any price and bear any burden to
prevent the collapse of America's largest financial
institutions, and to assure repayment to the creditors doing
business with them. So long as this remains the case, the worst
effects of AIG's rescue on the marketplace will linger.
In this report, the Panel presents a comprehensive overview
of the AIG transactions based on a review of many thousands of
documents. In addition to reviewing the likelihood of repayment
from AIG, the Panel focuses on the decisions by the Federal
Reserve and Treasury to rescue AIG and the ways they executed
that rescue. Their decisions set the course for the AIG rescue
and the broader TARP and raise significant policy questions
that the Federal Reserve and Treasury may face again--questions
that are best answered in careful consideration of the
aftermath of AIG's rescue rather than in the throes of the next
crisis.
Through a series of actions, including the rescue of AIG,
the government succeeded in averting a financial collapse, and
nothing in this report takes away from that accomplishment. But
this victory came at an enormous cost. Billions of taxpayer
dollars were put at risk, a marketplace was forever changed,
and the confidence of the American people was badly shaken. How
the government will manage those costs, both in the specific
case of AIG and in the more general case of TARP, remains a
central challenge--one the Panel will continue to review.

FIGURE 1: OVERVIEW OF THE AIG TRANSACTIONS

The government's rescue of AIG involves several different
funding facilities provided by different government entities,
with various changes to the transactions over time. The
following tables summarize the sources of funds for AIG's
rescue and the current status of that assistance, as well as
the uses to which those funds were put. The report discusses
these transactions in more detail.

--------------------------------------------------------------------------------------------------------------------------------------------------------
Status Over
Type of Length of Loan/ Capital/ Changes to Time: Exposure
Transaction Date Transaction/ Term of Available Credit Interest Rate Oversight Previous at Height;
Security Investment to AIG or ML Transactions Total Current
entity Exposure
--------------------------------------------------------------------------------------------------------------------------------------------------------
TARP-SSFI/AIGIP
--------------------------------------------------------------------------------------------------------------------------------------------------------
11/25/2008................... Treasury Perpetual Life $40.0B.......... Treasury........ Total current
purchased (Preferred); 10- 10% quarterly exposure is
Series D Fixed year life dividends, highest to
Rate Cumulative (Warrants). cumulative. date. Treasury
Preferred and holds:.
Warrants for --$40B in
common stock. Series E Fixed
Rate Non-
Cumulative
Preferred
Stock.
--$7.5B in
Series F Fixed
Rate Non-
Cumulative
Perpetual
Preferred
Stock.
--Warrants
equal to 2% of
common shares
outstanding.
Accrued and
unpaid
dividends from
original
Series D
Preferred
Stock of $1.6B
outstanding
must be paid
at redemption.
Additional
$0.2B
commitment fee
to be paid
from AIG's
operating
income in
three equal
installments
over 5-year
life of
revolving
credit
facility.
Capital used to
pay down
original Fed
credit
facility;
Trust
ownership
percentage on
conversion
becomes 77.9%,
with Treasury
holding
warrants equal
to an
additional 2%
common stock
ownership.
4/17/2009.................... Treasury Perpetual Life.. 10% quarterly Treasury....... Treasury
exchanged dividends, non- exchanged
Series D for cumulative. Series D
Series E Fixed Preferred
Rate Non- Shares for
Cumulative Series E Fixed
Preferred Rate Non-
Shares and Cumulative
Warrants for Preferred
common stock. Shares.
Accrued and
unpaid
dividends of
$1.6B from
Series D
shares must be
paid at time
of Series E
redemption.
4/17/2009.................... Treasury Perpetual Life $29.8B.......... 10% quarterly Treasury....... Additional
purchased (Preferred); 10- dividends, non- capital
additional year life cumulative. injection that
Series F Fixed (Warrants). reflects a
Rate Non- commitment of
Cumulative up to $30.0B
Preferred reduced by
Shares and $0.2B in
Warrants for retention
common stock. payments made
by AIGFP to
employees in
March 2009.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Maiden Lane II
--------------------------------------------------------------------------------------------------------------------------------------------------------
11/10/2008................... FRBNY formed LLC 6 years, to be Up to $22.5B.... 1-month LIBOR + FRBNY with Terminates Principal
to purchase extended at 100 bps (loan asset Securities balance
RMBS from AIG FRBNY's by FRBNY); 1- management by Borrowing exposure at
insurance discretion. month LIBOR + BlackRock Facility. closing
subsidiaries, 300 bps Financial Formation of (height):
lending money (deferred Management. an LLC to be $19.5B on Fed
to the LLC for purchase price lent money senior loan
this purpose. to AIG subs). from FRBNY to Total current
purchase RMBS exposure on
from AIG outstanding
insurance principal
subsidiaries. amount and
AIG sub accrued
receives a 1/6 interest due
participation to FRBNY:
in any $14.9B as of 5/
residual 27/2010, with
portfolio cash deferred
flows after payment and
loan accrued
repayment. interest due
FRBNY receives to AIG
5/6 of any subsidiaries
residual cash of $1.1B as of
flows. 5/27/2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Maiden Lane III
--------------------------------------------------------------------------------------------------------------------------------------------------------
11/10/2008................... FRBNY formed LLC 6 years, to be Up to $30.0B.... 1-month LIBOR + FRBNY with Same as above, Principal
to purchase extended at 100 bps (loan asset only for balance
multisector FRBNY's by FRBNY); 1- management by purchase of exposure at
CDOs from discretion. month LIBOR + BlackRock multisector closing
counterparties 300 bps Financial CDOs from (height):
of AIGFP, (repayment to Management. counterparties $24.3B on Fed
lending money AIG of equity of AIGFP. AIG senior loan
to the LLC for contribution and FRBNY Total current
this purpose. amount). receive 33% exposure on
and 67%, outstanding
respectively, principal
of any amount and
remaining accrued
proceeds after interest due
repayment of to FRBNY:
loan and $16.6B as of 5/
equity 27/2010, with
contribution. outstanding
principal and
accrued
interest on
loan due to
AIG of $5.3B
as of 5/27/
2010
--------------------------------------------------------------------------------------------------------------------------------------------------------

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

FIGURE 3: GOVERNMENT ASSISTANCE TO AIG AS OF MAY 27, 2010 \2\
[Dollars in millions]
------------------------------------------------------------------------
Assistance
Amount Amount
Authorized Outstanding as
of 5/27/10
------------------------------------------------------------------------
FRBNY
------------------------------------------------------------------------
Revolving Credit Facility............... $34,000 $26,133
Maiden Lane II: Outstanding principal 22,500 14,532
amount of loan extended by FRBNY.......
Net portfolio holdings of Maiden -- 15,910
Lane II LLC........................
Accrued interest payable to FRBNY... -- 342
Maiden Lane III: Outstanding principal 30,000 16,206
amount of loan extended by FRBNY.......
Net portfolio holdings of Maiden -- 23,380
Lane III LLC \3\...................
Accrued interest payable to FRBNY... -- 427
Preferred interest in AIA Aurora LLC.... 16,000 16,266
Accrued dividends on preferred .............. 125
interests in AIA Aurora LLC........
Preferred interest in ALICO SPV......... 9,000 9,150
Accrued dividends on preferred .............. 70
interests in ALICO Holdings LLC....
-------------------------------
Total FRBNY..................... 111,500 83,251
------------------------------------------------------------------------
TARP
------------------------------------------------------------------------
Series E Non-cumulative Preferred stock. 40,000 40,000
Unpaid dividends on Series D .............. 1,600
Preferred stock....................
Series F Non-cumulative Preferred stock. 29,835 7,544
-------------------------------
Total TARP...................... 69,835 49,144
========================================================================
Net borrowings.......................... 181,335 129,831
Accrued interest payable and unpaid .............. 2,564
dividends..............................
-------------------------------
Total Balance Outstanding....... $181,335 $132,395
------------------------------------------------------------------------
\2\ U.S. Department of the Treasury, Troubled Asset Relief Program
Transactions Report for Period Ending May 26, 2010, at 18 (May 28,
2010) (online at www.financialstability.gov/docs/transaction-reports/5-
28-10%20Transactions%20Report%20as%20of%205-26-10.pdf) (hereinafter
``Treasury Transactions Report''); Board of Governors of the Federal
Reserve System, Factors Affecting Reserve Balances (H.4.1) (May 27,
2010) (online at www.federalreserve.gov/releases/h41/20100527/)
(hereinafter ``Federal Reserve H.4.1 Statistical Release'').
\3\ Federal Reserve H.4.1 Statistical Release, supra note 2 (``Dividends
accrue as a percentage of the FRBNY's preferred interests in AIA
Aurora LLC and ALICO Holdings LLC. On a quarterly basis, the accrued
dividends are capitalized and added to the FRBNY's preferred interests
in AIA Aurora LLC and ALICO Holdings LLC.'').

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

SECTION ONE:

A. Overview

At the height of the government support, AIG and its
affiliates had received $89.5 billion in loans from the Federal
Reserve, $43.8 billion through Maiden Lanes II and III, and
$49.1 billion in investments from Treasury. The government
outlay remains high, with $26.1 billion in loans outstanding
from the Federal Reserve's Revolving Credit Facility as of May
27, 2010, $25.4 billion in preferred holdings of AIG related
special purpose vehicles (SPVs), and the same Treasury support
outstanding as at its height. The government controls 79.8
percent of AIG's equity and has appointed 2 of its 13
directors. Only Fannie Mae and Freddie Mac, institutions in
government conservatorship, have received more money from the
government.
This report examines how AIG, a unique amalgamation of
insurance and other financial companies, got into trouble, and
looks at some of the regulatory challenges presented by such an
entity. It follows the taxpayers' money. And it examines the
actions taken by various governmental entities, primarily the
Federal Reserve Bank of New York (FRBNY),\4\ which took the
lead in the AIG rescue, the reasons those entities gave for the
various decisions taken in the rescue, and the effectiveness of
the government in achieving its objectives. The report also
examines how those actions were explained to the taxpayer both
contemporaneously and subsequently.
---------------------------------------------------------------------------
\4\ FRBNY is one of 12 regional banks within the Federal Reserve
System.
---------------------------------------------------------------------------
The government chose to rescue AIG in full, rather than
conditioning any rescue on shared losses with the creditors,
whether through negotiation or bankruptcy. The significance of
this choice cannot be overstated. The decision determined the
parameters of all subsequent actions and decisions, and thus
the report examines the choice in detail. Because the
government chose to rescue AIG as a whole, all AIG's creditors
were paid off in full. The report explains how the government's
funds were used and who benefitted. It also asks how those
results might have differed if bankruptcy, or some other option
than wholesale rescue, had been chosen.
Looking forward, the report examines AIG's plans to repay
the taxpayers and the government's plans to exit its AIG
holdings.
The Panel's mandate is to review the use by the Secretary
of the Treasury of his authority under the Emergency Economic
Stabilization Act of 2008 (EESA) and his administration of the
TARP. Treasury's actions, and the role Treasury chose to play
with respect to AIG, cannot be understood except in the context
of the actions taken by the Board of Governors of the Federal
Reserve System (the Board) and FRBNY. The report therefore
looks at the actions taken by all these governmental entities.
Although the roles of the various parties are set out in the
report, the governmental entities worked together closely and,
for the ease of reading, are in some places referred to
collectively as ``the government.''
The report builds on the work done by other oversight
bodies and will later this year be supplemented by a wide-
ranging report on all aspects of the AIG rescue by the
Government Accountability Office (GAO). The Financial Crisis
Inquiry Commission has also held hearings looking into the role
of complex derivative securities in the financial crisis and
the part played by AIG. The Special Inspector General for the
Troubled Asset Relief Program (SIGTARP) has initiated an
investigation into the manner in which public disclosure of the
identity of certain of AIG's counterparties was delayed.
As those future reports and investigations will show, the
AIG story is not yet complete. The complexities of the company,
and its cross-holdings and cross-subsidizations, discussed in
the report, may mean that some time will elapse before the true
financial position of AIG and its subsidiaries and their future
are clear. Moreover, analysis of the rescue is dependent to
some extent to the narrative framework presented by the
government. While the report tests some of the assertions made
by the various government entities--and reflects a review by
the Panel staff of thousands of government documents--it is
inevitably dependent to some extent on the information that
those entities are willing to share and the manner in which
they present the facts examined. The Panel has no subpoena
power, and as a result it is entirely dependent upon the
goodwill of private entities. AIG has provided extensive
documentation to the Panel. Some of AIG's counterparties have
not provided all documentation requested by the Panel.
Context is everything with AIG. The government's later
actions were shaped by the policy decisions it made and the
actions it took in one turbulent week in September 2008. Its
involvement was dictated by the unique threat to financial
stability that it believed AIG's situation posed. It is
therefore crucial to understand the nature of AIG, the ways
different parts of AIG were regulated, and the state of affairs
in the world when the government first contemplated the
prospect of AIG's failure.

B. AIG Before the Government Rescue

1. AIG's History

At its peak, AIG was one of the largest publicly traded
companies in the world, whose principal businesses included
insurance and financial services. Hank Greenberg, the long-term
CEO of AIG, was chosen to succeed Cornelius Starr, the founder
of the company, after leading AIG's North American operations.
During his tenure, which ran from 1968 until 2005, the company
grew considerably, diversified its product offerings, and
expanded to more than 100 countries around the world. On March
14, 2005, AIG's board forced Greenberg to step down amid
increased scrutiny, followed by then New York Attorney General
Eliot Spitzer and later the U.S. Securities and Exchange
Commission (SEC) filing civil charges against Greenberg for his
role in fraudulent business practices and accounting fraud that
misrepresented AIG's earnings.\5\
---------------------------------------------------------------------------
\5\ Securities and Exchange Commission, SEC Charges Hank Greenberg
and Howard Smith for Roles in Alleged AIG Accounting Violations (Aug.
6, 2009) (online at www.sec.gov/news/press/2009/2009-180.htm).
---------------------------------------------------------------------------
AIG Financial Products (AIGFP), which contributed to the
liquidity crisis at AIG, was created in 1987. AIGFP, as well as
other swap dealers, rely heavily on the credit rating of the
parent company. A triple-A rating usually affords the entity
considerable leverage in negotiating contracts. Specifically, a
triple-A rating provides leverage regarding if and when
collateral is to be posted and the trigger and amounts of
collateral, and it offers latitude in negotiations when
problems arise. In the spring of 2005, rating agency Standard &
Poor's (S&P) lowered the long-term senior debt and counterparty
ratings of AIG from `AAA' to `AA.' As discussed in Section B3,
this proved disastrous for AIGFP.\6\
---------------------------------------------------------------------------
\6\ American International Group, Inc., Form 10-K for the Fiscal
Year Ended December 31, 2005, at 14 (Mar. 16, 2006) (online at
www.sec.gov/Archives/edgar/data/5272/000095012306003276/
y16349e10vk.htm) (hereinafter ``AIG Form 10-K for FY05'').
---------------------------------------------------------------------------

2. AIG's Structure and Regulatory Scheme

The scale of and linkages across AIG's operations posed
unique managerial and regulatory challenges. Prior to the
rescue, AIG was the world's largest insurance organization,
with over $1 trillion in assets and 76 million customers in
over 130 countries. Core insurance operations encompassed both
general insurance, including property and casualty, commercial
and industrial, and life insurance, including annuities and
retirement services. In addition to insurance, AIG's primary
business units included financial services and asset
management.
Figure 5 below outlines the primary operations housed
within AIG's four core business segments in 2008 as well as the
relevant regulatory bodies--if any--that were responsible for
oversight.

FIGURE 5: AIG CURRENT PRIMARY BUSINESS SEGMENTS
----------------------------------------------------------------------------------------------------------------
Life Insurance &
General Insurance Retirement Services Financial Services Asset Management \8\
----------------------------------------------------------------------------------------------------------------
Function
----------------------------------------------------------------------------------------------------------------
Property/casualty insurance.......... Individual and group Capital markets........ Investment advisory
life insurance Consumer finance....... Brokerage
products. Insurance premium Private banking
Retirement services.... finance. Clients include AIG
Annuities.............. Aircraft leasing....... subsidiaries,
institutional and
individual investors
Commercial/industrial insurance......
Specialty insurance..................
Reinsurance..........................
----------------------------------------------------------------------------------------------------------------
Key Regulators \7\
----------------------------------------------------------------------------------------------------------------
50 state insurance regulators........ 50 state insurance Office of Thrift Securities and Exchange
regulators. Supervision. Commission \8\
Texas International Securities and Exchange International
Regulators. Commission. Regulators
International
Regulators.
Arizona, Delaware, Missouri, New
York, Pennsylvania, Tennessee, Texas
International Regulators.
----------------------------------------------------------------------------------------------------------------
\7\ Only domestic regulators are named here. International subsidiaries are overseen by the relevant regulators
in the country of operation. The Office of Thrift Supervision had regulatory responsibility over the holding
company, AIG Inc. (and therefore all of AIG) prior to September 18, 2008. FRBNY and Treasury now act as AIG's
de facto primary regulators.
\8\ The Securities and Exchange Commission has a regulatory relationship with several AIG subsidiaries,
including AIG Asset Management LLC, AIG Financial Securities Corp, and SunAmerica Capital Services Inc. SEC
does not regulate the AIG parent company or AIGFP.

Prior to the financial crisis, AIG generated annual revenue
of more than $100 billion. During the 2004 to 2006 period,
insurance operations accounted for nearly 90 percent of AIG's
total net revenue, as shown in Figure 6. Approximately half of
the company's net revenue during this period came from outside
of the United States, largely concentrated in Asia.

FIGURE 6: REVENUE BY SEGMENT (LEFT PIE) AND REVENUE BY GEOGRAPHIC
REGION (RIGHT PIE), 2004-2006 (AGGREGATE) \9\

---------------------------------------------------------------------------
\9\ American International Group, Inc., Form 10-K for the Fiscal
Year Ended December 31, 2006, at 4, 124 (Mar. 1, 2007) (online at
www.sec.gov/Archives/edgar/data/5272/000095012307003026/
y27490e10vk.htm) (hereinafter ``Form 10-K for the Fiscal Year Ended
December 31, 2006''); AIG Form 10-K for FY05, supra note 6, at 4, 94;
American International Group, Inc., Form 10-K for the Fiscal Year Ended
December 31, 2004, at 4, 147 (May 31, 2005) (online at www.sec.gov/
Archives/edgar/data/5272/000095012305006884/y03319e10vk.htm)
(hereinafter ``AIG Form 10-K for FY04'').
---------------------------------------------------------------------------

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

AIG's product and regional diversity was predicated on
maintaining an exceptional credit rating, which helped bolster
its insurance operations and allowed the company to use its low
cost of funds as leverage to boost non-insurance business
lines, including aircraft leasing and consumer finance. AIG's
longtime AAA credit rating also increased its attractiveness as
a counterparty in the capital markets, helping the company
further expand its product base in the United States and around
the world. The product and geographic breadth of AIG's
operations, however, were not matched by a coherent regulatory
structure to oversee its business. The Office of Thrift
Supervision (OTS), a federal agency that regulates the U.S.
thrift industry, was specifically charged with overseeing the
parent and it failed to do so. Whether the OTS or a more
coherent regulatory framework could have prevented the build-up
in risks that the company's own management team failed to
understand is unlikely, but this does not obscure the point
that AIG's holding company regulator had the power and the duty
to spot and require the company to curtail its risk.
AIG insurance subsidiaries operate and are licensed in all
50 states, and the states regulate the firm's domestic
insurance subsidiaries.\10\ All of AIG's domestic insurance
subsidiaries are domiciled in one of 14 states or Puerto Rico,
and each of those jurisdictions has primary regulatory
authority over its domiciled subsidiaries.\11\
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\10\ See McCarran-Ferguson Act, 15 U.S.C. Sec. Sec. 1011-1015. The
McCarran-Ferguson Act exempts insurance from federal regulation unless
expressly stated by Congress. It does not mandate that states regulate
insurance; it states that no ``Act of Congress shall be construed to
invalidate, impair, or supersede any law enacted by any State for the
purpose of regulating the business of insurance, . . . unless such Act
specifically relates to the business of insurance.'' 15 U.S.C.
Sec. 1012(b).
The state insurance agencies work together through the National
Association of Insurance Commissioners (NAIC) to coordinate regulation,
set certain uniform standards, and determine accreditation standards
for state insurance regulators. One of these accreditation standards
requires state regulators to conduct quarterly financial analyses of
the state's multi-state domiciliary insurance companies and full
examinations every 5 years. Regulators of non-domiciliary companies may
also choose to conduct examinations, or they may rely on the lead
regulator's examination. The insurance regulators will also communicate
with other regulators, such as OTS.
\11\ Most of these states have more than one AIG subsidiary;
Delaware, North Carolina, New York, and Pennsylvania all have six or
more. This excludes more than 100 foreign governments that regulate
AIG's foreign insurance subsidiaries. See House Committee on Oversight
and Government Reform, Written Testimony of Timothy F. Geithner,
secretary, U.S. Department of the Treasury, The Federal Bailout of AIG,
at 3 (Jan. 27, 2010) (online at oversight.house.gov/images/stories/
Hearings/Committee_on_Oversight/TESTIMONY-Geithner.pdf) (hereinafter
``Testimony of Sec. Geithner''). An insurance company is domiciled in
the state in which it is organized or which it has chosen as its state
of domicile.
---------------------------------------------------------------------------
The states, through the National Association of Insurance
Commissioners (NAIC), coordinate so that AIG's insurance
subsidiaries have four lead regulators. Texas is the lead
regulator for life insurance companies, Pennsylvania for
property & casualty, New York for personal lines, and Delaware
for ``surplus'' or specialized lines. Domestic regulators, lead
and otherwise, perform AIG's examinations concurrently, because
of the commonality of systems between companies.\12\ Each lead
regulator's main role is to coordinate examinations and other
regulatory functions among the various state regulators. The
lead regulator has no special legal authority; its role is
merely to coordinate the various state regulators. Each state
still has responsibility for examining its domiciled
subsidiaries.\13\ This regulation entails regular financial
examinations as well as scrutiny of major transactions,
solvency issues, and other matters. The lead regulator and the
individual state regulators each conduct regular examinations,
but the lead regulator coordinates them. The state insurance
regulators, including the lead regulators, only examine the AIG
holding company to the extent that it relates to the insurance
subsidiaries.\14\
---------------------------------------------------------------------------
\12\ Panel staff conversation with the National Association of
Insurance Commissioners (Apr. 2, 2010).
\13\ Panel staff conversation with New York State Insurance
Department (June 3, 2010).
\14\ Though examinations of the holding company are limited to how
it relates to the subsidiaries, the regulators obtain additional
information about the holding company through informal channels, such
as regular communications with holding company management and review of
public filings. Panel staff conversation with New York State Insurance
Department (June 3, 2010).
---------------------------------------------------------------------------
Foreign insurance regulators, operating under their own
countries' laws, have jurisdiction over AIG's overseas
insurance subsidiaries.
The OTS was the regulator of AIG's holding company, AIG
Group, Inc., after it granted a federal charter to AIG Federal
Savings Bank (AIG FSB) in May 2000.\15\ OTS was responsible for
monitoring AIG's operations, ensuring compliance with relevant
laws, and preventing risks that could affect the safety and
soundness of the firm.\16\ The regulatory approach of OTS in
regulating a thrift holding company such as AIG is predicated
on evaluating the overall holding company to ensure that no
harm is done to the thrift. As a result, OTS took a bottom-up
approach to regulating AIG, from the thrift to the holding
company, as opposed to a top-down, comprehensive approach to
regulation.\17\ Although AIG's insurance subsidiaries were
subject to the oversight of state and foreign regulators, OTS
was the firm's consolidated supervisor, responsible for
coordinating overall supervision.\18\
---------------------------------------------------------------------------
\15\ Office of Thrift Supervision, OTS Approves AIG Acquisition of
American General Bank (Aug. 1, 2001) (online at files.ots.treas.gov/
77152.html).
\16\ See House Financial Services, Subcommittee on Capital Markets,
Insurance and Government Sponsored Enterprises, Written Testimony of
Scott M. Polakoff, acting director, Office of Thrift Supervision,
American International Group's Impact on the Global Economy: Before,
During, and After Federal Intervention, at 7 (Mar. 18, 2009) (online at
www.house.gov/apps/list/hearing/financialsvcs_dem/ots_3.18.09.pdf)
(hereinafter ``Written Testimony of Scott Polakoff'').
\17\ Panel staff conversation with the Office of Thrift Supervision
(May 21, 2010).
\18\ U.S. Government Accountability Office, Troubled Asset Relief
Program: Status of Government Assistance Provided to AIG, GAO-09-975
(Sept. 2009) (online at www.gao.gov/new.items/d09975.pdf) (hereinafter
``GAO Report'').
---------------------------------------------------------------------------
The interlocking nature of AIG's businesses as well as the
vast array of counterparties with which these businesses
transacted posed an impediment to regulators constrained by
functional and regional limitations on their oversight. In
particular, AIGFP, the chief purveyor of AIG's credit default
swaps (CDS) business, fell outside the scope of the state
insurance regulators. Although OTS examined AIGFP in its
regulation of the holding company, the CDS book of business
fell outside of its regulatory authority.\19\ In addition,
because OTS was considered an ``equivalent regulator'' by
European Union (EU) standards, AIGFP's activities were only
regulated by European regulators when they coincided with the
European business of Banque AIG, a French subsidiary of AIGFP.
This regulatory arrangement excluded any comprehensive
examination and regulation of CDS activity within AIGFP.\20\
Certain other financial operations inside AIG--including
capital markets, consumer finance and aircraft leasing--were
regulated on a piecemeal basis or escaped regulation entirely.
---------------------------------------------------------------------------
\19\ Panel staff conversation with the Office of Thrift Supervision
(May 21, 2010). Credit default swaps were also exempted from regulation
by the Securities and Exchange Commission (SEC) and the Commodities
Future Trading Commission (CFTC) as a result of the Commodities Futures
Modernization Act of 2000.
\20\ Panel staff conversation with the Office of Thrift Supervision
(May 21, 2010).
---------------------------------------------------------------------------

3. The Causes of AIG's Problems

The trigger and primary cause of AIG's collapse came from
inside AIGFP. This business unit, which included CDS on
collateralized debt obligations (CDOs) backed by subprime
mortgages, produced unrealized valuation losses and collateral
calls that engulfed AIG in the fall of 2008. While the risk
overhang in this business would have likely been sufficient to
bring down the firm on its own, AIG's securities lending
operations, which involved securities pooled from AIG's
domestic life insurance subsidiaries, significantly raised the
level of difficulty associated with executing a private sector
solution or an orderly bankruptcy.\21\ In the words of Marshall
Huebner of Davis Polk & Wardwell, a law firm that represented
FRBNY, the securities lending problems contributed to a
``double death spiral.'' \22\ The problems in AIGFP exacerbated
the problems in securities lending, and vice versa, as
collateral demands from both sets of counterparties quickly
imperiled the company's liquidity position as it struggled to
meet its cash demands. Meanwhile, the company's insurance
operations were incapable of generating the requisite cash
either through normal operations or asset sales to fund the
parent company. In both cases, the threats within these
businesses emanated from outsized exposure to the deteriorating
mortgage markets, owing to grossly inadequate valuation and
risk controls, including insufficient capital buffers as losses
and collateral calls mounted.
---------------------------------------------------------------------------
\21\ AIG's securities lending operations are discussed below in
Section B.3.b (a detailed explanation of this business is provided in
Annex V). Securities lending normally provides a low-risk mechanism for
insurance companies and other long-term investors in the financial
markets to earn modest sums of money on assets that would otherwise be
sitting idle. However, rather than investing the cash collateral from
borrowers in low-risk short-term securities in order to generate a
modest yield, AIG invested in more speculative securities tied to the
RMBS market. Consequently, these investments posed a duration mismatch
(securities lending counterparties could demand a return of their
collateral with very little notice), that was exacerbated by valuation
losses and illiquidity in the mortgage markets that impaired AIG's
ability to return cash to its securities lending counterparties.
\22\ FRBNY and Treasury briefing with the Panel and Panel staff
(Apr. 12, 2010).
---------------------------------------------------------------------------
AIG was taking risks with the assets of its life insurance
subsidiaries through its securities lending program, creating a
potential $15 billion-plus cash drain on their operations, a
shortfall that may have threatened the solvency of these units
in the absence of government assistance, as discussed in
Section B3b.\23\ Excluding the liquidity issues stemming from
AIG's securities lending program, industry observers and
regulators viewed the core operations on the life insurance
side of the company as generally sound.\24\ The same held true
for AIG's property-casualty insurance business. As a result of
the financial crisis, life insurance companies industry-wide
felt pressure from declining asset values. At AIG, as asset
valuations for CDS portfolios moved closer to levels at which
collateral requirements were triggered, reserve requirements
for embedded guarantees in certain insurance products were
increased, but this pressure did not otherwise translate into
immediate liquidity issues for the company.
---------------------------------------------------------------------------
\23\ As of September 30, 2008, the fair value of the approximately
$40 billion RMBS portfolio in AIG's securities lending program was
approximately $23.5 billion. American International Group, Form 10-Q
for the Quarterly Period Ended September 30, 2008, at 52 (Nov. 10,
2008) (online at www.sec.gov/Archives/edgar/data/5272/
000095012308014821/y72212e10vq.htm) (hereinafter ``AIG Form 10-Q for
Third Quarter 2008'').
\24\ Panel staff conversation with the National Association of
Insurance Commissioners (Apr. 2, 2010); Standard and Poor's
conversation with Panel staff (May 13, 2010) (noting prior to September
2008 AIG primarily derived its high credit rating from its insurance
subsidiaries).
---------------------------------------------------------------------------
a. Credit Default Swaps
AIG's downfall stemmed in large part from its CDS on multi-
sector CDOs, which exposed the firm to the vaporization of
value in the subprime mortgage market.\25\ While many
counterparties purchased these contracts to hedge or minimize
credit risk, AIG essentially took the other side, a one-way,
long-term bet on the U.S. mortgage market.\26\ This bet was
premised on the presumed security of the `AAA'-plus ratings on
the underlying CDOs, aided by the subordination structures
built into the underlying collateral pools, as well as AIG's
once stellar `AAA' credit rating. AIG relied on these factors
to serve as a bulwark against market volatility that would
undermine the value of the reference securities, and
necessitate mark-to-market valuation losses and the posting of
collateral to AIG's trading partners. AIGFP's model for CDOs
was insufficiently robust to anticipate the impact of the
significant declines in value associated with the market
meltdown. This basic failure of comprehensive modeling and
prudent risk/reward analysis on what was a relatively small
slice of AIGFP's business ultimately brought down the entire
firm and imperiled the U.S. financial system.
---------------------------------------------------------------------------
\25\ See Annex III for an explanation of AIG's CDS business and the
CDS market more generally.
\26\ This was in contrast to other market participants,
particularly dealers, which sought to balance the risk in their
portfolios by accumulating both long and short positions to better net
risk positions.
---------------------------------------------------------------------------
AIGFP's obligations were guaranteed by its highly-rated
parent company (`AAA'-rated by Standard & Poor's since 1983),
an arrangement that facilitated easy money via much lower
interest rates from the public markets, but ultimately made it
difficult to isolate AIGFP from its parent, with disastrous
consequences.\27\ The company's stellar earnings, business
diversity, and sizable equity base allowed the firm to borrow
at relatively cheaper levels in the capital markets. This
allowed for the emergence of a ``carry trade'' mentality--i.e.,
borrowing at low rates, investing/lending at higher rates, and
pocketing the difference, or spread--in pursuing investments
that would maximize the value of AIG's balance sheet and low
cost of funds.\28\ It is rare for any financial institution,
much less one with significant capital markets operations, to
have a AAA-rating.\29\ Major banks and other capital markets
players could not compete with AIG's rating and its resulting
access to lower-cost funding and more permissive collateral
arrangements. Of course, AIG's rating would skew its internal
risk/reward dynamics, as it could enter new markets more
cheaply and deploy its balance sheet far more extensively than
other competitors in the marketplace. As discussed in more
detail below, the firm continued to underwrite multi-sector
CDOs for almost a year after losing its AAA-rating in 2005.
---------------------------------------------------------------------------
\27\ House Committee on Oversight and Government Reform, Written
Testimony of Elias Habayeb, former senior vice president and chief
financial officer, AIG Financial Services, The Federal Bailout of AIG,
at 3 (Jan. 27, 2010) (online at oversight.house.gov/images/ stories/
Hearings/Committee_on_Oversight/ 2010/012710_AIG_Bailout/TESTIMONY-
Habayeb.pdf) (hereinafter ``Written Testimony of Elias Habayeb'').
\28\ See Congressional Oversight Panel, Testimony of Robert
Benmosche, president and chief executive officer, American
International Group, COP Hearing on TARP and Other Assistance to AIG
(May 26, 2010) (hereinafter ``Testimony of Robert Benmosche'').
\29\ In 2005, for example, the year AIG lost its AAA rating, only
four other financial companies had a AAA-rating from Standard &
Poor's--Berkshire Hathaway, GE Capital, Syncora Guarantee, and Toyota
Motor Credit.
---------------------------------------------------------------------------
In turn, the parent company benefited from the modest
earnings diversity offered by AIGFP's capital markets
business.\30\ AIG's sterling credit rating was a differentiator
in the market, and allowed the division to move aggressively
into new business lines with lower levels of competition,
expanding its scope as a counterparty to and underwriter of
risk products, as institutional investors and financial
institutions sought out more sophisticated instruments to hedge
or speculate on credit, or other financial assets, through a
variety of derivatives instruments.\31\ AIGFP both enabled and
participated in this market. Federal Reserve Chairman Bernanke
later characterized AIGFP as a ``hedge fund . . . attached to a
large and stable insurance company.'' \32\
---------------------------------------------------------------------------
\30\ AIGFP was viewed favorably by AIG investors and the ratings
agencies. From their vantage point, AIGFP was a risk management tool
for AIG's core insurance business because it diversified the company's
earnings base. ``The establishment of a separate entity by an insurance
company to offer financial products could satisfy one or more of the
following benefits: the creation of capital efficiencies, isolation of
the risk related to a specific business line for risk-management
purposes, and the creation of a noninsurance entity that is not
encumbered by possible regulatory restrictions.'' Standard & Poor's
Ratings Services, Rating Financial Product Companies Higher Than
Related Insurance Companies (Apr. 29, 2004) (online at
www.standardandpoors.com/prot/ratings/articles/en/us/
?assetID=1245173065318).
\31\ These included over-the-counter (OTC) derivatives and
exchange-traded derivatives. OTC contracts, such as credit default
swaps and forward contracts, are privately negotiated contracts between
two parties. On the other hand, exchange-traded derivatives, including
futures and option contracts, are traded on an exchange and settled
through a clearing house.
\32\ Senate Budget Committee, Testimony of Ben S. Bernanke,
chairman, Board of Governors of the Federal Reserve System, Economic
and Budget Challenges for the Short and Long Term (Mar. 3, 2009).
---------------------------------------------------------------------------
AIGFP entered the fledging credit derivatives market in
1998 when it underwrote its first credit default swap (CDS)
with JP Morgan.\33\ CDS contracts are privately negotiated
contracts that obligate one party to pay another in the event
that a third party cannot pay its obligation.\34\ CDS contracts
function in a similar manner to insurance contracts, although
their payoff structure is closer to that of a put option.\35\
---------------------------------------------------------------------------
\33\ Panel staff briefing with Weil Gotshal (May 12, 2010).
\34\ BMO Capital Markets, Credit Default Swaps (online at
www.bmocm.com/products/marketrisk/credit/swaps/default.aspx) (accessed
June 8, 2010).
\35\ See Annex III for a more detailed discussion of CDS contracts.
Also, for a definition of CDS contracts in prior reports see
Congressional Oversight Panel, December Oversight Report: Taking Stock:
What Has the Troubled Asset Relief Program Achieved?, at 35 (Dec. 9,
2009) (online at cop.senate.gov/documents/cop-120909-report.pdf).
---------------------------------------------------------------------------
Over time AIGFP became a central player in the fast-growing
CDS market, underwriting its first corporate arbitrage CDS in
2000 and its first multi-sector CDS in 2004.\36\ AIGFP's
corporate arbitrage CDS portfolio was comprised of CDS
contracts written on corporate debt and collateralized loan
obligations (CLOs) and its multi-sector CDS portfolio is
comprised of CDS contracts written on CDOs. The collateral
pools backing the corporate debt and CLO CDS portfolio included
baskets of investment-grade corporate bonds and loans of
commercial and industrial loans of large banks. The collateral
pools backing the multi-sector CDOs included prime, Alt-A, and
subprime residential mortgage-backed securities (RMBS);
commercial mortgage-backed securities (CMBS); and other asset-
backed securities (ABS).\37\ CDS written on corporate debt,
CLOs, and multi-sector CDOs serve as protection against
``credit events'' of the issuer of the reference obligation,
including bankruptcy, failure to pay, acceleration of payments
on the issuer's obligations, default on the issuer's
obligations, restructuring of the issuer's debt, and similar
events.\38\
---------------------------------------------------------------------------
\36\ Panel staff briefing with Weil Gotshal (May 12, 2010).
\37\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 18,
116, 121-22.
\38\ Senate Committee on Agriculture, Nutrition and Forestry,
Written Testimony of Robert Pickel, chief executive officer,
International Swaps and Derivatives Association, Role of Financial
Derivatives in Current Financial Crisis, at 1 (Oct. 14, 2008) (online
at www.isda.org/press/pdf/Testimony-of-Robert-Pickel.pdf) (hereinafter
``Written Testimony of Robert Pickel'').
---------------------------------------------------------------------------
Figure 7 shows the explosion in the CDS market from its
infancy in 2001 to a market with over $60 trillion in notional
contracts outstanding in 2007.

FIGURE 7: NOTIONAL AMOUNT OF CREDIT DEFAULT SWAPS OUTSTANDING \39\

---------------------------------------------------------------------------
\39\ International Swaps and Derivatives Association, ISDA Market
Survey: Historical Data (online at www.isda.org/statistics/
historical.html) (accessed June 8, 2010).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

AIGFP's operating income grew from $131 million in 1994 to
$949 million in 2006, paralleling the boom in the overall
derivatives market, as well as the CDS market. While the credit
markets provided a source of steady profits for AIGFP, the
division's operating income represented a relatively small
percentage of AIG's total operating income, contributing just 7
percent to firmwide net income in 2006.\40\ More importantly,
as recent events make clear, the risk involved in this business
was dramatically disproportionate to the revenue produced. For
example, losses in 2007 totaled $11.5 billion, twice the
aggregate net income produced by this division from 1994 to
2006.\41\
---------------------------------------------------------------------------
\40\ AIG Form 10-K for FY04, supra note 9, at 24.
\41\ American International Group, Inc., Form 10-K for the Fiscal
Year Ended December 31, 2007, at 34 (Feb. 28, 2008) (online at
www.sec.gov/Archives/edgar/data/5272/000095012308002280/
y44393e10vk.htm) (hereinafter ``AIG Form 10-K for FY07'').
---------------------------------------------------------------------------

FIGURE 8: AIGFP'S OPERATING INCOME VS. CONTRIBUTION TO CONSOLIDATED AIG
RESULTS \42\

---------------------------------------------------------------------------
\42\ AIG Form 10-K for FY04, supra note 9, at 24; AIG Form 10-K for
FY05, supra note 6, at 74; American International Group, Inc. Form 10-K
for the Fiscal Year Ended December 31, 2002, at 63 (Mar. 31, 2003)
(online at www.sec.gov/Archives/edgar/data/5272/000095012303003570/
y65998e10vk.txt); American International Group, Inc., Form 10-K for the
Fiscal Year Ended December 31, 1999, at 45 (Mar. 30, 2000)
(www.sec.gov/Archives/edgar/data/5272/0000950123-00-002999.txt);
American International Group, Inc., Form 10-K for the Fiscal Year Ended
December 31, 1996, at 38 (Mar. 28, 1997) (online at www.sec.gov/
Archives/edgar/data/5272/0000950123-97-002720.txt).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

This risk stemmed from a relatively small contributor to
the firm's overall derivatives exposure. AIGFP grouped its CDS
business into three separate categories, based on the
underlying assets that were being insured: corporate debt/CLOs
(corporate arbitrage), regulatory capital, and multi-sector
CDOs. At its peak in 2007, these three groups represented an
aggregate CDS portfolio of $527 billion,\43\ constituting just
20 percent of the unit's overall derivatives exposure of $2.66
trillion.\44\ In addition to its credit book, AIGFP also
engaged in a wide variety of other derivative and financial
transactions. These included standard and customized interest
rate, currency, equity, commodity, and credit products;
structured borrowings through notes, bonds, and guaranteed
investment agreements (GIAs); and various commodity, foreign
exchange trading, and market-making activities. These
activities were responsible for the majority of AIG's
derivatives activity.\45\
---------------------------------------------------------------------------
\43\ In addition to its credit book, AIGFP also engaged in a wide
variety of financial transactions through its Capital Markets division.
These included standard and customized interest rate, currency, equity,
commodity, and credit products; structured borrowings through notes,
bonds, and guaranteed investment agreements; and various commodity,
foreign exchange trading, and market-making activities. Capital Markets
was responsible for the majority of AIG's derivatives activity. AIG
Form 10-K for FY04, supra note 9, at 12, 75, 93.
\44\ Congressional Oversight Panel, Testimony of Jim Millstein,
chief restructuring officer, U.S. Department of the Treasury, COP
Hearing on TARP and Other Assistance to AIG (May 26, 2010) (hereinafter
``Testimony of Jim Millstein'').
\45\ AIG Form 10-K for FY04, supra note 9, at 75, 93-4.
---------------------------------------------------------------------------
Only $149 billion, or 6 percent, of AIGFP's total
derivatives portfolio in 2007 was classified as Arbitrage CDS,
comprised of both the multi-sector CDO and corporate debt/CLO
components (see Figure 9).\46\ Ultimately, these two portfolios
accounted for 99 percent of AIGFP's unrealized valuation losses
in 2007 and 2008.\47\ AIGFP's multi-sector CDO subset of the
Arbitrage portfolio, which represented approximately 3 percent
of the notional value of AIGFP's total credit and non-credit
derivatives exposure, accounted for over 90 percent of these
losses.\48\ Ultimately, these losses were driven by just 125 of
the roughly 44,000 contracts entered into by AIGFP.\49\
---------------------------------------------------------------------------
\46\ AIG Form 10-K for FY07, supra note 41, at 122.
\47\ American International Group, Inc., Form 10-K for the Fiscal
Year Ended December 31, 2008, at 116 (Mar. 2, 2009) (online at
www.sec.gov/Archives/edgar/data/5272/000095012309003734/
y74794e10vk.htm) (hereinafter ``AIG Form 10-K for FY08'').
\48\ See Figure 36 in Section I.2(f) for an outline of the
exposures and losses within AIGFP's credit portfolio, from 2008 to the
first quarter of 2010.
\49\ Testimony of Robert Benmosche, supra note 28.
---------------------------------------------------------------------------

FIGURE 9: ARBITRAGE CDS PORTFOLIO VS. NET NOTIONAL AMOUNT OF AIGFP'S
TOTAL DERIVATIVES PORTFOLIO \50\

---------------------------------------------------------------------------
\50\ American International Group, Inc., Form 10-K for the Fiscal
Year Ended December 31, 2009, at 130 (Feb. 26, 2010) (online at
www.sec.gov/Archives/edgar/data/5272/000104746910001465/a2196553z10-
k.htm) (hereinafter ``AIG Form 10-K for FY09''); AIG Form 10-K for
FY07, supra note 41, at 122.
---------------------------------------------------------------------------

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Drilling down further, at the end of September 2008, the
net notional amount of the multi-sector CDO book was $72
billion, or less than 20 percent, of AIGFP's total credit
portfolio. Approximately $55 billion, or 77 percent, of the
reference CDOs contained securities that included exposure to
the U.S. subprime mortgage market.\51\ Because AIGFP ceased
underwriting new subprime multi-sector CDS in 2005 (after
launching this product line in 2004), the majority of this
portfolio was exposed to 2004 and 2005 subprime RMBS
vintages.\52\ However--and this is very important--the
reference CDOs that AIG insured were not always static, and
thus weaker, newer vintages infected older pools of securities
as CDO managers adjusted portfolios.\53\ Weil Gotshal, a law
firm that represents AIG, states that AIG's Credit Risk
Management was in fact aware that some of the 2004 to 2005 CDO
portfolios were actively managed, but there is no further
information to suggest that this featured prominently in the
desk's understanding of this product's ongoing risk
profile.\54\ Ultimately, after considering these reinvestments
(less than 10 percent of the portfolio) and non-subprime and
CMBS deals closed in 2006 and 2007, approximately 26 percent of
the overall multi-sector CDO book included the particularly
toxic 2006 and 2007 vintages, of which 37 percent were exposed
to subprime or Alt-A mortgages.
---------------------------------------------------------------------------
\51\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 115-
16.
\52\ A handful of CDOs with subprime exposure, which were
apparently committed to before AIG decided to exit this business, were
underwritten in early 2006.
\53\ AIG Form 10-K for FY07, supra note 41, at 122. Managed CDOs
usually consist of a sponsor, collateral manager, and investors who buy
tranches with various maturity and credit risk characteristics. The
duration of a managed deal consists broadly of three phases in which
managers: (1) invest proceeds from sale of CDO securities; (2) actively
manage the collateral (as assets amortize) and reinvest the cash flows;
(3) and hold the collateral until maturity as assets are sold off and
investors are paid back. Managers tend to be financial institutions who
specialize in ``back office'' transactions.
\54\ Weil Gotshal conversation with Panel staff (May 24, 2010).
---------------------------------------------------------------------------

FIGURE 10: COMPOSITION AND VINTAGE OF AIGFP COLLATERAL SECURITIES IN
THE MULTI-SECTOR CDO BOOK (SEPTEMBER 30, 2008) \55\

---------------------------------------------------------------------------
\55\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 116.
---------------------------------------------------------------------------

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

In exchange for regular payments, which functioned much
like insurance premiums, AIGFP was obligated to provide credit
protection on a designated portfolio of loans or debt
securities. In general, protection on these assets--including
residential mortgages, commercial real estate loans, corporate
debt and European bank loan books--were structured so that
AIGFP was in a second-loss position. This meant that losses on
the reference securities would have to exceed a certain
threshold (referred to as an ``attachment point'') \56\ before
triggering a credit event.\57\ AIGFP offered protection on the
``super senior'' risk layer of these securities, a level that
would absorb losses only after subordinate, including AAA-
rated, tranches were impacted by a credit event.
---------------------------------------------------------------------------
\56\ Attachment points or subordination levels are described in
more detail below, but in general, the higher the attachment point, the
lower the level of credit risk (e.g., an attachment point of 20 percent
indicates a cushion on the first 20 percent of bad debt exposure).
\57\ See American International Group, Inc., Form 10-Q for the
Quarterly Period Ended September 30, 2009, at 55 (Nov. 6, 2009) (online
at www.sec.gov/Archives/edgar/data/5272/000104746909009659/a2195237z10-
q.htm). AIGFP will incur credit losses only after a shortfall of
principal and/or interest, or other credit events (in respect of the
protected loans and debt securities) exceed a specified threshold
amount or level of ``first loss.''
---------------------------------------------------------------------------
Figure 11, below, illustrates how the super senior level of
this protection was structured. (See Annex III for a more
detailed discussion of the CDS market more generally and the
nature of AIGFP's business.)

FIGURE 11: SUPER SENIOR RISK LAYER TRANSACTION EXAMPLE \58\

---------------------------------------------------------------------------
\58\ AIG Form 10-K for FY09, supra note 50, at 132.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

AIGFP's decision to cease underwriting new contracts on
subprime multi-sector CDOs in December 2005 was not related to
AIG's ratings downgrade from AAA that same year but rather
reflected AIGFP's view that underwriting standards had
deteriorated, according to Weil Gotshal, the counsel for AIGFP.
This decision, though, which would otherwise appear to be a
prudent reaction to changing market conditions, only impacted
the intake mechanism, as no serious effort was made to reduce
or hedge legacy exposures.\59\ AIGFP and AIG continued to view
the risk associated with these transactions as extraordinarily
remote and did not take steps to reduce or significantly hedge
legacy or new exposures.\60\ In fact, as noted above, legacy
positions on AIGFP's books would soon reflect the more
problematic credit issues as older reference securities were
replaced with more suspect ones by CDO managers. Former AIG CEO
Hank Greenberg has asserted publicly and in a conversation with
Panel staff that the company should have exited the multi-
sector CDO sector after AIG lost its AAA rating in March 2005,
arguing that the economics and risks of this business changed
with the ratings downgrade, since counterparties could
contractually demand more collateral if the value of the CDOs
began to deteriorate.\61\ However, there does not appear to be
any evidence that Mr. Greenberg advocated for such a position
shortly after the downgrade, a period when he was no longer the
CEO, but clearly a large shareholder with a unique perspective
on the company.\62\
---------------------------------------------------------------------------
\59\ Panel staff briefing with Weil Gotshal (May 12, 2010).
According to Weil Gotshal, there was no evidence of any discussion
about hedging or unwinding the CDS risk book at that time. Also
according to Gotshal, at the time that AIGFP changed the criteria for
CDS written on multi-sector CDOs, they did not hedge the portfolio. At
some point in 2006 there were small hedges put in place, but never on a
scale sufficient to hedge the $70 billion book.
\60\ Panel staff briefing with Weil Gotshal (May 12, 2010).
\61\ Panel staff briefing with Maurice ``Hank'' Greenberg, former
chief executive officer, AIG (May 13, 2010).
\62\ Panel staff could find no evidence that Mr. Greenberg used his
influence to push AIG to cease writing multi-sector CDS contracts in
the period shortly after the firm lost its AAA-rating. Fact Sheet on
AIGFP, E-mail from Boies, Schiller & Flexner LLP, counsel for former
AIG CEO Maurice ``Hank'' Greenberg, to Panel staff (May 18, 2010).
---------------------------------------------------------------------------
AIGFP continued to assume through the beginning of 2008
that the credit risk from its CDS portfolio was virtually non-
existent given the super-senior credit ratings of the reference
securities.\63\ This stance was by no means unique to AIG, as
other market participants, including Citigroup and Merrill
Lynch, also placed undue faith in the credit ratings of these
instruments. However, AIG's assertion is somewhat odd given
that the company underwrote this risk on behalf of clients who
clearly believed there was some risk in these instruments worth
insuring.
---------------------------------------------------------------------------
\63\ Panel staff briefing with Gerry Pasciucco, chief operating
officer, AIGFP (Apr. 23, 2010).
---------------------------------------------------------------------------
The company, both in investor presentations and through its
regulatory filings, continuously asserted that there was ``no
probable and reasonably estimable realized loss'' in its CDS
portfolio, based on its risk model's assessment of the credit
profile and the ratings of the reference obligations.\64\
Joseph Cassano, the head of AIGFP at the time, noted on the
company's second quarter 2007 earnings call: ``It is hard for
us, without being flippant, to even see a scenario within any
kind of realm or reason that would see us losing $1 in any of
those transactions.'' \65\ AIG's then-CEO, Martin Sullivan,
asserted in an investor presentation in December of 2007 that
because AIG's CDS business is ``carefully underwritten and
structured with very high attachment points to the multiples of
expected losses, we believe the probability that it will
sustain an economic loss is close to zero.'' \66\ According to
congressional testimony by the former chief financial officer
of AIG Financial Services, Elias Habayeb, it was not until the
summer of 2008 that AIG took action to reduce the size of its
legacy exposures.\67\
---------------------------------------------------------------------------
\64\ AIG Form 10-K for FY07, supra note 41, at 124.
\65\ American International Group, Inc., American International
Group Q2 2007 Earnings Call Transcript (Aug. 9, 2007) (online at
seekingalpha.com/article/44048-american-international-group-q2-2007-
earnings-call-transcript?source=bnet).
\66\ American International Group, Inc., American International
Group Investor Meeting: Final Transcript, at 5(Dec. 5, 2007).
\67\ Written Testimony of Elias Habayeb, supra note 27, at 5.
---------------------------------------------------------------------------
While AIG's assessment of the underlying credit quality of
the reference obligations may have been technically correct (as
AIGFP did not experience a ``credit loss'' event until the end
of 2008),\68\ AIGFP's models failed to anticipate the
consequences of declining market prices on the reference CDOs,
as well as the attendant liquidity risks stemming from
collateral calls from its CDS counterparties, and how these
factors might impact the company's own credit rating (this
dynamic is illustrated in greater detail below).\69\ This of
course became painfully evident as the subprime crisis
deepened, decimating liquidity and valuations in the underlying
reference mortgage markets. PricewaterhouseCoopers (PwC), AIG's
external auditor, noted in 2007 that AIG did not maintain
effective internal control over financial reporting due to a
material weakness related to the valuation of the AIGFP super
senior CDS portfolio.\70\
---------------------------------------------------------------------------
\68\ For CDS transactions requiring physical settlement, AIGFP's
payment obligations were triggered by the occurrence of a ``credit
event'' in respect to the reference obligation. All of AIGFP's CDS
transactions requiring physical settlement define a ``credit event'' as
a ``failure to pay,'' which is generally triggered by the failure of
the issuer of the reference CDO to make a payment under the reference
obligation. AIGFP experienced its first loss arising from a ``credit
event'' in the fourth quarter of 2008 in the amount of $15 million. AIG
Form 10-K for FY08, supra note 47, at 141, 168.
\69\ AIG Form 10-K for FY07, supra note 41, at 124.
\70\ AIG Form 10-K for FY07, supra note 41, at 202. See Section
B(4)(a) (Risk Management) for a further discussion of PwC's audit
findings.
---------------------------------------------------------------------------
In the lead-up and during the initial phase of the subprime
crisis, AIG was blinded by the limitations of its model,
believing that valuations would ultimately align upwards with
the underlying credit worthiness of the reference security.
AIG's model overlooked the obligation and, therefore, the
amount of collateral it could be required to post for its
multi-sector CDS portfolio in the event of a meltdown of the
markets for the underlying reference securities.
Accordingly, as the first collateral calls from trading
counterparties began in the summer of 2007, the firm stood
behind its models, arguing that valuations were temporarily
distorted by the absence of liquidity in the market, which
prevented the emergence of benchmark pricing. A battle of the
models ensued between AIG and its counterparties, resulting in
protracted discussions on valuations and corresponding
collateral obligations.\71\ Despite the uncertainty, AIGFP was
generally able to resolve valuation differences and negotiate
the collateral amounts with the counterparties.\72\
---------------------------------------------------------------------------
\71\ Panel staff briefing with Weil Gotshal (May 12, 2010).
\72\ AIG Form 10-K for FY07, supra note 41, at 124.
---------------------------------------------------------------------------
While one-off negotiations were manageable, increased
demands by counterparties ultimately left AIG with little room
to maneuver, given the risks of being perceived as unwilling or
unable to honor its obligations in the market, which could
conceivably impact the firm's ability to secure funding.\73\
However, as the crisis deepened in 2007, rating agencies began
to downgrade several of the referenced multi-sector CDOs,\74\
and prominent market participants, particularly Citigroup and
Merrill Lynch, began to report losses in their CDS
portfolios.\75\
---------------------------------------------------------------------------
\73\ Panel staff briefing with Weil Gotshal (May 12, 2010).
\74\ AIG Form 10-K for FY07, supra note 41, at 33.
\75\ In 2007, Citigroup and Merrill Lynch reported unrealized
losses on their subprime CDO portfolios in the amount of approximately
$18 billion and $17 billion, respectively. See Citigroup, Form 10-K for
the Fiscal Year Ended December 31, 2007, at 48 (Feb. 2, 2008) (online
at www.sec.gov/Archives/edgar/data/831001/000119312508036445/d10k.htm);
Merrill Lynch, Form 10-K for the Fiscal Year Ended December 28, 2007,
at 37 (Feb. 25, 2008) (online at www.sec.gov/Archives/edgar/data/65100/
000095012308002050/y46644e10vk.htm). The ratings agencies responded to
the news of the large losses and substantial exposures to subprime-
related assets (especially CDOs) by downgrading the ratings of both
companies. Fitch Ratings, Fitch Global Corporate Rating Activity:
Credit Quality Takes Negative Turn in 2007, at 4 (Mar. 6, 2008) (online
at www.fitchratings.com/creditdesk/reports/
report_frame.cfm?rpt_id=375822); Standard and Poor's, Research Update:
Merrill Lynch & Co. Inc. Ratings Lowered To `A/A-1' From A+/A-1', at 3
(June 2, 2008) (online at www2.standardandpoors.com/spf/pdf/events/
fiart66308.pdf).
---------------------------------------------------------------------------
These events changed the equation.\76\ The amount of
collateral AIG was required to post for CDS contracts was a
function of AIG's credit ratings, the rating of the reference
multi-sector CDO, and the market value of the reference
obligations.\77\ While market conditions remained similarly
illiquid, ratings downgrades on the reference securities and
valuation losses by market participants helped establish two of
the three primary triggers for collateral payments, making it
more difficult for AIG to continue to hide behind its models.
As a result, in 2007 AIG recognized an unrealized market
valuation loss totaling $11.25 billion, which primarily
occurred in the fourth quarter of 2007.\78\
---------------------------------------------------------------------------
\76\ In accordance with the adoption of FAS 155 as of January 1,
2006 (``Accounting for Certain Hybrid Financial Instruments--an
amendment of FAS 140 and FAS 133''), AIGFP began to record its credit
default swap portfolio according to its fair market value, which
resulted in a write-down of $11.5 billion in 2007. AIGFP used a complex
model, which relied on numerous assumptions, to estimate the fair value
of its super senior credit default swap portfolio. ``The most
significant assumption utilized in developing the estimate is the
pricing of the securities within the CDO collateral pools. If the
actual pricing of the securities within the collateral pools differs
from the pricing used in estimating the fair value of the super senior
credit default swap portfolio, there is potential for significant
variation in the fair value estimate.'' AIG Form 10-K for FY07, supra
note 41, at 123, 145.
\77\ AIG Form 10-K for FY09, supra note 50, at 148. See Annex III.B
for an explanation of collateral calls.
\78\ AIG Form 10-K for FY07, supra note 41, at 34; American
International Group, Inc., Conference Call Credit Presentation:
Financial Results for the Year Ended December 31, 2007, at 8, 15 (Feb.
29, 2008) (online at media.corporate-ir.net/media_files/irol/76/76115/
Conference_Call_Credit_Presentation_031408_revised.pdf) (hereinafter
``AIG Financial Results Conference Call--2007''). The large loss was a
consequence of the economic downturn and credit deterioration,
particularly in U.S. sub-prime mortgages. The unrealized market
valuation loss of $11.25 billion significantly exceeded AIG's estimates
of the realizable portfolio loss under a ``severe'' scenario.
---------------------------------------------------------------------------
As the value of the underlying CDOs continued to decline
thereafter, AIG--under mark-to-market accounting standards--
recorded valuation allowances on its contracts. While these
losses were in almost all cases unrealized non-cash valuation
charges, they corresponded with collateral calls from AIG's
counterparties, which contributed to a drain on AIG's cash
resources.\79\
---------------------------------------------------------------------------
\79\ See Annex III.B for a more detailed discussion of the nature
of the collateral rights AIG issued under CDS contracts.
---------------------------------------------------------------------------
Predictably, valuation write-downs into the billions of
dollars and collateral calls from CDS counterparties
intensified pressure on AIG's own credit rating, the third key
component in the collateral calculation cocktail. Subsequent
downgrades of AIG's credit rating in turn precipitated
additional collateral calls.\80\ This negative feedback loop,
illustrated below in Figure 12, eventually exposed the firm's
reckless securities lending business, as AIG was unable to meet
the cash calls from jittery trading partners worried about the
company's CDO exposure. And finally, according to one AIG
executive, as the crisis peaked toward mid-September 2008,
counterparties who owed AIG cash were ``sitting on their
hands.'' \81\
---------------------------------------------------------------------------
\80\ On March 30, 2005 S&P downgraded AIG's rating from `AAA' to
`AA+' because of its concern over AIG's internal controls, especially
regarding its financial transactions. S&P again lowered the rating to
`AA' in June 2005 based on AIG's significant accounting adjustments. In
February 2008, S&P placed a negative outlook on AIG's credit rating
because of concerns as to how AIG valued it CDS portfolio. The credit
rating was again downgraded in May 2008 to `AA-' based in large part on
the $5.9 billion loss on its CDS portfolio. As the crisis in the
financial markets escalated in September 2008, S&P became more
concerned with AIG's financial condition. The final nail in the coffin
occurred on September 15, 2008 when S&P lowered AIG's rating to `A-.'
Congressional Oversight Panel, Written Testimony of Rodney Clark,
managing director of ratings services, Standard & Poor's Financial
Services, COP Hearing on TARP and Other Assistance to AIG, at 3-5 (May
26, 2010) (online at cop.senate.gov/documents/testimony-052610-
clark.pdf) (hereinafter ``Written Testimony of Rodney Clark'').
\81\ Panel staff conversation with former AIG executive.
---------------------------------------------------------------------------

FIGURE 12: ILLUSTRATION OF NEGATIVE FEEDBACK LOOP

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

The demand for collateral calls accelerated in 2008 as a
result of the rapid deterioration of its multi-sector CDS
portfolio. In the first and second quarters of 2008, AIG
scrambled to post $20.8 billion in cash to meet its collateral
obligations for this portfolio.\82\ In the third quarter of
2008 (ending September 30, 2008), AIG had posted approximately
$31.5 billion in collateral as a result of the deterioration in
value of its multi-sector CDO portfolio.\83\
---------------------------------------------------------------------------
\82\ AIG Form 10-K for FY08, supra note 47, at 146. AIG posted
approximately $7 billion in cash collateral as of March 2008 and
approximately $13 billion in cash collateral as of June 2008.
\83\ AIG Form 10-K for FY08, supra note 47, at 68, 146. AIGFP
surrendered $35 billion of collateral previously posted in connection
with ML3, which terminated $62.1 billion net notional amount of multi-
sector CDS. For an in-depth discussion of ML3, see Section D.3.
---------------------------------------------------------------------------
Collateral calls stemming from AIGFP's other CDS portfolios
were, in comparison, immaterial.\84\ However, the liquidity
drain from the multi-sector portfolio accelerated demands by
the firm's securities lending counterparties for the return of
their cash collateral (discussed in more detail in Section
B.3(b) below). Unable to access private capital to meet
collateral calls stemming from its CDS book and securities
lending activities, AIG's liquidity crisis deepened against a
deteriorating market backdrop that saw the firm report
unrealized mark-to-market valuation losses on its multi-sector
CDS book that totaled just under $40 billion as of the end of
2008.\85\
---------------------------------------------------------------------------
\84\ By the end of 2008, collateral postings for the corporate
arbitrage portfolio totaled $2.3 billion, whereas collateral postings
for AIGFP's regulatory capital portfolio totaled $1.3 billion. AIG Form
10-K for FY08, supra note 47, at 146.
\85\ Panel staff briefing with Weil Gotshal (May 12, 2010).
---------------------------------------------------------------------------
Figure 13, below, outlines the growing demand for
additional cash collateral from AIGFP's multi-sector CDO
counterparties as the value of the underlying contracts (and
the market's perception of AIG as a reliable counterparty)
deteriorated. By the end of September 2008 AIG recorded
cumulative unrealized market valuation losses over the prior
two years of $33 billion on this portfolio. This coincided with
posted collateral of $32 billion, which represented 44 percent
of the notional value of the multi-sector CDS portfolio at the
time.\86\
---------------------------------------------------------------------------
\86\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 114;
AIG Form 10-K for FY08, supra note 47, at 146. AIG's collateral on this
portfolio ultimately reached $37 billion as of November 5, 2008.
Congressional Oversight Panel, Testimony of Timothy F. Geithner,
secretary, U.S. Department of the Treasury, COP Hearing with Treasury
Secretary Timothy F. Geithner, at 79 (Dec. 10, 2009) (online at
cop.senate.gov/documents/transcript-121009-geithner.pdf) (hereinafter
``COP Hearing with Secretary Geithner'').
---------------------------------------------------------------------------

FIGURE 13: COUNTERPARTY COLLATERAL DEMANDS VS. MARK-TO-MARKET LOSSES ON
MULTI-SECTOR CDO PORTFOLIO

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

While the multi-sector CDS portfolio was the primary
trigger for market concerns regarding AIGFP's exposure to the
deteriorating mortgage market, the potential termination of
AIG's largest credit book, the regulatory capital portfolio,
from a bankruptcy filing had the potential to cause significant
problems for numerous European banks.
The regulatory capital swaps allowed financial institutions
that bought credit protection from AIGFP to hold less capital
than they would otherwise have been required to hold by
regulators against pools of residential mortgages and corporate
loans. A hypothetical example helps illustrate how this worked.
According to the international rules established under Basel
I,\87\ which generally applied to European banks prior to AIG's
collapse, a bank that held an unhedged pool of loans valued at
$1 billion might be required to set aside $80 million, or 8
percent of the pool's value. But if the bank split the pool of
loans, so that the first losses were absorbed by an $80 million
junior tranche, and AIGFP provided credit protection on the
$920 million senior tranche, the bank could significantly
reduce the amount of capital it had to set aside.\88\
Importantly, AIG's regulatory capital swaps were sold by an
AIGFP subsidiary called Banque AIG, which was a French-
regulated bank.\89\ Under Basel I, claims on banks such as
Banque AIG were assigned a lower risk weighting in the
calculation of required capital reserves than the loans for
which the counterparties were buying credit protection would
have been assigned.\90\ This formula worked to the advantage of
the counterparties, which could then use some of their
regulatory capital savings to pay for the credit protection
from AIGFP, and could use the remaining amount to make more
loans, increasing their own leverage and risk. Because these
swaps allowed banks to take on greater risk by shifting their
liabilities to AIGFP, former AIG CEO Edward Liddy has referred
to the deals as a ``balance sheet rental.'' \91\
---------------------------------------------------------------------------
\87\ Basel I was introduced in July 1988 and was described as an
attempt to ``secure international convergence of supervisory
regulations governing the capital adequacy of international banks.''
Bank for International Settlements, International Convergence of
Capital Measurement and Capital Standards, at 1 (July 1988) (online at
www.bis.org/publ/bcbsc111.pdf). The committee that constructed Basel II
intended the majority of the framework which it set out to be
accessible for implementation as of the completion of 2006, while the
most complex approaches would be made available at the completion of
2007. Basel II sought to separate credit risk from operational risk and
align economic and regulatory capital more directly. Bank for
International Settlements, International Convergence of Capital
Measurement and Capital Standards: A Revised Framework, at 1-5 (Nov.
2005) (online at bis.org/publ/bcbs118.pdf).
\88\ See Jeffrey Rosenberg, Toward a Clear Understanding of the
Systemic Risks of Large Institutions, 5 Journal of Credit Risk, No. 2,
at 77 (Summer 2009).
\89\ Banque AIG entered into back-to-back contracts with AIGFP,
which thus bore the ultimate risk of the transaction.
\90\ See Houman B. Shadab, Guilty By Association? Regulating Credit
Default Swaps, 4 Entrepreneurial Business Law Journal, No. 2, at 448,
fn 199 (2010) (online at ssrn.com/abstract=1368026); U.S. Government
Accountability Office, Risk-Based Capital: Bank Regulators Need to
Improve Transparency and Overcome Impediments to Implementing the
Proposed Basel II Framework, at 15 (Feb. 2007) (GAO-07-253) (online at
www.gao.gov/new.items/d07253.pdf).
\91\ House Financial Services, Subcommittee on Capital Markets,
Insurance, and Government Sponsored Enterprises, Testimony of Edward
Liddy, chief executive officer, American International Group, Inc.,
American International Group's Impact on the Global Economy: Before,
During, and After Federal Intervention, at 63-64 (Mar. 18, 2009)
(online at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=111_house_hearings&docid=f:48868.pdf) (hereinafter
``Testimony of Edward Liddy'').
---------------------------------------------------------------------------
This business grew to become the largest portion of AIGFP's
CDS exposure, reflecting the demand for regulatory capital
savings among European banks.\92\ As of the end of 2007,
AIGFP's notional exposure on these swaps was $379 billion, or
about 72 percent of its notional exposure on its entire super
senior CDS portfolio.\93\ But these swaps were not one of the
key reasons that AIG was on the verge of filing for bankruptcy
on September 16, 2008; AIG's collateral payments to these
counterparties totaled less than $500 million at the time,\94\
an amount far lower than had been paid under AIG's multi-sector
CDO swaps. This disparity may have been due in part to
differences in the value of the underlying assets, as well as
differences in the way the swap contracts were structured.
Nonetheless, in September 2008, AIGFP's regulatory capital
swaps were a source of concern at FRBNY because of the
potential consequences that an AIG bankruptcy would have had on
the capital structures of the European banks that had bought
credit protection from AIG.\95\
---------------------------------------------------------------------------
\92\ American International Group, Inc., AIG: Is the Risk
Systemic?, at 18 (Mar. 6, 2009) (hereinafter ``AIG Presentation on
Systemic Risk'').
\93\ AIG Form 10-K for FY07, supra note 41, at 33.
\94\ AIG Form 10-K for FY08, supra note 47, at 146.
\95\ E-mail from Alejandro LaTorre to Timothy Geithner and other
Federal Reserve Bank of New York officials (Sept, 14, 2008)
(FRBNYAIG00496). See Section F(1)(b)(iv) for a more detailed discussion
of the potential impact of AIG failure on European banks.
---------------------------------------------------------------------------
b. Securities Lending
AIG's aggressive expansion of its securities lending
business, which is generally a low-risk and mundane financing
operation on Wall Street, ramped up the company's exposure to
the subprime mortgage market in late 2005.\96\ Ironically, this
business's growth and investment strategy coincided with the
time period that AIGFP stopped writing CDS on subprime-related
CDOs. Subsequently, after the government bailout and the
creation of ML2, AIG unwound this business.\97\
---------------------------------------------------------------------------
\96\ Memorandum from Kevin B. McGinn to AIG Credit Risk Committee,
AIGGIG Global Securities Lending (GSL) Cash Collateral Investment
Policy (Dec. 20. 2005).
\97\ AIG Form 10-K for FY08, supra note 47, at 251.
---------------------------------------------------------------------------
Apart from its risk profile, the mechanics of AIG's
securities lending program functioned in a similar fashion to
those used by custody firms and long-term asset managers. AIG
lent out securities owned by participating insurance
subsidiaries in exchange for cash collateral.\98\ Several of
AIG's life insurance subsidiaries participated in the
securities lending program, which essentially
aggregated the securities lending (and collateral investment)
operations of these subsidiaries. These subsidiaries entered
into securities lending agreements with an affiliated lending
agent (AIG
Securities Lending Corp.) that authorized the agent to lend
their securities to a list of authorized borrowers (primarily
major banks and brokerage firms) on their behalf or for their
benefit. This effectively centralized investment decisions
related to securities lending collateral within AIG's asset
management operations group, and away from the individual life
insurance subsidiaries.\99\ By appointing an affiliated agent
to manage the securities lending program, the subsidiaries
provided AIG's asset management operations group with some
measure of control of the securities lending program.
---------------------------------------------------------------------------
\98\ See Annex V for a more detailed discussion of the mechanics of
securities lending.
\99\ See, e.g., SunAmerica Annuity and Life Assurance Company,
Annual Statement for the Year 2009, at 19.1, 19.18 (Dec. 31, 2009)
(hereinafter ``SunAmerica 2009 Annual Statement''). The program was
managed by an affiliated lending agent (AIG Securities Lending Corp.)
and an affiliated investment advisor (e.g., AIG Institutional Asset
Management). AIG Form 10-Q for Third Quarter 2008, supra note 23, at
104, 143-44.
---------------------------------------------------------------------------
Securities lending normally provides a low-risk way for
insurance companies to earn modest sums of money on assets that
would otherwise be sitting idle.\100\ AIG's program, however,
was unusual in two ways.
---------------------------------------------------------------------------
\100\ See Annex V for a full discussion of securities lending.
---------------------------------------------------------------------------
The first difference, alluded to above, involves the degree
of risk that AIG took when it invested the cash collateral it
received. Because securities lending agreements allow the
counterparties to require the lender to return their cash
collateral at any time, the cash collateral is normally
invested in liquid securities, such as short-term Treasury
bonds, or kept in cash to meet laddered collateral demands that
range from overnight to roughly three months in maturity.\101\
Beginning in late 2005, however, AIG used some of this
collateral to buy RMBS, with the intention of maximizing its
returns.\102\ At the height of AIG's securities lending program
in 2007, the U.S. pool held $76 billion in invested
liabilities, 60 percent of which were RMBS.\103\
---------------------------------------------------------------------------
\101\ Panel and staff briefing with AIG CFO David Herzog, chief
financial officer, AIG (May 17, 2010).
\102\ See AIG Form 10-K for FY08, supra note 47, at 40 (``Under
AIG's securities lending program, cash collateral was received from
borrowers in exchange for loans of securities owned by AIG's insurance
company subsidiaries. The cash was invested by AIG in fixed income
securities, primarily residential mortgage-backed securities (RMBS), to
earn a spread'').
\103\ Congressional Oversight Panel, Written Testimony of Michael
Moriarty, deputy superintendent for property and casualty markets, New
York State Insurance Department, COP Hearing on TARP and Other
Assistance to AIG, at 4 (May 26, 2010) (online at cop.senate.gov/
documents/testimony-052610-moriarty.pdf) (hereinafter ``Written
Testimony of Michael Moriarty''). See Section B.6, supra, for a
discussion of the insurance regulators' insistence on the dismantling
of the securities lending pool.
---------------------------------------------------------------------------
Additionally, while AIG management has asserted that it
began to reduce the size of the securities lending program in
the fourth quarter of 2007, AIG CFO David Herzog, who was
controller at the time of the rescue, noted that these efforts
were primarily motivated by a goal of reducing the large
relative size of this business to the firm's overall balance
sheet. He believed that addressing the increasingly illiquid
nature of the investments made with the collateral was a
byproduct of those efforts, but not the sole focus.\104\ This
effort was either tentative or was unduly complicated by market
conditions. In any case, there is little evidence that the
effort was accompanied by any meaningful reduction in the
proportion of securities lending collateral held in RMBS, which
posed a graver risk to the firm than the program's absolute
size relative to AIG's balance sheet.
---------------------------------------------------------------------------
\104\ Panel and staff briefing with AIG CFO David Herzog (May 17,
2010). As of December 2007, Securities Lending assets and liabilities
represented 7 percent and 8.5 percent, respectively, of AIG's total
balance sheet. AIG Form 10-K for FY07, supra note 41, at 130-31.
---------------------------------------------------------------------------
In contrast to Herzog's statements, the state insurance
regulators say that in mid-2007, when they discovered the RMBS
securities in the securities lending program, they were
concerned about the concentration of the investments, which
ultimately experienced liquidity issues. The regulators began
to work closely with AIG to address regulatory concerns. In
order to respond to those concerns, AIG developed a plan to
wind down the program and enact a plan to increase the
liquidity of the pool.\105\ This plan was for a gradual wind-
down of the program, aimed at avoiding realized losses to the
collateral pool from the sale of impaired securities.\106\ It
included guarantees by the AIG parent company against realized
losses in the pool of up to $5 billion.\107\
---------------------------------------------------------------------------
\105\ Panel staff conversation with Texas Department of Insurance
(May 24, 2010).
\106\ Panel call with Texas Department of Insurance (May 24, 2010).
See also AIG Form 10-Q for Third Quarter 2008, supra note 23, at 43
(``During the second quarter of 2008, AIG made certain revisions to the
American International Group, Inc. (as Guarantor) Condensed Statement
of Cash Flows, primarily relating to the effect of reclassifying
certain intercompany and securities lending balances''); Id. at 49
(``AIG parent also deposited amounts into the collateral pool to offset
losses realized by the pool in connection with sales of impaired
securities''); Senate Committee on Banking, Housing, and Urban Affairs,
Written Testimony of Eric Dinallo, superintendent, New York State
Insurance Department, American International Group: Examining What Went
Wrong, Government Intervention, and Implications for Future Regulation,
at 6 (Mar. 5, 2009) (online at banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore _id=8ee655c8-2aed-4d4b-b36f-
0ae0ae5e5863).
\107\ The size of the guarantee grew over time. In fall of 2007,
AIG had itself implemented a guarantee for up to $500 million of
realized losses. In order to respond to regulatory concerns, AIG
increased the guarantee to $1 billion on May 1, 2008 and then $5
billion on June 17, 2008. The insurance regulators were mindful of
liquidity pressures at the parent. At the insurance regulators'
quarterly meeting with AIG management in August 2008, they asked
holding company management to come to the next meeting prepared to
discuss liquidity at the holding company level. Panel staff
conversation with NAIC (Apr. 27, 2010).
---------------------------------------------------------------------------
While these RMBS were AAA-rated at the time AIG purchased
them, as the mortgage crisis deepened, the ratings of the
securities likewise deteriorated, along with liquidity in the
underlying market. So while AIG's counterparties could request
a return of their cash collateral with little notice, AIG had
invested the money in securities that were increasingly
illiquid after housing prices began to fall in 2006. This
duration mismatch represented an overly aggressive foray into
outright speculation, or a misreading of the risks associated
with subprime RMBS, or both.\108\
---------------------------------------------------------------------------
\108\ It is important to realize that, since AIG was both insuring
RMBS through their sale of CDS and also purchasing RMBS through their
investment of securities lending collateral, in order to assess the
risk to the company, one would need to know how these products moved
together, or co-varied. And, since AIG did not fully grasp the details
of the securities underlying the CDS, it would be almost impossible to
estimate the covariance, and therefore truly understand the risk they
were facing in their aggregate exposures across AIGFP and the company's
securities lending activities.
---------------------------------------------------------------------------
The second reason that AIG's securities lending program was
riskier than other such programs stemmed from payments the AIG
parent company made to the insurance subsidiaries that owned
the securities that had been lent out. In normal circumstances,
securities lending counterparties would be required to post
collateral of 100 to 102 percent of the market value of the
securities they borrowed, as specified by state insurance
regulators.\109\ But when unregulated companies started to lend
securities under terms that included lower collateral
requirements, AIG determined that lower collateral amounts were
necessary to compete in the market, with the AIG parent company
making up the difference and posting the collateral deficit up
to 100 percent.\110\
---------------------------------------------------------------------------
\109\ See National Association of Insurance Commissioners Model
Laws, 280-1, Sec. 16(E).
\110\ Panel call with Texas Department of Insurance (May 24, 2010);
see AIG Form 10-Q for Third Quarter 2008, supra note 23, at 49
(``Historically, AIG had received cash collateral from borrowers of
100-102 percent of the value of the loaned securities. In light of more
favorable terms offered by other lenders of securities, AIG accepted
cash advanced by borrowers of less than the 102 percent historically
required by insurance regulators. Under an agreement with its insurance
company subsidiaries participating in the securities lending program,
AIG parent deposited collateral in an amount sufficient to address the
deficit''); see also SunAmerica 2009 Annual Statement, supra note 99,
at 19.1 (``The Company's lending agent received primarily cash
collateral in an amount in excess of the market value of the securities
loaned. Such collateral was held by the lending agent for the benefit
of the Company and [was] not available for the general use of the
Company. Since the collateral was restricted, it was not reflected in
the Company's balance sheet as an asset and offsetting liability'').
This restricted collateral could be used to pay the securities lending
counterparties or reinvested. Had the AIG parent filed for bankruptcy,
the subsidiaries would have had access to the collateral in order to
pay the counterparties.
---------------------------------------------------------------------------
As the subprime crisis deepened, and investors grew worried
about AIG's solvency (initially owing to its CDS portfolio),
counterparties to securities lending transactions sought to
ring-fence their duration exposure to AIG. They did this
initially by shortening the length of their exposure to AIG--
for example, from 90-day or 30-day liabilities to 3-day or
overnight ones--before ultimately opting to close out their
exposure, demanding the return of their cash collateral in
exchange for the securities they had borrowed. Between
September 12 and September 30, 2008 securities lending
counterparties demanded that AIG return approximately $24
billion in cash.\111\ This proved difficult for AIG to do, as
losses on the RMBS in the context of an increasingly illiquid
market required AIG to look elsewhere for the cash, creating
yet another drain on the parent company's liquidity.\112\ The
situation was further complicated by AIG's aforementioned
subsidization of below-market terms to its securities
borrowers, as the company, in desperate need for cash, began to
accept collateral in some cases as low as 90 percent of the
value of the securities borrowed.\113\ By the end of August
2008, AIG had provided $3.3 billion, in the form of financing
terms and investment sales, to its insurance subsidiaries to
help plug the shortfall.\114\
---------------------------------------------------------------------------
\111\ Written Testimony of Michael Moriarty, supra note 103, at 4.
\112\ While specific data for mid-September 2008 is not available,
as of September 30, 2008, the fair value of the approximately $40
billion RMBS portfolio in AIG's securities lending program was
approximately $23.5 billion. AIG Form 10-Q for Third Quarter 2008,
supra note 23, at 52.
\113\ Panel staff briefing with David Herzog, chief financial
officer, AIG (May 17, 2010).
\114\ AIG Form 10-K for FY08, supra note 47, at 3.
---------------------------------------------------------------------------
The insurance regulators have asserted that the securities
lending program alone would not have caused the insolvency of
the insurance subsidiaries. This assumes, however, a situation
in which the problems at AIGFP did not exist. New York Deputy
Insurance Superintendent Michael Moriarty wrote in his
testimony to the Panel: ``Certainly, there would have been
losses, with some companies hurt more than others. But we
believe that there would have been sufficient assets in the
companies and in the parent to maintain the solvency of all the
companies.'' \115\ The existence of ``sufficient assets . . .
in the parent'' assumes that these assets were not needed for
AIGFP--a big assumption.\116\
---------------------------------------------------------------------------
\115\ Written Testimony of Michael Moriarty, supra note 103, at 5.
\116\ The New York Insurance Department has subsequently stated
that there would have been sufficient capital and assets within the
subsidiaries to resolve the securities lending issue without assistance
from the parent. Panel staff conversation with New York Insurance
Department (June 3, 2010).
---------------------------------------------------------------------------

4. Other Problematic Aspects of AIG's Financial Position and
Performance

While the primary causes of AIG's distress were the
collateral calls relating to its CDSs and securities lending
program, it appears that other aspects of the company--both
conventional and unconventional--may have amplified its
problems, and made it more difficult to assess AIG's true
financial position. Accounting, risk management, technology,
financial controls and--ultimately--company leadership
contributed to the problems that would engulf AIG.
a. Risk Management
The accounting treatment for AIGFP's CDSs on CDOs did not
necessarily encourage hard questions about their risk. Given
the perceived credit strength of the super senior tranches of
the CDOs, which put holders at the front of the line in terms
of cash flows, AIG (and many others in the marketplace) viewed
the risk as remote, similar to catastrophic risk, and did not
incur any capital charges on its balance sheet when it booked
the initial transactions. This encouraged both underpricing and
a large appetite for these products. And, as discussed above in
Section B.3(a), this adherence to a limited risk model led the
firm to overlook the potential consequences of protracted
liquidity risk, and the consequent mark-to-market valuation
losses on CDS exposure, as well as the liquidity constraints
from collateral calls.
As noted earlier, in 2007 AIG reported a material weakness
in its internal oversight and monitoring of the financial
reporting related to the valuation of the AIGFP CDS portfolio.
AIG did not have sufficient resources to design and carry out
effective controls over the valuation model, which hindered its
ability to adequately assess the relevance of third party
information to the model inputs in a timely manner.\117\
Changes to fair value accounting standards and the contraction
in the CDS market driven by deteriorating credit conditions
necessitated the development of a valuation model to estimate
the fair value of the portfolio as actual market data was no
longer readily available, and created a need for human
resources and processes that AIG was ultimately unable to
address quickly enough to ensure reliable valuation
results.\118\ Information sharing at appropriate levels,
especially between AIG and AIGFP, was also not effective in
regards to the CDS portfolio valuation, exacerbating the
problems inherent with the model's lack of comprehensive data
inputs and preventing them from being detected and
escalated.\119\ As a result of its lax oversight, AIG failed to
detect inaccuracies in AIGFP's fair value estimates of its
super senior CDS portfolio.\120\
---------------------------------------------------------------------------
\117\ AIG Form 10-K for FY07, supra note 41, at 202.
\118\ This period also coincided with the elimination of EITF 02-03
and the implementation of FAS 157's market valuation requirements.
\119\ AIG Form 10-K for FY07, supra note 41, at 202.
\120\ AIG revealed weaknesses in its oversight and monitoring of
AIGFP's valuation process for its super senior credit default swap
portfolio, including the timely sharing of information with AIG and
AIG's internal risk control groups. ``As a result, controls over the
AIGFP super senior credit default swap portfolio valuation process and
oversight thereof were not adequate to prevent or detect misstatements
in the accuracy of management's fair value estimates and disclosures on
a timely basis, resulting in adjustments for purposes of AIG's December
31, 2007 consolidated financial statements. In addition, this
deficiency could result in a misstatement in management's fair value
estimates or disclosures that could be material to AIG's annual or
interim consolidated financial statements that would not be prevented
or detected on a timely basis.'' AIG Form 10-K for FY07, supra note 41,
at 202. The revelations regarding AIG's lax oversight of AIGFP led S&P
to place AIG on negative outlook in February 2008. Written Testimony of
Rodney Clark, supra note 80, at 4.
---------------------------------------------------------------------------
This followed other accounting issues noted by AIG and PwC
in the course of the 2004 audit \121\ and uncovered by former
New York Attorney General Eliot Spitzer and former New York
State Insurance Superintendent Howard Mills, who filed a civil
lawsuit on May 26, 2005 against AIG, AIG's former chairman
Maurice Greenberg, and AIG's former chief financial officer
Howard Smith, charging them with manipulating AIG's financial
statements.\122\ In January 2006, AIG entered into a settlement
agreement with the New York Attorney General in which AIG made
payments totaling $1.6 billion in restitution and
penalties.\123\
---------------------------------------------------------------------------
\121\ For the fiscal year 2004, AIG noted five material weaknesses
in its financial statements related to the following: control
environment, controls over balance sheet reconciliations, controls over
accounting for certain derivative transactions/FAS 133 implementation,
controls over the evaluation of risk transfer/reinsurance, and controls
over income tax accounting. AIG Form 10-K for FY04, supra note 9, at
99.
\122\ Plaintiffs' Complaint, 2-4, People v. American International
Group, Inc., N.Y. App. Div. (May 26, 2005) (No. 401720-2005) (online at
www.ag.ny.gov/media_center/2005/may/Summons%20and%20Complaint.pdf). In
2005 problems with AIG's reinsurance division led to an investigation
by the Securities and Exchange Commission, the New York Attorney
General, the New York State Insurance Department, and the Justice
Department as to ``whether reinsurance companies controlled by AIG were
treated as separate entities in order to help hide AIG's exposure to
risk; whether reinsurance transactions are tantamount to loans that
should have been so listed; whether assets and liabilities were swapped
to smooth earnings; and, finally, whether AIG used finite reinsurance
to smooth earnings.'' The reinsurance revelations contributed to the
rating agencies' downgrade of the credit rating of AIG in 2005, AIG's
amendment of its 2005 10-K filing, and Mr. Greenberg's departure as
chairman and CEO of AIG.
\123\ Attorney General of the State of New York, Agreement Between
the Attorney General of the State of New York and American
International Group, Inc. and Its Subsidiaries, at 12-19 (Jan. 18,
2006) (online at www.ag.ny.gov/media_center/2006/feb/
signedSettlement.pdf).
---------------------------------------------------------------------------
While the problems at AIGFP can be viewed as a valuation
and risk management failure, exacerbated by accounting issues,
the life insurance subsidiaries' securities lending business
was a blatant risk-management failure. The decision to invest
cash collateral from the firm's securities lending customers in
RMBS represented a misjudgment of the volatility and liquidity
risks in the mortgage market. It was the duration mismatch on
these investments--in the context of the collapse in the
mortgage market--that created a liquidity crunch for the parent
company. The situation was exacerbated by the cross-funding
arrangements throughout the firm, which complicated the
relationship between AIG's subsidiaries and the parent company.
In addition, the life insurance subsidiaries were ramping up
the purchases of RMBS at the same time that AIGFP had decided
to stop writing swaps on subprime mortgage backed securities
because of the riskiness of the underlying bonds, highlighting
the failure of enterprise risk management at the company.
b. Technology
An additional factor which may have contributed to AIG's
financial troubles was shortfalls in its technological
infrastructure. AIGFP Chief Operating Officer Gerry Pasciucco,
who joined the division in the aftermath of government
assistance, asserts that the unit's technology and
infrastructure--which he described as similar to that of a
fast-growing hedge fund, but with few deficiencies that would
rise above the ``annoyance'' level--did not contribute to the
valuation and risk management challenges that engulfed AIG.
Rather than the models or the technology, Mr. Pasciucco
believes the inputs and the assumptions underlying those inputs
were the source of the problem.\124\
---------------------------------------------------------------------------
\124\ Panel staff conversation with Gerry Pasciucco (Apr. 23,
2010).
---------------------------------------------------------------------------
That said, while the systems within the individual
businesses may have been adequate, discussions with several
market observers point to systemic technology issues that may
have prevented AIG from adequately measuring its aggregate risk
exposures and inter-connections. In this context, it may have
been difficult for management and regulators to see the whole
picture across AIG's vast, interconnected business operations.
c. Reserves
Insurance companies report reserve estimates for both GAAP
and statutory reporting purposes, and due to inherent
differences in reserve requirements for each, the two estimates
often differ. Statutory reserves must be maintained at levels
required by state insurance regulators, while GAAP reserves
must meet the reserve estimate methodology required for
financial statement reporting. Insurance reserve estimate
methodology under GAAP employs assumptions, such as estimates
of expected investment yields, mortality, morbidity,
terminations, and expenses, applicable at the time of initial
contract with adjustments to the assumptions made over
time.\125\ As with any assumptions, the degree of subjectivity
and flexibility allows for a wide range of reserve results of
which AIG has historically chosen the lower end. Some market
observers believe that the company has had a deliberate and
consistent policy of slightly underreserving in a manner that
is not material to any one subsidiary, but is material on a
consolidated basis at the parent.\126\ The regulators review
life reserves on a legal entity basis and P&C reserves on a
pooled basis, but do not perform a group-wide consolidated
review of life reserves.\127\ Similarly, the ratings agencies
that rate insurance subsidiaries do not look at all
subsidiaries on a consolidated basis; but they do a
consolidated evaluation of all subsidiaries of a particular
group (life, property & casualty).\128\ Fitch placed AIG on
Ratings Watch Negative after it took a $1.8 billion after tax
reserve charge in the P&C operations in 2003.\129\ In addition,
AIG is required to include in its annual report with the SEC a
reestimate of its insurance reserves over a 10-year
period.\130\ The insurance reserves reestimate is calculated
based on current information rather than past information.\131\
The 2009 10-K shows consistent deficiencies in reserves over
the past 10 years, with the highest deficiency amount in 2001
and 2002, when the net deficiency amount totaled $22.0 billion
and $22.6 billion, respectively.\132\
---------------------------------------------------------------------------
\125\ Accounting Standards Codification (ASC) 944-40-30, Financial
Services--Insurance, Claim Costs and Liabilities for Future Policy
Benefits, Initial Measurement (online at asc.fasb.org/
section&trid=4737918%26analyticsAssetName =subtopic_page_section%26nav
_type=subtopic_page).
\126\ Panel staff conversation with industry participants (May 7,
2010).
\127\ Panel staff conversation with Texas Insurance Department (May
24, 2010). The regulators review statutory reserves, not GAAP reserves.
\128\ Panel staff conversations with rating agency (May 18, 2010);
Panel staff conversation with rating agency (May 19, 2010).
\129\ Fitch Ratings, Fitch Places AIG's Sr Debt on RW-Neg; Affirms
ST Rtg and Financial Strength Rtgs (Feb. 3, 2003).
\130\ SEC's Industry Guide 6 (Disclosures Concerning Unpaid Claims
and Claims Adjustment Expenses from Property--Casualty Insurance
Underwriters) provides disclosure guidance for companies with material
casualty insurance operations. Guide 6 calls for tabular information
depicting the activity with respect to loss reserves and revisions to
those estimates over time. See U.S. Securities and Exchange Commission,
Industry Guides, at 32 (online at www.sec.gov/about/forms/
industryguides.pdf).
\131\ As noted in the 2009 Form 10-K, the increase from ``the
original estimate[d] [reserve] generally results from a combination of
a number of factors, including claims being settled for larger amounts
than originally estimated.'' AIG Form 10-K for FY09, supra note 50, at
5.
\132\ This data shows ``losses and loss expense reserves. .
.excluding those with respect to asbestos and environmental claims.''
Including asbestos and environmental claims results in higher
deficiencies. AIG Form 10-K for FY09, supra note 50, at 7.
---------------------------------------------------------------------------
d. Cross-holdings
Inter-company transactions and cross-holdings complicated
AIG's financial position. Many of AIG's insurance subsidiaries
held common stock in other AIG insurance subsidiaries.\133\
This stock was counted towards regulatory capital of the
insurance subsidiaries. In addition to common stock, some
larger subsidiaries provided guarantees for smaller
subsidiaries.
---------------------------------------------------------------------------
\133\ For example, as of September 30, 2009, Pacific Union owned
67,435 shares of the parent company. See Pacific Union Assurance
Company, Quarterly Statement as of September 30, 2009 of the Condition
and Affairs of the Pacific Union Assurance Company, at Q07.2 (Nov. 11,
2009).
---------------------------------------------------------------------------
Beyond the insurance subsidiaries, AIGFP had liabilities
across AIG, both to the parent and other subsidiaries. AIGFP
had ``intercompany payables'' of $54 billion owed to the
parent.\134\ FRBNY considered the systemic risk of these
obligations to be high, as ``the failure of FP to perform on
obligations to other AIG entities may create an event of
default for the company,'' and the ``[f]ailure of FP may put at
risk the financial condition of other AIG operating
subsidiaries.'' The insurance and financing subsidiaries also
had $1.85 billion in derivatives exposure to AIGFP. The
subsidiaries with the largest exposures were ILFC ($695
million), AIG Matched Investment Program ($441.5 million),
SunAmerica LIC ($240.3 million), and American General ($225.4
million). Lastly, as discussed in Section B.6, all of Banque
AIG's risk was back-to-back with AIGFP, meaning that AIGFP was
liable for all of Banque AIG's obligations. An FRBNY staff
document describes that a default by AIGFP would have ``a
catastrophic impact on Banque AIG.'' \135\
---------------------------------------------------------------------------
\134\ This $54 billion is the sum of maturing AIGFP liabilities
plus collateral posted to third-parties--the parent had lent AIGFP
funds to pay off counterparties and AIGFP debtholders.
\135\AIGFP Systemic Risk Analysis--Draft, Attachment to e-mail sent
from Peter Juhas, advisor, Morgan Stanley, to Sarah Dahlgren, senior
vice president, Federal Reserve Bank of New York, at 1, 2 (Oct. 25,
2008) (FRBNY-TOWNS-R1-116163); Systemic Risks of AIG, Attachment to e-
mail sent from Michael Gibson to Rich Ashton, at 3 (Nov. 3, 2008)
(FRBNY-TOWNS-R1-122347-352).
---------------------------------------------------------------------------
Through 2008 and 2009, AIG provided capital contributions
to its subsidiaries. In total, AIG provided $27.2 billion to
its subsidiaries in 2008 and $5.7 billion in 2009.\136\ Of the
2008 capital contributions, $22.7 billion went to the domestic
life insurance subsidiaries, primarily to cover losses in the
securities lending portfolio.\137\ In 2008, the parent
contributed $4.4 billion to the foreign life insurance
subsidiaries after they experienced ``significant capital needs
following publicity of AIG parent's liquidity issues and
related credit ratings downgrades and reflecting the decline in
the equity markets.'' \138\ In 2009, AIG contributed $2.4
billion to its domestic life insurance subsidiaries ``to
replace a portion of the capital lost as a result of net
realized capital losses (primarily resulting from other-than-
temporary impairment charges) and other investment-related
items.'' \139\ The parent provided $624 million in funding to
foreign life insurance subsidiaries in 2009.\140\ In some
cases, the subsidiary paid the entire amount back later in the
year as a dividend.\141\
---------------------------------------------------------------------------
\136\ Although much of these payments are post-rescue, they reflect
issues that existed before the rescue, such as securities lending.
These numbers exclude MIP and Series AIGFP debt. A significant portion
of the 2008 capital contributions were to cover securities lending
liabilities at the life insurance subsidiaries. AIG Form 10-K for FY09,
supra note 50, at 48-49; AIG Form 10-K for FY08, supra note 47, at 48.
\137\ AIG Form 10-K for FY08, supra note 47, at 50, 251. The
insurance regulators have stated, however, that the subsidiaries could
have managed these liquidity needs on their own, without outside
assistance. See note 167 and accompanying text, infra.
\138\ AIG Form 10-K for FY08, supra note 47, at 50.
\139\ AIG Form 10-K for FY09, supra note 50, at 50.
\140\ AIG Form 10-K for FY09, supra note 50, at 50.
\141\ AIG Form 10-K for FY09, supra note 50, at 49 (``In 2009, AIG
made a capital contribution of $641 million to a Chartis U.S.
subsidiary, all of which was returned as a dividend to AIG later in the
year'').
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e. Leadership
Some view AIG's leadership as another factor leading to its
collapse. Though a controversial figure, Hank Greenberg is
widely acknowledged to have been the only person who fully
understood the company's vast web of inter-relationships.\142\
Some believe that, had he remained with the company, he would
have realized the implications of the market shift in late 2005
and required AIGFP to hedge its CDS exposure and also would
have provided stronger enterprise risk management.\143\ Among
other things, he might have noted the inconsistencies when the
securities lending program began purchasing RMBS at the same
time that AIGFP stopped writing CDS on subprime mortgage
products. Others believe that many of the company's bad
practices were developed under his watch. Lack of adequate
succession planning also played a role. Had AIG had a strong
succession plan in 2005 when Mr. Greenberg was forced to
resign, the new CEO could have had a more thorough
understanding of the complexity of the company, and thus could
have prevented or mitigated the damage. This complexity and
lack of transparency was not only a cause of the company's
troubles, it also impeded the rescue and recovery by obscuring
the nature and size of the problem.\144\
---------------------------------------------------------------------------
\142\ The charges brought against Mr. Greenberg, and forced him to
resign, were largely related to reinsurance transactions and an off-
shore entity. See Section B1, supra.
\143\ Panel staff call with industry analysts (Apr. 23, 2010).
\144\ Former AIG General Counsel Anastasia Kelly stated: ``There
wasn't focus on the fact that now that Hank's gone, what do we need,
what kind of succession planning should we have in place. . .A lot of
companies have very robust human resource-driven succession plans, have
people identified. AIG didn't have that. Maybe they would have had Hank
stay as long as he wanted to and had done it himself.'' She continued,
saying that when the crisis hit, AIG did not have the ``infrastructure
to call upon to respond'' and that ``there was no one in charge.'' Ian
Katz and Hugh Son, AIG Was Unprepared for Financial Crisis, Former Top
Lawyer Says, Bloomberg News (Mar. 13, 2010) (online at
www.bloomberg.com/apps/news?pid=20601087&sid=aYq7MDFtelkc).
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5. The Role of Credit Rating Agencies \145\
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\145\ Credit rating agencies, known formally as Nationally
Recognized Statistical Rating Organizations (NRSROs), are private, SEC-
registered firms that assign credit ratings to issuers, such as
companies, measuring their ``willingness and ability'' to repay their
financial obligations. In general, higher credit ratings lower an
issuer's borrowing costs, enhance its ability to raise capital, and
heighten its appeal as a business partner or counterparty. Credit
ratings can also be assigned to individual debt issues, such as
mortgage-backed securities, measuring their likelihood of default.
Rating agencies use letter-based rating scales to express credit
quality; for example, a `AAA' rating indicates the least amount of
credit risk, while a `D' rating indicates the most. Changes in credit
quality can trigger upgrades or downgrades along this rating scale.
Three rating agencies (S&P, Moody's, and Fitch) account for 98 percent
of all ratings generated by NRSROs. Although credit ratings technically
constitute only an opinion of credit quality, because ratings are used
to make investment decisions, and to satisfy certain regulatory and
investment requirements, credit ratings play a critical role in the
broader markets. See Standard and Poor's, Credit Ratings Definitions &
FAQs (online at www.standardandpoors.com/ratings/definitions-and-faqs/
en/us) (accessed June 9, 2010); Frank Partnoy, Rethinking Regulation of
Credit Rating Agencies: An Institutional Investor Perspective, at 4
(Apr. 2009) (online at www.cii.org/UserFiles/file/CRAWhitePaper04-14-
09.pdf).
---------------------------------------------------------------------------
Credit rating agencies played an exceptionally important
role in AIG's collapse and rescue. Credit rating downgrades
were a factor in AIG's problems, and the need to maintain
ratings significantly constrained the government agencies'
options in the rescue. Large insurance companies in general are
dependent on a sound credit rating that permits them to access
the bond markets cheaply. Many insurance customers are highly
ratings sensitive, and will not do business with insurers with
less than an investment grade credit rating. A low cost of
borrowing enables these companies to make a profit from the
spread between their cost of capital and the return on their
investments. AIG appears to have been more dependent on this
business model than most other insurance firms, as can be seen
in the frequent guarantee of the obligations of AIG
subsidiaries. Although AIG profited for many years from its AAA
credit rating, it also became particularly vulnerable to the
negative consequences of ratings downgrades.
AIG was a AAA company as recently as late 2004. In early
2005, all three major ratings agencies began downgrading AIG.
Although the agencies downgraded AIG again as its
vulnerabilities became more apparent in 2008, it still entered
September 2008 with relatively decent, investment-grade
ratings.\146\ On Monday, September 15, the day Lehman Brothers
failed, after the extent of AIG's liquidity problems became
known, AIG was again downgraded by all three major rating
agencies and by A.M. Best, a specialty insurance rating agency.
These downgrades prompted collateral calls that brought AIG to
the brink of bankruptcy, and ultimately resulted in FRBNY's
rescue. Less than two months later, ratings agencies again
warned of downgrades, concerned that FRBNY credit facility was
making AIG overleveraged. As discussed below, this event was a
factor in Treasury's intervention with TARP funds.
---------------------------------------------------------------------------
\146\ For example, as of September 14, 2008, AIG's senior unsecured
debt ratings were AA- from S&P, and Aa3 from Moody's.
---------------------------------------------------------------------------

6. Were Regulators Aware of AIG's Position?

In retrospect, it is clear that AIG's regulators failed to
assess the firm's risk adequately. OTS operated under ``a
statutory mandate to regulate federal savings associations in a
manner that preserves safety and soundness, protects the
federal deposit insurance funds, and promotes the provision of
credit for homes and other goods and services in accordance
with the best practices of thrift institutions in the United
States.'' \147\ As discussed earlier, OTS was the only
regulator that had explicit authority to look at the entire
company, and the only regulator with any authority over
AIGFP.\148\ But under federal law, OTS' regulatory authority
was predicated on the chief objective of protecting the thrift
subsidiary, with holding company regulation conducted in light
of that objective. As such, OTS generally did not interpret its
mandate broadly, focusing primarily on the company's regulated
thrift, which represented a small fraction of AIG's overall
business, and accounted for well under 1 percent of the holding
company's total assets.\149\
---------------------------------------------------------------------------
\147\ Office of Thrift Supervision, Legal Opinions: Operating
Subsidiaries and Federal Preemption (Oct. 17, 1994) (online at
www.ots.treas.gov/_files/56423.pdf); 12 U.S.C. 1464(a).
\148\ Testimony of Edward Liddy, supra note 91, at 39 (stating that
``while credit default swaps may be an unregulated product, they
absolutely, positively fell within a company that OTS regulated and we
indeed very much understood the risks of the profile of the credit
default portfolio as we were looking at it'').
\149\ Although OTS had oversight over the entire company, AIG FSB's
assets of $1.27 billion as of December 2008 constituted a mere 0.14
percent of AIG's total assets. See American International Group, Inc.,
2008 Annual Report, at 192 (Mar. 27, 2009) (online at phx.corporate-
ir.net/
External.File?item=UGFyZW50SUQ9MTQ4OHxDaGlsZElEPS0xfFR5cGU9Mw==&t=1);
see also Federal Financial Institutions Examination Council, AIG
Federal Savings Bank, Consolidated Statement of Condition (online at
www2.fdic.gov/Call_TFR_Rpts/
toccallreport1.asp?pInstitution=&pSQL=pcmbQtrEnd=12/31/
2008&pas_city=&pcmbState=ANY&pCert=35267&prdbNameSearch=&pDocket)
(accessed June 9, 2010).
---------------------------------------------------------------------------
Federal law regarding savings and loan holding companies is
generally aimed at protecting the safety and soundness of the
thrift subsidiary by preventing capital drains or overreaching
by affiliates within the holding company structure. OTS is
provided with the authority to examine the holding company and
its subsidiaries, as well as to restrict activities of the
holding company when there is reasonable cause to believe that
the activities constitute ``a serious risk to the financial
safety, soundness, or stability'' of the holding company's
subsidiary savings association.\150\ The Gramm-Leach-Bliley Act
of 1999 provided for coordination between the primary regulator
(in this case, OTS) and various functional regulators of the
holding company's subsidiaries (in this case, state insurance
regulators) and emphasized the safety and soundness of the
subsidiary depository institution as the primary objective of
regulation.\151\
---------------------------------------------------------------------------
\150\ See 12 U.S.C. 1467a (2009) for regulation of holding
companies.
\151\ Gramm-Leach-Bliley Act, Pub. L. 106-102, Sec. 401 (1999)
(online at www.gpo.gov/fdsys/pkg/PLAW-106publ102/pdf/PLAW-
106publ102.pdf); Congressional Oversight Panel, Written Testimony of
Michael E. Finn, Northeast regional director, Office of Thrift
Supervision, COP Hearing on TARP and Other Assistance to AIG, at 3 (May
26, 2010) (online at cop.senate.gov/documents/testimony-052610-
finn.pdf) (hereinafter ``Written Testimony of Michael E. Finn'').
---------------------------------------------------------------------------
OTS supervises and examines holding company enterprises,
such as AIG, within regulated holding companies, but it
generally relies on specific functional regulators for findings
and issues related to the various holding company subsidiaries
examined by other functional regulators to reduce duplication
of work. In its role as supervisory regulator, OTS must consult
with the functional regulator of a holding company subsidiary
before further examining or making authoritative decisions
regarding that entity and must prove that it needs information
that might indicate an adverse impact on the holding
company.\152\ According to OTS staff, to their knowledge, the
determination to prove the need to further examine a subsidiary
regulated by another functional regulator and obtain more
information was never made or exercised during its regulation
of AIG.\153\ Since no other functional regulator was overseeing
AIGFP, the potential for missed clues about future liquidity or
credit risks was high.
---------------------------------------------------------------------------
\152\ Pub. L. 106-102, Sec. 401 (online at www.gpo.gov/fdsys/pkg/
PLAW-106publ102/pdf/PLAW-106publ102.pdf); Panel staff conversation with
OTS (May 21, 2010).
\153\ Panel staff conversation with OTS (May 21, 2010).
---------------------------------------------------------------------------
After becoming the regulator of AIG's holding company in
2000, OTS began conducting targeted, risk-focused reviews of
AIG's businesses, including AIGFP, in 2004 and made
recommendations regarding risk management oversight, financial
reporting transparency, and corporate governance to AIG's
senior management and Board of Directors.\154\ OTS began
holding annual ``supervisory college'' meetings with the firm's
key foreign and U.S. insurance regulators in 2006 to share
information and coordinate actions, with certain meetings
including AIG personnel and others limited to only supervisors.
OTS rolled out a formal, risk-focused continuous supervision
plan for large holding companies such as AIG that same year,
well after the ramp-up in CDS contracts within AIGFP.\155\ In
January 2007, French bank regulator Commission Bancaire,
coordinating supervisor of AIG's European operations, deemed
the supervision of AIG by OTS as having equivalency status in
accordance with the EU's Financial Conglomerates
Directive.\156\ This decision exempted London-based AIGFP from
oversight by UK and European regulators, except in instances of
AIGFP activity affecting Banque AIG's European activity and
transactions,\157\ but it did not provide OTS with any
additional regulatory authority or powers in its supervision of
AIG.\158\
---------------------------------------------------------------------------
\154\ Written Testimony of Michael E. Finn, supra note 151, at 13.
\155\ Testimony of Edward Liddy, supra note 91, at 217.
\156\ OJ C 28 E of 11.2.2003, Directive 2002/87/EC of the European
Parliament and of the Council (Dec. 16, 2002) (online at eur-
lex.europa.eu/pri/en/oj/dat/2003/l_035/l_03520030211en00010027.pdf);
Office of Thrift Supervision, Press Release: OTS 07-011--OTS Receives
EU Equivalency Designation for Supervision of AIG (Feb. 22, 2007)
(online at www.ots.treas.gov/
%5C?p=PressReleases&ContentRecord_id=df05bfa2-8364-45a7-bf4c-
18437165c11f).
\157\ Panel staff conversation with OTS (May 21, 2010).
\158\ Written Testimony of Michael E. Finn, supra note 151, at 12.
---------------------------------------------------------------------------
In 2007, as the housing market deteriorated, OTS increased
its surveillance of AIGFP and its portfolio of mortgage-related
CDSs. Among other things, OTS recommended that AIGFP review its
CDS modeling assumptions in light of worsening market
conditions and that it increase risk monitoring and controls.
Beginning in February 2008, in response to a material weakness
finding in AIG's CDS valuation process, OTS again stepped up
its efforts to force AIG to manage the risks associated with
its CDS portfolio. OTS downgraded the firm's CORE rating \159\
in March 2008 and wrote a formal letter to AIG's General
Counsel regarding AIG's risk management failure.\160\ In August
2008, OTS began to review AIG's remediation plan to improve
practices and processes earlier criticized by OTS.\161\ During
this same month, the OTS field examiner to AIG met with
personnel from FRBNY at the request of the bank, largely for
FRBNY to obtain information and data about AIG's current state
from the field examiner. The most forceful protective action
taken by OTS occurred in September 16, 2008, when, in light of
mounting problems at the holding company level, OTS precluded
AIG FSB from engaging in transactions with affiliates without
its knowledge and lack of objection, restricted capital
distributions, required minimum liquidity be maintained, and
required retention of counsel to advise the board about pending
corporate issues and risks.\162\
---------------------------------------------------------------------------
\159\ The OTS evaluates a supervised company's managerial
resources, financial resources, and future prospects through the CORE
holding company examination components: Capital, Organizational
Structure, Risk Management, and Earnings. The examination reviews a
company's capital adequacy in light of inherent risk, ability to absorb
unanticipated losses, ability to support debt maturities, and overall
strategy. A CORE rating is assigned based on the results of the OTS
examination.
\160\ Written Testimony of Scott Polakoff, supra note 16, at 15-16.
\161\ Panel staff conversation with OTS (May 21, 2010).
\162\ Written Testimony of Michael E. Finn, supra note 151, at 14.
---------------------------------------------------------------------------
All of these steps were too little, too late to address the
company's vast exposure to a rapidly deteriorating housing
market and economy. As former Acting OTS Director Scott M.
Polakoff later acknowledged: ``OTS did not foresee the extent
of risk concentration and profound systemic impact CDS caused
within AIG.'' Polakoff also stated that OTS should have
directed AIG to stop originating CDSs and begin reducing its
CDS portfolio before December 2005.\163\ Former senior
personnel at OTS have admitted that they should have stopped
AIGFP's CDSbook of business in 2004 and that they ``did not
foresee the extent that the mortgage market would deteriorate
and the impact on the liquidity of AIGFP.'' \164\ While OTS
claims to have reviewed the valuation models that AIG used and
worked with the external auditors in understanding the
valuation process, they readily admit to not grasping the
inherent complexities of the CDS business, the degree of risk
taken on by AIG through its most troublesome subsidiaries, and
the comprehensive impact of collateral triggers on AIG's
liquidity and ability to operate as a going concern in a worst
case scenario. Some have speculated that AIG founded its thrift
in 2000 primarily to secure supervision from the supposedly lax
OTS.\165\
---------------------------------------------------------------------------
\163\ Written Testimony of Scott Polakoff, supra note 16, at 18.
\164\ Written Testimony of Scott Polakoff, supra note 16, at 17.
\165\ See, e.g. Paul Kiel, Banks' Favorite (Toothless) Regulator,
ProPublica (Nov. 25, 2008) (online at www.propublica.org/article/banks-
favorite-toothless-regulator-1125).
---------------------------------------------------------------------------
Prior to AIG's collapse, OTS deemed the capital at the
thrift level to be adequate, and as that was its starting point
for regulation, it did not take more forceful actions against
the holding company. As OTS monitored actions by management and
encouraged corrective action in 2008, OTS put a protective
hedge around the thrift to ensure it remained well capitalized
and that its capital could not be drained by the holding
company. Furthermore, OTS personnel note that after the fall of
Bear Stearns in early 2008, all OTS field regulators were
conducting heightened evaluations of the major banks with a
focus on CDS practices, mortgage lines, and off-balance sheet
transactions.\166\
---------------------------------------------------------------------------
\166\ Panel staff conversation with OTS (May 21, 2010).
---------------------------------------------------------------------------
AIG's insurance regulators had more success in taking
action regarding the company's securities lending program. In
mid-2007, as part of its examination process, Texas, the lead
regulator for the firm's life insurance subsidiaries,
discovered that AIG was purchasing RMBS with its securities
lending collateral (a practice that began in late 2005).\167\
When Texas discovered this, various state insurance regulators
began working closely with management to develop both short
(guarantees) and long (wind-down) term plans to address the
regulators' concerns with the program.\168\ AIG's goal was to
wind down the program gradually, so as not to force the
subsidiaries to sell assets at a loss.\169\ During this period
they required detailed monthly reporting on the securities
lending portfolio. They also closely monitored realized and
unrealized losses from the program and capital levels at the
subsidiaries.
---------------------------------------------------------------------------
\167\ NAIC has stated that AIG should have disclosed to the
regulators this material change in the composition of the assets
purchased.
\168\ Panel staff conversation with Texas Department of Insurance
(May 24, 2010). The New York Insurance Department learned of the RMBS
purchases in mid-2006; they discovered them when reviewing AIG's risk-
based capital reporting. Because the RMBS were AAA-rated liquid assets
at the time, New York did not raise the RMBS purchases as an issue.
Panel staff conversation with New York Insurance Department (June 3,
2010).
\169\ Through the wind down of the program, the insurance
subsidiaries had $5 billion in realized losses and $7.873 billion in
unrealized losses, as of July 2008, from the securities lending
program. Panel staff conversation with Texas Department of Insurance
(May 24, 2010).
---------------------------------------------------------------------------
At the November 2007 AIG Supervisory College, the Texas
Department of Insurance informed OTS and the other regulators
of the securities lending issue.\170\ The Texas regulators
discussed the securities lending issue as part of its
presentation to the other regulators, and also held a private
conversation with OTS about the issue afterwards.\171\ This
presentation included a summary of what they had found in the
examination, as well as a mention of the $1 billion in
unrealized losses the program had incurred to date. OTS did not
follow up on this issue with the Texas regulators after this
meeting.
---------------------------------------------------------------------------
\170\ Texas also informed the other insurance regulators with
domiciled subsidiaries that participated in the program.
\171\ Panel staff conversation with Texas Department of Insurance
(May 24, 2010).
---------------------------------------------------------------------------
Texas had a plan in place if the program had to be wound
down quickly, but it was not implemented because of FRBNY's
rescue. From its height of $76 billion, the securities lending
portfolio had been wound down to $58 billion by September 2008
\172\--a significant decrease, though not enough to avoid
enormous liquidity strains at the height of AIG's troubles. The
regulators have stated that, had it not been for the ``run'' by
securities lending counterparties, caused by the public
liquidity crunch at AIGFP, the insurance subsidiaries would
have been able to gradually wind down the program without
significant assistance from the parent.\173\
---------------------------------------------------------------------------
\172\ Written Testimony of Michael Moriarty, supra note 103, at 4.
\173\ See Panel staff conversation with Texas Department of
Insurance (May 24, 2010); Written Testimony of Michael Moriarty, supra
note 103, at 4-5 (``At that point, the crisis caused by Financial
Products caused the equivalent of a run on AIG securities lending.
Borrowers that had reliably rolled over their positions from period to
period for months began returning the borrowed securities and demanding
their cash collateral. From September 12 to September 30, borrowers
demanded the return of about $24 billion in cash.'').
---------------------------------------------------------------------------
Though supervision of each of the four main insurance
groups was coordinated, it is not clear that the regulators
coordinated further to analyze all of the insurance
subsidiaries on a consolidated basis. Lead regulators evaluated
the subsidiaries individually as well as each group as a whole.
While all of AIG's insurance regulators talk regularly about
issues related to the company, they do not engage in any
consolidated review of all of the subsidiaries across groups.

C. The Rescue

1. Key Events Leading up to the Rescue

AIG's problems did not arrive out of the blue in mid-
September 2008. More than six months earlier, in February, the
firm announced that AIGFP had recognized $11.1 billion in
unrealized market valuation losses on its CDS contracts for the
fourth quarter of 2007, and that the head of the business would
resign.\174\ On May 21, AIG raised $20 billion in capital
through sales of common stock, mandatory convertible stock, and
hybrid fixed maturity securities.\175\ On June 15, the company
announced that CEO Martin Sullivan was leaving his post and
being replaced by Chairman Robert Willumstad.\176\ In late
June, the company recognized $13.5 billion in unrealized losses
against its RMBS and other structured securities
investments.\177\ In July, Mr. Willumstad discussed AIG's
condition with rating agencies, which said they would wait to
review the firm's ratings until after AIG announced its
strategic plans, which was then scheduled for September
25.\178\ On July 29, Mr. Willumstad spoke to then-President
Timothy Geithner about the possibility of getting access to the
Federal Reserve's Discount Window; according to Mr. Willumstad,
President Geithner expressed the view that if the Federal
Reserve were to provide liquidity to AIG, it would only
exacerbate the potential of a run on AIG by its creditors.\179\
From mid-July through August 2008, AIG management reviewed
measures to address the liquidity problems of its securities
lending portfolio and the collateral calls on AIGFP's
CDSs.\180\ On August 18, AIG raised $3.25 billion through a 10-
year debt issuance that paid 8.25 percent,\181\ but the company
felt that it needed more capital. In late August, AIG contacted
triple-A-rated insurer Berkshire Hathaway about the possibility
of providing a $5 billion backstop to AIG's guaranteed
investment contracts.\182\ Around the same time, AIG hired JP
Morgan Chase to help develop alternatives as the market and the
company's condition deteriorated rapidly.\183\ But those
efforts proved insufficient.
---------------------------------------------------------------------------
\174\ AIG Form 10-K for FY07, supra note 41, at 197; AIG Financial
Results Conference Call--2007, supra note 78; Allstair Barr and Greg
Morcroft, AIG Shares Plunge After Company Posts $5.29 Billion Loss,
MarketWatch (Feb. 29, 2008) (online at www.marketwatch.com/story/aig-
shares-fall-after-loss-troubled-unit-chief-resigns).
\175\ American International Group, Inc., Credit Exposure to AIG
(Sept. 16, 2008), Attachment to e-mail from Antonio Moreano of FRBNY to
others at FRBNY (Sept. 16, 2008) (FRBNYAIG00444).
\176\ American International Group, Inc., AIG Names Robert B.
Willumstad Chief Executive Officer (Sept. 15, 2008) (online at
web.aig.com/2008/mem7755/mem7755NewCEO.pdf).
\177\ American International Group, Inc., Form 10-Q for the
Quarterly Period Ended June 30, 2008, at 112 (Aug. 6, 2008) (online at
www.sec.gov/Archives/edgar/data/5272/000095012308008949/
y59464e10vq.htm) (hereinafter ``AIG Form 10-Q for the Second Quarter
2008''). This figure includes gross unrealized losses on RMBS ($10
billion), CMBS ($2 billion) and CDO/ABS ($1.5 billion).
\178\ Congressional Oversight Panel, Written Testimony of Robert
Willumstad, former chairman and chief executive officer, American
International Group, Inc., COP Hearing on TARP and Other Assistance to
AIG, at 3 (May 26, 2010) (online at cop.senate.gov/documents/testimony-
052610-willumstad.pdf) (hereinafter ``Written Testimony of Robert
Willumstad'').
\179\ Congressional Oversight Panel, Testimony of Robert
Willumstad, former chairman and chief executive officer, American
International Group, Inc., COP Hearing on TARP and Other Assistance to
AIG (May 26, 2010) (hereinafter ``Testimony of Robert Willumstad'').
\180\ AIG Form 10-K for FY08, supra note 47, at 3.
\181\ AIG Form 10-K for FY08, supra note 47, at 56.
\182\ Warren Buffett conversation with Panel staff (May 25, 2010).
\183\ American International Group, Inc. Form 10-K for the Fiscal
Year Ended December 31, 2008, at 3 (Mar. 2, 2009) (online at sec.gov/
Archives/edgar/data/5272/000095012309003734/y74794e10vk.htm).
---------------------------------------------------------------------------
AIG's growing problems were unfolding within the broader
context of the financial crisis. JPMorgan Chase's government-
supported acquisition of Bear Stearns happened on March 24,
2008, and Bank of America purchased Countrywide Financial Corp.
on June 5. The financial market deterioration accelerated in
September. Between September 7-15, the markets reflected a
level of turmoil unseen for decades. On September 7, the U.S.
government took control of Fannie Mae and Freddie Mac,\184\ a
decision that cemented the market's view, already widely held,
that taxpayers would assume their liabilities if the two
mortgage giants became imperiled. Three major events shook the
financial system in the two days prior to FRBNY's bailout of
AIG. Bank of America announced that it was buying Merrill Lynch
amid concerns about Merrill's exposure to securities based on
residential mortgages.\185\ In addition, at midday on September
16, the assets of a money-market mutual fund that had exposure
to Lehman fell below $1 per share, a rare occurrence known as
``breaking the buck,'' which further stoked investors' fears;
\186\ that week, money-market mutual funds were subjected to
enormous withdrawals, especially by institutional
investors.\187\ And finally, as described in more detail below,
Lehman Brothers filed for bankruptcy,\188\ in what became the
largest bankruptcy case in U.S. history.\189\
---------------------------------------------------------------------------
\184\ See U.S. Department of the Treasury, Statement by Secretary
Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency
Action to Protect Financial Markets and Taxpayers (Sept. 7, 2008)
(online at www.ustreas.gov/press/releases/hp1129.htm).
\185\ See Bank of America Corporation, Bank of America Buys Merrill
Lynch Creating Unique Financial Services Firm (Sept. 15, 2008) (online
at newsroom.bankofamerica.com/index.php?s=43&item=8255).
\186\ See The Reserve, Important Notice Regarding Reserve Primary
Fund's Net Asset Value (Nov. 26, 2008) (online at www.reservefunds.com/
pdfs/Press Release Prim NAV 2008_FINAL_112608.pdf).
\187\ See Bank for International Settlements, International Banking
and Financial Developments, BIS Quarterly Review, at 72 (Mar. 2009)
(online at www.bis.org/publ/qtrpdf/r_qt0903.pdf) (hereinafter
``International Banking and Financial Developments'').
\188\ See U.S. Securities and Exchange Commission, Statement
Regarding Recent Market Events and Lehman Brothers (Sept. 14, 2008)
(online at www.sec.gov/news/press/2008/2008-197.htm).
\189\ House Committee on Financial Services, Written Testimony of
Anton R. Valukas, court-appointed bankruptcy examiner, Lehman Brothers
Bankruptcy: Public Policy Issues Raised by the Report of the Lehman
Bankruptcy Examiner, at 2 (Apr. 20, 2010) (online at www.house.gov/
apps/list/hearing/financialsvcs_dem/valuks_4.20.10.pdf).
---------------------------------------------------------------------------
Various data illustrate the turmoil that racked the
financial markets in the fall of 2008. The Dow Jones Industrial
Average fell by about 25 percent between September 9 and
October 9, from 11,231 to 8,579.\190\ Arguably more important,
the cost of interbank borrowing soared to historic levels, a
situation that held the potential to choke off the supply of
credit in the U.S. economy. The spread between the three-month
rate at which banks typically lend to each other and the three-
month Treasury bill rate rose from 1.16 percent on September 9
to 3.02 percent on September 17.\191\ The spread between the
interest rate for 30-day commercial paper loans, which many
businesses use to finance their day-to-day operations, and the
rate for Treasury bonds also skyrocketed.\192\ Figure 14
includes data that quantify the problems experienced between
August-November 2008 both by AIG and in the financial markets
more generally.
---------------------------------------------------------------------------
\190\ Bloomberg, Dow Jones Industrial Average Chart (online at
www.bloomberg.com/apps/cbuilder?ticker1=INDU%3AIND) (accessed June 8,
2010).
\191\ Bloomberg, TED Spread Chart (online at www.bloomberg.com/
apps/cbuilder?ticker1=.TEDSP%3AIND) (accessed June 8, 2010).
\192\ See Board of Governors of the Federal Reserve System,
Commercial Paper Rates and Outstanding (online at
www.federalreserve.gov/releases/cp/) (accessed June 8, 2010); Board of
Governors of the Federal Reserve System, Market Yield on U.S. Treasury
Securities at 1-month Constant Maturity, Quoted on Investment Basis
(online at www.federalreserve.gov/releases/h15/data/Business_day/
H15_TCMNOM_M1.txt) (accessed June 8, 2010).

FIGURE 14: INDICATORS OF FINANCIAL MARKET UPHEAVAL193
----------------------------------------------------------------------------------------------------------------
3-Month
TED Spread 3-Month Treasury AIG Stock Dow Jones AIG CDS
(bps) LIBOR-OIS Bond Yield Price ($) Industrial Spread (bps)
Spread (bps) (%) Average
----------------------------------------------------------------------------------------------------------------
August 15, 2008............. 96 77 1.85 459.8 11,659.9 300.7
September 15, 2008.......... 180 105 1.02 95.2 10,917.5 1,527.6
October 15, 2008............ 433 345 0.22 48.6 8,577.9 1,816.9
November 7, 2008............ 198 176 0.31 42.2 8,943.8 2,923.9
----------------------------------------------------------------------------------------------------------------
193 SNL Financial.

In early September, AIG met with the major rating agencies
about the company's liquidity problems.\194\ On Tuesday,
September 9, Mr. Willumstad again spoke with President
Geithner. Mr. Willumstad noted AIG's widening credit spreads
and multi-billion-dollar losses in recent quarters, and stated
that he expected further losses.\195\ Then on Friday, September
12, the company's deterioration accelerated. S&P placed AIG on
a watch status with negative implications, and noted that its
review of the company could lead to a lower rating of up to
three notches. Two financial services subsidiaries of AIG were
unable to replace all of their maturing commercial paper, and
AIG's parent company advanced loans to them so that they could
meet their obligations.\196\ Also on Friday, Mr. Willumstad
called Warren Buffett, CEO of Berkshire Hathaway, to discuss a
possible investment in AIG. Later in the day, Mr. Buffett
received a packet of materials about AIG's property & casualty
insurance business, which AIG was interested in selling to
Berkshire Hathaway. But Mr. Buffett quickly concluded that the
assets for sale were not attractive enough, and he would have
had trouble raising the $25 billion that AIG would have needed
to receive for its property & casualty business.\197\
---------------------------------------------------------------------------
\194\ House Committee on Oversight and Government Reform, Written
Testimony of Robert B. Willumstad, former chief executive officer,
American International Group, Inc., The Causes and Effects of the AIG
Bailout, at 3-4 (Oct. 7, 2008) (online at oversight.house.gov/images/
stories/documents/20081007101054.pdf); AIG Form 10-K for FY08, supra
note 47, at 3-4. AIG's meeting with Standard & Poor's happened on Sept.
11, 2008.
\195\ Testimony of Robert Willumstad, supra note 179.
\196\ The two subsidiaries were International Lease Finance
Corporation (ILFC) and American General Finance (AGF). AIG Form 10-K
for FY08, supra note 47, at 4.
\197\ Warren Buffett conversation with Panel staff (May 25, 2010).
---------------------------------------------------------------------------
After the markets closed on Friday, an e-mail by an FRBNY
employee stated that hedge funds were panicking about AIG.
``Every bank and dealer has exposure to them,'' read the e-
mail, which was sent to William Dudley, then executive vice
president of FRBNY's Markets Group and currently FRBNY's
president, among others. ``People I heard from worry they can't
roll over their funding. . . . Estimate I hear is 2 trillion
balance sheet.'' \198\ That same evening, officials from FRBNY
and the Federal Reserve Board of Governors met with AIG senior
executives. At this meeting, AIG stated that it had $8 billion
cash in its holding company and enough liquidity to last for
the next two weeks. AIG estimated that it might have to pay out
$18.6 billion over the next week if, as expected, its ratings
were downgraded the following week.\199\ Also Friday, AIG
informed Treasury and the New York state insurance regulators
of its severe liquidity problems, principally due to increasing
demands to return cash collateral under its securities lending
program and collateral calls on AIGFP's CDS portfolio.\200\ AIG
found itself unable to obtain short-term or long-term financing
in the public debt markets. This, coupled with its inability to
roll over commercial paper coming due, posed the most
significant immediate threat to the company's solvency.\201\
---------------------------------------------------------------------------
\198\ E-mail from Hayley Boesky, vice president, Federal Reserve
Bank of New York, to William Dudley, executive vice president, Federal
Reserve Bank of New York, and other Federal Reserve Bank of New York
officials (Sept, 12, 2008) (FRBNYAIG00511).
\199\ E-mail from Alejandro LaTorre, vice president, Federal
Reserve Bank of New York, to Timothy F. Geithner, president, Federal
Reserve Bank of New York, and other Federal Reserve Bank of New York
officials (Sept. 12, 2008) (FRBNYAIG00509).
\200\ See GAO Report, supra note 18, at 11-15; Testimony of Sec.
Geithner, supra note 11, at 3; AIG Form 10-K for FY08, supra note 47,
at 40.
\201\ AIG Form 10-K for FY08, supra note 47, at 201.
---------------------------------------------------------------------------
At the same time as AIG's collapse, Lehman Brothers was
also on the verge of bankruptcy. On Friday, President Geithner
called together representatives of 12 major financial
institutions to participate in discussions regarding a private-
sector consortium rescue for Lehman. The financial institutions
committed to financing $40 billion of Lehman's real estate
assets in order to facilitate Lehman's acquisition by Barclays;
those efforts would soon unravel, though.\202\
---------------------------------------------------------------------------
\202\ FRBNY conversation with the Panel (May 11, 2010).
---------------------------------------------------------------------------
While top government officials were continuing to deal with
the problems facing Lehman Brothers and Merrill Lynch, teams
from FRBNY and the New York State Insurance Department worked
Saturday to determine how a failure of AIG would affect the
financial system and the broader economy, and examined their
options for containing the damage from an AIG failure.\203\ The
Governor of New York, David Paterson, and the State Insurance
Department considered allowing AIG to tap $20 billion from its
insurance subsidiaries, as part of an emergency plan devised by
AIG. (The following Monday, Governor Paterson announced
publicly that the authorities would allow this transaction,
though it did not actually happen in the end.) \204\
---------------------------------------------------------------------------
\203\ Testimony of Sec. Geithner, supra note 11, at 4-5.
\204\ David A. Paterson, governor, State of New York, Governor
Paterson Announces New York Will Facilitate Financing Plan for World's
Largest Insurance Provider (Sept. 15, 2008) (online at www.state.ny.us/
governor/press/press_0915082.html). See also e-mail from Patricia
Mosser, senior vice president, Federal Reserve Bank of New York, to
Scott Alvarez of Federal Reserve Board of Governors, among others
(Sept. 13, 2008) (FRBNYAIG00508).
---------------------------------------------------------------------------
At 11 a.m. Saturday, Federal Reserve officials held a call
with AIG CEO Willumstad and CFO Steven Bensinger, among others,
during which AIG said it had a plan over the next six to 12
months to sell approximately $40 billion in assets, including
domestic and foreign life insurance subsidiaries; these assets
equaled 35-40 percent of the company. AIG said that in addition
to the aforementioned assistance from the New York State
Insurance Department, it needed bridge financing, and was
interested in tapping Federal Reserve lending facilities.
Federal Reserve officials got the impression that AIG had not
approached private financial institutions about obtaining this
financing, likely because AIG believed that it would be turned
down. This phone call also included a discussion of the Federal
Reserve's emergency lending authority under Section 13(3) of
the Federal Reserve Act. The Federal Reserve officials stated
that 13(3) lending to AIG would send a negative signal to the
market, and told AIG that they ``should not be particularly
optimistic,'' given the history and hurdles of 13(3)
lending.\205\
---------------------------------------------------------------------------
\205\ E-mail from Patricia Mosser, senior vice president, Federal
Reserve Bank of New York, to Scott Alvarez of Federal Reserve Board of
Governors, among others (Sept. 13, 2008) (FRBNYAIG00508). For a
discussion of the Federal Reserve authority under 13(3), see Section
C.4.
---------------------------------------------------------------------------
During that weekend, a small number of private equity firms
submitted bids to acquire a controlling interest in AIG.\206\
JC Flowers & Co. LLC, a private equity firm in New York, made
two different efforts. Its first overture involved a plan to
combine private equity with asset sales, along with the
upstreaming of assets, as contemplated by the New York State
Insurance Department, from AIG's insurance subsidiaries to the
parent company. This plan also relied on a backstop of AIG
guaranteed investment contracts by Berkshire Hathaway; AIG
contacted Mr. Buffett about the idea, but it never came to
fruition.\207\ The second attempt jointly offered private
equity from JC Flowers and German insurance firm Allianz SE.
The latter plan, which was regarded by some senior officials at
the FRBNY as a ``takeover offer,'' called for AIG to more than
double its outstanding shares and was contingent on AIG gaining
access to the Federal Reserve's lending facilities.\208\ A
later account provided in former Treasury Secretary Henry M
Paulson Jr.'s book, ``On The Brink,'' characterized the offers
as an attempt by Flowers to ``buy pieces of AIG on the cheap. .
.'' \209\ The buyout firms Kohlberg Kravis Roberts & Co. and
TPG Capital also expressed interest in acquiring at least some
portion of AIG, according to news reports at the time.\210\ For
its own part, AIG was also still trying to renegotiate the
terms of its most burdensome financial instruments. In addition
to its talks with private equity firms, AIG's efforts to raise
capital and otherwise improve its liquidity position included
conversations with sovereign wealth funds, and the retention of
Blackstone Advisory Services LP to assist in these
efforts.\211\
---------------------------------------------------------------------------
\206\ AIG got assistance during this process from investment
banking advisors JPMorgan Chase and Citigroup. Testimony of Robert
Willumstad, supra note 179.
\207\ E-mail from Patricia Mosser, senior vice president, FRBNY, to
others at FRBNY and the Federal Reserve Board (Sept. 14, 2008)
(FRBNYAIG00495); Warren Buffett conversation with Panel staff (May 25,
2010).
\208\ E-mail from Patricia Mosser, senior vice president, FRBNY, to
others at FRBNY and the Federal Reserve Board (Sept. 14, 2008)
(FRBNYAIG00495).
\209\ Henry M. Paulson, Jr., On The Brink, at 200, 217 (2010)
(hereinafter ``On The Brink''). Of course, given AIG's precarious
condition at the time, it is neither surprising nor unusual that some
market participants sought to take advantage by offering to buy assets
at a discount.
\210\ Andrew Ross Sorkin et al., AIG Seeks $40 billion in Fed Aid
to Survive, New York Times Dealbook Blog (Sept. 14, 2008) (online at
dealbook.blogs.nytimes.com/2008/09/14/aig-seeks-fed-aid-to-survive/).
\211\ AIG Form 10-K for FY08, supra note 47, at 4.
---------------------------------------------------------------------------
Between Friday, September 12 and the evening of Saturday,
September 13, AIG's own estimate of the size of the hole in its
balance sheet rose from $20 billion to $40 billion.\212\
Saturday evening, Mr. Willumstad told Secretary Paulson and
President Geithner that he believed AIG could probably raise
$30 billion that weekend,\213\ but only if the potential
investors and the New York State Insurance Department received
assurances that the company would survive after it got the $30
billion. Mr. Willumstad believed that the Federal Reserve was
the only entity that could provide such an assurance. But Mr.
Willumstad says he was told that there would be no government
solution for AIG.\214\
---------------------------------------------------------------------------
\212\ Testimony of Robert Willumstad, supra note 179.
\213\ Testimony of Robert Willumstad, supra note 179.
\214\ Testimony of Robert Willumstad, supra note 179. For a
discussion of whether a hybrid public-private solution would have been
feasible, see Section F.1, infra.
---------------------------------------------------------------------------
Throughout the weekend of September 13-14, representatives
of large financial institutions were meeting at FRBNY regarding
the potential rescue of Lehman Brothers. Two of the CEOs on
hand provided assurances to FRBNY officials that there would be
a private-sector solution for AIG, according to recent
testimony before the Panel by a senior FRBNY official.\215\ And
right up until FRBNY stepped in to rescue AIG, senior
government officials remained hopeful that the private sector
would produce an alternative solution resembling the bailout of
Long-Term Capital Management ten years earlier.\216\ The LTCM
bailout was seen as a model because the government did not
provide assistance, and the firms that did provide emergency
credit were repaid with interest.\217\
---------------------------------------------------------------------------
\215\ Congressional Oversight Panel, Testimony of Thomas C. Baxter,
Jr., general counsel and executive vice president of the legal group,
Federal Reserve Bank of New York, COP Hearing on TARP and Other
Assistance to AIG (May 26, 2010) (hereinafter ``Testimony of Thomas C.
Baxter'').
\216\ FRBNY conversation with the Panel (May 11, 2010).
\217\ House Committee on Banking and Financial Services, Written
Testimony of Alan Greenspan, chairman, Board of Governors of the
Federal Reserve System, Private-Sector Refinancing of the Large Hedge
Fund: Long-Term Capital Management, 105th Cong. (Oct. 1, 1998) (online
at www.federalreserve.gov/boarddocs/testimony/19981001.htm)
(hereinafter ``Written Testimony of Alan Greenspan''); FRBNY
conversation with the Panel (May 11, 2010).
---------------------------------------------------------------------------
By Sunday morning, FRBNY staffers were preparing to brief
President Geithner on the pros and cons of providing AIG access
to the Federal Reserve's Discount Window.\218\ Later that
afternoon, President Geithner received from his staff a
spreadsheet showing which banks had the largest estimated
exposure to AIG, as well as an FRBNY presentation about the
strength of AIG's subsidiaries, and a two-page memo laying out
the pros and cons of lending to AIG.\219\ At 5 p.m. Sunday, Mr.
Willumstad, after having been summoned to FRBNY notified
Secretary Paulson and President Geithner that AIG had failed to
raise any capital, and that the hole in the firm's balance
sheet had grown again.\220\ Mr. Willumstad's latest plan was
for the Federal Reserve to provide a $40 billion bridge loan,
to be accompanied by $10 billion that AIG thought it could
generate from unencumbered securities. President Geithner again
said that the government was not going to lend, and that Mr.
Willumstad should seek a bridge loan from a consortium of
private lenders.\221\
---------------------------------------------------------------------------
\218\ E-mail from Paul Whynott, Federal Reserve Bank of New York,
to Sarah Dahlgren, Brian Peters, Jim Mahoney, Catherine Voigts, and
Christopher Calabria (Sept. 14, 2008) (FRBNYAIG00459-460).
\219\ Pros and Cons on AIG Lending, E-mail and attachments from
Alejandro LaTorre, assistant vice president, Federal Reserve Bank of
New York (Sept. 14, 2008) (FRBNYAIG00496-505).
\220\ Mr. Willumstad testified that the balance sheet hole was $60
billion by Sunday night. Secretary Paulson, in his book, put the figure
at $50 billion. See Testimony of Robert Willumstad, supra note 179; On
The Brink, supra note 209.
\221\ On The Brink, supra note 209, at 217-218.
---------------------------------------------------------------------------
In a recent interview with the Panel, Secretary Geithner
said that on Sunday night, he got government officials to start
thinking about the implications of an AIG failure both on U.S.
insurance subsidiaries and around the world.\222\ Nonetheless,
Secretary Geithner has stated that as late as that night, ``it
still seemed inconceivable that the Federal Reserve could or
should play any role in preventing AIG's collapse.'' \223\ Also
Sunday evening, government officials contacted Morgan Stanley
about serving as an adviser to the government in another effort
to effect a private-sector rescue of AIG.\224\ Government
officials also summoned JPMorgan Chase for a meeting; AIG asked
to be included in the talks, but the firm received word that it
was not invited.\225\
---------------------------------------------------------------------------
\222\ Panel conversation with Secretary Geithner (June 2, 2010).
\223\ Testimony of Sec. Geithner, supra note 11, at 4; Panel
conversation with Secretary Geithner (June 2, 2010).
\224\ Rescue Effort Participant conversation with Panel staff (May
24, 2010).
\225\ Testimony of Robert Willumstad, supra note 179. Mr. Geithner
says that on Sunday night he wanted a more organized effort by AIG's
advisors to approach potential investors, including institutions that
had an interest in AIG's survival, even though the probability of
success in such an effort was low. Panel conversation with Secretary
Geithner (June 2, 2010).
---------------------------------------------------------------------------
Shortly after midnight on the morning of Monday, September
15, Lehman Brothers announced that it was filing for
bankruptcy.\226\ Only at this point did the focus of top
government officials turn to AIG. President Geithner called
Lloyd Blankfein, Goldman Sachs' CEO, and asked him to convene a
team to work on a private-sector rescue.\227\ Around 11 a.m.,
representatives from JPMorgan Chase and Goldman Sachs--along
with representatives from AIG, the New York State Insurance
Department, Treasury, and Morgan Stanley, which was acting in
its new capacity as an adviser to the government--convened for
a meeting at FRBNY.\228\ Government officials hoped that these
banks, by syndicating a multi-billion dollar loan with other
large financial institutions, would be able to provide the
private-sector bailout that AIG had been unable to organize
over the weekend.\229\ President Geithner spoke at the
beginning of the meeting, and according to the accounts of
several people who were there, he either strongly downplayed or
ruled out the possibility of a government rescue of AIG.\230\
Then he left. Secretary Paulson, after spending the weekend in
New York dealing with Merrill Lynch and Lehman Brothers, had
returned to Washington by Monday morning and was not in
attendance.\231\ According to one person who was in the room,
the meeting that ensued was largely run by JPMorgan Chase and
Goldman Sachs, though representatives of FRBNY and Treasury
were also present.\232\
---------------------------------------------------------------------------
\226\ See Lehman Brothers, Press Release: Lehman Brothers Announces
it Intends to File Chapter 11 Bankruptcy Petition (Sept. 15, 2008)
(online at www.lehman.com/press/pdf_2008/
091508_lbhi_chapter11_announce.pdf). See also Lehman Brothers Holdings
Inc., Voluntary Petition, United States Bankruptcy Court, Southern
District of New York (Sept. 14, 2008) (online at
www.bankruptcylitigationblog.com/uploads/file/voluntary petition.pdf).
\227\ Rescue Effort Participant conversation with Panel staff (June
2, 2010); Panel conversation with Secretary Geithner (June 2, 2010).
\228\ See Federal Reserve Bank of New York, Visitors List (Sept.
15, 2008) (FRBNYAIG00488).
\229\ In an e-mail circulated sent to FRBNY staff that morning,
Brian Peters of FRBNY noted that FRBNY had no supervisory authority
over AIG and stated: ``As a result, we need to be clear that we are NOT
holding ourselves out as responsible when we deal with firms and other
supervisors. . . . We also believe that the private sector is and
should be actively working on a resolution, and that based on our
earlier dimensioning work that AIG has options (albeit unpleasant) to
solve this themselves.'' AIG: Important, E-mail from Brian Peters,
senior vice president, risk management function, Federal Reserve Bank
of New York (Sept. 15, 2008) (FRBNYAIG 00491-492).
\230\ One participant recalls Geithner saying that the banks should
not assume that the Federal Reserve would bail out AIG, so the private
sector needed to find the solution; others remember Geithner saying
that he wanted the banks to explore a private solution given that
government money was not going to be available. Morgan Stanley
conversation with Panel staff (May 24, 2010); GS conversation with
Panel staff (June 2, 2010).
\231\ On The Brink, supra note 209.
\232\ Morgan Stanley conversation with Panel staff (May 24, 2010).
Mr. Willumstad testified that the meeting ended around 12:30 or 1 p.m.,
and that he did not believe at that time that a loan syndicate to
rescue AIG was being put together. Testimony of Robert Willumstad,
supra note 179.
---------------------------------------------------------------------------
The assembled bankers later proceeded to AIG's
headquarters, where they received additional information about
the firm's liquidity position and the value of its
businesses.\233\ Later in the day, the group returned to FRBNY.
The atmosphere throughout the day was described by one banker
in attendance as highly frenetic, with various participants
taking part in numerous side meetings and conversations.\234\
It is not clear exactly when, but at some point, the private-
sector banks developed a $75 billion term sheet for an AIG
rescue. The idea was that the private-sector lending would
serve as a bridge loan until AIG could sell enough assets to
stabilize itself.\235\ Although AIG has stated that Goldman
Sachs and JPMorgan Chase made efforts on Monday to syndicate
the loan,\236\ it is not clear what other firms they contacted,
or whether their efforts met with any success.
---------------------------------------------------------------------------
\233\ Rescue Effort Participant conversation with Panel staff (May
24, 2010).
\234\ Rescue Effort Participant conversation with Panel staff (May
24, 2010).
\235\ See AIG Form 10-K for FY08, supra note 47, at 4. FRBNY's
visitors list from Sept. 15, 2008, also shows that representatives of
Morgan Stanley, the law firm Sullivan & Cromwell, the New York
Insurance Department, and Treasury were at FRBNY that morning. Federal
Reserve Bank of New York Visitors List, September 15, 2008, Attachment
to e-mail sent by Campbell Cole of FRBNY (Sept. 15, 2008)
(FRBNYAIG00487-488).
\236\ AIG Form 10-K for FY08, supra note 47, at 4.
---------------------------------------------------------------------------
At a press conference Monday afternoon at the White House,
Secretary Paulson was asked if the Federal Reserve was going to
provide a bridge loan to AIG, and he responded by saying that
``what is going on right now in New York has nothing to do with
any bridge loan from the government. What's going on in New
York is a private-sector effort . . . '' \237\ AIG's problems
were compounded further Monday afternoon, when three major
rating agencies, Fitch Ratings, Moody's Investors Service, and
Standard & Poor's, all downgraded AIG's credit ratings,
triggering $20 billion in collateral calls and transaction
termination payments.\238\ Moody's attributed its decision to
the impact on AIG's ``liquidity and capital position'' of the
``continuing deterioration in the U.S. housing market.'' It
also signaled that ``further downgrades . . . are likely if the
immediate liquidity and capital concerns are not fully
addressed.'' \239\ At this point, AIG's ability to meet
collateral demands, already severely strained by the sharp
decline in mortgage-linked asset values, was being exhausted in
the wake of the Lehman bankruptcy and the subsequent rating
downgrades of AIG. On Monday alone, AIG made payments of $5.2
billion to its securities lending counterparties.\240\
---------------------------------------------------------------------------
\237\ The White House, Press Briefing by Dana Perino and Secretary
of the Treasury Henry Paulson (Sept. 15, 2008) (online at georgewbush-
whitehouse.archives.gov/news/releases/2008/09/20080915-8.html).
\238\ Testimony of Sec. Geithner, supra note 11, at 6; AIG Form 10-
K for FY08, supra note 47, at 4.
\239\ Standard & Poor's Ratings Services, Research Update: American
International Group Inc. Ratings Placed on CreditWatch with Negative
Implications (Sept. 12, 2008); Standard & Poor's Ratings Services,
Research Update: American International Group Ratings Lowered and Kept
on CreditWatch Negative (Sept. 15, 2008); Moody's Investors Service,
Rating Action: Moody's Downgrades AIG (senior to A2); LT and ST Ratings
Under Review (Sept. 15, 2008) (online at www.wgains.com/assets/
attachments/MoodysPressRelease.pdf).
\240\ AIG Form 10-K for FY08, supra note 47, at 4.
---------------------------------------------------------------------------
Just after 7 p.m. Monday, bankers from Goldman Sachs,
JPMorgan Chase and Morgan Stanley, along with representatives
from AIG, Treasury, and the New York State Insurance
Department, reconvened for another meeting at FRBNY.\241\ There
was a sense among the bankers assembled that AIG's problems
were too big for the private-sector banks, especially within a
limited timeframe created by AIG's swift descent and the
prevailing economic conditions.\242\ Secretary Geithner says
that by late Monday, he knew that the private-sector talks had
failed, even though FRBNY did not get formal notification until
early Tuesday morning; \243\ Secretary Geithner says that he
never thought the private-sector talks had a high probability
of success.\244\
---------------------------------------------------------------------------
\241\ Federal Reserve Bank of New York, Visitors List, September
15, 2008, 7:05 pm EST.
\242\ Rescue Effort Participant conversation with Panel staff (May
24, 2010).
\243\ Testimony of Thomas C. Baxter, supra note 215.
\244\ Panel conversation with Secretary Geithner (June 2, 2010).
---------------------------------------------------------------------------
Government officials have given two reasons as to why the
private-sector rescue effort collapsed.\245\ One was that the
banks could not establish with any precision what AIG's
liquidity needs were.\246\ The other reason was that after the
Lehman bankruptcy, the combination of AIG's rising liquidity
needs and increased concern about capital preservation by large
financial institutions caused them to pull back on their
willingness to participate.\247\
---------------------------------------------------------------------------
\245\ Donald L. Kohn, vice chairman of the Board of Governors of
the Federal Reserve System, offered the following testimony in 2009:
``The private sector worked through the weekend of September 13-14 to
find a way for private firms to address AIG's mounting liquidity
strains. But that effort was unsuccessful in a deteriorating economic
and financial environment in which firms were not willing to expose
themselves to risks. . . .'' Senate Committee on Banking, Housing, and
Urban Affairs, Written Testimony of Donald L. Kohn, vice chairman,
Board of Governors of the Federal Reserve System, American
International Group: Examining What Went Wrong, Government
Intervention, and Implications for Future Regulation, at 4 (Mar. 5,
2009) (online at banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore_id=aa8bcdf2-f42b-4a60-b6f6-
cdb045ce8141) (hereinafter ``Testimony of Donald Kohn'').
\246\ Panel conversation with FRBNY staff (Apr. 12, 2010). One bank
that participated in the private-sector rescue effort told the Panel
that the banks also concluded that AIG did not have adequate collateral
to support the necessary loan. Panel conversation with Rescue Effort
Participants. In connection with the September 15 private-sector rescue
effort, SIGTARP states that ``an analysis of AIG's financial condition
revealed that liquidity needs exceeded the valuation of the company's
assets, thus making the private participants unwilling to fund the
transaction.'' SIGTARP goes on to state: ``FRBNY officials told SIGTARP
that, in their view, the private participants declined to provide
funding not because AIG's assets were insufficient to meet its needs,
but because AIG's liquidity needs quickly mounted in the wake of the
Lehman bankruptcy and the other major banks decided they needed to
conserve capital to deal with adverse market conditions.'' Office of
the Special Inspector General for the Troubled Asset Relief Program,
Factors Affecting Efforts to Limit Payments to AIG Counterparties, at 8
(Nov. 17, 2009) (online at sigtarp.gov/reports/audit/2009/
Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties.pdf)
(hereinafter ``SIGTARP Report on AIG Counterparties'').
\247\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010). More specifically, FRBNY states that in the wake of Lehman
Brothers' bankruptcy, JPMorgan Chase was lending $40 billion-$60
billion per night to keep Lehman's broker-dealer afloat. Panel
conversation with FRBNY staff (Apr. 12, 2010).
---------------------------------------------------------------------------
Whatever the reasons, the private sector rescue effort fell
apart. Instead, the term sheet that the banks had developed
became the template for the AIG rescue package that FRBNY
proceeded to put together later on Tuesday.

2. The Rescue Itself

On Tuesday, September 16, AIG was poised to fail. That
morning, the two AIG subsidiaries that the previous week had
lost access to the commercial paper market drew down a combined
$11.1 billion from their revolving credit facilities with the
parent company.\248\ Between September 2 and 15, AIG's stock
price had fallen by 79 percent.\249\ The cost of a CDS that
provided $1 million of protection against an AIG default within
five years had risen by more than 900 percent, from around
$37,000 on September 1 to around $350,000 on September 16.\250\
---------------------------------------------------------------------------
\248\ AIG Form 10-K for FY08, supra note 47, at 4.
\249\ Bloomberg, American International Group Inc. Stock Price
Chart (online at www.bloomberg.com/apps/cbuilder?ticker1=AIG%3AUS)
(accessed June 8, 2010).
\250\ Bloomberg data.
---------------------------------------------------------------------------
Early that morning, FRBNY staff e-mailed a staff proposal
to President Geithner that would have allowed AIG's parent
company to fail while having the government reinsure
approximately $38 billion in AIG stable value wrap contracts,
which provide a layer of security around the value of workers'
pension funds. The staff proposal stated that an act of
Congress would be necessary to implement the idea.\251\ Also in
the early morning hours of Tuesday, President Geithner received
an FRBNY memo stating that an AIG failure could be more
systemic than Lehman's failure, in part because of AIG's retail
businesses. The memo went on to discuss how an AIG bankruptcy
might unfold; it reflected FRBNY's uncertainty about the health
of AIG's insurance subsidiaries, and noted various potential
negative consequences that an AIG bankruptcy could have on the
financial system.\252\
---------------------------------------------------------------------------
\251\ Proposal to Insulate Retail Impact of AIGFP Failure, e-mail
from Alejandro LaTorre, vice president, Federal Reserve Bank of New
York, to Timothy F. Geithner, president, Federal Reserve Bank of New
York (Sept. 16, 2008) (FRBNYAIG00474-478) (hereinafter ``Proposal to
Insulate Retail Impact of AIGFP Failure'').
\252\ Systemic Impact of AIG Bankruptcy, Attachment to e-mail from
Alejandro LaTorre of FRBNY to FRBNY President Geithner (Sept. 16, 2008)
(FRBNYAIG00483-486). The memo, sent to Mr. Geithner at 3:16 a.m.,
states that AIG's derivatives book was more complex than Lehman
Brothers'; that an AIG bankruptcy would be a bigger surprise than
Lehman's; and that it would occur on the back of the Lehman bankruptcy,
among other negative aspects of an AIG failure.
---------------------------------------------------------------------------
Later Tuesday morning, representatives from Goldman Sachs
and JPMorgan Chase took part in a final meeting at FRBNY
regarding AIG. FRBNY officials' recollection is that JPMorgan
Chase said they were bowing out of the rescue talks and were
not going to listen to any further discussion.\253\ FRBNY
officials have said they concluded that continuing to seek a
private-sector solution was futile.\254\ The Panel found no
evidence that FRBNY officials, following the previous night's
failure, made any further effort with respect to the private-
sector rescue effort.
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\253\ FRBNY conversation with the Panel (May 11, 2010). Thomas
Baxter, FRBNY's executive vice president and general counsel, told the
Panel that he believes Marshall Huebner, the Davis Polk & Wardwell
lawyer who was then representing the private-sector banking consortium,
delivered the news. Testimony of Thomas C. Baxter, supra note 215.
\254\ FRBNY conversation with the Panel (May 11, 2010).
---------------------------------------------------------------------------
Also on Tuesday morning, President Geithner participated in
a conference call about AIG with Secretary Paulson and Chairman
Bernanke. According to Thomas Baxter Jr., FRBNY's general
counsel, who also participated in the call, the government
officials faced ``a binary choice to either let AIG file for
bankruptcy or to provide it with liquidity.'' \255\ A similar
situation had occurred with Lehman just one day before, and in
that case the government officials had chosen bankruptcy.
During this call, according to Mr. Baxter, the decision was
made that the consequences of a bankruptcy were far worse than
those that would come from providing liquidity to AIG.\256\ The
decision would not be finalized, though, until the Federal
Reserve Board authorized the loan under its emergency authority
in Section 13(3) of the Federal Reserve Act.
---------------------------------------------------------------------------
\255\ Congressional Oversight Panel, Joint Written Testimony of
Thomas C. Baxter, Jr., general counsel and executive vice president of
the legal group, and Sarah Dahlgren, executive vice president of
special investments management and AIG monitoring, Federal Reserve Bank
of New York, COP Hearing on TARP and Other Assistance to AIG, at 3 (May
26, 2010) (online at cop.senate.gov/documents/testimony-052610-
baxter.pdf) (hereinafter ``Joint Written Testimony of Thomas C. Baxter
and Sarah Dahlgren''). For the Panel's analysis of this assertion, see
Section F.1, supra.
\256\ FRBNY conversation with the Panel (May 11, 2010).
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In order for the Federal Reserve to use its 13(3)
authority, AIG needed to come up with sufficient collateral to
allow the Federal Reserve to lend on a secured basis. (The law
required that the Federal Reserve be secured to its
satisfaction.) That afternoon, FRBNY security personnel went to
AIG's headquarters at 80 Pine Street in lower Manhattan, and,
after collecting stock certificates representing billions of
dollars worth of AIG's equity stakes in its insurance
subsidiaries, walked back to FRBNY.\257\ It is not clear
exactly when the Federal Reserve Board voted to authorize
lending to AIG, but it appears to have happened before 3:30
p.m., when FRBNY sent AIG the terms of a secured lending
agreement that it was prepared to provide. In Washington,
meanwhile, Secretary Paulson and Chairman Bernanke briefed the
President and the President's Working Group on Financial
Markets, as well as congressional leadership, about the rescue
plan that FRBNY was developing. Also that afternoon, the head
of bank supervision at FRBNY held a conference call with
foreign banking and insurance supervisors to send a message
that FRBNY was providing liquidity to AIG.\258\
---------------------------------------------------------------------------
\257\ FRBNY conversation with the Panel (May 11, 2010). As part of
the final Guarantee and Pledge Agreement associated with the creation
of the Revolving Credit Facility (RCF) and executed on September 22,
2008, AIG pledged a portion of its equity interest in the following
subsidiary companies: AIG BG Holdings, Inc. (1,000 shares), AIG Capital
Corporation (10,000 shares), AIG Federal Savings Banks (1,000 shares),
AIG Retirement Services (100 shares), AIG Trading Group (4,000 shares
and 1,192 shares of non-cumulative preferred stock), American
International Underwriters Overseas, Ltd. (20,000,000 shares), American
Life Insurance Company (300,000 shares), Transatlantic Holdings, Inc.
(17,073,690 shares), and an uncertified number of shares in AIG Life
Holdings (International) LLC, AIG Castle Holdings LLC, and AIG Castle
Holdings II LLC. Furthermore, AIG pledged $1.16 billion in financial
instruments as collateral. Finally, AIG pledged 64 financial agreements
held by the parent and certain subsidiaries: International Lease
Finance Company ($35.6 billion), American General Finance, Inc. ($2.6
billion), American General Finance Corporation ($4.1 billion), and
American International Group, Inc. ($63.6 billion). American
International Group, Inc., Form 8-K, Agreement Executed September 22,
2008, at 193 (Sept. 26, 2008) (online at www.sec.gov/Archives/edgar/
data/5272/000095012308011496/y71452e8vk.htm).
\258\ FRBNY officials say that prior to the Federal Reserve's
exercise of authority under Section 13(3), they did not have any
conversation with European banking supervisors about the consequences
an AIG bankruptcy could have on European banks. FRBNY conversation with
the Panel (May 11, 2010).
---------------------------------------------------------------------------
The FRBNY offer was for an $85 billion credit facility, on
the same terms put together the previous day by the private-
sector banks; \259\ FRBNY simply took the private-sector's $75
billion term sheet and added $10 billion as a cushion.\260\ In
mere days, the estimated cost of saving AIG had risen from $20
billion to $85 billion. Mr. Willumstad learned of the
government's offer Tuesday afternoon, and was told that it was
non-negotiable. Secretary Paulson told Mr. Willumstad that as
part of the agreement, he would have to resign as AIG's CEO.
AIG's Board of Directors met over the next few hours and agreed
to the government's proposal that evening.\261\
---------------------------------------------------------------------------
\259\ Initially, the facility had a two-year term, and interest
accrued on the outstanding balance at a rate of the 3-month London
Interbank Offer Rate (LIBOR) plus 850 basis points. The loan is
collateralized by all the assets of AIG and of its primary non-
regulated subsidiaries (including the stock of substantially all of the
regulated subsidiaries).
\260\ FRBNY says this cushion was added in anticipation of looming
liquidity concerns, and because the Federal Reserve did not want to
have to increase the line of credit at a later date. FRBNY conversation
with the Panel (May 11, 2010).
\261\ Written Testimony of Robert Willumstad, supra note 178, at 5.
---------------------------------------------------------------------------
At 9 p.m. Tuesday, the Federal Reserve Board of Governors,
with the full support of Treasury, announced that, using its
authority under Section 13(3) of the Federal Reserve Act, it
had authorized FRBNY to establish an $85 billion RCF for
AIG.\262\ (That same evening, FRBNY advanced $14 billion in
credit to AIG.) \263\ The $85 billion facility would be secured
by AIG's assets and would ``assist AIG in meeting its
obligations as they come due and facilitate a process under
which AIG will sell certain of its businesses in an orderly
manner, with the least possible disruption to the overall
economy.'' \264\ In exchange for the provision of the credit
facility from the federal government, AIG provided to the
United States Treasury preferred shares and warrants that, if
the warrants were exercised, would give the government a 79.9
percent ownership stake in AIG.\265\
---------------------------------------------------------------------------
\262\ The Board's vote was 5-0, with Chairman Ben Bernanke, Vice
Chairman Donald Kohn, and Governors Kevin Warsh, Elizabeth Duke and
Randall Kroszner all casting votes. Board of Governors of the Federal
Reserve System, Notice of a Meeting Under Expedited Procedures (Sept.
17, 2008) (online at www.federalreserve.gov/boarddocs/meetings/2008/
20080916/expedited.htm). See also On The Brink, supra note 209.
\263\ Joint Written Testimony of Thomas C. Baxter and Sarah
Dahlgren, supra note 255, at 4.
\264\ Board of Governors of the Federal Reserve System, Report
Pursuant to Section 129 of the Emergency Economic Stabilization Act of
2008: Securities Borrowing Facility for American International Group,
at 2 (Oct. 14, 2008) (online at www.federalreserve.gov/monetarypolicy/
files/129aigsecborrowfacility.pdf) (hereinafter ``Securities Borrowing
Facility for AIG'').
\265\ Because neither Treasury nor the Federal Reserve had the
authority to own these shares, the terms were written so that the
shares would be held by the U.S. Treasury. FRBNY conversation with the
Panel (May 11, 2010). The government's AIG bailout plan involving its
obtaining a 79.9 percent equity stake in the company was closely
modeled on the approach taken with GSEs Fannie Mae and Freddie Mac.
Treasury conversation with Panel staff (May 13, 2009). The ownership
percentage of directly under 80 percent was chosen due to the
consequences of ``push down'' accounting. When a purchase transaction
results in one company becoming substantially owned by another, the
financial statements of the purchased company should reflect the new
basis of accounting for the purchased assets and liabilities shown in
the financial statements of the parent company, which would be based on
the purchase price. Thus, the new basis of the assets and liabilities
per the parent company are ``pushed down'' to the purchased company,
causing either a net positive or a net negative adjustment to balance
sheet valuation depending on the discrepancy between the purchase price
and the balance sheet carrying values. This can have significant
ramifications for the company's equity, key ratios, and overall
valuation. Push down basis of accounting is required in ``purchase
transactions that result in an entity becoming substantially wholly
owned,'' which in practice, means 95 percent or more. Push down
accounting is permitted if ownership in an entity is between 80 and 95
percent, and it is prohibited with less than 80 percent ownership.
Accounting Standards Codification (ASC) 805-50-S99, Business
Combinations (formerly Emerging Issues Task Force, Topic D-97, Push-
Down Accounting) (online at asc.fasb.org/subtopic&nav
_type=topic_page%26analyticsAssetName=topic
_page_subtopic%26trid=2899256). Thus, the government's maintenance of
its ownership in AIG below the 80 percent threshold ensures that push
down accounting is disallowed and not an issue. Securities and Exchange
Commission, SEC Staff Accounting Bulletin: Codification of Staff
Accounting Bulletins, Topic 5(J) (June 16, 2009) (online at
www.sec.gov/interps/account/sabcodet5.htm#5j).
---------------------------------------------------------------------------
At the time, the Federal Reserve stated that its goal was
to provide AIG with sufficient liquidity to meet its
obligations, and to allow for the orderly disposition of
certain AIG businesses.\266\ In more recent comments, FRBNY
officials have maintained that they decided on a bailout
because AIG needed liquidity, and stated that the Federal
Reserve believed that AIG was solvent on the basis of its
balance sheet.\267\ FRBNY does not dispute that AIG's massive
liquidity problem pre-dated Lehman's bankruptcy, but notes that
there was a general pull-back in private sector liquidity after
Lehman filed for bankruptcy. FRBNY officials say that the
government took a 79.9 percent equity interest in AIG because
it believed the taxpayer should receive the same terms and
conditions that the private sector wanted,\268\ and the 79.9
percent equity interest was in the private sector consortium's
term sheet.
---------------------------------------------------------------------------
\266\ Board of Governors of the Federal Reserve System, Press
Release (Sept. 16, 2008) (online at www.federalreserve.gov/newsevents/
press/other/20080916a.htm) (hereinafter ``Federal Reserve Press
Release'').
\267\ FRBNY conversation with Panel (Apr. 12, 2010).
\268\ The Panel notes that in contrast to the position that the
government took with regard to AIG, the government has in other
instances during the financial crisis not taken advantage of the terms
the private sector would have gotten. See Congressional Oversight
Panel, February Oversight Report: Valuing Treasury's Acquisitions, at
7-9 (Feb. 6, 2009) (online at cop.senate.gov/documents/cop-020609-
report.pdf) (discussion of a report by the international valuation firm
Duff & Phelps that compares Treasury's investments with those made by
private investors).
---------------------------------------------------------------------------

3. The Key Players in the Rescue

The rescue of AIG was ultimately led by FRBNY, acting on
behalf of the Board of Governors of the Federal Reserve System
and in close consultation with Treasury. The other key players
in the story include the OTS, the New York State Superintendent
of Insurance, other state insurance regulators, and numerous
Wall Street lawyers, advisors, counterparties and investors. As
discussed in section K.5, many of these actors, particularly
advisors and attorneys, played more than one role in the
rescue. Notwithstanding these parties' internal conflicts
rules, these entanglements create an overwhelming perception by
the public that Wall Street was helping Wall Street, using
taxpayer funds.
Federal Reserve Bank of New York. The rescue of AIG was led
by FRBNY and the Federal Reserve System, which began to focus
on AIG's conditions toward the end of the week of September 7-
13, 2008. Treasury was directly involved in discussions of
AIG's conditions and the consequences for the financial system
of an AIG failure, but it had little if any authority to
provide funds to AIG at the time; EESA was not enacted until
October 3, 2008. Similarly, other AIG regulatory bodies, such
as state insurance regulators and OTS, possessed oversight
authority but lacked any legal authority to step in and provide
funds and aid to the company.
On September 16, the Federal Reserve authorized FRBNY to
provide assistance to AIG in the form of an $85 billion lending
facility under the authority of Section 13(3) of the Federal
Reserve Act.\269\ As indicated, Treasury had been involved in
discussions of the rescue package and the Board and FRBNY acted
in cooperation with Treasury and the Administration.\270\ At
the time of the initial aid to AIG, now-Secretary Geithner was
the President of FRBNY, a position whose incumbent is appointed
by the bank's board of directors (themselves primarily bankers
or investment bankers) with the approval of the Federal
Reserve.\271\
---------------------------------------------------------------------------
\269\ Federal Reserve Press Release, supra note 266. In general,
Section 13(3) allows the Board of Governors of the Federal Reserve
System to authorize a Federal Reserve bank (such as FRBNY) to provide
emergency assistance to corporations, with certain limitations, if they
determine that unusual and exigent circumstances exist (by the
affirmative vote of at least five members). This lending authority has
been rarely invoked and had not been used until the onset of the
financial crisis (with the assistance in March 2008 to Bear Sterns)
since the Great Depression. For additional discussion of Section 13(3),
see Section C.4.b and Annex IV.
\270\ Testimony of Sec. Geithner, supra note 11, at 1.
\271\ Board of Governors of the Federal Reserve System, Federal
Reserve Bank Presidents (Nov. 6, 2009) (online at
www.federalreserve.gov/aboutthefed/bios/banks/default.htm). Steve
Friedman, former chairman of the Board of Directors of the Federal
Reserve Bank of New York at the time of the AIG bailout and a director
at Goldman Sachs since April 2005 and Stone Point Capital, a private
equity firm, stated in testimony before the House Committee on
Oversight and Government Reform that he had no involvement in the
decisions regarding AIG and that ``the directors of the 12 Federal
Reserve banks have no role in the regulation, supervision, or oversight
of banks, bank-holding companies, or other financial institutions.''
Friedman stated that the Board of Governors in Washington effectively
acts as the board of directors in the traditional sense, with the
actual board of directors for each Federal Reserve bank serving more of
an advisory capacity. House Committee on Oversight and Government
Reform, Written Testimony of Steve Friedman, former chairman, Federal
Reserve Bank of New York, The Federal Bailout of AIG (Jan. 27, 2010)
(online at oversight.house.gov/images/stories/Hearings/
Committee_on_Oversight/2010/012710_AIG_Bailout/TESTIMONY-Friedman-
revised.pdf).
---------------------------------------------------------------------------
Treasury. Treasury's participation in the initial rescue of
AIG was limited, as discussed above, to an advisory role. It is
clear, however, that all actions taken by FRBNY were in close
consultation with Treasury. In October 2008, that authority was
provided through the passage of EESA, and Treasury took on a
greater role in the AIG rescue as the government expanded and
restructured its aid. See Sections D.2 and F.3 for a fuller
discussion and analysis of Treasury's later role.
Office of Thrift Supervision. OTS was involved in
conversations with Treasury and other officials during the
weekend of the Lehman bankruptcy, as Treasury was concerned
about AIG as well. Through these conversations and its own
monitoring around this time, OTS became more aware of liquidity
concerns at the holding company level, putting protections
around the thrift to ensure that it remained well capitalized.
OTS was not involved in any consultative manner with Treasury
or the Federal Reserve concerning actions taken towards AIG,
however. The calls between OTS and Treasury or the Federal
Reserve were ultimately to provide OTS with an update of
actions being taken, as opposed to seeking OTS officials'
knowledge or opinions.
OTS continued to act as AIG's consolidated supervisor until
FRBNY's loan to the company on September 16, 2008. At the close
of the transaction, AIG was no longer defined as a savings and
loan holding company under federal statute, and thus the
holding company was no longer an entity subject to regulation
by OTS.\272\ As its role of equivalent regulator for EU and
international purposes was based on its regulation of the
holding company, OTS was no longer considered the equivalent
regulator once its role as holding company regulator ended. OTS
regulates only AIG FSB currently.\273\
---------------------------------------------------------------------------
\272\ Testimony of Edward Liddy, supra note 91, at 17.
\273\ Panel staff conversation with OTS (May 21, 2010).
---------------------------------------------------------------------------
State Insurance Regulators. Each of AIG's domestic
insurance companies is a stand-alone legal entity with its own
primary insurance regulator from the state in which it is
domiciled.\274\ During the government's rescue, the state
insurance regulators were heavily involved in the protection of
the insurance subsidiaries but were not called upon to provide
any capital infusions from outside the AIG group. See Section
F.1 for further analysis of the role played by the state
insurance regulators.
---------------------------------------------------------------------------
\274\ American International Group, Inc., AIG and AIG Commercial
Insurance Overview and Financial Update (Nov. 13, 2008) (online at
www.aig.com/aigweb/internet/en/files/RSSPres111308b_tcm20-132858.pdf).
---------------------------------------------------------------------------
Private Sector Actors. Numerous private entities also
played important roles in the government's rescue of AIG. In
some cases these private-sector actors played more than one
role. The following list is not exhaustive, but it provides an
overview of the roles that key private-sector actors played at
various stages before and during the rescue:
JPMorgan Chase became an advisor to AIG in late
August 2008; it provided AIG advice on raising capital in the
private markets. In the last two days before the government's
rescue of AIG, FRBNY asked JPMorgan Chase to play a different
role, as one of the financial institutions that would invest in
the insurer in order to save it from bankruptcy. JPMorgan Chase
was also the lead agent on a $15 billion, multi-bank line of
credit to AIG that the insurer sought but was unable to tap in
the hours before the government's initial bailout.\275\
---------------------------------------------------------------------------
\275\ See Sections C1 and C2, supra; AIG Drawing on Its Credit
Line, E-mail from Edgar Moreano, Federal Reserve Bank of New York, to
other Federal Reserve Bank of New York officials (Sept. 16, 2008)
(FRBNYAIG00470-472); E-mail from Jacqueline Lovisa, FRBNY to others at
FRBNY re: AIG Update--Important (Sept. 16, 2008) (FRBNYAIG00439-440).
---------------------------------------------------------------------------
Goldman Sachs was one of AIG's largest
counterparties until November 2008, when the government took
steps to close out the exposure that Goldman and other large
financial institutions had to AIG. On September 15, 2008, at
the invitation of FRBNY, Goldman Sachs also took part in the
failed private-sector rescue talks.\276\
---------------------------------------------------------------------------
\276\ See Section C2, supra, and Sections D3 and D4, infra.
---------------------------------------------------------------------------
Morgan Stanley was also one of AIG's
counterparties until November 2008, though its exposure to AIG
was significantly smaller than Goldman's. Morgan Stanley was
hired by the government as an advisor in the private-sector
rescue talks from September 14-16, 2008. More recently, Morgan
Stanley has served as FRBNY's banker in connection with its
investment in AIG.\277\
---------------------------------------------------------------------------
\277\ See Section C1, supra, and Sections D3 and F7, infra.
---------------------------------------------------------------------------
The law firm Davis Polk & Wardwell advised
JPMorgan Chase in the failed attempt to organize a private-
sector rescue of AIG. It was Davis Polk & Wardwell that
informed FRBNY on the morning of September 16, 2008, that the
private-sector effort had unraveled. In a matter of minutes,
Davis Polk & Wardwell transitioned to become an advisor to
FRBNY and Treasury in the government's own rescue. Davis Polk &
Wardwell's contract with FRBNY does not prevent it from also
representing AIG's counterparties.\278\
---------------------------------------------------------------------------
\278\ Testimony of Thomas C. Baxter, supra note 215; Columbia Law
School, It Really Was Too Big to Fail: Government's Lead Outside
Counsel in AIG Rescue Takes a Look Back (Mar. 3, 2010) (online at
www.law.columbia.edu/media_inquiries/news_events/2010/march2010/aig-
huebner); Engagement agreement between Davis Polk & Wardwell and the
Federal Reserve Bank of New York, at Sec. 10 (Sept. 16, 2008) (online
at www.newyorkfed.org/aboutthefed/DavisPolk.pdf).
---------------------------------------------------------------------------
BlackRock Solutions acted as an advisor to AIG
regarding the mortgage-related exposure at AIGFP in the months
prior to the government rescue.\279\ Since the bailout, FRBNY
has retained BlackRock to manage and sell the mortgage-related
instruments that two FRBNY-established SPVs purchased from AIG
in late 2008.\280\
---------------------------------------------------------------------------
\279\ BlackRock is one of the world's largest asset management
firms. As of March 31, 2010, BlackRock's assets under management were
$3.36 trillion. The firm manages these funds using a wide range of
investment categories including equity, debt, cash management, real
estate, and alternative investments (hedge funds). BlackRock employs
over 8,500 individuals in 24 countries. The firm is publicly traded on
the New York Stock Exchange and does not have a majority shareholder.
Merrill Lynch, currently a subsidiary of Bank of America, PNC Financial
Services Group and Barclays PLC own approximately 34.1 percent, 24.6
percent and 19.9 percent of BlackRock respectively.
Through its subsidiary, BlackRock Solutions, the firm provides
advisory services, risk management analysis, and investment platforms.
BlackRock Solutions is walled off from the rest of BlackRock. BlackRock
conversation with Panel staff (May 18, 2010). As of March 31, 2010,
BlackRock Solutions was utilized by clients with portfolios totaling
approximately $9 trillion. The Financial Markets Advisory practice of
BlackRock Solutions provides valuations and risk analysis on securities
such as credit derivatives, securitized products and bonds. This
practice also specializes in asset disposition for distressed
portfolios.
\280\ Joint Written Testimony of Thomas C. Baxter and Sarah
Dahlgren, supra note 255, at 11; see Sections F.4, F.5, and J.1, infra.
---------------------------------------------------------------------------
Blackstone Advisory Services LP was retained by
AIG in September 2008 to assist with its efforts to raise
capital. Following the rescue, Blackstone continued to help AIG
to restructure and sell its business units. Blackstone has
hired away at least one AIG employee who had been charged with
the same basic task within AIG.\281\
---------------------------------------------------------------------------
\281\ See Section C.1, supra; The Blackstone Group, Advisory and
Restructuring Selected Transactions (Mar. 2, 2009) (online at
www.blackstone.com/cps/rde/xchg/bxcom/hs/5694.htm); The Blackstone
Group, Our People (online at www.blackstone.com/cps/rde/xchg/bxcom/hs/
firm_ourpeople_6244.htm) (accessed June 8, 2010).
---------------------------------------------------------------------------
For a fuller discussion of the multiple roles private-
sector institutions played in the government's rescue of AIG,
and the problems raised by those roles, see Section K.5.

4. The Legal Options for Addressing AIG's Problems in September 2008

This section discusses the legal options and legal
constraints that the Federal Reserve, FRBNY, and Treasury were
facing in September 2008 when the Federal Reserve decided to
authorize FRBNY to provide funds to AIG to meet its liquidity
needs and avoid bankruptcy. A detailed analysis of the
decisions made by the Federal Reserve, FRBNY, and Treasury is
provided in Section F. The Federal Reserve, FRBNY, and Treasury
have described their choice as ``binary,'' either allowing AIG
to file for bankruptcy or providing it with liquidity,\282\ but
as discussed more below and in Section F, more options were
available than providing continuing capital so that all of
AIG's creditors would be paid in full.
---------------------------------------------------------------------------
\282\ Joint Written Testimony of Thomas C. Baxter and Sarah
Dahlgren, supra note 255, at 4.
---------------------------------------------------------------------------
a. The Bankruptcy Regime That Would Have Applied
Bankruptcy was one option for AIG in mid-September 2008. It
would have provided a mechanism to gather, value, and protect
AIG's assets (within the limitations discussed below) by
imposing an automatic stay on creditors while they negotiated a
payment plan.\283\ A bankruptcy filing would have constituted
an event of default for AIG's various derivative contracts, and
it would have stopped collateral calls by and termination
payments to the counterparties to those derivative
contracts.\284\ Those counterparties, however, would not have
been subject to the automatic stay, and would have been able to
close out their agreements,\285\ seize collateral that had been
posted prior to the bankruptcy filing, mitigate their losses,
and offset or net out other obligations.\286\ They would have
been subject to the substantial discount negotiated for
unsecured creditors as part of the bankruptcy plan for any
deficiency claims they asserted.\287\
---------------------------------------------------------------------------
\283\ For a more detailed discussion of the general protections
provided by bankruptcy law, see Annex IV. Generally, creditors are
subject to an automatic stay to protect the debtor's assets while they
negotiate a payment plan, cannot get an unfair advantage from payments
or collateral transfers made while the debtor was insolvent, and cannot
terminate or modify contracts based on the debtor's financial condition
or bankruptcy filing. See 11 U.S.C. 362(a), 365(e)(1), 544, 545, 547,
548. The decision of which subsidiaries would seek bankruptcy
protection would be made on an entity-by-entity basis, weighing a
variety of factors such as financial condition, the likely outcome of
the bankruptcy, and the potential consequences on consumers, suppliers,
creditors, and investors and taking into account that several of AIG's
subsidiaries would not be able to file for bankruptcy in the U.S., as
discussed below.
\284\ It should be noted that AIG was not forced to post
collateral. AIG could have refused to do so, also resulting in an event
of default that would allow the counterparty requesting collateral to
cancel the contract. However, such a refusal would have had negative
business consequences for AIG, resulting in a loss of trust by its
various counterparties that would hinder its ability to operate as a
financial company.
\285\ For an explanation of what it means to ``close out'' a
derivative contract, see Annex III (What are Credit Default Swaps?).
\286\ For a more detailed discussion of the specific provisions in
the bankruptcy code providing additional protection or favorable
treatment to counterparties to various financial instruments, see Annex
IV. Generally, counterparties to various ``financial instruments''--
defined broadly to include credit default swaps issued by AIG and AIG's
repurchase agreements--are exempt from the automatic stay, the
prohibition on modifying or terminating contracts based on a bankruptcy
filing, and various avoidance actions related to pre-bankruptcy
collateral transfers. See 11 U.S.C. 101, 362(b)(6)-(7), 362(b)(17),
362(b)(27), 362(o), 546(e)-(g), 546(j), 553, 555, 556, 559, 560, 561.
These statutory provisions, including those added to or amended by the
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (``2005
amendments''), provide a ``safe harbor'' to the counterparties to
various financial contracts and are thus often referred to as the
``safe harbor'' provisions. The Federal Reserve, FRBNY, and Treasury
(as well as the SEC, CFTC, FDIC, and OCC) were proponents of the safe
harbor provisions. See, e.g., House Committee on the Judiciary,
Committee Report on the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005, 109th Cong., at 20 (Feb. 2005) (H. Rept. 109-
31) (online at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=109_cong_reports&docid=f:hr031p1.109.pdf).
\287\ Counterparties do not receive special priority for their
deficiency claims, if any; these deficiency claims are unsecured claims
subject to the discount negotiated for unsecured creditors as part of
the bankruptcy plan.
---------------------------------------------------------------------------
Even though bankruptcy would have assisted the
reorganization or liquidation of the AIG parent company and the
derivatives portfolio, bankruptcy would not have covered all
parts of AIG because the bankruptcy court would not have had
jurisdiction over AIG's domestic or foreign insurance
subsidiaries or other foreign subsidiaries without a sufficient
connection to the United States.\288\ This removes a
substantial number of AIG's businesses from the purview of the
bankruptcy court.\289\ It is unclear how a bankruptcy filing
would have affected the business or solvency of the insurance
subsidiaries, the actions of the various insurance regulators,
or the decisions of current and prospective insurance customers
regarding insurance coverage.\290\ The cross-border
implications for the foreign subsidiaries--and the potential
problems arising from the interplay between different
regulatory and insolvency regimes--are also unclear. Moreover,
once AIG had entered bankruptcy, it would have likely lost the
confidence of market counterparties necessary to operate as a
financial company, although normal considerations may not have
applied if the government was the debtor-in-possession (DIP)
lender.\291\
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\288\ See 11 U.S.C. Sec. 109(a) (requiring U.S. connection),
109(b)(2) (excluding domestic insurance companies and certain banks
from Chapter 7 bankruptcy), 109(b)(3) (excluding foreign insurance
companies from Chapter 7), 109(d) (making these Chapter 7 exclusions
applicable to Chapter 11).
\289\ For example, AIG ``owns the largest commercial and industrial
insurance company in the U.S. and one of our country's and the world's
largest life insurance companies.'' House Committee on Oversight and
Government Reform, Written Testimony of Eric Dinallo, superintendent,
New York State Insurance Department, The Causes and Effects of the AIG
Bailout, at 2 (Oct. 7, 2008) (online at oversight.house.gov/images/
stories/documents/20081007100906.pdf) (hereinafter ``Written Testimony
of Eric Dinallo'').
\290\ For additional discussion of the potential impact on the
insurance subsidiaries, see Section E2 and Annex VIII. For example,
some of AIG's insurance regulators (New York, Texas, and Pennsylvania)
have provided that they would not necessarily have seized AIG's
insurance subsidiaries if the AIG parent company had filed for
bankruptcy (providing Conseco Inc. as an example of an insurance
holding company bankruptcy (Chapter 11) that did not require the
insurance regulators to seize the insurance subsidiaries (who remained
solvent before and after the holding company filed)). However, they
indicated that they would have seized the subsidiaries if they believed
formal action was necessary to protect the insurance subsidiaries or
their policyholders. Panel staff conversation with Texas Department of
Insurance (May 24, 2010); Panel staff conversation with NAIC (Apr. 23,
2010).
\291\ For additional explanation of DIP financing, see Section E.
The government may have provided an additional level of comfort,
reliability, financial stability, or negotiating leverage to an AIG
bankruptcy. However, it should be noted that the timing of an AIG
bankruptcy would determine the government DIP lender. For example, if
AIG had filed for bankruptcy before the enactment of EESA, Treasury
would not have had the authority to be the DIP lender, leaving only the
Federal Reserve banks to serve as the lender of last resort under
Section 13(3) of the Federal Reserve Act.
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Finally, it is unclear how an AIG bankruptcy filing would
have impacted the company's many counterparties or the
financial system as a whole. Despite concerns about AIG's
financial condition and its ability to pay, many of its CDS
counterparties had not decided to close out their derivative
contracts by mid-September 2008. If AIG had filed for
bankruptcy, however, they probably would have done so,
resulting in some level of disorder in the capital markets and
causing liquidity pressure on some of the counterparties.\292\
The severity of the market impact and how quickly the markets
would have been able to recover are unclear. If the Lehman
Brothers bankruptcy is any guide, the impact of an AIG
bankruptcy on the financial system would have been severe. As
discussed more below, when Lehman filed for bankruptcy, the
LIBOR-OIS spread (a measure of illiquidity in financial
markets) spiked significantly, providing one measure of the
extent of the impact of Lehman's filing on the markets.\293\
AIG was a much larger company with a more complicated corporate
structure, more subsidiaries, more counterparties to its
various derivative contracts and securities lending agreements,
and an insurance component that reached many individuals and
businesses. The potential impact of an AIG bankruptcy filing is
discussed in more detail in Sections E.2 and F.1 below.
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\292\ As discussed above, the bankruptcy filing would have
constituted an event of default giving the counterparties the option to
terminate or close out their derivative contracts. It should be noted
that this discussion relates to CDS contracts issued by AIG.
\293\ On September 15, 2008, the LIBOR-OIS spread jumped 22 percent
from its level on the previous trading day to 105 basis points. By
September 30, 2008, the metric had reached 232 basis points, a 168
percent increase from the trading day prior to Lehman Brother's
bankruptcy. This metric, which averaged 74 basis points for the first
three quarters of 2008, spiked to an average of 294 basis points during
October 2008. For additional discussion of the importance of the LIBOR-
OIS spread and Lehman's impact on the markets, see Section F.1(b)(iv).
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There was no legal structure or resolution authority that
had the capacity to address the resolution of AIG, the impact
of an AIG bankruptcy filing on its insurance subsidiaries, the
cross-border implications for the foreign subsidiaries, and the
potential systemic consequences for the financial system as a
whole. Treasury did not have the authority to act because
Congress had not yet passed EESA.\294\ As a result, the only
alternative to bankruptcy that the government saw was
intervention by the Federal Reserve using its emergency powers
under Section 13(3) of the Federal Reserve Act. As indicated
below, however, when it came to 13(3), more options were
available to the Federal Reserve and FRBNY than the specific
actions they took, beginning with the $85 billion RCF to make
funds immediately available to AIG to fund its liquidity needs.
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\294\ EESA was enacted on October 3, 2008. Treasury provided part
of AIG's government assistance thereafter, such as the $40 billion
preferred stock investment on November 10, 2008, as part of its SSFI
under the TARP. See, e.g., U.S. Department of the Treasury, Treasury to
Invest in AIG Restructuring Under the Emergency Economic Stabilization
Act (Nov. 10, 2008) (online at www.treas.gov/press/releases/
hp1261.htm). As discussed in Section C.2 above, however, it should be
noted that even though Treasury's formal participation in the AIG
rescue began after the passage of EESA, it was in close consultation
with the Federal Reserve and FRBNY regarding the forms of assistance
provided to AIG.
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b. The Federal Reserve's Section 13(3) Authority
Section 13(3) of the Federal Reserve Act provides the
Federal Reserve with the authority to authorize Federal Reserve
banks to provide emergency assistance to individuals,
partnerships, and corporations in limited circumstances as the
lender of last resort.\295\ It provides that the Federal
Reserve Board ``may authorize any Federal Reserve bank . . . to
discount . . . notes, drafts, and bills of exchange'' for ``any
individual, partnership, or corporation'' if three conditions
are met. First, the Board of Governors must determine that
``unusual and exigent'' circumstances exist by the affirmative
vote of at least five members. Second, the notes, drafts, and
bills of exchange must be secured to the satisfaction of the
Federal Reserve bank. Third, the Federal Reserve bank must
determine that the person or institution involved cannot secure
adequate credit from other banking institutions.\296\ In
addition to Section 13(3), the Federal Reserve banks have the
authority to exercise ``incidental powers as shall be necessary
to carry on the business of banking within the limitations
prescribed by this Act.'' \297\ Thus, the incidental powers
provision could supplement the authority granted in Section
13(3), but it would not give the Federal Reserve banks
authority to take actions that were specifically prohibited by
the Federal Reserve Act (Section 13(3) or otherwise).
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\295\ See 12 U.S.C. 343. Section 13(13) of the Federal Reserve Act,
12 U.S.C. 347c, allows the Federal Reserve to make advances to
individuals, partnerships, and corporations, but these advances cannot
exceed 90 days and must be secured by U.S. Treasury, U.S. agency, or
U.S. agency-guaranteed obligations.
\296\ 12 U.S.C. 343; see also David H. Small and James A. Clouse,
The Scope of Monetary Policy Actions Authorized Under the Federal
Reserve Act, at 14-16 (July 19, 2004) (online at
www.federalreserve.gov/pubs/feds/2004/200440/200440pap.pdf). Section
13(3) also provides that the discounted instruments must bear interest
``at rates determined under section 14(d),'' and Section 14(d) provides
that discount rates are to be set at least every 14 days, ``with a view
of accommodating commerce and business.'' Regulation A provides one set
of authorizations for Federal Reserve lending under Section 13(3)--
clarifying that credit must not be available from ``other sources''
(not just other ``banking institutions''), adding the gloss that the
institution's ``failure to obtain such credit would adversely affect
the economy,'' and providing that the discount rate will be ``above the
highest rate in effect for advances to depository institutions''--but
this does not preclude the Federal Reserve Board from authorizing
lending pursuant to Section 13(3) under other authorities. Panel staff
conversation with Federal Reserve Board staff (May 27, 2010); 12 CFR
Sec. 201.4(d) (Regulation A).
\297\ 12 U.S.C. Sec. 341(4).
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There is very little historical precedent to shape the
interpretation of Section 13(3).\298\ The provision was enacted
during the Great Depression and was used to extend 123 loans
totaling around $1.5 million to a variety of businesses from
1932 to 1936.\299\ The Federal Reserve's authority was
broadened significantly in 1991, allowing the Federal Reserve
to authorize any Federal Reserve bank to discount notes,
drafts, or bills of exchange that ``are indorsed or otherwise
secured to the satisfaction of the Federal Reserve bank''--
removing the restriction that it could only discount the types
of paper that could be discounted for member banks. The change
both provided the Federal Reserve with additional flexibility
and potentially made borrowing under the section more
attractive.\300\ However, loans were not actually made pursuant
to the Federal Reserve's Section 13(3) authority again from
1936 until 2008.\301\ Since March 2008, the Federal Reserve has
relied on Section 13(3) several times, three times in providing
assistance to AIG: the original $85 billion RCF in September
2008, a $37.8 billion Securities Borrowing Facility (SBF) in
October 2008, and the Maiden Lane facilities (ML2 and ML3) in
November 2008.\302\
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\298\ It should be noted that the Federal Reserve Board not only
had broad discretion under the statute but it is also generally
relatively insulated from legal challenge. It is unclear whether anyone
would have standing to sue the Federal Reserve related to its actions
involving AIG, and in any event, the standard of review is very
deferential (requiring clear evidence of arbitrariness or
capriciousness). See Huntington Towers, Ltd. v. Franklin National Bank,
559 F.2d 863, 868 (2d Cir. 1978) (``Absent clear evidence of grossly
arbitrary or capricious action on the part of [the Federal Reserve
Bank] . . . it is not for the courts to say whether or not the actions
taken were justified in the public interest, particularly where it
vitally concerned the operation and stability of the nation's banking
system.''); Raichle v. Federal Reserve Bank, 34 F.2d 910 (2d Cir. 1929)
(``It would be an unthinkable burden upon any banking system if its
open market sales and discount rates were to be subject to judicial
review. . . . The remedy sought would make the courts, rather than the
Federal Reserve Board, the supervisors of the Federal Reserve System,
and would involve a cure worse than the malady.''). These cases do not
involve actions taken by the Federal Reserve pursuant to Section 13(3),
but their reasoning is arguably equally applicable.
\299\ See Howard H. Hackley, Lending Functions of the Federal
Reserve Banks: A History, at 130 (May 1973). According to the Bureau of
Labor Statistic's CPI inflation calculator, $1.5 million in 1936 ``has
the same buying power'' as $23.5 million in 2010. The largest single
loan was for $300,000 (roughly the same buying power as $4.7 million in
2010).
\300\ See James A. Clouse, Recent Developments in Discount Window
Policy, Federal Reserve Bulletin No. 975 (Nov. 1994). Section 13(3) was
also modified in 1935 by changing the requirement that notes, drafts,
and bills of exchange be ``indorsed and secured'' to ``indorsed or
secured.'' In 2008, Congress added a requirement that the Federal
Reserve Board must report to the House Committee on Financial Services
and the Senate Committee on Banking, Housing, and Urban Affairs on its
justifications for exercising its Section 13(3) authority, the specific
terms of the actions taken, and periodic updates on the status of the
loan. EESA Sec. 129(a)-(b). Copies of the reports must be sent to the
Congressional Oversight Panel. EESA Sec. 129(e). The Federal Reserve
has also made the reports public by releasing them on its website
(www.federalreserve.gov).
\301\ It should be noted that the Federal Reserve invoked Section
13(3) to authorize the Federal Reserve banks to make loans to thrifts
under certain terms and conditions from July 1, 1966 to March 1, 1967
and again from December 24, 1969 to April 1, 1970, but no thrift
institutions took advantage of the lending facility. See Board of
Governors, 56th Annual Report, at 92-93 (1969); Board of Governors,
53rd Annual Report, at 91-92 (1966). The Federal Reserve banks have
also relied on Section 13(b), which was enacted in 1934 and repealed in
1958, to provide up to $280 million in working capital to any
established business with maturities up to five years and no loan
limits. See David Fettig, Lender of More than Last Resort: Recalling
Section 13(b) and the Years When the Federal Reserve Opened Its
Discount Window to Businesses, Banking and Policy Issues Magazine, at
45-46 (Dec. 2002) (online at www.minneapolisfed.org/pubs/region/02-12/
lender.pdf).
\302\ See Federal Reserve Bank of St. Louis, Clarifying the Roles
and the Spending: The Separate Functions of the Fed, Treasury and FDIC
(Fall 2009) (online at www.stlouisfed.org/publications/cb/articles/
?id=1659) (providing information on recent Federal Reserve programs
authorized under Section 13(3): collateralized funding provided to Bear
Sterns, collateralized funding provided to AIG, Money Market Investment
Funding Facility, Term Asset-Backed Securities Loan Facility, Term
Securities Loan Facility, and Primary Dealer Credit Facility. For an
analysis of the Federal Reserve's legal authority to provide these
particular facilities, see Annex IV.
---------------------------------------------------------------------------
In addition to the facilities ultimately authorized by the
Federal Reserve and entered into by FRBNY, other options would
have been allowed (or available to the Federal Reserve) under
Section 13(3) to deal with AIG's liquidity problems.\303\ For
example, in September 2008, the Federal Reserve could have
authorized FRBNY to provide, under certain terms and
conditions, short-term funding to give the parties more time to
prepare a solution for AIG's liquidity problems, conditional
lending that more equitably distributed the ``pain'' that would
have resulted from an AIG failure, or a guarantee of a private
loan or a portion of AIG's outstanding obligations.\304\
---------------------------------------------------------------------------
\303\ Thus, although the Federal Reserve's decision was binary in
the sense that it could have allowed AIG to enter bankruptcy in
September 2008, or it could have provided assistance to prevent such a
bankruptcy filing, the Federal Reserve's options of the types of
assistance it could have provided under Section 13(3) included more
than the full payment of all of AIG's creditors.
\304\ For additional discussion and evaluation of these three
alternatives, see Section F.
---------------------------------------------------------------------------
The Federal Reserve could have agreed to provide a short-
term loan or bridge loan to AIG, secured by the same assets
posted as collateral for the $85 billion RCF under Section
13(3). It could have made clear to AIG and its subsidiaries,
their creditors, their regulators, and the markets that this
funding was being extended to allow the parties more time to
negotiate a prepackaged bankruptcy, to prepare for a regular
bankruptcy, or to otherwise restructure or reorganize AIG's
businesses or contractual obligations going forward. It should
be noted, however, that any such short-term arrangement would
have produced its own complications. Because contractual and
safe harbor provisions provided favorable treatment to certain
of AIG's creditors,\305\ the Federal Reserve and FRBNY would
have had to use their authority under Section 13(3) to impose
restrictions on the use of the funds to prevent an unfair
advantage for these creditors in the event of a later
bankruptcy.\306\ For example, to the extent that AIG had the
ability to use the funds to provide additional collateral to
its CDS counterparties, those funds could not have been used in
a way that would help AIG effectively reorganize or survive.
Instead, the public funds would have simply increased the level
of security of the counterparties, providing additional
protection to these counterparties in the event of an AIG
bankruptcy filing (as discussed above, the CDS counterparties
would not be subject to the automatic stay, could keep
previously posted collateral, and would not be subject to
various avoidance actions).
---------------------------------------------------------------------------
\305\ For example, CDS counterparties and parties to AIG repo
funding would receive favorable treatment under the bankruptcy code,
and securities lending counterparties would enjoy similar contractual
protections, if the regulators did not seize the life insurance
subsidiaries participating in the securities lending program.
\306\ Section 13(3) specifically provides that the assistance
provided by the Federal Reserve ``shall be subject to such limitations,
restrictions, and regulations as the Board of Governors of the Federal
Reserve System may prescribe.'' 12 U.S.C. Sec. 343.
---------------------------------------------------------------------------
The Federal Reserve could also have imposed additional
terms or conditions on its extension of credit so that the pain
of an AIG rescue could be shared more equitably. For example,
Martin Bienenstock, partner and chair of business solutions and
government department, Dewey & LeBoeuf, testified before the
Panel that ``all lenders are justified in requiring shared
sacrifice'' and that FRBNY could have used its lender status
``to demand concessions'' from the material creditors of AIG's
business that were insolvent or not profitable.\307\
---------------------------------------------------------------------------
\307\ Congressional Oversight Panel, Written Testimony of Martin
Bienenstock, partner and chair of business solutions and government
department, Dewey & LeBoeuf, COP Hearing on TARP and Other Assistance
to AIG, at 1, 4 (May 26, 2010) (online at cop.senate.gov/documents/
testimony-052610-bienenstock.pdf) (hereinafter ``Written Testimony of
Martin Bienenstock'').
---------------------------------------------------------------------------
Finally, Section 13(3) is sufficiently broad that the
Federal Reserve could have authorized FRBNY to provide a
guarantee for a private loan to AIG or for a portion of AIG's
outstanding obligations under certain terms and
conditions.\308\ A guarantee is simply an obligation to provide
funds if needed; this is little different than the credit
facilities made available to AIG. FRBNY could lend up to a
stated amount, under certain terms and conditions, as needed,
to a corporation that was unable to otherwise obtain adequate
credit; the facility guaranteed AIG creditors by making up to
$85 billion available to AIG to satisfy claims on the company.
---------------------------------------------------------------------------
\308\ Panel staff conversation with Federal Reserve Board staff
(May 28, 2010). Without the proposed terms and conditions, it is
difficult to say whether the Federal Reserve could authorize or FRBNY
could provide a certain type of guarantee under Section 13(3). However,
this paragraph will provide a general discussion of possibilities and
limitations.
---------------------------------------------------------------------------
In general, the Federal Reserve would be able to authorize
a guarantee pursuant to Section 13(3) only if the guarantee
were fully secured.\309\ Thus, the amount of the guarantee
would be ``capped'' by the value of available or unencumbered
assets that could be posted as collateral.\310\ The Federal
Reserve System (and the taxpayers) would still have been liable
(or at risk) for the full amount of the guaranteed private loan
\311\ or the guaranteed AIG obligations,\312\ but it would not
have had to provide funds to AIG initially and could have
created a period in which markets could have stabilized, and
the possibility of a private-sector solution could have
increased.\313\ On the other hand, the Federal Reserve would
not have been able to authorize an open-ended guarantee or
blanket assurance to AIG's creditors that AIG or its insurance
subsidiaries would continue to be viable or to operate as going
concerns in the near or medium term because AIG would not have
had sufficient collateral for such an open-ended
guarantee.\314\ In addition, any Section 13(3) transaction must
involve a ``discount'' or a fee structured as the economic
equivalent of previously computed interest.\315\ A guarantee of
a private loan would allow the creditors to rely on the full
faith and credit of the United States, and there is no reason
to think that the strength of such a credit would not reduce,
or modify, the otherwise required interest rate, but that would
have to be shown.\316\
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\309\ Section 13(3) requires that assistance provided must be
``indorsed or otherwise secured to the satisfaction of the Federal
Reserve bank.'' 12 U.S.C. Sec. 343.
\310\ As part of a hybrid public-private solution, AIG may have
pledged the same assets as collateral for both the private loan and the
public guarantee. In that case, the private creditors would have had to
agree to release collateral to FRBNY in the amount of any claims that
they asserted in relation to the public guarantee. In the alternative,
the private consortium or syndicate may not have required AIG to
provide collateral for the loan because the protection offered by the
Federal Reserve's guarantee provided sufficient security.
\311\ Because the Federal Reserve would have been liable for the
entire $85 billion under either the $85 billion Revolving Credit
Facility or a guarantee of an $85 billion private loan, its risk
profile would have been the same under either option. If FRBNY had
issued a guarantee for such a loan, the transaction could be viewed as
``for'' AIG, under the authorizing statute.
\312\ If the Federal Reserve guaranteed a portion of AIG's
obligations, AIG would still have been required to raise capital to
address its liquidity needs from other sources.
\313\ The Federal Reserve would have to provide funds only when AIG
defaulted on its obligations.
\314\ In an open-ended guarantee, the Federal Reserve would not be
able to quantify the extent of its potential exposure, making it
difficult for the Federal Reserve to obtain adequate collateral or
security. The Federal Reserve could estimate liabilities on a certain
date based on current business or market conditions. However, the
numbers and assumptions underlying the estimate will change (e.g., as
the company generates additional liabilities or market conditions
change), resulting in a significant level of uncertainty or risk for a
guarantor. It is questionable whether any company would have sufficient
assets to secure such an open-ended guarantee or compensate a guarantor
for taking on so much risk.
\315\ As discussed in Annex IV, the term ``discount'' has been
interpreted broadly to refer to any purchase of paper (or essentially
any advance of funds in return for a note) with previously-computed
interest. See Board of Governors of the Federal Reserve System, Federal
Reserve Bulletin, at 269 (Mar. 1958).
\316\ Another path to satisfaction of the ``discount'' condition
would be to argue that the guarantee, like the loan, was ``for'' the
benefit of AIG, although not made to AIG directly.
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D. Subsequent Government Actions

1. Securities Borrowing Facility: October 2008

By September 30, 2008, just 14 days after the Federal
Reserve Board approved the $85 billion RCF, AIG had already
drawn down approximately $61 billion of that money.\317\ It
became apparent that the facility would be inadequate to meet
all of AIG's obligations.\318\ The Federal Reserve Board and
FRBNY worried about further ratings downgrades, which would--
among other adverse effects--trigger more collateral calls on
AIGFP.\319\
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\317\ AIG used these funds for the following: $35.3 billion to
cover loans to AIGFP for collateral postings, GIA, and other
maturities; $13.3 billion in capital contributions for insurance
subsidiaries; $3.1 billion to repay securities lending obligations;
$2.7 billion for AIG funding commercial paper maturities; $1.5 billion
for intercompany loan repayment; $1.0 billion each in contributions for
AIG Consumer Finance Group's (AIGCFG) subsidiaries and debt repayments;
and $2.7 billion in additional borrowing. Including paid in kind
interest and fees on the amount borrowed, AIG's total balance
outstanding on the facility was $62.96 billion at the end of September.
AIG Form 10-Q for Third Quarter 2008, supra note 23, at 43; Board of
Governors of the Federal Reserve System, Data Download Program (online
at www.federalreserve.gov/datadownload/) (hereinafter ``Federal Reserve
Data Download Program'') (accessed May 28, 2010).
\318\ Securities Borrowing Facility for AIG, supra note 264, at 2.
\319\ House Committee on Oversight and Government Reform, Written
Testimony of Thomas C. Baxter, executive vice president and general
counsel, Federal Reserve Bank of New York, The Federal Bailout of AIG,
at 5-6 (Jan. 27, 2010) (online at oversight.house.gov/images/stories/
Hearings/Committee_on_Oversight/2010/012710_AIG_Bailout/TESTIMONY-
Baxter.pdf) (hereinafter ``Testimony of Thomas C. Baxter'').
---------------------------------------------------------------------------
On October 6, 2008, the Federal Reserve Board approved an
additional SBF to allow FRBNY to lend up to $37.8 billion to
AIG.\320\ The lending would occur on an overnight basis, with
FRBNY borrowing investment-grade fixed income securities from
AIG's life insurance subsidiaries in return for cash
collateral.\321\ The facility allowed AIG to replenish
liquidity to its securities lending program--by extending its
then-outstanding lending obligations where those obligations
were not rolled over or replaced by transactions with other
private market participants--while giving FRBNY possession and
control of the securities.
---------------------------------------------------------------------------
\320\ Financial Stability Oversight Board, Minutes of the Financial
Stability Oversight Board Meeting, at 2 (Nov. 9, 2008) (online at
www.financialstability.gov/docs/FSOB/FINSOB-Minutes-November-9-
2008.pdf). The Federal Reserve Board publicly announced the Securities
Borrowing Facility on October 8, 2008, the day that FRBNY established
it. See Board of Governors of the Federal Reserve System, Press Release
(Oct. 8, 2008) (online at www.federalreserve.gov/newsevents/press/
other/20081008a.htm) (hereinafter ``Federal Reserve Press Release'').
\321\ These securities were previously lent by AIG's insurance
subsidiaries to third parties. The maximum amount of credit that FRBNY
could extend at any one time was $37.8 billion. The Board made this
authorization under Section 13(3) of the Federal Reserve Act.
---------------------------------------------------------------------------
In its report to Congress shortly after establishing this
facility, the Board wrote that the facility ``addresses
liquidity strains placed on AIG due to the ongoing withdrawal
of counterparties from securities borrowing transactions'' and
``reduce[s] the pressure on AIG to liquidate immediately the
portfolio of RMBS that were purchased with the proceeds of the
securities lending transactions.'' \322\ Furthermore, the Board
wrote, ``The size of the Secured Borrowing Facility will permit
the Reserve Bank, if necessary, to replace all remaining
securities borrowing counterparties of AIG.'' \323\
---------------------------------------------------------------------------
\322\ Securities Borrowing Facility for AIG, supra note 264, at 2.
\323\ Securities Borrowing Facility for AIG, supra note 264.
---------------------------------------------------------------------------
During this period, AIG made extensive use of the
Commercial Paper Funding Facility (CPFF), one of several
liquidity programs that the Federal Reserve created during the
financial crisis to deal with market stress. The CPFF purchased
three-month unsecured and asset-backed commercial paper
directly from qualified borrowers.\324\ Three AIG
subsidiaries--AIG Funding, Curzon Funding, and Nightingale
Finance--were authorized to sell commercial paper to this
facility in maximum amounts of $6.9 billion, $7.2 billion and
$1.1 billion, respectively, while a fourth, ILFC, lost its
access to this facility in January 2009 after S&P downgraded
its short term credit rating.\325\ Access to this Federal
Reserve facility effectively supplemented the RCF and allowed
AIG to maintain short-term borrowing on the same favorable
terms that other major financial institutions were enjoying at
the peak of the financial crisis.
---------------------------------------------------------------------------
\324\ The CPFF incurred no losses, and earned approximately $5
billion in earnings from credit enhancement fees, registration fees,
and interest income. At its height in January 2009, it held $350
billion in commercial paper. It ceased purchasing new commercial paper
on February 1, 2010, and its balance of commercial paper holdings was
zero as of April 26, 2010. Board of Governors of the Federal Reserve
System, Credit and Liquidity Programs and the Balance Sheet, at 10 (May
2010) (online at www.federalreserve.gov/monetarypolicy/files/
monthlyclbsreport201005.pdf) (hereinafter ``Credit and Liquidity
Programs and the Balance Sheet''); Board of Governors of the Federal
Reserve System, Data Download Program (Factors Affecting Reserve
Balances (H.4.1)--Net portfolio holdings of Commercial Paper Funding
Facility LLC: Wednesday level) (online at www.federalreserve.gov/
datadownload/) (accessed June 2, 2010).
\325\ ``AIG Funding use[d] the proceeds to refinance AIG's
outstanding commercial paper as it mature[d], meet other working
capital needs and make prepayments under the Fed Facility while the two
other programs use[d] the proceeds to refinance maturing commercial
paper. On January 21, 2009, S&P downgraded ILFC's short-term credit
rating and, as a result, ILFC [could] no longer participate in the
CPFF.'' At the end of December 2009, AIG had $4.7 billion outstanding
under CPFF. American International Group, Inc., What AIG Owes the U.S.
Government (Mar. 31, 2010); AIG Form 10-K for FY09, supra note 50, at
18.
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2. The TARP Investment and First Restructuring: November 2008

Throughout the fall of 2008, it became clear that the
rating agencies took an increasingly dim view of AIG's
underlying creditworthiness. This growing skepticism
intensified throughout the Lehman weekend amidst mounting
concerns connected to its CDS positions. AIG and its
subsidiaries were placed on credit watch with negative
implications by S&P. On Monday, September 15, S&P lowered AIG's
rating to A- due to mounting derivatives losses and diminished
capacity to meet collateral obligations.
The only factor preventing AIG's creditworthiness from
deteriorating immediately after September 16, 2008 was FRBNY's
$85 billion RCF, said Rodney Clark, a managing director in
S&P's rating services.\326\ On October 3, Moody's downgraded
AIG's senior unsecured debt rating to A3 from A2, and
maintained a continuing watch review for possible further
downgrades potentially triggered by activities related to AIG's
global divestiture plan.\327\ AIG was also expected to report
an approximately $25 billion loss on November 10, 2008.
---------------------------------------------------------------------------
\326\ Written Testimony of Rodney Clark, supra note 80, at 5.
\327\ Moody's Investor Service, Global Research (Nov 10, 2008).
---------------------------------------------------------------------------
The credit rating agencies advised AIG that the company's
upcoming November 10 report of third quarter results would
likely trigger a ratings downgrade in the absence of a
``parallel announcement of solutions to its liquidity
problems.'' \328\ AIG was having difficulty selling assets to
pay down debt from the RCF and meet anticipated liquidity
needs, particularly in light of continuing collateral calls
under its CDS contracts.\329\ Consequently, in the days leading
up to AIG's earnings announcement, the Federal Reserve and
Treasury hurried to put together additional financial
assistance from the federal government that would address AIG's
growing debt burden.
---------------------------------------------------------------------------
\328\ Testimony of Thomas C. Baxter, supra note 319, at 9.
\329\ Board of Governors of the Federal Reserve System, Report
Pursuant to Section 129 of the Emergency Economic Stabilization Act of
2008: Restructuring of the Government's Financial Support to the
American International Group, Inc. on November 10, 2008, at 4 (online
at federalreserve.gov/monetarypolicy/files/129aigrestructure.pdf)
(hereinafter ``Federal Reserve Report on Restructuring''); Testimony of
Thomas C. Baxter, supra note 319, at 9.
---------------------------------------------------------------------------
On November 10, 2008, FRBNY and Treasury announced a
comprehensive multi-pronged plan to address AIG's liquidity
issues, create a ``more durable capital structure,'' and
provide AIG with more time and increased flexibility to sell
assets and repay the government.\330\ This restructuring was
intended to stabilize AIG's businesses and address rating
agency concerns in order to allow an orderly
restructuring.\331\ As Secretary Geithner later stated,
``[a]voiding any downgrade of AIG's credit rating was
absolutely essential to sustaining the firm's viability and
protecting the taxpayers' investment.'' \332\
---------------------------------------------------------------------------
\330\ Board of Governors of the Federal Reserve System, Federal
Reserve Board and Treasury Department Announce Restructuring of
Financial Support to AIG (Nov. 10, 2008) (online at
www.federalreserve.gov/newsevents/press/other/20081110a.htm)
(hereinafter ``Federal Reserve Press Release Announcing
Restructuring'').
\331\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
\332\ Testimony of Sec. Geithner, supra note 11, at 8.
---------------------------------------------------------------------------
As part of the November 10 restructuring announcement,
Treasury said it planned to use $40 billion of TARP money to
purchase newly issued AIG perpetual preferred shares and
warrants to purchase AIG common stock;\333\ this initiative was
known as the Systemically Significant Failing Institutions
program (SSFI), and AIG was its only beneficiary. At the same
time, FRBNY reduced AIG's line of credit under the RCF to $60
billion. FRBNY also announced that it was restructuring the
facility by extending the loan from two to five years and
lowering the interest rate and fees charged.
---------------------------------------------------------------------------
\333\ The perpetual preferred shares were later known as the Series
D Preferred Stock Purchase Agreement. American International Group,
Inc., U.S. Treasury, Federal Reserve and AIG Establish Comprehensive
Solution for AIG, at 1 (Nov. 10, 2008) (online at media.corporate-
ir.net/media_files/irol/76/76115/reports/Restructuring10Nov08LTR.PDF).
---------------------------------------------------------------------------
On November 10, AIG reported a third-quarter 2008 loss of
$24.5 billion, of which $19 billion was due to the securities
lending program and AIGFP's CDSs.\334\ Also on that day,
Treasury and the Federal Reserve Board announced two major
initiatives to increase and restructure federal assistance to
AIG; FRBNY would be authorized to create two limited liability
companies or SPVs--ML2 and ML3--to purchase troubled assets
from AIG and its subsidiaries.
---------------------------------------------------------------------------
\334\ Federal Reserve Report on Restructuring, supra note 329, at
4.
---------------------------------------------------------------------------

3. Maiden Lane II

Maiden Lane II (ML2) was set up by FRBNY to address the
liquidity problems AIG was encountering in early November 2008
in its securities lending program, which was the same objective
for which FRBNY had established the SBF just a few weeks
earlier. But the SBF was only intended as a temporary solution
to the ongoing liquidity pressure on AIG stemming from the
unwinding of AIG's securities lending program. On November 10,
FRBNY, in close consultation with the Board, announced the
creation of ML2, which would purchase RMBS assets from AIG's
securities lending collateral portfolio. The motivating force
was to get contingent liabilities off AIG's balance sheet.\335\
The Federal Reserve authorized FRBNY to lend up to $22.5
billion to ML2; AIG also acquired a subordinated $1 billion
interest in the facility, which would absorb the first $1
billion of losses.\336\ On December 12, FRBNY extended a $19.5
billion loan to ML2 to fund its RMBS purchases from AIG's life
insurance subsidiaries (which had $39.3 billion face value) in
connection with the termination of the outstanding $37.8
billion of securities loans and related agreements with AIG.
---------------------------------------------------------------------------
\335\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
\336\ As a result of this transaction, AIG's remaining exposure to
losses from its U.S. securities lending program were limited to
declines in market value prior to closing and its $1 billion of
funding.
---------------------------------------------------------------------------
The differences between ML2 and ML3 must be emphasized. ML2
purchased deeply discounted securities from AIG, which was then
able to use the proceeds of those sales to close out related
obligations. In contrast, in ML3, discussed in the following
section, the SPV purchased securities from AIG's counterparties
in transactions, the net effect of which was to give those
counterparties the full notional value of their securities.
AIG used the proceeds to repay all of its outstanding debt
under the SBF, thereby terminating that short-lived
arrangement, as well as ending the securities lending program
under which AIG had acquired the RMBS.\337\ As discussed above,
the SBF established in October 2008 was designed to be a
temporary solution to the liquidity pressures facing AIG. AIG's
counterparties in the securities lending program, whose claims
were finally closed out by the ML2 transaction, are set out in
the table below and discussed further in Section F below.\338\
---------------------------------------------------------------------------
\337\ AIG Form 10-K for FY08, supra note 47, at 251 (``The life
insurance companies applied the initial consideration from the RMBS
sale, along with available cash and $5.1 billion provided by AIG in the
form of capital contributions, to settle outstanding securities lending
transactions under the U.S. Securities Lending Program, including those
with the NY Fed, which totaled approximately $20.5 billion at December
12, 2008, and the U.S. Securities Lending Program and the Securities
Lending Agreement with the NY Fed have been terminated.'').
\338\ See Section F.2 for further discussion of the Securities
Borrowing Facility.

FIGURE 15: PAYMENTS TO COUNTERPARTIES FOR U.S. SECURITIES LENDING
[Dollars in billions]
------------------------------------------------------------------------
Counterparty Amount
------------------------------------------------------------------------
Barclays..................................................... $7.0
Deutsche Bank................................................ 6.4
BNP Paribas.................................................. 4.9
Goldman Sachs................................................ 4.8
Bank of America.............................................. 4.5
HSBC......................................................... 3.3
Citigroup.................................................... 2.3
Dresdner Kleinwort........................................... 2.2
Merrill Lynch................................................ 1.9
UBS.......................................................... 1.7
ING.......................................................... 1.5
Morgan Stanley............................................... 1.0
Societe Generale............................................. 0.9
AIG International Inc........................................ 0.6
Credit Suisse................................................ 0.4
Paloma Securities............................................ 0.2
Citadel...................................................... 0.2
----------
Total.................................................... $43.8
------------------------------------------------------------------------

Cash flows generated by assets of ML2, i.e., principal and
interest from amortization of mortgages and other loans
underlying the securities, are now being used to pay down the
loans to this SPV owned by FRBNY.\339\ As of March 31, 2010
(see Figure 16), the principal balance of the FRBNY loan to ML2
had decreased by 28 percent from its original level of $19.5
billion to $15.3 billion. Since the inception of this SPV,
FRBNY has earned $309 million in accrued and capitalized
interest from its investments in ML2. Additionally, as of
December 31, 2009, FRBNY received $55.3 million in proceeds
from the sales of assets in ML2.\340\ The Federal Reserve
estimates the market value of ML2 as of March 31, 2010 at $16.2
billion, slightly above the outstanding FRBNY loan balance of
$15.3 billion and slightly below the total outstanding
principal balance, including the $1 billion AIG contribution to
ML2, meaning that as of the date of the estimate, FRBNY
anticipated payment in full on its loans, and payment in part
on AIG's contribution. After repayment of the FRBNY loan,
remaining funds from ML2 will be used to pay AIG's $1 billion
subordinated interest and any residual value will be split
five-sixths to FRBNY, one-sixth to AIG.\341\ The ability of AIG
to retain some upside was apparently designed to satisfy rating
agencies.
---------------------------------------------------------------------------
\339\ Board of Governors of the Federal Reserve System, Federal
Reserve System Monthly Report on Credit and Liquidity Programs and the
Balance Sheet, at 17 (Oct. 2009) (online at www.federalreserve.gov/
monetarypolicy/files/monthlyclbsreport200910.pdf) (hereinafter
``Federal Reserve System Monthly Report'').
\340\ Maiden Lane II LLC, Financial Statement for the Year Ended
December 31, 2009, and for the Period October 31, 2008 to December 31,
2008, and Independent Auditors' Report (Apr. 21, 2010) (online at
www.fednewyork.org/aboutthefed/annual/annual09/
MaidenLaneIIfinstmt2010.pdf ) (hereinafter ``ML II Financial Statement
for Year End Dec. 31, 2009'').
\341\ Federal Reserve Bank of New York, AIG RMBS LLC Facility:
Terms and Conditions (Dec. 16, 2008) (online at www.newyorkfed.org/
markets/rmbs_terms.html).

FIGURE 16: OUTSTANDING PRINCIPAL BALANCE OF MAIDEN LANE II AS OF MARCH
31, 2010 \342\
[Dollars in billions]
------------------------------------------------------------------------
FRBNY Senior AIG
Loan Contribution Total
------------------------------------------------------------------------
Funding, December 12, 2008... $19.5 $1 $20.5
Accrued and Capitalized .309 .044 .353
Interest....................
Repayments................... (4.5) -- (4.5)
------------------------------------------
Total.................... $15.3 $1 $16.4
------------------------------------------------------------------------
\342\ Credit and Liquidity Programs and the Balance Sheet, supra note
324; Board of Governors of the Federal Reserve System, Factors
Affecting Reserve Balances (H.4.1) (Mar. 25, 2010) (online at
www.federalreserve.gov/releases/h41/) (hereinafter ``Federal Reserve
H.4.1 Statistical Release'').

4. Maiden Lane III

Following the initial rescue of AIG via the government's
extension of an $85 billion line of credit, FRBNY increasingly
sought a resolution of AIGFP's sizable multisector CDO CDS
exposure, which had grown to $72 billion as of September 30,
2008.\343\ The terms of the CDSs required collateral to be
posted on a decline in market value of the reference
securities, the CDOs, and also in the event of an AIG ratings
downgrade. Hence, the rating downgrade of September 15 and the
ongoing drop in CDO values resulted in collateral calls that
put severe strain on AIG's liquidity.\344\ At the end of
September, AIG's management, financial advisors, and legal
counsel presented certain options to FRBNY and its financial
advisors ``for addressing the liquidity and mark-to-market
losses.'' \345\ Also in late October, FRBNY took over from the
Chief Financial Officer of AIGFP the ongoing negotiations with
the CDS counterparties through which AIG and FRBNY sought to
unwind the transactions and eliminate any further financial
exposure to AIG from this business.\346\ In late October and
early November, BlackRock Solutions developed three options to
accomplish this objective.
---------------------------------------------------------------------------
\343\ Written Testimony of Elias Habayeb, supra note 27, at 3.
\344\ Collateral calls for AIGFP multi-sector CDOs totaled $16.1
billion at the end of July. On August 6, 2008, AIGFP announced a
further $16.5 billion in collateral posting. The S&P rating for AIG was
downgraded to A- with a negative outlook on September 15, 2008. As a
result of this downgrade, AIGFP estimated it needed $20 billion to meet
collateral demands and transaction termination payments. AIGFP was
subsequently required to fund approximately $32 billion fifteen days
following this rating downgrade. AIG Form 10-K for FY08, supra note 47,
at 3-4; Office of the Special Inspector General for the Troubled Asset
Relief Program, Quarterly Report to Congress, at 140-141 (Oct. 21,
2009) (online at www.sigtarp.gov/reports/congress/2009/
October2009_Quarterly_Report_to_Congress.pdf).
\345\ Written Testimony of Elias Habayeb, supra note 27, at 7.
\346\ Written Testimony of Elias Habayeb, supra note 27, at 8-9.
---------------------------------------------------------------------------
The first option developed by BlackRock Solutions would
have required AIGFP's counterparties to cancel their credit
default swap contracts and retain some of the risk in the
underlying CDOs. This would be accomplished by having the
counterparties sell the underlying CDOs to an SPV funded
jointly by FRBNY, AIG and the counterparties themselves, with
counterparties' interest subordinate to that of FRBNY. The
problems with this option were the intensive work required to
negotiate the arrangements with each counterparty and the lack
of incentive for the counterparties to retain long term
exposure to the performance of the CDOs through the
subordinated loan to the SPV.
The second option entailed creation of an SPV to assume
AIG's position in the CDS contracts with performance by the SPV
guaranteed by FRBNY. The counterparties would agree to give up
the right to make further collateral calls in return for
FRBNY's assurance against further loss in value of the CDOs.
This option would have conferred no benefit to AIG's
counterparties other than strengthening the credit quality of
their CDSs. However, the result of the enhanced credit quality
of the CDS would have required counterparties to return part of
the collateral to the SPV which was replacing AIG. FRBNY chose
not to pursue this option because of concerns about the open-
ended taxpayer exposure through the FRBNY guarantee and legal
impediments to the Federal Reserve's ability to provide the
broad guarantee contemplated in this arrangement.\347\ It
appears that there was some discussion of using the TARP to
provide a guarantee; in the end, the TARP was not used for this
purpose.
---------------------------------------------------------------------------
\347\ Written Testimony of Elias Habayeb, supra note 27, at 3, 7.
For a description of other options considered, see Testimony of Thomas
C. Baxter, supra note 319, at 7-11. See also Office of the Special
Inspector General for the Troubled Asset Relief Program, Factors
Affecting Efforts to Limit Payments to AIG Counterparties, at 13-14
(Nov. 17, 2009) (online at sigtarp.gov/reports/audit/2009/
Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties.pdf).
---------------------------------------------------------------------------
Ultimately, FRBNY recommended, and the Federal Reserve and
Treasury agreed, that the best option would be to have FRBNY,
through an SPV, purchase the CDOs underlying the credit swap
contracts from the counterparties and thereby extinguish those
contracts. The selection of this option led to the
counterparties permanently keeping $35 billion in cash
collateral and in effect receiving the entire notional amount
of the CDOs at a time when the market value for those CDOs was
less than one half of that amount. Although taxpayers were
exposed to downside risk in this arrangement, they also
retained rights to the upside; the government however, as
approximately 80 percent owner of AIG, participated in the
losses which the $35 billion in collateral represented. At the
same time, this arrangement terminated the CDS contracts and
the ongoing liquidity pressure on AIG they were generating.
Hence, on November 10, 2008, the Federal Reserve authorized
FRBNY to lend up to $30 billion to Maiden Lane III (ML3), a
newly created SPV, to purchase the relevant CDOs.\348\ In
total, FRBNY loaned ML3 $24.3 billion, and AIG made a $5
billion equity investment in ML3. ML3 then purchased the CDOs
from 16 of AIG's counterparties at a market value of about
$27.2 billion.\349\ The counterparties kept the $35 billion
cash collateral they had already received from AIG in earlier
collateral calls, and agreed to terminate AIG's CDS contracts.
The combination of market value payments and cash collateral
approximated the par value of the CDS contracts, or $62
billion.
---------------------------------------------------------------------------
\348\ Written Testimony of Elias Habayeb, supra note 27, at 8-10.
For instance, on November 25, 2008, FRBNY made a senior loan to ML3 of
$15 billion, and AIG made a $5 billion equity investment in ML3. See
Board of Governors of the Federal Reserve System, Factors Affecting
Reserve Balances (H.4.1) (Nov. 28, 2008) (online at
www.federalreserve.gov/Releases/H41/20081128/). Actual transactions
subsequently occurred on November 25, December 18, and December 22,
2008.
\349\ ML II Financial Statement for Year End Dec. 31, 2009, supra
note 340, at 4.
---------------------------------------------------------------------------
All CDOs owned by ML3 were based on cash assets; no
synthetic CDOs were accepted for inclusion in this SPV.
Further, ML3 did not acquire all the CDSs of AIGFP. Regulatory
filings reveal that, on December, 31 2008, AIG was left with
roughly $12.5 billion of potentially risky multi-sector CDOs
that were excluded from a larger $62.1 billion purchase by ML3.
The multi-sector CDOs that remained on AIG's books were either
largely or entirely synthetics. In the fourth quarter of 2008,
AIGFP's synthetic multi-sector CDOs had a net notional value of
$9.8 billion, according to documents subpoenaed from the
Federal Reserve and later shared with the Panel.\350\
---------------------------------------------------------------------------
\350\ In the fourth quarter of 2008, CDS written on synthetic
positions required the insurer to post approximately $3.0 billion of
collateral on the aforementioned notional amount of $9.8 billion of
synthetics. The larger figure ($12.5 billion) reported in AIG's SEC
filings decreased to $12.0 billion net notional amount in the first
quarter of 2009, and decreased further in the first quarter of 2010 to
$7.6 billion. Spreadsheet provided to the Panel by FRBNY showing AIGFP
multi-sector CDS as of Nov. 5, 2008 (FRBNY-TOWNS-R1-171934); AIG Form
10-K for FY08, supra note 47, at 41
---------------------------------------------------------------------------
As reflected in the $35 billion in payments noted above,
both prior to receiving the federal bailout on September 16 and
during the interim period when government assistance was
limited to the RCF, AIG had made cash collateral payments to
the counterparties. For example, as seen in Figure 17, the
largest purchaser of credit protection on its CDO exposure,
Societe Generale, received a total of $16.5 billion in full
satisfaction of its contracts. These payments consisted of $5.5
billion received in the months prior to any government
assistance being provided to AIG; $4.1 billion received between
September 16 and November 10; and $6.9 billion from ML3, which
was announced on November 10 and whose first closing occurred
on December 3.
This example serves to illustrate the point that through
the combination of collateral payments and the purchase of CDOs
by ML3, FRBNY assured that counterparties in these cases
received 100 percent of the notional value of their CDSs.\351\
Although one counterparty, UBS, agreed to a 2 percent
concession if the other counterparties took this haircut, FRBNY
was not able to negotiate a concession with the other
counterparties.\352\ The report of SIGTARP notes there were a
number of policy considerations that limited FRBNY's ability to
secure concessions from AIG's CDS counterparties. The report
states that FRBNY was unwilling to use its role as a regulator
to compel haircuts from the institutions it oversaw. FRBNY also
decided against any attempts to interfere with the sanctity of
the contracts AIG had executed with its counterparties as well
as refusing to threaten a possible bankruptcy of AIG since it
never intended to allow the firm to collapse. Finally, FRBNY
was concerned that imposed concessions by the counterparties
would be negatively viewed by the rating agencies. Mr. Barofsky
concludes that while these concerns were valid, these decisions
greatly hampered any possibility of concessions from the
counterparties.\353\
---------------------------------------------------------------------------
\351\ Amounts actually paid were in excess of par to compensate for
``the economic costs borne by the counterparties'', i.e., the charges
paid ``to break financing arrangement to deliver the bonds'' and
``forgone income'' related to the lower interest that could be earned
by reinvesting the cash collateral relative to the interest rates paid
on that collateral to AIGFP.
\352\ House Committee on Oversight and Government Reform, Written
Testimony of Neil Barofsky, special inspector general for the Troubled
Asset Relief Program, The Federal Bailout of AIG, at 5 (Jan. 27, 2010)
(online at oversight.house.gov/images/stories/Hearings/
Committee_on_Oversight/2010/012710_AIG_Bailout/
Testimony_Jan_27_2010_House_Committee_on_Oversight_and_Government_Reform
.pdf). For further discussion, please reference section below.
\353\ SIGTARP Report on AIG Counterparties, supra note 246, at 29.
---------------------------------------------------------------------------
Indeed, in the course of settlement of the ML3 purchases,
the SPV returned $2.5 billion in collateral overpayments to
AIGFP. In the table below, ``pre-govt'' refers to counterparty
payments made before September 16, 2008.

FIGURE 17: MAIDEN LANE III RELATED PAYMENTS TO AIGFP COUNTERPARTIES \354\
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Collateral
Counterparty --------------------------------------- ML3 Total
Pre-Govt Post-RCF Net
----------------------------------------------------------------------------------------------------------------
Societe Generale............................... $5.5 $4.1 $9.6 $6.9 $16.5
Goldman Sachs.................................. 5.9 2.5 8.4 5.6 14.0
Deutsche Bank.................................. 3.1 2.6 5.7 2.8 8.5
Merrill Lynch.................................. 1.3 1.8 3.1 3.1 6.2
Calyon......................................... 2.0 1.1 3.1 1.2 4.3
UBS............................................ 0.5 0.8 1.3 2.5 3.8
DZ Bank........................................ 0.1 0.7 0.8 1.0 1.8
Barclays....................................... 0.0 0.9 0.9 0.6 1.5
Bank of Montreal............................... 0.3 0.2 0.5 0.9 1.4
Royal Bank of Scotland......................... 0.4 0.2 0.6 0.5 1.1
Wachovia....................................... (0.5) 0.7 0.2 0.8 1.0
Bank of America................................ 0.1 0.2 0.3 0.5 0.8
Rabobank....................................... (0.2) 0.5 0.3 0.3 0.6
Dresdner Bank.................................. 0.0 0.0 0.0 0.4 0.4
HSBC Bank...................................... 0.0 0.2 0.2 0.0 0.2
LBW............................................ 0.0 0.0 0.0 0.1 0.1
----------------------------------------------------------------
Total...................................... $18.5 $16.5 $35.0 $27.2 $62.2
----------------------------------------------------------------------------------------------------------------
\354\ ``Pre-Govt'' refers to counterparty payments made prior to September 16, 2008. ``Post-RCF'' refers to
payments made during the period from September 16 through November 9, 2008. The Post-RCF total excludes
payments of $5.9 billion made on September 16 and thereafter to counterparties other than those that received
payments from Maiden Lane III and listed in this table.

As in the case of ML2, cash flows generated by ML3 are now
being used to pay down FRBNY's loans to the SPV.\355\ As of
March 31, 2010 (see Figure 18), the principal amount
outstanding under the FRBNY loan to ML3 had decreased to $17.3
billion from its original level of $24.3 billion, a 40 percent
reduction. Since the inception of this SPV, FRBNY has earned
$390 million in accrued and capitalized interest from its
investments in ML3. As of December 31, 2009, FRBNY had received
$1.8 million in proceeds from the sales of assets in ML3.\356\
The Federal Reserve estimates the market value of ML3 as of
March 31, 2010 at $23.7 billion, well above the outstanding
FRBNY loan balance of $17.3 billion and in excess of the total
principal balance, including the $5.2 billion AIG equity
contribution to ML3. After repayment of the loan to FRBNY,
remaining funds from ML3 will be paid 2/3 to FRBNY and 1/3 to
AIG.\357\
---------------------------------------------------------------------------
\355\ Federal Reserve System Monthly Report, supra note 339, at 17.
\356\ Federal Reserve Bank of New York, Maiden Lane III LLC
Financial Statements for the Year Ended December 31, 2009, and for the
Period October 31, 2008 to December 31, 2008, and Independent Auditor's
Report, at 7 (Apr. 21, 2010) (online at www.newyorkfed.org/aboutthefed/
annual/annual09/MaidenLaneIIIfinstmt2010.pdf).
\357\ Federal Reserve Bank of New York, AIG CDO LLC Facility: Terms
and Conditions (Dec. 3, 2008) (online at www.newyorkfed.org/markets/
aclf_terms.html).

FIGURE 18: OUTSTANDING PRINCIPAL BALANCE OF MAIDEN LANE III AS OF MARCH
31, 2010 \358\
[Dollars in billions]
------------------------------------------------------------------------
FRBNY Senior AIG
Loan Contribution Total
------------------------------------------------------------------------
Funding, November 25, 2008... $15.1 $5 $20,.1
Funding, December 18, 2009... 9.2 -- 9.2
------------------------------------------
Funding subtotal......... 24.3 5 29.3
Accrued and capitalized .390 .231 .621
interest....................
Repayments................... (7.4) -- (7.4)
------------------------------------------
Principal Balance.... $17.3 $5.2 $22.5
------------------------------------------------------------------------
\358\ Credit and Liquidity Programs and the Balance Sheet, supra note
324; Federal Reserve H.4.1 Statistical Release, supra note 342.

5. Additional Assistance and Reorganization of Terms of Original
Assistance: March and April 2009

Although ML2, ML3, and Treasury's TARP initial capital
infusion helped relieve AIG's financial pressures, asset
valuations continued to decline, and AIG's losses increased
through the end of 2008. The company reported a net loss of
$61.7 billion for the fourth quarter of 2008 on March 2, 2009,
capping off a year in which AIG incurred approximately $99
billion in total net losses. A substantial contributor to AIG's
loss was the significant loss on investment holdings of AIG's
insurance subsidiaries in the fourth quarter of 2008, which
totaled $18.6 billion pre-tax. AIGFP suffered continuing losses
of $16.2 billion as well during that quarter.
These losses raised the prospect of another round of rating
agency downgrades and collateral calls that would require
further cash postings from AIG. In response, the Federal
Reserve and Treasury announced on March 2, 2009, that they
would again restructure their existing aid to AIG and provide
additional assistance. As with the November 2008 restructuring,
this decision was driven by the recognition that AIG faced
increasing pressure on its liquidity following a downgrade in
its credit ratings and the real risk of further
downgrades.\359\ FRBNY and Treasury have stated that
restructuring was also necessary to stabilize AIG and to
protect financial markets and the existing investment.\360\
---------------------------------------------------------------------------
\359\ Testimony of Sec. Geithner, supra note 11, at 8.
\360\ See U.S. Department of the Treasury, U.S. Treasury and
Federal Reserve Board Announce Participation in AIG Restructuring Plan
(Mar. 2, 2009) (online at www.financialstability.gov/latest/tg44.html)
(hereinafter ``Participation in AIG Restructuring Plan''). See also
House Committee on Financial Services, Written Testimony of William C.
Dudley, president and chief executive officer, Federal Reserve Bank of
New York, Oversight of the Federal Government's Intervention at
American International Group, at 5 (Mar. 24, 2009) (online at
www.house.gov/apps/list/hearing/financialsvcs_dem/hr03240923.shtml).
---------------------------------------------------------------------------
Under the March restructuring, Treasury substantially
increased its involvement in AIG, with the goal of improving
AIG's financial leverage. First, Treasury announced a new five-
year standby $29.8 billion TARP preferred stock facility, which
would allow AIG to make draw-downs as needed.\361\ As AIG draws
on this facility, the aggregate liquidation preference for
Treasury's preferred stock is adjusted upward. Treasury also
exchanged its November 2008 cumulative preferred stock interest
for noncumulative preferred stock, which more closely resembles
common stock and is, therefore, more favorably looked upon by
the credit rating agencies.\362\ By relaxing the dividend
requirement on its preferred shares with no offsetting increase
in principal owed, the exchange effected a concession to AIG
and served to improve its financial leverage.
---------------------------------------------------------------------------
\361\ See Participation in AIG Restructuring Plan, supra note 360;
U.S. Department of the Treasury, Troubled Asset Relief Program
Transaction Report for Period Ending June 2, 2010, at 20 (June 6, 2010)
(online at www.financialstability.gov/docs/transaction-reports/6-4-
10%20Transactions%20Report%20as%20of%206-2-10.pdf) (creating a $30
billion facility; this facility was reduced by $165 million,
representing bonuses paid to AIG Financial Products employees).
\362\ Noncumulative preferred stock is more like common stock
largely because its dividends are non-cumulative, which means that when
the company fails to make dividend payments, the payments do not
accumulate for later payment. Participation in AIG Restructuring Plan,
supra note 360.
---------------------------------------------------------------------------
FRBNY also took several actions at this time with respect
to the terms and structure of the RCF. First, it announced the
creation of SPVs for American International Assurance Company,
Limited (AIA) and American Life Insurance Company (ALICO), two
of AIG's foreign insurance company subsidiaries, through which
AIG would contribute the equity of AIA and ALICO in exchange
for preferred and common interests in the SPVs. AIG would then
transfer the preferred interests in the SPVs to FRBNY in
exchange for a $25 billion reduction in the outstanding balance
of the RCF, to $35 billion. In doing so, FRBNY essentially
provided another bailout to AIG by purchasing these two
subsidiaries and thereby improving its balance sheet. Second,
FRBNY further relaxed the interest rate terms on amounts
borrowed under the RCF.\363\ The combined effect of these
changes was to save AIG $1 billion in interest costs per year.
While FRBNY will receive less compensation for its risk
exposure, FRBNY concluded that restructuring the terms was in
the government's long-term interest, especially in light of
AIG's continued reliance on the RCF to pay its continuing
obligations.\364\
---------------------------------------------------------------------------
\363\ As noted in Figure 1, the previous terms implemented in
November 2008 called for an interest rate of LIBOR plus 3 percent, with
a floor of 3.5 percent. In April 2009 the floor was eliminated.
\364\ See Participation in AIG Restructuring Plan, supra note 360.
---------------------------------------------------------------------------
While Treasury and FRBNY negotiated the formal terms of the
restructuring throughout March, employee retention payments at
AIGFP attracted congressional scrutiny and public
animosity.\365\ At the same time, Treasury and the Federal
Reserve Board worked with outside counsel to consider a Chapter
11 filing, as one of several options.\366\
---------------------------------------------------------------------------
\365\ See Section J, infra, for a discussion of Executive
Compensation.
\366\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
---------------------------------------------------------------------------
On April 17, 2009, AIG and Treasury executed the
restructuring and additional equity purchase announced in
March.\367\ Although the $40 billion in preferred equity was
converted into non-cumulative preferred stock, this investment
cannot be fully redeemed until AIG repays the $1.6 billion in
missed dividends associated with the preferred stock that
Treasury acquired in November 2008.\368\ Under the April 2009
purchase agreement, Treasury committed to invest up to $29.835
billion in AIG preferred stock with warrants,\369\ of which
$7.5 billion had been drawn down as of February 17, 2010.\370\
---------------------------------------------------------------------------
\367\ Specifically, the parties entered into the Series E Exchange
Agreement (to exchange Series D Cumulative Preferred Stock for Series E
Non-Cumulative Preferred Stock) and the Series F Purchase Agreement.
American International Group, Inc., Form 10-Q for the Quarterly Period
Ended March 31, 2009, at 11 (May 7, 2009) (online at www.sec.gov/
Archives/edgar/data/5272/000095012309008272/y76976e10vq.htm)
(hereinafter ``AIG Form 10-Q for the First Quarter 2009'').
\368\ U.S. Department of the Treasury, Troubled Asset Relief
Program Transactions Report for Period Ending April 14, 2010, at 18
(Apr. 16, 2010) (online at www.financialstability.gov/docs/transaction-
reports/4-16-10%20Transactions%20Report%20as%20of%204-14-10.pdf)
(hereinafter ``Treasury Transactions Report'').
\369\ On April 17, 2009, Treasury provided additional assistance to
AIG and restructured its original investment. In consideration for its
investment through the Series D preferred shares Treasury received 2
percent of the issued and outstanding common stock on the original
investment date of November 25, 2008. Following AIG's stock split on
June 30, 2009, this represented 2,689,938.3 shares and has a strike
price of $50. As part of its purchase of Series F preferred stock,
Treasury received 150 common stock warrants, representing 3,000 common
shares, with an exercise price of $0.00002. Office of the Special
Inspector General for the Troubled Asset Relief Program, Quarterly
Report to Congress, at 46 (Apr. 20, 2010) (online at www.sigtarp.gov/
reports/congress/2010/April2010_Quarterly_Report_to_Congress.pdf)
(hereinafter ``SIGTARP Quarterly Report to Congress''); Treasury
conversations with Panel staff (June 2, 2010).
\370\ This represents Treasury's commitment of $30 billion, less
$165 million ``representing retention payments AIG Financial Products
made to its employees in March 2009.'' Treasury Transactions Report,
supra note 368, at 18.
---------------------------------------------------------------------------
A summary of the Treasury's holding of preferred stock is
shown in the following table.

FIGURE 19: TREASURY'S PREFERRED SHARES IN AIG
----------------------------------------------------------------------------------------------------------------
Par Value as of
Type Date Acquired June 7, 2010 Dividend Rate Comment/Status
----------------------------------------------------------------------------------------------------------------
Series C Preferred.............. September 16, 2008 $23.8 billion..... None.............. Fully tethered to
AIG stock price
Series D Preferred.............. November 25, 2008. $0 ($1.6 billion 10 percent No longer in
is outstanding quarterly, existence;
from unpaid cumulative. exchanged for
dividends). Series E
Preferred
Series E Preferred.............. April 17, 2009.... $40.0 billion..... 10 percent Replaced Series D
quarterly, non- Preferred
cumulative.
Series F Preferred.............. April 17, 2009.... $7.5 billion...... 10 percent Par value will
quarterly, non- increase as AIG
cumulative. draws down more
funds
----------------------------------------------------------------------------------------------------------------

6. Government's Ongoing Involvement in AIG

a. Status of Further Assistance
Since the restructuring of federal assistance in March and
April 2009, there have been no further significant changes in
the government's financial support for AIG. As previously
announced in March 2009, on December 1, 2009 AIG entered into
an agreement with FRBNY to reduce the debt AIG owed FRBNY,
which on that date stood at $45.1 billion, by $25 billion.\371\
In exchange, FRBNY received $25 billion of preferred equity
interests in two SPVs that in turn held the equity of two
foreign AIG subsidiaries, AIA and ALICO. FRBNY received
preferred interests of $16 billion in the AIA SPV and $9
billion in the ALICO SPV. Dividends for these investments
accrue as a percentage of FRBNY's preferred positions and are
capitalized and added to FRBNY's preferred interests.\372\ As
of May 27, 2010, the book value of FRBNY's preferred
investments, including accrued dividends, in the AIA SPV and
the ALICO SPV are $16.4 billion and $9.2 billion,
respectively.\373\ AIG has announced that it intends to
continue positioning AIA and ALICO for either an initial public
offering or a third-party sale.\374\
---------------------------------------------------------------------------
\371\ The data for the level of the RCF at the time of the
restructuring is as of November 25, 2009. This is the last reporting
date prior to the restructuring. American International Group, Inc.,
AIG Closes Two Transactions That Reduce Debt AIG Owes Federal Reserve
Bank of New York by $25 Billion (Dec. 1, 2009) (online at
phx.corporateir.net/
External.File?item=UGFyZW50SUQ9MjE4ODl8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1)
(hereinafter ``AIG Closes Two Transactions''); Federal Reserve H.4.1
Statistical Release, supra note 342.
\372\ Federal Reserve H.4.1 Statistical Release, supra note 2.
(``Dividends accrue as a percentage of the FRBNY's preferred interests
in AIA Aurora LLC and ALICO Holdings LLC. On a quarterly basis, the
accrued dividends are capitalized and added to the FRBNY's preferred
interests in AIA Aurora LLC and ALICO Holdings LLC'').
\373\ Federal Reserve H.4.1 Statistical Release, supra note 2.
\374\ AIG Closes Two Transactions, supra note 371 (``These
transactions advance AIG's goal of positioning two of the company's
leading international life insurance franchises, American International
Assurance Company, Limited (AIA) and American Life Insurance Company
(ALICO), for initial public offerings or third party sale, depending on
market conditions and subject to customary regulatory approvals'').
---------------------------------------------------------------------------
As of May 27, 2010, the total amount of funds invested in
AIG by the United States government, through both FRBNY and the
TARP, was approximately $132.4 billion. There was $83.3 billion
provided by FRBNY outstanding as of that date across four
different initiatives. $26.1 billion was outstanding under the
RCF as of May 27, 2010, a 64 percent decrease from the
$72.3billion outstanding under the facility on October 22,
2008. ML2 and ML3 owe FRBNY $14.9 billion and $16.6 billion,
respectively. FRBNY also owns a total of $25.6 billion of
preferred interests and accrued dividends on in the AIA SPV and
the ALICO SPV. Finally, the TARP currently owns $49.1 billion
in AIG preferred stock as a result of the initial $40 billion
investment, $1.6 billion in unpaid dividends associated with
this investment, and $7.54 billion of draw-downs from the $30
billion facility provided to AIG on April 17, 2009. The value
of these holdings, and the cashflow generated by them, is
discussed in more detail in Section H below.

FIGURE 20: BREAKDOWN OF U.S. GOVERNMENT INVESTMENT IN AIG OVER TIME
\375\

---------------------------------------------------------------------------
\375\ Federal Reserve H.4.1 Statistical Release, supra note 342;
U.S. Department of the Treasury, TARP Transaction Reports (Dec. 31,
2008_May 27, 2010) (online at www.financialstability.gov/latest/
reportsanddocs.html); AIG Form 10-K for FY09, supra note 50, at 45.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

b. AIG Trust
As discussed earlier in this section, FRBNY received a 77.9
percent equity interest in AIG ``for Treasury'' \376\ in return
for providing the company with access to an $85 billion credit
facility. On January 16, 2009, FRBNY announced the formation of
a trust--called the AIG Credit Facility Trust (AIG Trust)--to
oversee this equity interest ``in the best interests of the
U.S. Treasury.'' According to the trust agreement, the trustees
must aim to dispose of this interest ``in a value maximizing
manner'' and may not dispose of the stock without receiving
approval from FRBNY, which may not grant its approval without
first consulting with Treasury.\377\
---------------------------------------------------------------------------
\376\ See discussion in Annex IV.
\377\ Federal Reserve Bank of New York, AIG Credit Facility Trust
Agreement, at 8 (Jan. 22, 2009) (online at www.newyorkfed.org/
newsevents/news/markets/2009/AIGCFTAgreement.pdf) (hereinafter ``AIG
Credit Facility Trust Agreement'').
---------------------------------------------------------------------------
FRBNY initially named three individuals to serve as
trustees: Jill M. Considine, former chairman of the Depository
Trust & Clearing Corporation; Chester B. Feldberg, former
chairman of Barclays Americas; and Douglas L. Foshee, president
and chief executive officer of El Paso Corporation. These
trustees would be able to exercise control over the shares, but
they would neither occupy a seat on the company's board nor
supervise day-to-day management of the company. In announcing
the formation of the trust, FRBNY emphasized that in order to
avoid conflicts of interest that could result from its
regulatory responsibilities, it would have no ``discretion or
control over the voting and consent rights associated with the
equity interest in AIG.'' \378\ On February 26, 2010, FRBNY
announced that Peter A. Langerman, chairman, president, and
chief executive officer of the Mutual Series fund group of
Franklin Templeton Investments, would replace Mr. Foshee.\379\
---------------------------------------------------------------------------
\378\ Federal Reserve Bank of New York, Statement Regarding
Establishment of the AIG Credit Facility Trust (Jan. 16, 2009) (online
at www.newyorkfed.org/newsevents/news/markets/2009/an090116.html). See
also AIG Credit Facility Trust Agreement, supra note 377, at 2.
\379\ See Federal Reserve Bank of New York, Statement Regarding
Appointment of New Trustee to AIG Credit Facility Trust (Feb. 26, 2010)
(online at www.newyorkfed.org/newsevents/news/markets/2010/
an100226.html).
---------------------------------------------------------------------------
AIG continues to operate with a CEO and corporate board
and, as delineated in AIG's corporate governance guidelines,
AIG management submits regular reports to its board that detail
the company's performance, as well as ``significant events,
issues and risks'' that may affect performance.\380\ The
company's Corporate Governance Guidelines also specify that the
number of seats on the board may fluctuate between eight and
12, but it permits exceptions when a larger or smaller size is
``necessary or advisable in periods of transition or other
particular circumstances.'' The board currently has 13
directors. At least two-thirds of the directors must be
independent, and these independent directors select the
chairman.\381\
---------------------------------------------------------------------------
\380\ See American International Group, Inc., Corporate Governance
Guidelines (Apr. 7, 2010) (online at www.aigcorporate.com/
corpgovernance/CorporateGovernanceGuidelines.pdf) (hereinafter ``AIG
Corporate Governance Guidelines'') (``The Board, the Finance and Risk
Management Committee and the Audit Committee receive reports on AIG's
significant risk exposures and how these exposures are managed. AIG's
Chief Risk Officer provides reports to the Compensation and Management
Resources Committee with respect to the risks posed to AIG by its
employee compensation plans'').
\381\ Id.
---------------------------------------------------------------------------
When AIG failed to pay dividends for four consecutive
quarters on preferred stock held by Treasury, Treasury received
the right to appoint two directors to the Board. It exercised
this right on April 1, 2010, appointing Donald H. Layton,
former Chairman and CEO of E*Trade and Ronald A. Rittenmeyer,
former Chairman, President, and CEO of Electronic Data
Systems.\382\
---------------------------------------------------------------------------
\382\ See U.S. Department of the Treasury, Treasury Names Two
Appointees to AIG'S Board of Directors (Apr. 1, 2010) (online at
www.ustreas.gov/press/releases/tg623.htm).
---------------------------------------------------------------------------

E. The Impact of the Rescue: Where the Money Went

The decision to force a failing institution into bankruptcy
triggers a number of rules and processes, many of which are
automatic.\383\ The claims of some creditors are stayed,\384\
and established rules let the creditors decide whether to seek
to liquidate the failing business and distribute its assets, or
to continue it as a going concern.\385\ The creditors agree to
a plan of reorganization, which is then presented to a
bankruptcy court for approval.\386\ Shareholders are wiped out,
secured creditors look to their collateral, and unsecured
creditors may suffer significant losses. The person running the
business, who may be a trustee but is more likely to be the
DIP, may seek financing from a DIP lender, whose lending has
preference over other claims.\387\ The DIP lender has
significant leverage over the business and will generally be in
a position to decide which commercial contracts will be
continued and which terminated. As discussed above and in more
detail in Annex VIII, the process is complicated for non-
depository financial institutions by the fact that certain
kinds of financial contracts are not subject to an automatic
stay, which makes bankruptcy a less complete solution for such
companies. The result of the bankruptcy process in general,
however, is that unsecured creditors are unlikely to receive
the full amount of their claims, and they will not all be
treated the same: some will do better in the process than
others.
---------------------------------------------------------------------------
\383\ The bank resolution process triggers a similar set of rules
and processes.
\384\ Parties to various ``financial contracts'' are exempt from
the automatic stay and receive certain protections including their
ability to close their contracts, exercise contractual rights such as
the ability to collect previously posted collateral, offset or net out
other obligations, and assert deficiency claims, if any. See, e.g., 11
U.S.C. Sec. Sec. 101, 362(b)(6)-(7), 362(b)(17), 362(b)(27), 362(o),
546(e)-(g), 546(j), 553, 555, 556, 559, 560, 561.
\385\ Creditors can literally force a debtor into an involuntary
bankruptcy under certain conditions. See 11 U.S.C. Sec. 303 (explaining
the process for involuntary bankruptcies). Mounting creditor claims and
collateral calls may also cause the debtor to voluntarily file for
bankruptcy and choose whether to reorganize or liquidate under Chapter
11 or whether to liquidate under Chapter 7.
\386\ See 11 U.S.C. 1129 (providing plan confirmation
requirements). It should be noted that Chapter 11 includes a ``cram
down'' provision that allows the bankruptcy court to confirm a
bankruptcy plan over the objection of some creditors in certain
circumstances (e.g., as long as one class of impaired creditors has
accepted the plan, and the plan ``does not discriminate unfairly, and
is fair and equitable'' to each class of impaired, dissenting
creditors). See 11 U.S.C. Sec. 1129(b).
\387\ Generally, if the debtor seeks, or the creditors force the
debtor into Chapter 11 bankruptcy proceedings, a trustee can be
appointed or the debtor can remain in possession of the company during
the reorganization or liquidation process. See 11 U.S.C. Sec. 1105
(providing that the court can terminate the trustee and restore the
debtor to possession); 11 U.S.C. Sec. 1107 (explaining rights, powers,
and duties of a DIP). Cf. 11 U.S.C. Sec. Sec. 701-704, 721 (explaining
that only a trustee can operate the business in Chapter 7). A DIP
usually seeks financing (a ``DIP loan'') at the outset to provide cash
or working capital during the bankruptcy proceedings and to provide
some confidence to those necessary for a successful reorganization such
as vendors, customers, and employees. The DIP lender receives a lien
that has priority over pre-bankruptcy secured creditors (upon their
consent), administrative expenses incurred during bankruptcy, and all
other claims. See 11 U.S.C. Sec. 364(c) (providing priority over
administrative expenses, which have priority over other unsecured
claims); 11 U.S.C. Sec. 364(d) (allowing a priming lien or priority
over existing liens).
---------------------------------------------------------------------------
The government's decision to rescue AIG in full rather than
consider any alternatives is discussed in more detail
below.\388\ If AIG had sought bankruptcy protection and the
government had become the DIP lender, as was the case in the
bankruptcies of the automotive companies, it would have been in
a powerful position to reorganize AIG's business and
obligations and terminate commercial contracts.\389\ It did not
do so, however, and that choice had significant consequences in
two respects.
---------------------------------------------------------------------------
\388\ For additional discussion of the government's decision to
intervene, see Section C.2.
\389\ See Congressional Oversight Panel, September Oversight
Report: The Use of TARP Funds in the Support and Reorganization of the
Domestic Automotive Industry, at 44-45, 49, 111-12 (Sept. 9, 2009)
(online at cop.senate.gov/documents/cop-090909-report.pdf) (hereinafter
``September Oversight Report'').
---------------------------------------------------------------------------
First, the choice made by the government meant that it
could no longer condition financial assistance on the
willingness of AIG's creditors to accept discounts or other
losses in performing under or closing out their contracts with
AIG.\390\ Bankruptcy law is designed to force creditors to take
discounts or other losses under extant contracts. That being
the case, the threat of bankruptcy--negotiating in the shadow
of bankruptcy--also carries enormous power. As discussed in
more detail below, the government did not use that power, with
the result that all creditors were paid in full. This issue has
received the most attention insofar as it relates to the CDS
counterparties whose holdings were purchased by ML3. Those
counterparties, however, only received $27.1 billion of the
monies that AIG and related entities received from the
government. The counterparties to other instruments and
obligations have received larger sums, in total, as a result of
the government's assistance to AIG.
---------------------------------------------------------------------------
\390\ Only in bankruptcy or equivalent proceedings can parties to a
contract be made to accept less than they are owed under a contract. If
a party does not voluntarily accept less than it is owed, then a
default under the contract exists, and the aggrieved party may sue
under the law of the jurisdiction governing the contract. Cross-default
provisions may be triggered by the default. It should be noted that at
the time of the AIG rescue, AIG was attempting to negotiate with its
creditors to reduce its obligations. These negotiations apparently
ended once creditors realized that the government was going to rescue
AIG.
---------------------------------------------------------------------------
AIG had run out of money, and it was able to make payments
under all these claims only due to the intervention of the
government. Paying less than the full amount owed would have
amounted to contractual defaults that would likely have
triggered the bankruptcy that the government was trying to
avoid.\391\ The only way to avoid this consequence would have
been for every single creditor that had a contract big enough
to trigger cross-default provisions with AIG and that the
government wished to accept concessions to agree voluntarily to
accept less than it was owed. Once the government made clear
that it was committed to the wholesale rescue of AIG, however,
as discussed in more detail in Section F, it lost the
significant leverage it might have had over the thousands of
AIG creditors. This course of action particularly benefitted
those parties that would have fared worse in a bankruptcy--
small unsecured creditors--as opposed to the ML3
counterparties, whose claims would have enjoyed a privileged
position in bankruptcy.\392\ The ML3 counterparties were not
the only, or even the largest, counterparties to AIG credit
instruments to be paid off in full.
---------------------------------------------------------------------------
\391\ A cross-default is a common provision in loan and other
credit agreements that provides that the obligor will default under the
contract in question, despite otherwise being in compliance with its
terms, if it defaults under one or more other agreements. The purpose
of the cross-default is to permit a creditor to ``accelerate'' its
claim (declare the whole amount of the loan or obligation to be due)
when the debtor starts to show signs of distress by defaulting on
another contract, so that the creditor can get in line with other
creditors and pursue its claims, rather than having to wait till
amounts on its own contracts become payable and are defaulted on. The
dollar amount at which a default will cause a cross-default is usually
set so that a cross-default will not occur inadvertently or by reason
of a non-material default.
\392\ Bankruptcy law is premised on an automatic stay to protect
the assets of the business and to hold them while negotiations take
place with creditors. This protects the failing business from the kind
of bank run that would end its life in moments and it often forces
creditors to negotiate for a substantial discount in what they are
owed. But amendments to the Bankruptcy Code in 2005 (and following some
earlier amendments as well) excerpted ``financial contracts'' from the
automatic stay. See 11 U.S.C. Sec. Sec. 362(b)(6), (b)(7), (b)(17),
(b)(27), (o) (exempting various financial participants or holders of
commodities contracts, forward contracts, securities contracts,
repurchase agreements, swap agreements, and master netting agreements
from the automatic stay). For additional discussion of the safe harbor
provisions and how they would have applied to AIG's various financial
instruments, see below as well as Section E.2 and Annex IV.
---------------------------------------------------------------------------
For example, the counterparties to AIG's securities lending
program \393\ received a much larger aggregate cash settlement
(in exchange for the return of securities borrowed from AIG)
upon closing out their positions--$43.7 billion--than the $27.1
billion that went to the ML3 counterparties; in addition, the
largest securities lending counterparty, Barclays, received
more than the largest ML3 counterparty, Societe Generale.\394\
Even when the $16.5 billion in collateral posted to the ML3
counterparties after government assistance began is included,
the amounts paid out to the two sets of counterparties are
comparable, and much less attention has been paid to payouts to
securities lending counterparties.\395\
---------------------------------------------------------------------------
\393\ See Section B.3 for additional information on AIG's
securities lending program and Annex V for general background
information on securities lending.
\394\ American International Group, Inc., AIG Discloses
Counterparties to CDS, GIA and Securities Lending Transactions (Mar.
15, 2009) (online at media.corporate-ir.net/media_files/irol/76/76115/
releases/031509.pdf) (hereinafter ``AIG Discloses Counterparties to
CDS, GIA and Securities Lending Transactions'').
\395\ This is possibly due to the nature of the collateral
arrangements; the securities counterparties were highly collateralized
and some of them were overcollateralized, as discussed in Section B.3.b
above. At the time their securities lending arrangements were closed
out, those parties thus delivered securities with a market value higher
than the cash collateral returned to them.
---------------------------------------------------------------------------
The second consequence of avoiding bankruptcy was that the
government was not immediately able to reorganize any aspect of
AIG's business. Although the government is now the controlling
shareholder of AIG and has the ability to direct its operations
(subject to the operating principles subscribed to by the
Administration for companies in which the government holds a
controlling stake),\396\ the instant rearrangement of
commercial contracts that is possible in bankruptcy was not
possible here. Thus, AIG's normal course of business, such as
putting up cash collateral for new or existing contracts
(including both CDSs that would be eventually placed into ML3
and CDSs that AIG still covers), continued, so that
counterparties to those contracts benefitted from the
government cash. For example, $22.4 billion was provided to
AIGFP to use as collateral; \397\ presumably insurance
subsidiaries were also putting up collateral, so some part of
the $20.9 billion that went to insurance subsidiaries would
have ended up as cash collateral.\398\
---------------------------------------------------------------------------
\396\ The major principles guiding Treasury's role as a shareholder
with regard to corporate governance issues are the following: (1) as a
reluctant shareholder, Treasury intends to exit its positions as soon
as practicable; (2) Treasury does not intend to be involved in the day-
to-day management of any company; (3) Treasury reserves the right to
set conditions on the receipt of public funds to ensure that
``assistance is deployed in a manner that promotes economic growth and
financial stability and protects taxpayer value''; and (4) Treasury
will exercise its rights as a shareholder in a commercial manner,
voting only on core shareholder matters. House Oversight and Government
Reform Committee, Subcommittee on Domestic Policy, Written Testimony of
Herbert M. Allison, Jr., assistant secretary for financial stability,
U.S. Department of the Treasury The Government As Dominant Shareholder:
How Should the Taxpayers' Ownership Rights Be Exercised? (Dec. 17,
2009) (online at oversight.house.gov/images/stories/
Allison_Testimony_for_Dec-17-09_FINAL_2.pdf) (hereinafter ``Written
Testimony of Herb Allison'').
\397\ AIG Discloses Counterparties to CDS, GIA and Securities
Lending Transactions, supra note 394.
\398\ See American International Group, Inc., Supplemental Earnings
Information 4Q 2008, at 2 (online at media.corporate-ir.net/
media_files/irol/76/76115/Supplemental_Earnings_Information_Q408.pdf).
---------------------------------------------------------------------------
AIG's business is international, with a third of its
revenues derived from East Asia.\399\ In its normal (pre-
rescue) business operations, to the extent that any part of
AIG's non-U.S. business could not be funded locally, they
received operating funds from the United States. As a result of
the structure of the rescue, of the $21 billion of the
government's cash that became capital contributions to AIG's
insurance companies, $4.4 billion went to non-U.S. life
insurance companies, primarily in Taiwan, Hong Kong, and Japan.
One consequence of the nature of AIG's business is that some of
the government cash ended up in the hands of counterparties
that the American public might not have supported
assisting.\400\
---------------------------------------------------------------------------
\399\ For additional information on AIG's business and corporate
structure, see Section B.2, supra.
\400\ J. Michael Sharman, Did AIG Give $70 billion of its Bailout
Money to China?, The Star Exponent (May 19, 2009) (online at
starexponent.com/cse/news/opinion/columnists/article/
did_aig_give_70_billion_of_its_bailout_money_to_china/35929/).
---------------------------------------------------------------------------
In normal circumstances, the fact that money is fungible
means that it is difficult to trace the beneficiaries of a cash
infusion to a specific company. AIG in 2008 and 2009 presents
an easier case. On a consolidated basis, the company generated
so little cash from its operating activities \401\ that nearly
all the cash that flowed out of the company can be attributed
to government intervention. AIG has published some useful
detail on the ``use of funds,'' \402\ which, combined with the
company's financial statements, the Panel has used to follow
the money to determine the ultimate recipients of government
cash. While the Panel has been able to unearth the end
recipient of government funds in some cases, the limitations of
data and contract availability have prevented the determination
of end recipients in others. The results of this exercise
appear in Annex I.
---------------------------------------------------------------------------
\401\ AIG's reported cash flows from operating activities was a
mere $755 million for the year ended December 31, 2008, compared to
$35.2 billion for the prior year. The 2008 operating cash flows were
actually adjusted in the 2009 financial statements to reflect a
negative cash flows of $(122) million. AIG Form 10-K for FY08, supra
note 47, at 197; AIG Form 10-K for FY09, supra note 50, at 199.
\402\ AIG Discloses Counterparties to CDS, GIA and Securities
Lending Transactions, supra note 394.
---------------------------------------------------------------------------

1. The Beneficiaries of the Rescue

The beneficiaries of the AIG rescue were both direct and
indirect. Some received cash that they would not otherwise have
received, and others avoided exposure to liabilities that might
otherwise have arisen.
It is impossible to itemize the benefits received by every
single AIG creditor and counterparty, but the impact of the
rescue can be gauged by dividing the beneficiaries into broad
categories. Some individual beneficiaries appear in several
different categories. Some of the beneficiaries, as noted
below, were separately recipients of TARP funds. Some
beneficiaries might have been viewed as innocent victims of the
financial crisis had AIG failed and defaulted on its
obligations to them. Others might have been viewed as
themselves contributing to the conditions that produced the
crisis. Many are non-U.S. entities. Regardless of their nature,
they all benefitted from the rescue.
AIG Insurance Company Subsidiaries: An aggregate
$20.9 billion went as capital contributions to AIG's insurance
company subsidiaries in 2008:
--$4.4 billion in total went to non-U.S. life
insurance companies, with $1.8 billion to Nan Shan in
Taiwan and the remaining amount flowing to insurance
companies in Hong Kong and Japan.\403\
---------------------------------------------------------------------------
\403\ The Panel did not have access to foreign subsidiaries'
statutory filings and therefore does not know of any capital
contributions in 2009.
---------------------------------------------------------------------------
--$16.5 billion went to U.S. life insurance
companies.
These entities were direct beneficiaries of the government
rescue. By receiving capital contributions from the government,
the foreign and domestic life insurance subsidiaries were able
to meet their obligations under the securities lending program
and avoid liquidity or solvency concerns and potential ratings
downgrades.\404\
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\404\ For example, the insurance subsidiaries benefited from
downstream payments from the parent company to provide liquidity to the
securities lending program (AIG borrowed $11.5 billion from FRBNY by
September 30, 2008 to provide liquidity to the securities lending
program) as well as from the purchase of ML2 of their interest in the
RMBS held in connection with the securities lending program. See AIG
Form 10-K for FY08, supra note 47, at 166-67, 250-51. See additional
discussion of securities lending program below. AIG's domestic
property/casualty insurance subsidiaries did not receive capital
contribution or government funds to meet obligations under the
securities lending program (they had minimal participation in the
program). Some believe, however, that the insurance subsidiaries were
sufficiently well capitalized that they would have been able to remain
operating throughout a bankruptcy, and would have been able to resolve
the securities lending issues on their own. Panel staff conversation
with New York Insurance Department (June 3, 2010). The regulators have
also asserted that, had there not been a ``run'' by securities lending
counterparties caused by the liquidity crunch at AIGFP, the
subsidiaries would have been able to slowly wind down the program on
their own, and would not have experienced the immediate liquidity need.
The regulators have also stated that the subsidiaries had a plan in
place to manage an immediate securities lending liquidity crunch on
their own, without the infusion of government funds. Panel staff
conversation with Texas Department of Insurance (May 24, 2010).
---------------------------------------------------------------------------
In 2009 AIG's life insurance subsidiaries received $1,145.2
million in capital contributions from AIG. These contributions
were made to strengthen the subsidiaries' capital position and
risk-based capital ratios. American Home Assurance Company was
the only property and casualty insurance subsidiary to receive
capital contributions in 2009, receiving $234 million from AIG
related to the sale of shares in Transatlantic Holdings,
Inc.\405\
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\405\ American Home Assurance Company, PNC Annual Statement for the
Year Ended December 31, 2009 (Feb. 25, 2010) AGC Life Insurance
Company, Annual Statement for the Year Ended December 31, 2009 (Feb.
2010); American General Life and Accident Insurance Company, Annual
Statement for the Year Ended December 31, 2009 (Feb. 13, 2010);
American General Life Insurance Company of Delaware, Annual Statement
for the Year Ended December 31, 2009 (Feb. 2010); American General Life
Insurance Company of New York, Annual Statement for the Year Ended
December 31, 2009 (Feb. 2010); American General Life Insurance Company,
Annual Statement for the Year Ended December 31, 2009 (Feb. 2010);
Delaware American Life Insurance Company, Annual Statement for the Year
Ended December 31, 2009 (2010); SunAmerica Annuity and Life Assurance
Company, Annual Statement for the Year Ended December 31, 2009 (Feb.
17, 2010); SunAmerica Life Insurance Company, Annual Statement for the
Year Ended December 31, 2009 (Feb. 17, 2010); Variable Annuity Life
Insurance Company, Annual Statement for the Year Ended December 31,
2009 (Feb. 24, 2010); Western National Life Insurance Company, Annual
Statement for the Year Ended December 31, 2009 (Feb. 24, 2010).
---------------------------------------------------------------------------
AIG's insurance subsidiaries suffered reputational harm, to
the extent that people knew that the insurance company was
related to AIG,\406\ as a result of the government intervention
and other subsequent unfavorable press (such as controversial
bonus payments). The insurance regulators have provided that
for several months, the insurance subsidiaries experienced
heightened surrender activity and declining numbers of new
customers with each release of information unfavorable to
AIG.\407\ However, the insurance subsidiaries may have avoided
a higher level of reputational harm that could have resulted
from a bankruptcy filing of the AIG parent company. As a result
of avoiding the potentially more severe reputational effects of
a parent bankruptcy, the insurance subsidiaries were able to
avoid being seized by their regulators.\408\ The subsidiaries
thus had a greater ability to retain existing insurance
customers, attract new insurance customers, and satisfy
liabilities as they came due. Their customers benefited from
the payment of their claims in full, without potentially
protracted delay and without going through the process of
obtaining new insurance coverage (cancelling existing policies
and finding suitable replacement policies), if they felt such a
change would have been necessary.
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\406\ Some of AIG's insurance subsidiaries were insulated from
reputational harm because they operated under different brand names.
This may have prevented some existing customers from making a
connection between their insurer and AIG.
\407\ Panel staff conversation with NAIC (Apr. 27, 2010).
\408\ See Eric Dinallo, What I Learned at the AIG Meltdown: State
Insurance Regulation Wasn't the Problem, Wall Street Journal (Feb. 2,
2010) (online at online.wsj.com/article/
SB10001424052748704022804575041283535717548.html) (hereinafter ``State
Insurance Regulation Wasn't the Problem'') (``If AIG had gone bankrupt,
state regulators would have seized the individual insurance companies.
The reserves of those insurance companies would have been set aside to
pay policyholders and thereby protected from AIG's creditors. However,
. . . AIG's insurance companies were intertwined with each other and
the parent company. Policyholders would have been paid, but only after
a potentially protracted delay. It would have taken time to allocate
the companies's [sic] assets''). But see, Panel staff conversation with
Texas Department of Insurance (May 24, 2010) (the regulators would not
necessarily have seized the subsidiaries, but would probably have
monitored them closely); Panel staff conversation with New York
Insurance Department (June 3, 2010) (the regulators would not have
seized the subsidiaries, because they were well capitalized).
---------------------------------------------------------------------------
State Insurance Guarantee Funds and Non-AIG
Insurance Companies: The state insurance guarantee funds were
potentially indirect beneficiaries of the rescue. If the parent
had filed bankruptcy, the insurance regulators might have
seized the insurance subsidiaries either to protect them from
the bankruptcy or because of undercapitalization. To pay off
policy holders it is likely that the receivers would have
needed to access state insurance guarantee funds. These state
funds are funded by assessments to other, solvent, insurance
companies. The assessments required to cover the large numbers
of policyholders would have likely been a significant burden on
the state guarantee funds and other insurance companies.
Holders of AIG Commercial Paper: \409\ Commercial
paper issued or guaranteed by AIG and some of its subsidiaries
\410\ appears to have been rolled over, and thus, no direct
payout was made to the holders of this commercial paper.
However, the commercial paper could not have been rolled
without government support to AIG.\411\ The commercial paper
holders received a substantial indirect benefit from the
government's intervention to the extent that they continued
rolling over the paper they held or were repaid at
maturity.\412\ AIG had $15.1 billion and $5.6 billion of
commercial paper and extendible commercial notes outstanding,
on a consolidated basis, at June 30, 2008 \413\ and September
30, 2008,\414\ respectively.
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\409\ Commercial paper is a short-term, unsecured promissory note
issued by a corporation. See Thomas K. Kahn, Commercial Paper, Economic
Quarterly, Vol. 79, No. 2, at 45-8 (Spring 2003) (online at
www.richmondfed.org/publications/research/economic_quarterly/1993/
spring/pdf/hahn.pdf).
\410\ AIG Funding, Inc. issued commercial paper guaranteed by AIG
to provide short-term funding to AIG and its subsidiaries. Some of
AIG's other subsidiaries--such as International Lease Finance
Corporation (ILFC), American General Finance (AGF), and AIG Consumer
Finance Group (AIGCFG)--also issued commercial paper, but it was not
guaranteed by AIG. See AIG Form 10-Q for the Second Quarter 2008, supra
note 177, at 97-100. ILFC, AGF, and AIG maintained committed, unsecured
revolving credit facilities to support the commercial paper programs,
but ILFC and AGF had drawn the full amount of credit available in
September 2008. See AIG Form 10-Q for Third Quarter 2008, supra note
23, at 50, 58, 133.
\411\ AIG, like other issuers of commercial paper, also benefitted
from the Federal Reserve's Commercial Paper Funding Facility (CPFF),
which was designed to backstop the commercial paper market by
purchasing three-month unsecured commercial paper directly from
eligible issuers. For additional discussion of the CPFF, see Section
D.1. See also Congressional Oversight Panel, November Oversight Report:
Guarantees and Contingent Payments in TARP and Related Programs, at 30
(Nov. 6, 2009) (online at cop.senate.gov/documents/cop-110609-
report.pdf) (hereinafter ``November Oversight Report'').
\412\ The amount of relief would have depended on whether ILFC,
AGF, and AIG Consumer Finance Group (AIGCFG) also filed for bankruptcy.
Presumably, they would have because if they had not, they would likely
have been unable to roll over their commercial paper and would have
remained liable for their commercial paper obligations as they came
due. If all AIG subsidiaries that issued commercial paper had filed for
bankruptcy, then all of their commercial paper debt holders would have
been treated as unsecured creditors. If ILFC and AGF had not filed, it
is not clear that their commercial paper holders would have fared
better even though they would not have been subject to the discount
negotiated for unsecured creditors, at least not without direct or
indirect government assistance. ILFC and AGF would likely not have been
able to meet their commercial paper obligations as they came due
considering that they had drawn the full amount of available credit in
the committed, unsecured revolving credit facilities to meet previous
obligations. AIG's guarantee of commercial paper issued by AGF is an
executory contract that would have been rejected during the bankruptcy
and would have provided no recourse to the commercial paper holders.
See 11 U.S.C. 365.
\413\ AIG Form 10-Q for the Second Quarter 2008, supra note 177, at
2, 96. Of the total $15.1 billion outstanding at June 30, 2008, AIG
Funding had $5.8 billion, ILFC had $4.6 billion, AGF had $3.9 billion,
AIGCFG had $0.3 billion, and AIG Finance Taiwan Limited had $0.003
billion outstanding. Id. at 96.
\414\ See AIG Form 10-Q for Third Quarter 2008, supra note 23, at
2, 129. Of the total $5.6 billion outstanding at September 30, 2008,
AIG Funding had $1.944 billion, ILFC had $1.562 billion, AGF had $1.918
billion, AIGCFG had $0.168 billion, and AIG Finance Taiwan Limited had
$0.008 billion outstanding. Id. at 129.
---------------------------------------------------------------------------
Holders of Other AIG Debt: $2.1 billion was
received in principal and interest by holders of other AIG
debt, who became direct beneficiaries of the government rescue.
Total borrowings issued or guaranteed by AIG at June 30, 2008
amounted to $110 billion, with an additional $67 billion not
guaranteed. AIG's debt includes notes, bonds, junior
subordinated debt, loans, and mortgages payable. AIG guarantees
debt issued by AIGFP, AIG Funding, Inc's commercial paper,
AIGLH notes and bonds payable, and liabilities connected with
the trust preferred stock. The non-guaranteed debt includes
that issued by ILFC, American General Finance (AGF), AIGCFG,
and other subsidiaries. AIG borrowed $500 million in unsecured
funds in October 2007 from a third party bank, and this amount
was outstanding as of June 30, 2008 and scheduled to mature in
October 2008. AIG, ILFC, and AGF also maintain committed,
unsecured syndicate revolving credit facilities to support
their commercial paper programs and other general corporate
purposes.\415\
---------------------------------------------------------------------------
\415\ AIG Form 10-Q for the Second Quarter 2008, supra note 177, at
96-102.
---------------------------------------------------------------------------
Repo Counterparties: AIG's outstanding repurchase
agreements were approximately $9.7 billion and $8.4 billion as
of June 30, 2008 and September 30, 2008, respectively.\416\
AIG's repurchase agreement transactions were concentrated at
AIGFP and were utilized as a method to support the company's
liquidity, although the market significantly contracted during
2008. AIG refused to provide the identity of the counterparties
to the repurchase agreements.\417\
---------------------------------------------------------------------------
\416\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 2;
AIG Form 10-Q for the Second Quarter 2008, supra note 177, at 2.
Repurchase, or repo, agreements are a form of short-term borrowing and
are treated as collateralized financing transactions in most instances.
Repo agreements involve the sale of securities to investors with the
agreement to buy them back at a higher price after a set time period,
which is often overnight. The buy back exchange often involves
securities considered equivalent to the original securities sold, with
the specific characteristics necessary to be considered ``equivalent''
defined within the terms of each repo agreement (e.g., part of the same
issue, identical in type and nominal value). Reverse Repurchase
agreements are the purchases of securities with the agreement to sell
them at a higher price at a specified future date.
\417\ Panel staff conversation with AIG (June 3, 2010).
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Holders of AIGFP Debt: Holders of AIGFP debt were
direct beneficiaries of the government rescue, receiving cash
for interest and principal. $12.5 billion was paid to holders
of AIGFP debt.\418\ Total AIGFP borrowings, all guaranteed by
AIG, at June 30, 2008 equaled $54 billion. AIGFP's debt
included GIAs, notes, bonds, loans, mortgages payable, and
hybrid financial instrument liabilities.\419\
---------------------------------------------------------------------------
\418\ This amount includes what AIG classified as payments on
``maturing debt & other.'' AIG Discloses Counterparties to CDS, GIA and
Securities Lending Transactions, supra note 394.
\419\ AIG Form 10-Q for the Second Quarter 2008, supra note 177, at
96.
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Securities Lending Counterparties: Securities
lending counterparties were direct beneficiaries of the rescue,
as AIG returned the cash collateral they had delivered against
the securities they borrowed. $43.7 billion was paid to
securities lending counterparties, which were a variety of U.S.
and international (primarily European) banks. The largest
beneficiaries in this category were Barclays ($7.0 billion),
Deutsche Bank ($6.4 billion), BNP Paribas ($4.9 billion),
Goldman Sachs ($4.8 billion) \420\ and Bank of America ($4.5
billion).\421\ In return, the securities lending counterparties
delivered the borrowed securities. As discussed above, in many
cases AIG was undercollateralized in relation to the securities
lending counterparties, who thus returned securities with a
greater market value than the collateral that was returned to
them.\422\
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\420\ Goldman Sachs received $10 billion through the TARP Capital
Purchase Program.
\421\ Bank of America received $25 billion, with $15 billion
related to Merrill Lynch included due to the merger between the two
entities, through the TARP Capital Purchase Program, and received $20
billion through the TARP TIP. The only other TARP recipients among the
securities lending counterparties were Merrill Lynch ($1.9 billion;
recipient of $15 billion of TARP funds included in Bank of America
total), Citigroup ($2.3 billion; total TARP assistance of $20 billion
from TIP and $25 billion from CPP) and Morgan Stanley ($1.0 billion;
recipient of $10 billion of TARP funds).
\422\ See additional discussion of securities lending
counterparties at Section E.2.
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ML3 Counterparties: The ML3 counterparties were
direct beneficiaries of the government rescue. They received
government cash from two separate channels. As discussed above,
$27.1 billion was paid to the ML3 counterparties for the CDOs
that were placed into ML3. This money was channeled from the
government through ML3. In addition, prior to the ML3
transaction, the counterparties received $22.5 billion in
collateral directly from AIG as a direct result of government
intervention.\423\ The CDS counterparties were also benefited
by the continuation of the CDS contracts, which would have been
extraordinarily expensive to replace in light of the collapse
of the CDO market.
---------------------------------------------------------------------------
\423\ SIGTARP Report on AIG Counterparties, supra note 246, at 15.
---------------------------------------------------------------------------
--Some of those counterparties (Goldman, for example)
were acting as market intermediaries with respect to
the underlying CDOs or reference securities for the CDS
contracts.\424\ The actual benefit those second-level
counterparties received from closing out their CDS
contracts as part of the ML3 transaction would depend
upon their view of the future direction of any
reference securities that they held and the extent to
which the first-level counterparties were able to make
good on the second-level CDSs if AIG had failed to
deliver on the first-level CDSs. Within the limitations
of the fungibility of money, government cash flowed to
these second-level counterparties upon closing out
their CDSs. It should be noted that the details of the
transactions with the second-level counterparties have
not been made available to the Panel. The terms upon
which the first-level counterparties closed out their
contracts with the second-level counterparties could
very well have differed from the terms upon which the
first-level counterparties closed out their contracts
with AIG, and the first-level counterparties may have
been able to make a profit on that transaction. The
mechanics for closing out these transactions is set out
in more detail in Annex III.
---------------------------------------------------------------------------
\424\ The counterparties that the Panel has spoken to who were
acting as intermediaries have not identified their own counterparties.
See discussion of Goldman's position in more detail in Section F.5.
---------------------------------------------------------------------------
--Looking at the ML3 transactions as a whole over
time, the net effect of letting the counterparties keep
the collateral already posted and then be paid ``market
value'' (roughly speaking, the notional value of the
CDOs minus the collateral posted) is that AIG and its
controlling shareholder, the U.S. government, together
paid a total of par, the principal amount of those
CDOs, for them at a time when by definition they were
worth only the market value paid upon closeout of the
CDS contracts.
--Some of the counterparties had taken out additional
protection against an AIG failure in the form of CDSs
and other hedges on AIG itself. These counterparties
included Goldman.\425\ At least some of these CDSs on
AIG (including those held by Goldman) required the
posting of collateral. Upon closing out the ML3 CDSs,
the counterparties would be able to close out their AIG
protection and return any collateral to the providers
of such protection, who would thus no longer be exposed
to the risk of AIG's failure, and were thus indirect
beneficiaries of the government rescue. Goldman
declined to provide the Panel with the names of
entities writing this protection.
---------------------------------------------------------------------------
\425\ See discussion of Goldman's position in more detail in
Section F.5.
---------------------------------------------------------------------------
Other CDS Counterparties:
--Regulatory Capital Swap Counterparties: As
discussed in Section B3, supra, numerous European banks
entered into CDSs with a France-based subsidiary of
AIGFP in order to decrease the amount of regulatory
capital they were required to hold. Unlike the CDSs on
CDOs, these swaps were not terminated as part of the
government rescue. As a result, the benefits that the
counterparties received came not in the form of cash
but rather in the continuation of contracts that led to
more favorable regulatory treatment in the
counterparties' home countries. In other words, the
banks avoided having to raise additional capital or
sell assets, as they might have had to do if AIG had
filed for bankruptcy.
AIG has declined to release the full list of counterparties
to these trades, citing confidentiality laws, but the Panel has
obtained a copy of a list as of October 1, 2008 from FRBNY.
This document lists the top seven counterparties on these
trades as Dutch bank ABN AMRO ($56.2 billion notional
exposure),\426\ Danish bank Danske ($32.2 billion notional
exposure), German bank KFW ($30 billion notional exposure), and
French banks Credit Logement ($29.3 billion notional exposure),
Calyon ($24.3 billion notional exposure), BNP Paribas ($23.3
billion notional exposure) and Societe Generale ($15.6 billion
notional exposure).\427\
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\426\ In 2007, a consortium of Royal Bank of Scotland (RBS), Banco
Santander, and Fortis purchased ABN AMRO, which was split into pieces.
Then on October 3, 2008, less than three weeks after the U.S.
government's bailout of AIG, the Dutch government nationalized Fortis'
share of ABN AMRO. Fortis, Fortis Statement on Transaction with the
Government of the Netherlands (Oct. 3, 2008) (online at
www.holding.fortis.com/Documents/UK_PR_Fortis_03102008.pdf); Ageas,
Ageas and ABN AMRO (online at www.holding.fortis.com/en/Pages/
fortis_and_abn_amro.aspx) (accessed June 8, 2010). The documents
reviewed by the Panel do not shed light on specifically how an AIG
default on its regulatory capital swaps would have impacted RBS, Banco
Santander, and Fortis, though in early 2009, AIG did identify RBS and
Banco Santander as banks with exposure to its regulatory capital swaps
book. AIG Presentation on Systemic Risk, supra note 92, at 18.
\427\ Reg Capital Arb, E-mail from Paul Whynott, Federal Reserve
Bank of New York, to Alejandro LaTorre, vice president, Federal Reserve
Bank of New York (Nov. 4, 2008) (FRBNY-TOWNS-R1-188408).
---------------------------------------------------------------------------
Based on the capital rules under which these banks were
operating in 2008, the loss of credit protection for ABN AMRO
would have resulted in an estimated impact on its regulatory
capital in the amount of $3.6 billion; \428\ this means that
had AIG filed for bankruptcy, ABN AMRO would have needed to
raise an additional $3.6 billion in order to maintain its
current regulatory capital ratios. For Danske and KFW, the
estimated impact would have been around $2.1 billion each. For
Credit Logement, it would have been about $1.9 billion.\429\
Altogether, as of October 1, 2008, the banks that entered into
these trades with AIGFP obtained an estimated $16 billion in
capital relief, as shown in Figure 21.
---------------------------------------------------------------------------
\428\ Under Basel I, banks were required to hold 8 percent capital
against assets such as corporate loans that were assigned a 100 percent
risk weighting. But when AIGFP's regulated bank provided credit
protection, the risk weighting fell to 20 percent, and the banks were
only required to hold 8 percent capital against the 20 percent weighted
value of the loans, which equaled 1.6 percent of the assets. The
difference between these two regulatory treatments, 6.4 percent of the
assets, was the amount that the banks did not have to hold as capital
as a result of the AIGFP swaps. The regulatory capital relief would be
less for assets that would otherwise receive a risk weighting of less
than 100 percent under Basel I.
\429\ It is impossible to calculate the exact capital charges
avoided by these banks without knowing the risk weighting of each
underlying asset that received credit protection from AIGFP. The
calculations here reflect the methodology that AIG and FRBNY used to
calculate the exposure that the counterparties would have had in a
bankruptcy. Whether losing this cushion would have resulted in
inadequate regulatory capital (and thus a need to raise capital or sell
assets in a volatile market) depends on the extent to which each bank
was over-capitalized, and the extent to which their other assets lost
value.

FIGURE 21: LARGEST COUNTERPARTIES FOR AIGFP REGULATORY CAPITAL SWAPS AS
OF OCTOBER 1, 2008 \430\
[Dollars in billions]
------------------------------------------------------------------------
Estimated Capital
Counterparty Notional Amount Relief
------------------------------------------------------------------------
ABN AMRO (Netherlands)............ $56.0 $3.5
Danske (Denmark) \431\............ 32.2 2.1
KFW Bank (Germany)................ 30.0 1.9
Credit Logement (France).......... 29.3 1.9
Calyon (France)................... 24.3 1.6
BNP Paribas (France).............. 23.3 1.5
Societe Generale (France)......... 15.6 1.0
Other counterparties.............. 38.9 2.4
-------------------------------------
Total......................... $249.9 $16.0
------------------------------------------------------------------------
\430\ Reg Capital Arb, E-mail from Paul Whynott, Federal Reserve Bank of
New York, to Alejandro LaTorre, vice president, Federal Reserve Bank
of New York (Nov. 4, 2008) (FRBNY-TOWNS-R1-188408).
\431\ The Panel attempted to quantify the impact that the loss of this
credit protection would have had on capitalization of seven
counterparties listed in Figure 21. Infra note 428. For most of the
banks listed there, third-quarter 2008 data on tier 1 capital were not
available, but for Danske they were available. Danske had a tier 1
capital ratio of 10.0 percent in the third quarter of 2008, based on
tier 1 capital of $17.8 billion and risk-weighted assets of $176.9
billion. If Danske had lost its credit protection from AIGFP, its risk-
weighted assets would have risen by $25.8 billion, and its tier 1
capital ratio would have fallen to 8.8 percent. These calculations
rely on the same assumptions the Federal Reserve used in calculating
the capital relief for each of the seven banks in Figure 21 See infra
429, for more about these assumptions. Data provided by Danske Bank to
the Panel (May 21, 2010).

It is impossible to know, however, how the bank regulators
in various European countries would have responded to this
problem in September 2008. Given the extreme market unrest, and
the difficulties banks would have had raising capital at that
time, it seems possible that some countries would have granted
forbearance to their banks. FRBNY officials say they did not
consult European regulators about the consequences of a
bankruptcy prior to the Federal Reserve's decision to rescue
AIG,\432\ and the Federal Reserve's reluctance to discuss with
European regulators the impact of an AIG bankruptcy on European
banks continued until at least late October 2008.\433\ But a
memo circulated within FRBNY over the weekend of September 14-
15 noted that forbearance by the European regulators could
address the problem.\434\ On the other hand, it is certainly
possible that the European regulators would have taken a tough
stance, in which case their options included seizure, which
would have amounted to bailouts by European governments;\435\
it is also possible that the various banking regulators in
different countries would have had different reactions.
---------------------------------------------------------------------------
\432\ FRBNY conversation with the Panel (May 11, 2010). FRBNY
apparently remained reluctant to discuss AIG's regulatory capital swap
portfolio even after establishing the $85 billion line of credit. See
Federal Reserve Bank of New York draft memo, Systemic Risks of AIG
(Oct. 24, 2008) (FRBNY-TOWNS-R1-122617) (``To avoid shouting ``Fire!''
in a crowded theater, we have not approached the European regulators to
quantify the capital relief more precisely'').
\433\ See Federal Reserve Bank of New York draft memo, Systemic
Risks of AIG (Oct. 24, 2008) (FRBNY-TOWNS-R1-122617) (``To avoid
shouting ``Fire!'' in a crowded theater, we have not approached the
European regulators to quantify the capital relief more precisely.'').
\434\ Pros and Cons on AIG Lending, E-mail and attachments from
Alejandro LaTorre, assistant vice president, Federal Reserve Bank of
New York (Sept. 14, 2008) (FRBNYAIG00496-505).
\435\ KFW Bank is a government-owned bank, 80 percent owned by the
German government and 20 percent owned by federal states in Germany, so
the German taxpayers are responsible for its losses in any case. See
KfW Bankengruppe, Our Group (online at www.kfw.de/EN_Home/
KfW_Bankengruppe/Our_Group/index.jsp).
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GIA Counterparties: $12.1 billion of the
government's money ended up in the hands of municipalities and
state agencies that had GIAs with AIGFP.\436\ Municipalities
raising funds through bond and note issuances for public works
projects do not need access to all of the funds immediately.
They would thus lend the money to AIGFP under GIAs. AIGFP used
the proceeds from GIA issuances to invest in a diversified
portfolio of securities, including trading, available-for-sale,
those purchased under agreement to resell, and derivative
transactions. The proceeds from the disposal of these
securities were then used to fund maturing GIAs, other AIGFP
debt obligations, or new investments.\437\ GIAs are generally
not collateralized, but many of AIGFP's GIAs required the
posting of collateral or allowed the obligations to be called
at various times prior to maturity at the option of the
counterparties (for example, because of a rating downgrade).
AIG guaranteed the obligations of AIGFP under GIA
borrowings.\438\ Recipients of payments under AIGFP's GIAs, who
benefitted directly from the government rescue, included
California ($1.02 billion), Virginia ($1.01 billion) and Hawaii
($0.77 billion). Indirect beneficiaries of the government funds
include the projects that the GIA counterparties fund,
including affordable housing grants and complexes, college
tuition savings plans and student loans, fire stations, and
military housing.\439\
---------------------------------------------------------------------------
\436\ For AIGFP, a guaranteed investment agreement (GIA) is the
same as a guaranteed investment contract (GIC) (the terms are used
interchangeably). Panel staff conversation with AIG (May 27, 2010).
\437\ See AIG Form 10-K for FY08, supra note 47, at 158.
\438\ See AIG Form 10-K for FY08, supra note 47, at 51, 59, 277;
AIG Form 10-Q for Third Quarter 2008, supra note 23, at 132, 134; AIG
Form 10-Q for the Second Quarter 2008, supra note 177, at 40, 98, 101.
\439\ See, e.g., Colorado Housing and Finance Authority, What Is
CHFA? (online at chfainfo.com) (accessed June 8, 2010).
---------------------------------------------------------------------------
Holders of Stable Wrap Contracts: Trustees and
investment managers of defined contribution plans held
approximately $38 billion of stable value wrap contracts.
Stable value funds, a type of highly liquid investment only
offered in defined contribution and tuition assistance plans,
are designed to provide a high quality, fixed income portfolio
with a wrap contract to allow for the stability of a money
market but greater potential return. Wrap contracts for stable
value funds allow for the maintenance of principal and benefit
payments and participant investment transfers at book or
contract value by guaranteeing the participant's fund liquidity
at book, or initial investment, value. Gains and losses on the
fund assets are smoothed through amortized adjustments to
future benefit credits by the insurance company of financial
institution providing the wrap contract. When market value
falls below book value, the wrap contract requires the wrap
provider to make up the difference in the case of participant
withdrawal; when the reverse occurs, the insurance provider
maintains the excess for potential future losses.\440\ These
contracts allow workers to withdraw their pension funds at book
value as opposed to market value in times of market
dislocation, thus avoiding any loss of book value due to market
deterioration. While only a small amount of government funds
was used to make payments under these wrap contracts, the
pension plans holding the wrap contracts benefitted
significantly from not losing this insurance.\441\
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\440\ If there is a difference between the book and market values
of a stable value fund due to external circumstances, such as a rapid
decline in interest rate benchmarks, the wrap investment contract will
typically close the difference between the book and market values.
These investments are not mutual funds. See Stable Value Investment
Association, Employee Benefits Plans Stable Value Concurrent Sessions,
at 13 (May 11, 2010).
\441\ During the time leading up to the rescue, the government
considered providing government backing to these contracts if AIG had
not been rescued wholesale. Proposal to Insulate Retail Impact of AIGFP
Failure, supra note 251.
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Employees and Contractors: To the extent that cash
flowed into the company through operations and government
funds, employees, suppliers, and contractors were paid in the
normal course of business.
As noted throughout this section, some of the beneficiaries
of the AIG rescue were also recipients of TARP funds
themselves. Goldman Sachs, Bank of America, and Merrill Lynch
received an aggregate of $12.9 billion, $5.2 billion, and $6.8
billion, respectively, in government funds as AIGFP CDS
counterparties, recipients of ML3 payments, and securities
lending counterparties. Effectively Bank of America received
$12.0 billion when factoring in its merger with Merrill Lynch.
Citigroup received $2.3 billion solely as a result of its being
a securities lending counterparty. Wachovia received a total of
$1.5 billion as a CDS counterparty and recipient of ML3
payment, and Morgan Stanley received $1.2 billion as a CDS and
securities lending counterparty. JP Morgan is the TARP-
recipient bank to obtain the least amount of government funds
from AIG, receiving $0.4 billion as a CDS counterparty. The top
ten AIG counterparties were the recipients of $72.2 billion of
the government funds received by the company. The following are
the top ten recipients: Goldman Sachs ($12.9 billion), Societe
Generale ($11.9 billion), Deutsche Bank ($11.8 billion),
Barclays ($7.9 billion), Merrill Lynch ($6.8 billion),\442\
Bank of America ($5.2 billion), UBS ($5.0 billion), BNP Paribas
($4.9 billion), HSBC ($3.5 billion), and Calyon ($2.4 billion).
Though these ten counterparties account for over half of the
government funds received by AIG, there were countless other
recipients through GIAs, debt obligations, and the remaining
CDS and securities lending counterparties.
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\442\ As noted earlier, when accounting for the merger between
Merrill Lynch and Bank of America, the funds received from AIG amount
to $12.0 billion, the second highest amount received.
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2. How the Beneficiaries Would Have Fared in Bankruptcy

In order to assess the consequences of the decision to
rescue AIG, the Panel considered what might have happened, in
general terms, to these various constituencies if AIG had filed
for bankruptcy.
AIG Insurance Company Subsidiaries: As indicated
above, insurance companies are not allowed to file for
bankruptcy,\443\ and the impact on the insurance subsidiaries
from a parent company bankruptcy would depend on a variety of
factors and how these factors influenced the actions of their
insurance regulators.\444\ Whether the insurance regulators
took informal action (such as heightened supervision) or more
formal action (some form of seizure or receivership) would have
depended on the bankruptcy's impact on the insurance
subsidiaries' books of business (for example, whether current
policyholders took their business elsewhere), the subsidiaries'
ability to attract new policyholders, and the ability of the
state insurance funds to satisfy liabilities after the
insurance subsidiaries' assets had been exhausted, if
necessary. It would also depend on the existence of
intercompany lending arrangements or guarantees and the impact
of the securities lending program on the solvency or financial
health of the subsidiaries.\445\ The ultimate question is
whether AIG would be able to preserve the value of the
insurance subsidiaries and whether the insurance subsidiaries
continued to maintain sufficient assets to pay their
policyholders.\446\ Around the time of the rescue, the
insurance regulators stated that the insurance subsidiaries
were solvent.\447\ They have since explained that, because the
subsidiaries were well-capitalized, they would not necessarily
have seized them in the event of a parent bankruptcy and that
they would have taken into consideration the factors described
above when determining whether they needed to take regulatory
action to protect the subsidiaries and their
policyholders.\448\
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\443\ 11 U.S.C. 109(b)(2).
\444\ The shares of an insurance company are in the estate of the
bankrupt holding company and can be sold if the relevant regulator
consents. In AIG's case of course, the shares were pledged as
collateral for the Revolving Credit Facility and are being sold in any
event to repay the government.
\445\ See, e.g., AIG Form 10-Q for Third Quarter 2008, supra note
23, at 126-27 (``AIG's Domestic Life Insurance and Retirement Services
companies have three primary liquidity needs: the funding of
surrenders; returning cash collateral under the securities lending
program; and obtaining capital to offset other-than-temporary
impairment charges''). AIG believed that the insurance subsidiaries had
sufficient resources to fund surrenders, but significant capital
contributions were made in the first nine months of 2008 to provide
liquidity to the securities lending pool to fund securities lending
payables and to the insurance subsidiaries to offset reductions in
capital due to significant other-than-temporary impairment charges. Id.
The need for capital infusions suggests that securities lending
obligations could have resulted in liquidity or solvency concerns for
some of AIG's insurance subsidiaries.
\446\ For additional discussion of the potential impact on AIG's
insurance subsidiaries from a parent company bankruptcy and of the
various options available to the insurance regulators, see Annex VIII.
\447\ Written Testimony of Eric Dinallo, supra note 289.
\448\ Panel staff call with National Association of Insurance
Commissioners (Apr. 27, 2010). The NY insurance regulators have
provided Executive Life of New York as an example of seizure not being
automatic for solvent insurance subsidiaries upon the bankruptcy filing
of the holding company but later becoming necessary; the NY insurance
regulators seized Executive Life of New York insurance subsidiaries
several months after the parent company bankruptcy filing because a run
on the insurance subsidiaries had developed. Panel staff conversation
with New York State Insurance Department (June 3, 2010).
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State Insurance Funds and Non-AIG Insurance
Companies: Since insurance subsidiaries cannot seek bankruptcy
protection, state insurance regulators would have had to
address any insolvent or illiquid insurance subsidiaries
through their resolution tools and use state insurance funds to
satisfy liabilities to policyholders in excess of the value of
their assets. To the extent that an insurance subsidiary was
undercapitalized,\449\ state insurance regulators--and state
insurance guarantee funds--would have had to step in. If that
turned out to be the case, an AIG bankruptcy could have
affected all of the non-AIG insurance companies that would have
been assessed to replenish or expand state insurance
funds.\450\
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\449\ See discussion of state insurance company oversight in
Section B.2 above.
\450\ It should be noted that state insurance guarantee funds carry
statutory caps on the amounts that can be assessed annually from
solvent insurers. See, e.g., Tex. Insur. Code 463.153(c). Because of
AIG's size, it is likely that guarantee fund assessments would have
reached these caps. Panel staff conversation with Debra Hall, expert in
insurance receivership (May 14, 2010); Panel staff conversation with
David Merkel, insurance actuary (May 18, 2010).
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Holders of AIG Commercial Paper: If AIG had filed
for bankruptcy, its commercial paper would not have been rolled
over, that is, the parent company and subsidiaries would have
been unable to access the commercial paper market for short-
term funding absent government support. Because AIG's
commercial paper debt was unsecured, the holders would have
been subject to the substantial discount negotiated for
unsecured creditors in a bankruptcy plan and might have
received next to nothing for their unsecured claims. Thus, the
commercial paper debt holders received a substantial indirect
benefit by AIG's avoidance of bankruptcy.\451\
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\451\ The amount of the benefit would have depended on whether
ILFC, AGF, and AIGCFG also filed for bankruptcy. Presumably, they would
have because if they did not, they would likely have been unable to
roll over their commercial paper and would remain liable for their
commercial paper obligations as they came due (without the guarantee of
the parent company, which would have been rejected during the
bankruptcy).
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Parties to AIG Repo Funding: If AIG had filed for
bankruptcy, the parties to AIG's repurchase (``repo'')
agreements would have benefited from safe harbor provisions in
the bankruptcy code giving them additional protection or
favorable treatment.\452\ Counterparties ``to any repurchase
agreement'' are exempted from the automatic stay that prevents
creditors from taking action to collect on their debts after
the bankruptcy filing.\453\ The repo participants are
specifically allowed to exercise any contractual right to cause
the liquidation, termination, or acceleration of their
repurchase agreements based on the bankruptcy filing.\454\ If
the repo participants liquidate one or more repurchase
agreements and have agreed to deliver the assets subject to the
repurchase agreements to the debtor, they will be able to keep
the market prices received to the extent of the stated
repurchase prices; any excess as well as the liquidation
expenses will be considered property of the estate subject to
the normal rights of setoff.\455\ Thus, the effect of an AIG
bankruptcy filing on parties to AIG's repurchase agreements
would have been minimal. Because of the nature of repurchase
agreements, the counterparties would have been fully secured or
collateralized.\456\
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\452\ This discussion also applies to a bankruptcy filing by AIGFP;
AIGFP obtained funding for its operations, in part, through repurchase
agreements. See AIG Form 10-K for FY08, supra note 47, at 51.
\453\ See 11 U.S.C. 362(b)(7) (providing that a bankruptcy filing
does not operate as stay ``of the exercise by a repo participant or
financial participant of any contractual right . . . under any security
agreement or arrangement or other credit enhancement forming a part of
or related to any repurchase agreement, or of any contractual right . .
. to offset or net out any termination value, payment amount, or other
transfer obligation arising under or in connection with 1 or more such
agreements, including any master agreement for such agreements''). The
term ``repo participant'' is defined broadly to include any entity that
had an outstanding repurchase agreement with the debtor. 11 U.S.C.
101(46). The term ``repurchase agreement'' is also broadly defined to
include agreements ``for the transfer of one or more certificates of
deposit, mortgage related securities . . ., mortgage loans, interests
in mortgage related securities or mortgage loans, eligible bankers'
acceptances, qualified foreign government securities . . ., or
securities that are direct obligations of, or that are fully guaranteed
by, the United States or any agency of the United States against the
transfer of funds by the transferee of such certificates of deposit,
eligible bankers' acceptances, securities, mortgage loans, or
interests, with a simultaneous agreement by such transferee to transfer
to the transferor thereof certificates of deposit, eligible bankers'
acceptance, securities, mortgage loans, or interests of the kind
described in this clause, at a date certain not later than 1 year after
such transfer or on demand, against the transfer of funds'' (as well as
reverse repurchase agreements). 11 U.S.C. 101(47). See also 11 U.S.C.
362(b)(27) (providing the same protection to parties to repurchase
agreements under master netting agreements).
\454\ See 11 U.S.C. 362(b)(7); 11 U.S.C. 559 (``The exercise of a
contractual right of a repo participant or financial participant to
cause the liquidation, termination, or acceleration of a repurchase
agreement because of a condition of the kind specified in section
365(e)(1) of this title [including a bankruptcy filing] shall not be
stayed, avoided, or otherwise limited by operation of any provision of
this title . . .''). See also 11 U.S.C. 362(b)(27); 11 U.S.C. 561
(providing the same protection to parties with various repurchase
agreements under a master netting agreement). For the purposes of this
section. the term ``contractual right'' is specifically defined to
include ``a right set forth in a rule or bylaw of a derivatives
clearing organization . . ., a multilateral clearing organization . .
., a national securities exchange, a national securities association, a
securities clearing agency, a contract market designated under the
Commodity Exchange Act, a derivatives transaction execution facility
registered under the Commodity Exchange Act, or a board of trade . . .
or in a resolution of the governing board thereof and a right, whether
or not evidenced in writing, arising under common law, under law
merchant or by reason of normal business practice.'' 11 U.S.C. 559.
\455\ See 11 U.S.C. 559 (``In the event that a repo participant or
financial participant liquidates one or more repurchase agreements with
a debtor and under the terms of one or more such agreements has agreed
to deliver assets subject to repurchase agreements to the debtor, any
excess of the market prices received on liquidation of such assets (or
if any such assets are not disposed of on the date of liquidation of
such repurchase agreements, at the prices available at the time of
liquidation of such repurchase agreements from a generally recognized
source or the most recent closing bid quotation from such a source)
over the sum of the stated repurchase prices and all expenses in
connection with the liquidation of such repurchase agreements shall be
deemed property of the estate, subject to the available rights of
setoff'').
\456\ For additional explanation of repurchase agreements, see
Section E.1 above.
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Holders of Other AIG or AIGFP Debt: \457\ If AIG
and AIGFP had filed for bankruptcy, their creditors would have
been protected to the extent that their claims were
secured.\458\ To the extent that the creditors were unsecured
or undersecured, they would have been subject to the
substantial discount negotiated in the bankruptcy plan and, as
a result, would have incurred substantial losses. Thus,
unsecured (and undersecured) creditors received a significant
indirect benefit from the government's decision to rescue
AIG.\459\
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\457\ For additional information on the holders of AIG and AIGFP
debt, see Section E.1 above.
\458\ See 11 U.S.C. 362(b)(3), 546(b), 547(c)(3). 547(c)(5),
547(e)(2)(A) (regarding perfection of security interests),
1129(b)(2)(A) (providing that secured creditors retain their interest
in property or receive the value of their secured claims or interest
for plan confirmation).
\459\ See 11 U.S.C. 507 (priority of bankruptcy claims); 1129
(requirements for plan confirmation).
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Securities Lending Counterparties: If AIG had
filed for bankruptcy, it is unclear what would have happened to
capital contributions from the parent company to the insurance
subsidiaries, past or future, related to the securities lending
program.\460\ Capital contributions made to the insurance
subsidiaries within 90 days of the bankruptcy filing could
technically have been challenged as preferential
transfers,\461\ but such challenges would have practical
limitations. Because AIG's stock in its insurance subsidiaries
was its most valuable asset, it is unlikely that creditors
would have wanted to diminish the value of the insurance
subsidiaries by taking action to weaken their financial
strength. Subsequent collateral transfers might even have been
allowed in order to preserve their value, although this might
have been less likely.\462\ In addition, the insurance
regulators might have seized the insurance subsidiaries, making
it difficult or impossible for the creditors to undo previous
capital contributions.\463\
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\460\ For example, AIG made capital contributions to offset
realized losses from the sale of securities in the pool ($5 billion),
to maintain capital and surplus levels after unrealized losses from the
decline in market value of the securities in the pool, and
contributions to make up the shortfall when securities lending
transactions had collateral levels less than 100 percent ($434
million). The contributions to offset realized losses (make whole
agreements) and to make up the difference in collateral levels (between
agreed upon level and 100 percent) were part of guarantees provided by
AIG to the insurance subsidiaries. Panel call with Texas Department of
Insurance (May 24, 2010).
\461\ 11 U.S.C. 547(b).
\462\ The guarantee could have been rejected under 11 U.S.C. 365.
Transfers between the parent and the insurance subsidiaries would have
been greatly constrained and would have depended on the decisions of
the interested parties on how best to maximize the value of AIG's
assets.
\463\ Panel call with Texas Department of Insurance (May 24, 2010).
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As discussed above, the insurance subsidiaries would not
have been able to file for bankruptcy and would have remained
liable for all outstanding securities lending obligations, and
their ultimate ability to survive or reorganize would have
depended on the impact of the bankruptcy filing on their
business and customers and the actions taken by their insurance
regulators through state regulatory procedures.\464\ It is
unclear whether all of the insurance subsidiaries had
sufficient capital or resources to meet these obligations. The
securities lending collateral pools were already experiencing
liquidity strains, and AIG was providing significant capital to
fund collateral calls or returns of cash collateral and to
offset losses recognized by the insurance subsidiaries. The
securities lending counterparties had the contractual right to
terminate the loans at any time or because of an event of
default (such as failing to pay or repay cash collateral to
either mark collateral to market or on termination of the loan,
an act of insolvency, or certain regulatory actions).\465\ They
would have been able to accelerate performance, set off against
any other obligations, and withhold delivery or sell borrowed
securities to satisfy any unpaid obligations.\466\ Thus, they
would have been protected to the extent that they were
collateralized and would have been able to assert a claim for
any shortfall as well as for reasonable costs and expenses
incurred.\467\
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\464\ Because the insurance subsidiaries would not have been able
to file for bankruptcy, the bankruptcy safe harbor provisions would not
have applied to these contracts.
\465\ Events of default include failing to pay or repay cash
collateral to either mark collateral to market or on termination of the
loan, an act of insolvency, or certain regulatory actions. See
International Securities Lending Association, Global Master Securities
Lending Agreement, at 16-19 (July 2009).
\466\ See id. Generally, neither party is required to make delivery
to the other unless that party is satisfied that the other party will
make the necessary delivery in return. See id., at 17. These rights
were the contractual equivalent of the bankruptcy safe harbor
provisions for various financial contracts.
\467\ Securities lending counterparties have the right to mark the
securities lending collateral to market so that the ``posted
collateral'' (or cash collateral provided to the AIG securities lending
program) equals the aggregate of the ``required collateral values'' (or
market value of securities equivalent to the loaned securities and the
applicable margin). See id. If at any time on any business day, the
aggregate market value of posted collateral (cash) exceeds the
aggregate of the required collateral values, the Borrower (securities
lending counterparty) may demand the Lender (AIG insurance
subsidiaries) to repay or deliver equivalent collateral (cash) to
eliminate the excess. Id. The parties also have the right to set off
other obligations under the collateral agreement. Id., at 12-13. If the
collateral had been marked to market, the counterparties would not have
been exposed to early termination because the value of lent securities
held by the counterparties would have matched the amount of cash
collateral that had not yet been repaid. The counterparties would also
have been able to demand reasonable costs and expenses incurred as a
result of failure to deliver equivalent collateral. See id., at 18, 21,
23.
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The impact of a bankruptcy on the securities lending
counterparties would depend on whether they were
overcollateralized or undercollateralized.
--If the securities lending counterparties were
overcollateralized (or AIG's securities lending agreements were
undercollateralized), the value of the securities loaned by AIG
to the counterparties would have exceeded the value of the cash
collateral provided to AIG by some margin.\468\ As a result,
these counterparties would have been fully secured if the
insurance subsidiaries defaulted on their obligations or had
been unable to return the cash collateral. The counterparties
would have been able to sell the lent securities to satisfy any
unpaid obligations of the AIG insurance subsidiaries.
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\468\ According to regulators at the Texas Department of Insurance,
by July 31, 2008, roughly 1/4 to 1/3 of AIG's securities lending
counterparties were asking for collateral requirements of less than 100
percent (or were asking AIG to loan securities in return for cash
collateral below the value of the lent securities), some as low as 90
percent. AIG made up the difference between the collateral required and
100 percent, contributing $434 million as of July 31, 2008. Panel call
with Texas Department of Insurance (May 24, 2010).
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--If the securities lending counterparties were
undercollateralized (or AIG's securities lending agreements
were overcollateralized), the value of the securities loaned by
AIG to the counterparties would have been less than the value
of the cash collateral provided to AIG by some margin.\469\
Thus, in the event of default, the securities lending
counterparties would not have been able to satisfy any unpaid
obligations of the AIG insurance subsidiaries by selling the
lent securities. Without help from the AIG parent, the funds
for these obligations would have needed to come from the assets
of the insurance subsidiaries. Further, the termination or
payout process may have been complicated or prolonged in the
event of intervention by the insurance regulators. If the
regulators had placed the insurance subsidiaries into
receivership, the securities lending counterparties would have
been treated as general creditors for any deficiency claims
asserted, would likely not have received anything from the
regulators for these deficiency claims, and would have had to
wait several years for the determination of whether and to what
extent they would have been paid. They would, for example, have
had to wait for priority claims--such as the claims of
policyholders--to be paid in full. The counterparties thus
benefited by receiving their cash collateral, in full, on
demand, and by avoiding the need to sell securities in a
depressed or distressed market (and the accompanying costs and
expenses) to cover their positions, assert and seek payments
for any deficiency, and deal with insurance regulators (if, for
example, the regulators had seized the insurance subsidiaries).
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\469\ See AIG Form 10-Q for Third Quarter 2008, supra note 23, at
49 (``Historically, AIG had received cash collateral from borrowers of
100-102 percent of the value of the loaned securities).
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The charts in Annex VIII also compare the impact of
bankruptcy or rescue on both undercollateralized and
overcollateralized counterparties.
CDS Counterparties: If AIG had filed for
bankruptcy, the counterparties to AIG's various CDS contracts
would have benefited from safe harbor provisions giving them
additional protection or favorable treatment. Counterparties
``to any swap agreement'' are exempted from the automatic stay
that prevents creditors from taking action to collect on their
debts after the bankruptcy filing.\470\ The counterparties are
specifically allowed to terminate their CDS contracts based on
the bankruptcy filing and exercise their contractual rights, if
any, to seize previously posted collateral or to offset or net
out any other obligations.\471\ If the counterparties were
undersecured, however, they would have had to assert any
deficiency claims as general unsecured creditors. Thus, the
benefit to the CDS counterparties of government assistance such
as ML3 or AIG's avoidance of bankruptcy depends on the extent
that the creditors were undersecured or non-collateralized and
the extent to which the counterparties would have been subject
to the substantial discount negotiated in a bankruptcy plan.
The counterparties' level of security would change as market
conditions or fair values of outstanding affected transactions
(or the values of underlying reference securities, such as CDOs
and CLOs) fluctuated and depending on AIG's ability to post
additional collateral, among other things. On an aggregate
basis, the CDS counterparties that participated in ML3 were
overcollateralized; they returned $2.5 billion to AIG as part
of the ML3 closeout.\472\ For second-level CDS counterparties,
the benefit of the government assistance depends on the
soundness of the first-level counterparties or their ability to
make good on the second-level CDSs if AIG fails to perform on
the first-level CDSs.
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\470\ See 11 U.S.C. 362(b)(17) (providing that a bankruptcy filing
does not operate as stay ``of the exercise by a swap participant or
financial participant of any contractual right . . . under any security
agreement or arrangement or other credit enhancement forming a part of
or related to any swap agreement, or of any contractual right . . . to
offset or net out any termination value, payment amount, or other
transfer obligation arising under or in connection with 1 or more such
agreements, including any master agreement for such agreements''). The
term ``swap participant'' is defined broadly to include any entity that
had an outstanding swap agreement with the debtor. 11 U.S.C. 101(53C).
The term ``swap agreement'' is also broadly defined to include a
variety of instruments including interest rate, currency, equity index,
equity, debt index, debt, total return, credit spread, credit,
commodity index, commodity, weather, emissions, and inflation swaps. 11
U.S.C. 101(53B). See also 11 U.S.C. 362(b)(27) (providing the same
protection to counterparties with various derivative contracts under
master netting agreements).
\471\ See 11 U.S.C. 362(b)(17); 11 U.S.C. 560 (``The exercise of
any contractual right of any swap participant or financial participant
to cause the liquidation, termination, or acceleration of one or more
swap agreements because of a condition of the kind specified in section
365(e)(1) of this title [including a bankruptcy filing] or to offset or
net out any termination values or payment amounts arising under or in
connection with the termination, liquidation, or acceleration of one or
more swap agreements shall not be stayed, avoided, or otherwise limited
by operation of any provision of this title . . . ''). See also 11
U.S.C. 362(b)(27); 11 U.S.C. 561 (providing the same protection to
counterparties with various derivative contracts under a master netting
agreement).
\472\ For additional information on ML3, see Section D.4. It should
be noted that if AIG or AIGFP had filed for bankruptcy, many of the CDS
counterparties would have been undercollateralized because collateral
calls were calculated at mid-mark. Thus, they would have had to assert
an unsecured claim for any deficiency that would have been subject to
the bankruptcy discount. Whether the counterparties would have been
better off in a bankruptcy would depend on whether or how long they
continued to hold (or intermediate on behalf of clients who held) the
underlying reference securities or CDOs. The insurance on the CDOs
would have disappeared, and the counterparties would have had ``naked
exposure'' to changes in the value of the CDOs. If the counterparties
attempted to sell the CDOs immediately or at a price below the
difference in value of the CDS contract and the collateral posted on
the bankruptcy date, the counterparties would have been worse off. If
the counterparties held the CDOs or sold the CDOs after the value
rebounded beyond the value of the difference in value of the CDS
contract and the collateral posted on the bankruptcy date, then they
would have been better off. Thus, it is likely that some of the
counterparties would have been better off in bankruptcy if they
continued to hold the CDOs in light of the increase in the valuation of
the ML3 securities.
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The charts in Annex VIII also compare the impact of rescue
or bankruptcy on differently-placed counterparties.
Other CDS Counterparties:
--Other CDO Swap Counterparties: Like the CDS
counterparties discussed above, if AIG filed for
bankruptcy, its other CDO swap counterparties would be
able to terminate their CDS contracts, seize previously
posted collateral, and offset or net out any other
obligations. To the extent that the other CDO swap
counterparties were unsecured or undersecured, they
would be subject to the substantial discount negotiated
for unsecured creditors as part of the bankruptcy plan.
These counterparties benefited from AIG's avoidance of
bankruptcy by receiving additional collateral as a
result of the government rescue (a direct benefit) and
from continuing their CDS contracts and avoiding forced
losses as a result of an AIG bankruptcy (indirect
benefits).
--Regulatory Capital Swap Counterparties: The
regulatory capital CDS counterparties also would have
benefited from the safe harbor provisions in the
bankruptcy code, but only to the extent of the limited
collateral that they held. The protection issued by
AIGFP to Banque AIG would end, and Banque AIG is not
likely to have been able to continue providing such
protection after the failure of its parent. As
described in Section E1, it seems likely that the
impact of a bankruptcy on the counterparties that held
these swaps would have hinged on the performance of the
banks' other assets held as regulatory capital and
whether or not the banking regulators in their
countries provided forbearance.
Based on the capital rules under which these banks were
operating in 2008, the loss of credit protection for ABN AMRO
would have resulted in an estimated impact on its regulatory
capital in the amount of $3.6 billion;\473\ this means that had
AIG filed for bankruptcy, ABN AMRO would have needed to raise
an additional $3.6 billion in order to maintain its current
regulatory capital ratios. For Danske and KFW, the estimated
impact would have been around $2.1 billion each. For Credit
Logement, it would have been about $1.9 billion.\474\
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\473\ Under Basel I, banks were required to hold 8 percent capital
against assets such as corporate loans that were assigned a 100 percent
risk weighting. But when AIGFP's regulated bank provided credit
protection, the risk weighting fell to 20 percent, and the banks were
only required to hold 8 percent capital against the 20-percent weighted
value of the loans, which equaled 1.6 percent of the assets. The
difference between these two regulatory treatments, 6.4 percent of the
assets, was the amount that the banks did not have to hold as capital
as a result of the AIGFP swaps. The regulatory capital relief would be
less for assets that would otherwise receive a risk weighting of less
than 100 percent under Basel I.
\474\ It is impossible to calculate the exact capital charges
avoided by these banks without knowing the risk weighting of each
underlying asset that received credit protection from AIGFP. The
calculations here reflect the methodology that AIG and FRBNY used to
calculate the exposure that the counterparties would have had in a
bankruptcy. Whether losing this cushion this would have resulted in
inadequate regulatory capital (and thus a need to raise capital or sell
assets in a volatile market) depends on the extent to which each bank
was over-capitalized, and the extent to which their other assets lost
value.
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Municipalities and State Agencies with Guaranteed
Investment Agreements: GIAs are similar to traditional loans
that would not benefit from the safe harbor provisions. If AIG
and AIGFP filed for bankruptcy, municipalities with GIAs would
have been subject to the automatic stay, would not have been
able to close out their contracts immediately, and would have
been subject to the normal rights of setoff.\475\ To the extent
that they were secured or collateralized, they could request
relief from the stay.\476\ However, the trustee or DIP could
challenge the level of security and potentially void some of
the transfers made to the municipalities (e.g., if the security
interests of the municipalities were not properly perfected or
the transfer would constitute preferential transfers).\477\ The
municipalities would assert general unsecured claims for any
deficiency that would be subject to the substantial bankruptcy
discount.\478\ By avoiding bankruptcy, these municipalities
benefited to the extent that the payments they received as a
result of government assistance exceeded the value of posted
collateral that could not be recovered through various
avoidance actions.\479\ They also benefited by avoiding delays
in payment, legal fees incurred to protect and maximize
collection on their claims, and potential ratings downgrades or
disruptions in the municipal bond market.
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\475\ 11 U.S.C. 362 (providing no exemption for municipalities from
the automatic stay); 365(e)(1)(A)-(B) (providing that creditors cannot
terminate or modify an executory contract on account of the financial
condition of the debtor or the filing of a bankruptcy petition); 553
(providing setoff rights).
\476\ 11 U.S.C. 362(d)(2)(A)-(B) (providing relief ``if the debtor
does not have an equity in such property; and such property is not
necessary to an effective reorganization''). See also 11 U.S.C. 506
(explaining the determination of secured status). As of September 2008,
AIG had outstanding GIA obligations of $13.6 billion. AIG had posted
$8.5 billion of collateral for these GIAs, leaving $5.1 billion of the
GIAs uncollateralized. Panel staff conversation with AIG (May 25,
2010).
\477\ See, e.g., 11 U.S.C. 547(b) (providing that a transfer to a
creditor may be avoided if it was made for the benefit of the creditor,
on account of an antecedent debt, while the debtor was insolvent,
within 90 days of the bankruptcy filing, and would enable the creditor
to receive more than the creditor would have received in bankruptcy if
the transfer had not been made); 11 U.S.C. 547(c)(3), 547(c)(5),
547(e)(1) (relating to the perfection of security interests). The
trustee or DIP has the burden of proving avoidability. 11 U.S.C.
547(g).
\478\ AIG's guarantees of AIGFP's GIA obligations were executory
contracts that would have been rejected during the bankruptcy and would
have provided no recourse to the municipalities with GIAs. See 11
U.S.C. 365.
\479\ According to the 2007 and 2008 AIG annual reports, AIG had
outstanding GIA obligations of $19.9 billion at December 31, 2007 and
$13.9 billion at December 31, 2008, and the fair value of securities
pledged as collateral were $14.5 billion and $8.4 billion (or roughly
72.9 percent and 60.4 percent of the outstanding amounts),
respectively. See AIG Form 10-K for FY08, supra note 47, at 53, 277;
AIG Form 10-K for FY07, supra note 41, at 89, 171.
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Pension Plans with Wrap Contracts: An AIG or AIGFP
bankruptcy would have terminated pension funds' wrap coverage
and, in turn, would have resulted in instability and additional
risk in stable value funds.\480\ Pension funds holding the
stable value wrap contracts would not have lost the entire $38
billion of their stable value funds in the event of bankruptcy,
but they would have lost the insurance \481\ in a market where
replacement insurance of this type was becoming increasingly
unavailable.\482\ Pension funds would have had to write down
their assets from book to market value, resulting in
significant losses to workers' portfolios in the markets of
late 2008,\483\ although the precise amount of these losses
cannot be ascertained. Workers or retail investors may have
been encouraged to withdraw funds, and confidence in the
stability of pension plans would have been damaged. The extent
of the potential impact on pension investors is unclear.
---------------------------------------------------------------------------
\480\ See Testimony of Thomas C. Baxter, supra note 319, at 4. It
should be noted that in the event of an AIG or AIGFP bankruptcy, the
wrap contracts would likely have been rejected under 11 U.S.C. 365.
\481\ See Testimony of Thomas C. Baxter, supra note 319, at 4
(``AIG also had approximately $38 billion of what are called stable
value wrap contracts . . . . Workers whose 401(k) plans had purchased
these contracts from AIG to insure against the risk that their stable
value funds would decline in value could have seen that insurance
disappear in the event of an AIG bankruptcy''); House Committee on
Financial Services, Written Testimony of Ben S. Bernanke, chairman,
Board of Governors of the Federal Reserve System, Oversight of the
Federal Government's Intervention at American International Group, at 2
(Mar. 24, 2009) (online at www.house.gov/apps/list/hearing/
financialsvcs_dem/statement_-_bernanke032409.pdf) (hereinafter
``Written Testimony of Ben Bernanke'') (``Workers whose 401(k) plans
had purchased $40 billion of insurance from AIG against the risk that
their stable value funds would decline in value would have seen that
insurance disappear''). See also AIG Presentation on Systemic Risk,
supra note 92, at 18 (``Failure to provide a wrap on $38 billion of
stable value funds could result in millions of lost value . . . '');
Stable Value Investment Association, FAQ: Your Questions Answered About
Stable Value (Mar. 23, 2009) (online at stablevalue.org/help-desk/faq/)
(``If an issuer of a contract that wraps or covers a fixed income
portfolio (synthetic GIC) became insolvent, it is important to remember
that the bulk of the assets--the portfolio of fixed income securities
that support the stable value fund--are already owned by the 401(k)
plan and its participants. In the event of any ultimate claim against
the issuer for failure to meet any financial obligation under the
contract, such claim would be settled during the normal bankruptcy
process'').
\482\ See Eleanor Laise, ``Stable'' Funds in Your 401(k) May Not
Be, Wall Street Journal (Mar. 26, 2009) (online at www.wsj.com/article/
SB123802645178842781.html#articleTabs%3Darticle) (``[M]any banks and
insurance companies are growing reluctant to provide the `wrap
contracts' that help smooth the funds' returns, leaving some stable-
value managers scrambling to find alternatives. . . . Even stable-value
funds with strong market-to-book rations are finding wrap providers
less than welcoming. . . . [M]ost wrap providers aren't taking in any
new money''). Vanguard Group principal Sue Graef further explained that
AIG wrapped about 10 percent of the fund's assets, and it had been a
slow process to replace them. Id.
\483\ See Financial Accounting Standards Board ASC 715-30-35
(requiring pension plan assets to be marked to market). See also
Testimony of Thomas C. Baxter, supra note 319, at 4 (``Pension plans
would have been forced to write down their assets from book to market
value, resulting in significant losses in participants' portfolios'').
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Employees: Employees of the AIG companies filing
for bankruptcy would have received wages, salaries, and
commissions for services rendered during the bankruptcy, and
with some limitations, they would have received wages,
salaries, and commissions that were earned within six months of
the bankruptcy filing but not yet paid, if any.\484\ However,
avoiding bankruptcy likely saved many employees of the AIG
parent company and various subsidiaries--both filing and non-
filing--from losing their jobs. In addition, AIG employees were
able to avoid limitations or prohibitions related to bonuses,
retention bonuses, severance payments, and other payments
outside of the ordinary course of business.\485\
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\484\ Employees receive administrative expense priority for wages,
salaries, and commissions earned during the bankruptcy proceedings and,
unless they agree otherwise, must be paid in full before the plan can
be confirmed. See 11 U.S.C. 503(b)(1), 507(a)(2) (providing
administrative expense priority); 11 U.S.C. 1129(a)(9)(A) (requirement
payment for plan confirmation). They also receive administrative
expense priority for up to $10,000 of wages, salaries, and commissions
(including vacation, severance, and sick leave) that were earned within
180 days of the bankruptcy filing but not yet paid. See 11 U.S.C.
507(a)(4) (providing administrative expense priority); 11 U.S.C.
1129(a)(9)(B) (requiring payment for plan confirmation).
\485\ See 11 U.S.C. 503(c)(1) (providing that the debtor cannot
make a transfer to induce an insider to stay unless the court finds
that it is essential for retention, the employee is essential to the
survival of the business, and the transfer is not greater than 10 times
the mean amount paid to nonmanagement or not greater than 25 percent of
previous amounts paid to the insider); 11 U.S.C. 503(c)(2) (providing
that the debtor cannot make severance payments unless they are part of
a plan offered to all full-time employees and the amount is not greater
than 10 times the mean amount paid to nonmanagement); 11 U.S.C.
503(c)(3) (prohibiting payments outside the ordinary course of business
and not justified by the facts and circumstances of the case, including
payments to officers, managers, or consultants hired after the
bankruptcy filing).
---------------------------------------------------------------------------
Suppliers and Contractors: Contractors are
generally unsecured creditors subject to the substantial
discount negotiated in the bankruptcy plan. The treatment of
suppliers is more complicated and depends on when the goods
were received and whether the suppliers were secured (or had a
perfected security interest). Suppliers would have been
protected to the extent that they were secured and would have
had an unsecured claim for any deficiency.\486\ They would have
had the right to reclaim goods provided, but not yet paid for,
around the time of the bankruptcy filing.\487\ They would also
have received administrative expense priority for the value of
goods provided during the bankruptcy.\488\
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\486\ See 11 U.S.C. 362(b)(3), 546(b), 547(c)(3). 547(c)(5),
547(e)(2)(A) (regarding perfection of security interests),
1129(b)(2)(A) (providing that secured creditors retain their interest
in property or receive the value of their secured claims or interest
for plan confirmation).
\487\ See 11 U.S.C. 546(c)(1)(A)-(B) (providing supplier with the
right of reclamation for goods sold in the ordinary course of business,
if the debtor was insolvent, and within 45 days before the bankruptcy
filing and requiring the supplier to demand the goods in writing within
45 days of receipt or 20 days after the bankruptcy filing); 11 U.S.C.
503(b)(9), 546(c)(2) (providing administrative expense priority for
such goods if the supplier does not demand reclamation in writing).
\488\ See 11 U.S.C. 503(b)(9), 507(a)(2) (providing administrative
expense priority for goods received within 20 days before the
bankruptcy filing and in the ordinary course of business); 11 U.S.C.
1129(a)(9)(A) (requiring payment for plan confirmation).
---------------------------------------------------------------------------
The Panel is not questioning whether it was appropriate for
AIG to fulfill its obligations to any specific category of
beneficiary. The Panel notes, however, that in cases where the
government intervenes on a more discriminating basis--such as
when the Federal Deposit Insurance Corporation (FDIC) seizes a
bank or in bankruptcy, as was the case in the support to
General Motors and Chrysler--the government has the ability to
select among the relationships and obligations that it believes
it most needs to continue in order to best extract value from
the failing business and protect the taxpayers. Like any post-
crisis financer, the government would have the ability to
condition the extension of new credit on an assurance that the
business would be using the money in ways that would cause the
business to survive, not just to pay off old debt. Thus, if
some form of resolution authority had existed for AIG, the
government might have chosen to make capital contributions to
AIG's insurance subsidiaries so they could continue as
adequately funded businesses, generating cash flow for their
parent. \489\ It might have chosen to sell off some parts of
AIG's business in Section 363-type sales.\490\ Some bondholders
\491\ might have been forced to take their place in line in
liquidation, while other creditors might have fared better.
---------------------------------------------------------------------------
\489\ See Congressional Oversight Panel, Testimony of Timothy F.
Geithner, secretary, U.S. Department of the Treasury, COP Hearing with
Treasury Secretary Timothy Geithner (Sept. 10, 2009) (online at
cop.senate.gov/hearings/library/hearing-121009-geithner.cfm) (``This is
the tragic failure about the regime we came in with because we did not
have the legal capacity to manage the orderly unwinding of a large,
complex financial institution. We do have the capacity to unwind small
banks and thrifts, but did not have it for an entity like AIG. And that
forced us to do things that we would not ever want to do.'')
\490\ Section 363 of the Bankruptcy Code allows the debtor to
propose to sell property of the estate outside of the ordinary course
of business as part of the reorganization effort. 11 U.S.C. 363(b). The
proceeds of the sale can be used to fund the debtor's operations or to
raise capital to pay creditors. Section 363 sales provide substantial
advantages: buyers have clear title to the purchased assets and the
estate can maximize the value of the assets sold, ultimately benefiting
the creditors. 11 U.S.C. 363(f) (``The trustee may sell property . . .
free and clear of any interest in such property of an entity other than
the estate, only if (1) applicable nonbankruptcy law permits sale of
such property free and clear of such interest; (2) such entity
consents; (3) such interest is a lien and the price at which such
property is to be sold is greater than the aggregate value of all liens
on such property; (4) such interest is in bona fide dispute; or (5)
such entity could be compelled, in a legal or equitable proceeding, to
accept a money satisfaction of such interest.'') Distributions to
creditors will be made in accordance with priority rules. See 11 U.S.C.
507. There are no restrictions on how the purchaser subsequently uses
the purchased assets. See September Oversight Report, supra note 389,
at 44-45, 49, 111-12. However, state insurance regulators would have to
approve the sale of insurance subsidiaries domiciled within their state
under state insurance laws, and as discussed in the next section, it
would be difficult to get value if there had been a ``run'' on the
insurance subsidiaries as a result of the bankruptcy filing of the AIG
parent company and other domestic, non-regulated subsidiaries.
\491\ Bondholders are included in the discussion of other holders
of AIG and AIGFP debt in Section E.1. These bondholders would be
treated as unsecured creditors; see explanation of treatment of AIG and
AIGFP unsecured debt holders above.
---------------------------------------------------------------------------
As a result of the government's decision to rescue AIG,
pre-bailout shareholders were diluted, but not completely wiped
out, as they would have been in bankruptcy, and as occurred in
the bankruptcies of the automotive companies several months
later. However, pre-bailout shareholders of AIG were much more
significantly diluted than shareholders were in the subsequent
rescues of Citigroup and Bank of America.
This means that even though the taxpayers may lose some
portion of the government's investment in AIG--which could be
in the billions of dollars--pre-bailout shareholders still have
the potential to profit from AIG's future recovery.\492\
---------------------------------------------------------------------------
\492\ See Congressional Oversight Panel, March Oversight Report:
The Unique Treatment of GMAC under TARP, at 88 (Mar. 10, 2010) (online
at cop.senate.gov/documents/cop-031110-report.pdf) (hereinafter ``March
Oversight Report'') (discussing a similar issue with pre-bailout
shareholders of GMAC).
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F. Analysis of the Government's Decisions

1. Initial Crisis: September 2008

a. The Government's Justification for the Rescue
The following section sets forth the justifications offered
by the Federal Reserve and Treasury with respect to their
rescue of AIG; the Panel's analysis of those justifications
follows.
Officials at FRBNY, Treasury, and the Federal Reserve say
they became fully aware of the fact (if not the full extent) of
the severe liquidity problems facing AIG on September 12.\493\
The Panel notes, however, that FRBNY had earlier awareness of
at least some of the looming issues facing AIG. Mr. Willumstad,
then-AIG CEO, had a conversation with FRBNY President Geithner
in late July 2008 regarding possible access to the Federal
Reserve's discount window. In addition, on September 9, 2008,
Mr. Willumstad spoke to President Geithner about the potential
for AIG to become a primary dealer in order to gain access to
the Federal Reserve's discount window, and again made no
progress. Mr. Willumstad clarified, however, that during these
conversations, he did not state that ``AIG was facing serious
issues.'' \494\
---------------------------------------------------------------------------
\493\ Testimony of Thomas C. Baxter, supra note 215; Congressional
Oversight Panel, Testimony of Sarah Dahlgren, executive vice president
of special investments management and AIG monitoring, Federal Reserve
Bank of New York, COP Hearing on TARP and Other Assistance to AIG (May
26, 2010) (stating that FRBNY understood the threat AIG posed to the
economy on September 12, and acknowledging that ``AIG was not one of
the top 10 exposures'' for the institutions that it supervised at that
time); e-mail from Hayley Boesky, vice president, Federal Reserve Bank
of New York, to William Dudley, executive vice president, Federal
Reserve Bank of New York, and other Federal Reserve Bank of New York
officials (Sept., 12, 2008) (FRBNYAIG00511) (stating ``Now focus is on
AIG. I am hearing worse than LEH [Lehman]. Every bank and dealer has
exposure to them. People I heard from worry they can't roll over their
funding . . . Estimate I hear is 2 trillion balance sheet''); E-mail
from Alejandro LaTorre, vice president, Federal Reserve Bank of New
York, to Timothy F. Geithner, president and chief executive officer,
Federal Reserve Bank of New York, and other Federal Reserve Bank of New
York officials (Sept. 12, 2008) (FRBNYAIG00509) (providing an update on
the AIG situation (``[t]he key takeaway is that they are potentially
facing a severe run on their liquidity over the course of the next
several (approx. 10) days if they are downgraded by Moody's and S&P
early next week'') and noting that FRBNY and Board of Governors of the
Federal Reserve Board officials met with senior executives at AIG to
discuss their liquidity and risk exposure).
\494\ Testimony of Robert Willumstad, supra note 179.
---------------------------------------------------------------------------
While the Federal Reserve had no role in supervising or
regulating AIG and was also not lending to the company,\495\
the Federal Reserve was the only governmental entity at the
time with the legal authority to provide liquidity to the
financial system in emergency and exigent circumstances.\496\
Through internal discussions and a dialogue with AIG and its
state insurance regulators, the Board and FRBNY ultimately
chose to provide AIG with assistance after identifying the
systemic risks associated with the company and contemplating
the consequences of an AIG bankruptcy or partial rescue.\497\
As discussed above, on September 16, the Board, with the full
support of Treasury,\498\ authorized FRBNY under section 13(3)
of the Federal Reserve Act to lend up to $85 billion to AIG in
order to assist the company in meeting its obligations as they
came due. The Board determined that, in the then-existing
environment, ``a disorderly failure of AIG could add to already
significant levels of financial market fragility and lead to
substantially higher borrowing costs, reduced household wealth,
and materially weaker economic performance.'' \499\ According
to Mr. Liddy, who became AIG's CEO the following day, ``[t]his
facility was the company's best alternative.'' \500\ Later that
day, the AIG Board of Directors voted to approve the
transaction.\501\
---------------------------------------------------------------------------
\495\ Given this role, FRBNY emphasized that it had three main
tasks with respect to helping facilitate an AIG resolution: (1) a
``need to understand the exposures of our firms (banks and IBs);'' (2)
a ``need to stay in the information loop, but `low key' our
interactions with NYS-Insurance and the UK-FSA. We will have some light
interface with other supervisors (OTS, etc.);'' and (3) ``[t]hrough
Legal, we want to understand how the bankruptcy process will play
out.'' E-mail from Brian Peters, senior vice president, risk management
function, Federal Reserve Bank of New York, to Federal Reserve Bank of
New York officials (Sept. 15, 2008) (FRBNYAIG00491).
\496\ For further discussion of the legal options available to AIG
in September 2008, see Section B3, infra. The Federal Reserve's ability
to act was dependent upon the Board's authorization to invoke Section
13(3) of the Federal Reserve Act, which was provided on September 16,
2008.
\497\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
\498\ At the time FRBNY provided AIG with the $85 billion revolving
credit facility, Treasury only provided a very short statement, with
then-Secretary Paulson noting that ``[t]hese are challenging times for
our financial markets. We are working closely with the Federal Reserve,
the SEC and other regulators to enhance the stability and orderliness
of our financial markets and minimize the disruption to our economy. I
support the steps taken by the Federal Reserve tonight to assist AIG in
continuing to meet its obligations, mitigate broader disruptions and at
the same time protect the taxpayers.'' U.S. Department of the Treasury,
Statement by Secretary Henry M. Paulson, Jr., on Federal Reserve
Actions Surrounding AIG (Sept. 16, 2008) (online at www.treas.gov/
press/releases/hp1143.htm). In a subsequent letter to Timothy F.
Geithner, then-president and CEO of the Federal Reserve Bank of New
York, Secretary Paulson stressed that ``the situation at AIG presented
a substantial and systemic threat'' to our financial markets, and that
the government's decision to assist AIG ``was necessary to prevent the
substantial disruption to financial markets and the economy that could
well have occurred from a disorderly wind-down of AIG.'' Letter from
Henry M. Paulson, Jr., secretary, U.S. Department of the Treasury, to
Timothy F. Geithner, president and chief executive officer, Federal
Reserve Bank of New York (Oct. 8, 2008) (online at
www.federalreserve.gov/monetarypolicy/files/letter_aig.pdf).
\499\ Federal Reserve Press Release, supra note 266. In its review
of FRBNY documents and e-mails from this time, the Panel verified that
FRBNY officials analyzed the systemic impact of an AIG bankruptcy, and
concluded that AIG could be more systemic in nature than Lehman due to
the retail dimension of its business. E-mail from Alejandro LaTorre to
Timothy Geithner and other FRBNY personnel (Sept. 16, 2008) (FRBNY
AIG00483-486); E-mail from Alejandro LaTorre, vice president, Federal
Reserve Bank of New York, to Timothy F. Geithner, president and chief
executive officer, Federal Reserve Bank of New York, and other Federal
Reserve Bank of New York officials (Sept. 14, 2008) (FRBNYAIG00496-
499); E-mail from Hayley Boesky, vice president, Federal Reserve Bank
of New York, to William Dudley, executive vice president, Federal
Reserve Bank of New York, and other Federal Reserve Bank of New York
officials (Sept., 12, 2008) (FRBNYAIG00511).
\500\ American International Group, Inc., AIG Signs Definitive
Agreement with Federal Reserve Bank of New York for $85 Billion Credit
Facility (Sept. 23, 2008) (online at media.corporate-ir.net/
media_files/irol/76/76115/releases/092408.pdf).
\501\ American International Group, Inc., AIG Statement on
Announcement by Federal Reserve Board of $85 Billion Secured Revolving
Credit Facility (Sept. 16, 2008) (online at www.aigcorporate.com/
newsroom/index.html) (hereinafter ``AIG Statement on $85 Billion
Secured Revolving Credit Facility'').
---------------------------------------------------------------------------
Secretary Geithner has stated that ``[t]he decision to
rescue AIG was exceptionally difficult and enormously
consequential.'' \502\ Chairman Bernanke has said the Federal
Reserve's decision-making was driven by the ``prevailing market
conditions and the size and composition of AIG's obligations,''
\503\ as well as ``AIG's central role in a number of markets
other firms use to manage risks, and the size and composition
of AIG's balance sheet.'' \504\ The Federal Reserve's actions
were also informed by its judgment that an AIG collapse would
have been much more severe than that of Lehman Brothers because
of its global operations, substantial and varied retail and
institutional customer base, and the various types of financial
services it provided.\505\
---------------------------------------------------------------------------
\502\ Testimony of Sec. Geithner, supra note 11, at 1.
\503\ Senate Committee on Banking, Housing, and Urban Affairs,
Written Testimony of Ben S. Bernanke, chairman, Board of Governors of
the Federal Reserve System, Turmoil in US Credit Markets: Recent
Actions Regarding Government Sponsored Entities, Investment Banks and
Other Financial Institutions, at 2 (Sept. 23, 2008) (online at
banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore_id=bbba8289-b8fa-46a2-a542-
b65065b623a1). See also E-mail from Alejandro LaTorre, assistant vice
president, Federal Reserve Bank of New York, to Timothy Geithner (and
other FRBNY personnel), president and chief executive officer, Federal
Reserve Bank of New York (Sept. 16, 2008) (FRBNYAIG00483-486); E-mail
from Alejandro LaTorre, vice president, Federal Reserve Bank of New
York, to Timothy F. Geithner, president and chief executive officer,
Federal Reserve Bank of New York, and other Federal Reserve Bank of New
York officials (Sept. 14, 2008) (FRBNYAIG00496-499); E-mail from Hayley
Boesky, vice president, Federal Reserve Bank of New York, to William
Dudley, executive vice president, Federal Reserve Bank of New York, and
other Federal Reserve Bank of New York officials (Sept., 12, 2008)
(FRBNYAIG00511).
\504\ Ben S. Bernanke, chairman, Board of Governors of the Federal
Reserve System, Current Economic and Financial Conditions, Remarks at
the National Association for Business Economics, 50th Annual Meeting,
Washington, DC (Oct. 7, 2008) (online at www.federalreserve.gov/
newsevents/speech/bernanke20081007a.htm) (hereinafter ``Remarks by Ben
Bernanke''). See also E-mail from Alejandro LaTorre, assistant vice
president, Federal Reserve Bank of New York, to Timothy Geithner (and
other FRBNY personnel), president and chief executive officer, Federal
Reserve Bank of New York (Sept. 16, 2008) (FRBNYAIG00483-486); E-mail
from Alejandro LaTorre, vice president, Federal Reserve Bank of New
York, to Timothy F. Geithner, president and chief executive officer,
Federal Reserve Bank of New York, and other Federal Reserve Bank of New
York officials (Sept. 14, 2008) (FRBNYAIG00496-499); E-mail from Hayley
Boesky, vice president, Federal Reserve Bank of New York, to William
Dudley, executive vice president, Federal Reserve Bank of New York, and
other Federal Reserve Bank of New York officials (Sept., 12, 2008)
(FRBNYAIG00511).
\505\ See Ben S. Bernanke, chairman, Board of Governors of the
Federal Reserve System, Four Questions About the Financial Crisis,
Speech at the Morehouse College, Atlanta, GA (Apr. 14, 2009) (online at
www.federalreserve.gov/newsevents/speech/bernanke20090414a.htm);
Remarks by Ben Bernanke, supra note 504; E-mail from Alejandro LaTorre,
assistant vice president, Federal Reserve Bank of New York, to Timothy
Geithner (and other FRBNY personnel), president and chief executive
officer, Federal Reserve Bank of New York (Sept. 16, 2008) (FRBNY
AIG00483-486); E-mail from Alejandro LaTorre, vice president, Federal
Reserve Bank of New York, to Timothy F. Geithner, president and chief
executive officer, Federal Reserve Bank of New York, and other Federal
Reserve Bank of New York officials (Sept. 14, 2008) (FRBNYAIG00496-
499).
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i. Systemic Risks
a. Systemic Risks Articulated in September 2008
At the time of the initial decision to assist AIG, the
Federal Reserve and Treasury publicly identified three primary
ways in which an AIG failure posed systemic risk.
First, the Federal Reserve and Treasury assert that they
concluded that, given AIG's role as a large seller of CDSs on
CDOs, an AIG failure could have exposed its counterparties to
large losses and disrupted the operation of the payments and
settlements system.\506\ According to Secretary Geithner, if
the AIG parent holding company had filed for bankruptcy,
defaults on over $100 billion of debt and on trillions of
dollars of derivatives would have resulted.\507\ The Federal
Reserve and Treasury argue that this would have adversely
impacted numerous financial institutions and the financial
system as a whole. The primary fear of the Federal Reserve and
Treasury was that defaults directly related to AIG would have
spread throughout the financial system, affecting transactions
between other counterparties, negatively affecting investor
confidence, and further destabilizing the economy. Furthermore,
the Federal Reserve and Treasury contend that banks and other
counterparties that used the AIGFP CDSs as credit protection in
the event of loss on the underlying securities would likely
have suddenly seen their positions become unhedged and
uncollateralized \508\ as market conditions worsened and the
underlying assets further declined in value, resulting in
reduced capital levels.\509\
---------------------------------------------------------------------------
\506\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); E-mail from Dianne Dobbeck, assistant vice president,
financial sector policy and analysis, Federal Reserve Bank of New York,
to Federal Reserve Bank of New York officials (Sept. 15, 2008); E-mail
from Hayley Boesky, vice president, Federal Reserve Bank of New York,
to William Dudley, executive vice president, Federal Reserve Bank of
New York, and other Federal Reserve Bank of New York officials (Sept.,
12, 2008) (FRBNYAIG00511). For further analysis of the impact of an AIG
failure on the entire derivatives market, see Section F.1(b), infra.
\507\ Testimony of Sec. Geithner, supra note 11, at 6. See also
Testimony of Jim Millstein, supra note 44, at 2 (stating that without
government assistance, ``AIG would have then defaulted on more than $2
trillion notional of derivative obligations and on over $100 billion of
debt to institutions'').
\508\ The Panel notes, however, that some of AIGFP's CDS
counterparties have stated that they were not exposed to credit risk
from AIG's default. For further discussion of AIGFP CDS counterparties
and the creation of Maiden Lane III, see Section F.5, infra. The Panel
notes that in a bankruptcy filing, virtually all of the multi-sector
CDO CDS counterparties would have terminated as of the petition date
and would have been entitled to retain all previously posted cash
collateral (which essentially means their unsecured claim would become
secured to the extent of that collateral), hold onto the referenced
CDOs (for those that were not holding naked positions), or continue the
contract.
\509\ E-mail from Alejandro LaTorre, assistant vice president,
Federal Reserve Bank of New York, to Timothy Geithner, president and
chief executive officer, Federal Reserve Bank of New York, and other
FRBNY personnel (Sept. 16, 2008) (FRBNY AIG00483-486); E-mail from
Alejandro LaTorre, vice president, Federal Reserve Bank of New York, to
Timothy F. Geithner, president and chief executive officer, Federal
Reserve Bank of New York, and other Federal Reserve Bank of New York
officials (Sept. 14, 2008) (FRBNYAIG00496-499); E-mail from Hayley
Boesky, vice president, Federal Reserve Bank of New York, to William
Dudley, executive vice president, Federal Reserve Bank of New York, and
other Federal Reserve Bank of New York officials (Sept. 12, 2008)
(FRBNYAIG00511).
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Second, the Federal Reserve and Treasury attribute some of
their actions to a stated belief that an AIG default could have
triggered severe disruptions to an already distressed
commercial paper market.\510\ The Federal Reserve and Treasury
concluded that an AIG default on its commercial paper could
have adversely impacted money market mutual funds since AIG had
issued $20 billion in commercial paper to money market mutual
funds, approximately four times as much as Lehman
Brothers.\511\ In the government's view, this could have
substantially disrupted the commercial paper market by reducing
credit availability for borrowers even on a short-term basis
and causing higher lending rates. This concern escalated after
the money market disruptions that occurred in the wake of the
Lehman Brothers bankruptcy filing, including the ``breaking of
the buck'' seen at the Reserve Primary Fund.\512\
---------------------------------------------------------------------------
\510\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); E-mail from Alejandro LaTorre, assistant vice president,
Federal Reserve Bank of New York, to Timothy Geithner (and other FRBNY
personnel), president and chief executive officer, Federal Reserve Bank
of New York (Sept. 16, 2008) (FRBNY AIG00483-486) (attaching a memo
referencing how a bankruptcy of AIG commercial paper ``has significant
contagion potential'' and that if its commercial paper could not be
rolled over, ``issuers draw down on bank lines,'' causing credit
extension to dry up, bank capitalization to further deteriorate, and
ratings downgrades to take place). For further analysis of the impact
of an AIG failure on the commercial paper market, see Section F.1(b),
infra.
\511\ E-mail from Alejandro LaTorre, assistant vice president,
Federal Reserve Bank of New York, to Timothy Geithner (and other FRBNY
personnel president and chief executive officer, Federal Reserve Bank
of New York (Sept. 16, 2008) (FRBNY AIG00483-486).
\512\ As the Panel noted in its November 2009 oversight report, the
Lehman Brothers bankruptcy ``quickly triggered a broad-based run of
investor redemptions in prime funds and the reinvestment of capital
into government funds.'' November Oversight Report, supra note 411, at
29. In response, on September 19, 2008, two weeks before EESA was
signed into law, Treasury announced the Temporary Guarantee Program for
Money Market Funds, a voluntary program that allowed all publicly
offered money market funds meeting certain criteria to participate in
exchange for signing a guarantee agreement and paying fees.
Although no other money market mutual funds ``broke the buck,''
investors liquidated $169 billion from prime funds and reinvested $89
billion into government funds. International Banking and Financial
Developments, supra note 187, at 72.
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Third, the Federal Reserve and Treasury assert that they
feared that an AIG failure could have undermined an already
fragile economy by weakening business and investor
confidence.\513\ After the placement of Fannie Mae and Freddie
Mac into government conservatorship on September 7 and the
Lehman Brothers bankruptcy filing on September 15, financial
markets destabilized considerably. AIG maintained financial
relationships with a large number of banks, insurance
companies, and other market participants across the globe. A
failure of AIG in this environment, according to the Federal
Reserve and Treasury, could have further shaken investor
confidence and contributed to increased borrowing costs and
additional economic deterioration. In this context, the Federal
Reserve and Treasury officials state that they believed that
the unfolding crisis and the increasingly fragile state of the
economy necessitated swift action to prevent a total collapse
of the financial system.\514\
---------------------------------------------------------------------------
\513\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); E-mail from Alejandro LaTorre, assistant vice president,
Federal Reserve Bank of New York, to Timothy Geithner, president and
chief executive officer, Federal Reserve Bank of New York, and other
FRBNY personnel (Sept. 16, 2008) (FRBNY AIG00483-486) (attaching a memo
analyzing the systemic impact of an AIG bankruptcy on market liquidity
and related spillover effects).
\514\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010).
---------------------------------------------------------------------------
b. Evolution of Systemic Risk Justifications
The focus of the government's systemic risk justification
changed over time. The Panel notes that, at the time of their
initial intervention, the Federal Reserve and Treasury seem to
have been cautious in their public statements about the
systemic risks associated with AIG for fear that they might
further destabilize the economy and weaken investor confidence
if they itemized all of the potential consequences associated
with a company as large and interconnected as AIG. Nonetheless,
rather than staying committed to the idea that a rescue of AIG
was necessary given the environment in September 2008 and in
order to stem the rapid loss of confidence in our financial
system that was occurring, the Federal Reserve and Treasury
have changed the emphasis of the rationales underlying their
intervention in the months since then.\515\
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\515\ The Panel notes that the rationales supporting the AIG
intervention appear well-coordinated between the Federal Reserve and
Treasury, with Chairman Bernanke and Secretary Geithner's speeches and
testimonies (as well as those given by their colleagues) in the months
subsequent to the initial intervention adhering to a consistent story
line, even as the story has evolved.
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In September 2008, neither the Federal Reserve nor Treasury
publicly expressed specific concern about the effect of an AIG
bankruptcy on existing insurance policyholders.\516\ As
discussed above, AIG's insurance operations were viewed as
generally sound (excluding the liquidity issues stemming from
AIG's securities lending program on the life insurance side),
and its insurance subsidiaries had significant value as going
concerns at the time the government intervened.\517\ Toward the
end of 2008 and into early 2009, however, the Federal Reserve
and Treasury began to voice concerns about the desire to
preserve value at the insurance company subsidiary level and
the consequences of the unraveling of AIG's insurance
subsidiaries on households and businesses.\518\ According to
the Federal Reserve and Treasury, letting AIG's business units
start to fail would have resulted in catastrophe.\519\ In his
January 2010 testimony before the House Oversight and
Government Reform Committee, Secretary Geithner stated:
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\516\ The Panel recognizes, however, that internal FRBNY e-mails
and memos circulated at this time indicate that while the impact of an
AIG bankruptcy on the insurance subsidiaries did not appear to be a
main focus of concern, there was at least some thought given to the
impact of an AIG bankruptcy on regulated insurance subsidiaries. E-mail
from Alejandro LaTorre, vice president, Federal Reserve Bank of New
York, to Timothy F. Geithner, president and chief executive officer,
Federal Reserve Bank of New York, and other Federal Reserve Bank of New
York officials (Sept. 14, 2008) (FRBNY AIG00496-499) (attaching a memo
with six reasons for support to AIG focused on AIG's institutional
trading partners in capital markets operations); E-mail from Alejandro
LaTorre, vice president, Federal Reserve Bank of New York, to Timothy
Geithner, president and chief executive officer, Federal Reserve Bank
of New York, and other FRBNY personnel (Sept. 16, 2008) (FRBNY
AIG00483-486) (attaching a memo with analysis of an AIG bankruptcy on
the insurance subsidiaries (both if financially healthy and not
financially healthy); E-mail from Dianne Dobbeck, assistant vice
president, financial sector policy and analysis, Federal Reserve Bank
of New York, to Federal Reserve Bank of New York officials (Sept. 15,
2008); E-mail from Hayley Boesky, vice president, Federal Reserve Bank
of New York, to William Dudley, executive vice president, Federal
Reserve Bank of New York, and other Federal Reserve Bank of New York
officials (Sept, 12, 2008) (FRBNY AIG00511).
\517\ For further discussion of the financial condition of the
insurance company subsidiaries at the time of the government's
intervention in AIG, see Section E.2 (AIG Insurance Company
Subsidiaries), infra.
\518\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010). See, e.g., Testimony of Sec. Geithner, supra note 11, at 5-6
(stating that ``if AIG had failed, the crisis almost certainly would
have spread to the entire insurance industry.'' And that ``the seizure
by local regulators of AIG's insurance subsidiaries could have delayed
Americans' access to their savings, potentially triggering a run on
other institutions''); House Committee on Financial Services, Written
Testimony of Timothy F. Geithner, secretary, U.S. Department of the
Treasury, Oversight of the Federal Government's Intervention at
American International Group (Mar. 24, 2009) (online at www.house.gov/
apps/list/hearing/financialsvcs_dem/statement_-_geithner032409.pdf);
Board of Governors of the Federal Reserve System, U.S. Treasury and
Federal Reserve Board Announce Participation in AIG Restructuring Plan
(Mar. 2, 2009) (online at www.federalreserve.gov/newsevents/press/
other/20090302a.htm) (hereinafter ``Treasury and the Federal Reserve
Announce Participation in Restructuring'') (stating that since ``AIG
provides insurance protection to more than 100,000 entities, including
small businesses, municipalities, 401(k) plans, and Fortune 500
companies who together employ over 100 million Americans,'' as well as
having ``over 30 million policyholders in the U.S.'' and a role as a
``major source of retirement insurance for, among others, teachers and
non-profit organizations,'' the ``potential cost to the economy and the
taxpayer of government inaction would be extremely high''). See also
AIG Presentation on Systemic Risk, supra note 92.
\519\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010) (noting that this was already starting to happen as the
insurance regulators notified AIG on September 16, 2008 that it would
no longer be permitted to borrow funds from its insurance company
subsidiaries under a revolving credit facility that AIG had maintained,
and they subsequently required AIG to repay any outstanding loans under
this facility and terminate it).

AIG was one of the largest life and health insurers
in the United States. AIG was also one of the largest
property & casualty insurers in the United States,
providing insurance to 180,000 small businesses and
other corporate entities, which employ about 100
million people. History suggests that the withdrawal of
a major underwriter from a particular market can have
large, long-lasting effects on the households and
---------------------------------------------------------------------------
businesses that rely on basic insurance protection.

Beginning in March 2009, the Federal Reserve and Treasury
publicly raised concerns that a sudden loss of AIG insurance
capacity could have severely disrupted the market, potentially
creating a market capacity shortage and significant premium
increases for consumers, businesses, and financial
institutions. They also feared a run driven by a substantial
influx of life insurance policyholders either drawing on the
savings and credit features of their policies or surrendering
their policies entirely, especially since some such ``runs''
were seen in foreign jurisdictions.\520\
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\520\ E-mail from Alejandro LaTorre, assistant vice president,
Federal Reserve Bank of New York, to Timothy F. Geithner, president and
chief executive officer, Federal Reserve Bank of New York and other
FRBNY personnel (Sept. 16, 2008) (FRBNY AIG00483-486); FRBNY and
Treasury briefing with Panel and Panel staff (May 11, 2010); FRBNY and
Treasury briefing with Panel and Panel staff (Apr. 12, 2010).
Policymakers have pointed out that some runs were seen in foreign
jurisdictions. According to press reports, insurance policyholders in
Singapore, Taiwan, Thailand, Vietnam, and Hong Kong sought to terminate
their insurance policies with two of AIG's insurance subsidiaries (AIA
and Nan Shan Life Insurance) after learning of AIG's financial troubles
and despite the Federal Reserve's $85 billion rescue. See, e.g.,
Hundreds of AIG Policyholders Throng Asian Offices, Agence France
Presse (Sept. 17, 2008) (online at afp.google.com/article/
ALeqM5iTq3SSoWfqiVVsrYgM0hnTOp0ZdQ); The Good, the Bad and the
Opportunity, Financial Express (Sept. 24, 2008); AIG Insurance Woes
Will Not Affect Vietnam, Asia Pulse (Sept. 22, 2008). After a number of
policyholders in Singapore terminated their insurance policies, Mr. Low
Kwok Mun, an official with the Monetary Authority of Singapore (MAS),
issued the following statement on September 18, 2008: ``AIA currently
has sufficient assets in its insurance funds to meet its liabilities to
policyholders. Policyholders should not act hastily to terminate their
insurance policies as they may suffer losses from the premature
termination and lose the insurance protection they may need.'' Low Kwok
Mun, executive director of Insurance Supervision, Monetary Authority of
Singapore, Statement on AIA's Policy Conservation Programme (Sept. 18,
2008) (online at www.mas.gov.sg/news_room/press_releases/2008/
Comments_from_MAS_on_AIA_Policy_Conservation_Programme.html).
---------------------------------------------------------------------------
In recent interviews with Panel staff, the Federal Reserve
and Treasury have stated that an AIG bankruptcy would have
likely resulted in both domestic and foreign regulatory seizure
of the regulated insurance company subsidiaries.\521\
Furthermore, the Federal Reserve and Treasury contend that with
respect to foreign regulatory seizure, the seizure by one
regulator in a given region would have likely had a domino
effect and led to the seizure of insurance businesses in
multiple jurisdictions across the region. In both the domestic
and foreign realms, the Federal Reserve and Treasury have
asserted that there might have been insufficient capital or
liquidity to pay all policyholder claims, that some
policyholders might not have been able to qualify for coverage
at other companies, and that a significant amount of policy
cancellations would have further undermined the stability of
the subsidiaries.\522\
---------------------------------------------------------------------------
\521\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010). For further discussion of the possible impact of an AIG
bankruptcy on the insurance company subsidiaries, see Section F.1(b),
infra.
\522\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
---------------------------------------------------------------------------
Given that the parent company and its insurance company
subsidiaries are also very closely intertwined through the
credit rating system, the Federal Reserve and Treasury stressed
that a bankruptcy by the parent entity would have adversely
impacted both the credit and insurance ratings of its
subsidiaries. Credit rating agency guidelines typically
stipulate that the parent company cannot move more than three
notches in ratings from those of its subsidiaries without the
subsidiaries themselves also being impacted by downgrades. Had
the AIG parent entity filed for bankruptcy, it would have
received a ``D'' credit rating, and because of the three notch
rule, the subsidiaries would have likely been downgraded to
CCC+, CC-, or lower. While a downgrade of a parent does not
necessarily result in the downgrade of a well-capitalized
subsidiary, A.M. Best, a leading rating agency for the
insurance industry, has indicated that if the parent is no
longer rated investment-grade, then this would be an important
factor in its assessment of both credit ratings and financial
strength ratings for the insurance subsidiaries.\523\ According
to the Federal Reserve and Treasury, any ratings downgrades
that might have occurred would have increased the odds that the
subsidiaries would be subject to heightened scrutiny by the
regulators or placed into conservatorship or receivership.
---------------------------------------------------------------------------
\523\ A.M. Best conversations with Panel staff (May 18, 2010);
Treasury conversations with Panel staff (Jan. 5, 2010).
---------------------------------------------------------------------------
According to the Federal Reserve and Treasury, AIG's
insurance company subsidiaries would not have been insulated
from the adverse consequences of a bankruptcy due to the
substantial ties they enjoyed with each other by virtue of
securities lending requirements and other intercompany
funding.\524\ Many of AIG's subsidiaries also owned interests
in, or had provided intercompany funding to, other AIG
entities, and these investments typically formed part of their
regulatory capital. Any defaults on the underlying securities
and loans as a result of a bankruptcy filing might have further
destabilized AIG's subsidiaries.
---------------------------------------------------------------------------
\524\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
---------------------------------------------------------------------------
Recent statements by Federal Reserve and Treasury officials
suggest that the regulators have tried to respond to public
displeasure with the AIG bailout by looking for more
sympathetic beneficiaries of their decision to intervene than
financial institutions. In his March 2009 testimony before the
House Financial Services Committee, Chairman Bernanke stressed
that an AIG failure would have also had detrimental impacts on
market confidence in other areas, including state and local
governments that invested with AIG, retirement plans that
purchased insurance from AIG, and banks that extended loans and
credit lines to the company.\525\ In January 2010, former
Treasury Secretary Paulson testified that ``if AIG had gone
down, [he] believe[d] that we would have had a situation where
Main Street companies, industrial companies of all sizes, would
not have been able to raise money for their basic funding. And
they wouldn't have been able to pay their employees. They would
have had to let them go. Employees wouldn't have paid their
bills. This would have rippled through the economy.'' \526\
Furthermore, Secretary Paulson added that had AIG failed, he
believes that it ``would have taken down the whole financial
system and our economy. It would have been a disaster.'' \527\
---------------------------------------------------------------------------
\525\ Written Testimony of Ben Bernanke, supra note 481, at 2.
\526\ House Committee on Oversight and Government Reform, Testimony
of Henry M. Paulson, Jr., former secretary, U.S. Department of the
Treasury, The Federal Bailout of AIG (Jan. 27, 2010) (publication
forthcoming) (online at oversight.house.gov/
index.php?option=com_content&task=view&id=4756&Itemid=2) (hereinafter
``Testimony of Henry M. Paulson, Jr.'').
\527\ Id. Additionally, Secretary Geithner built on these concerns
in his January 2010 testimony before the House Committee on Oversight
and Government Reform, stating that as the regulators considered how to
respond to AIG's problems, ``[s]tate and local governments halted
public works projects because they couldn't obtain financing. School
construction and renovation projects stopped. Hospitals postponed plans
to add beds and equipment. Universities across the nation faced
difficulty paying employees. High school students changed plans for
college education, which suddenly appeared much more expensive. Ships
that transport goods sat empty, in part because trade credit was simply
unavailable. Factories were closing and millions of Americans were
losing their jobs.'' Testimony of Sec. Geithner, supra note 11, at 4.
---------------------------------------------------------------------------
On the one hand, these expanded rationales might suggest
that many observers have perhaps understated AIG's risk to the
financial system as a whole by focusing primarily on the direct
effects of a default on AIG's counterparties. At the point of
initial intervention, there were so many different problems
posed by AIG that the regulators might have responded to any
one of them with a rescue, and in totality they felt they had
no option but to step in. On the other hand, the lack of
complete transparency at the time of the initial intervention
indicates that the government has failed to follow a consistent
and cohesive message with respect to its rationale for
assisting AIG, calling into question the factors that were
actually driving the decision-making at the various points in
time that assistance was offered and restructured. While the
Panel recognizes that there is a fair amount of agreement on
the systemic consequences of an AIG failure, there are
differing opinions on what would have been the consequences for
the insurance subsidiaries, the retail distribution network and
policyholders. Thus, to some extent, at least some of the
government's justifications seem to have pivoted over time into
a political argument (that has less factual support) with
respect to the impact of an AIG failure on the insurance
subsidiaries, retail sectors and policyholders.
In its assessment of government actions to deal with the
current financial crisis, the Panel has regularly called for
transparency, accountability, and clarity of goals. While the
government had to make the bailout decision in a very short
amount of time and with incomplete information, the Panel
stresses that the government also has a special obligation to
be transparent (and consistent) in explaining why it was
committing $85 billion of public funds.
ii. Balance Sheet Considerations
Two other areas of concern for the Federal Reserve and
Treasury were AIG's inability to articulate the amount of
assistance it needed and the speed with which its requests for
assistance escalated between September 12 and 16.\528\ Not only
was the company not able to provide a sense of its balance
sheet and its exposure to either potential private sector
investors or the government, but its capital deficit was
growing much faster than available capital. This also appears
to have been a factor in the breakdown in private-sector
efforts to provide a solution for AIG, as AIG could not produce
certainty on any of the metrics on which lenders typically
lend.\529\ This lack of knowledge and awareness, according to
the Federal Reserve and Treasury, was due to the sheer size of
the company, the company's involvement in complex derivatives
transactions, the substantial intercompany ties, and the global
aspect of its business.\530\ Further, there was no regulator
monitoring systemic risk who might have called for such an
accounting. As Secretary Paulson has noted, the fact that AIG
was ``seriously underregulated'' meant that the parent entity
essentially functioned as an unregulated holding company with
no single regulator having ``a complete picture of AIG.'' \531\
---------------------------------------------------------------------------
\528\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); Testimony of Sec. Geithner, supra note 11, at 3 (noting that
``neither AIG's management nor any of AIG's principal supervisors--
including the state insurance commissioners and the OTS--understood the
magnitude of risks AIG had taken or the threat that AIG posed to the
entire financial system'').
\529\ The private rescue participants state that although they were
working on a term sheet for a facility in the amount of $75 billion
there was never any certainty with respect either to the amount of
money needed for the rescue or the value of the collateral to support
that rescue. Panel conversation with Rescue Effort Participants. FRBNY
and Treasury briefing with Panel and Panel staff (Apr. 12, 2010). For
further discussion of the private sector rescue attempt, see Section
C.1, supra.
\530\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); Testimony of Sec. Geithner, supra note 11, at 3 (stating
that AIG's parent holding company ``was largely unregulated'' and that,
``[d]espite regulators in 20 different states being responsible for the
primary regulation and supervision of AIG's U.S. insurance
subsidiaries, despite AIG's foreign insurance activities being
regulated by more than 130 foreign governments, and despite AIG's
holding company being subject to supervision by the Office of Thrift
Supervision (OTS), no one was adequately aware of what was really going
on at AIG'').
\531\ Testimony of Henry M. Paulson, Jr., supra note 526. See
Section E.2 for further discussion of regulatory capital issues and
foreign banks' receipt of some of the U.S. government assistance
provided to AIG.
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iii. International Considerations
Given the sheer size of AIG as well as its substantial
exposure and interconnectedness across the globe, there were
other practical considerations at play in the decision to
assist AIG. Numerous non-U.S. parties had an interest in AIG,
but it remains unclear whether they contacted the Federal
Reserve Board and Treasury to express their concerns. These
included several European central bankers who were worried
about the impact of an AIG failure on European financial
institutions and markets, and who, according to one journalist,
spoke with Chairman Bernanke on September 16, urging the
Federal Reserve to do whatever it could to prevent an AIG
failure.\532\
---------------------------------------------------------------------------
\532\ James B. Stewart, Eight Days, The New Yorker, at 59 (Sept.
21, 2009) (online at www.newyorker.com/reporting/2009/09/21/
090921fa_fact_stewart). The Panel has asked both the Federal Reserve
Board and FRBNY whether these conversations between foreign central
bankers and Chairman Bernanke took place in the hours preceding the
Federal Reserve Board's decision to authorize the rescue of AIG under
section 13(3), but was unable to verify that these did in fact take
place.
---------------------------------------------------------------------------
In explaining its decision to lend to AIG, the government
has not emphasized the international ramifications of the
choice it faced. But as discussed in Section F, the shocks of
an AIG bankruptcy would have been felt across the globe and
perhaps especially in Europe. Records from around the time of
the rescue show that FRBNY did take these international
considerations into account.\533\
---------------------------------------------------------------------------
\533\ See E-mail from Alejandro LaTorre, assistant vice president,
Federal Reserve Bank of New York, to Timothy Geithner, president,
Federal Reserve Bank of New York, and other FRBNY personnel (Sept. 16,
2008) (FRBNY AIG00483-486) (with attached memo); E-mail from Alejandro
LaTorre, vice president, Federal Reserve Bank of New York, to Timothy
F. Geithner, president, Federal Reserve Bank of New York, and other
Federal Reserve Bank of New York officials (Sept. 14, 2008)
(FRBNYAIG00496-499).
---------------------------------------------------------------------------
b. Panel's Analysis of Options Available to the Government
and Decisions Made
While recognizing that policymakers faced a deepening
financial crisis and that there were many issues of serious
concern and a limited amount of time in which to respond, the
Panel notes that several conclusions can be drawn from the
actions taken by FRBNY with respect to AIG in September 2008.
FRBNY's decisions were made in the belief that it alone could
act and that it had to choose between options that were all
unattractive. There is nothing unusual about central banks
acting as the lender of last resort. However, by adopting the
term sheet developed by the private sector consortium and
retaining most of its terms and conditions, FRBNY chose to act,
in effect as if it were a private investor in many ways, when
its actions also had serious public consequences whose full
extent it may not have appreciated.\534\ FRBNY also failed to
recognize the AIG problem and get involved at a time when it
could have had more options. While the reasons for FRBNY's
failure are not clear, it is clear that when FRBNY finally
realized AIG was failing and that there would be no private
sector solution, Chairman Bernanke and President Geithner
failed to consider any options other than a full rescue. To
have the government step in with a full rescue was not the
approach used in prior crises, including Bear Stearns and Long-
Term Capital Management. It is also clear that by the time
FRBNY focused on the problem, time was limited, and the breadth
and scope of legal counsel sought were narrow. FRBNY chose
lawyers from a limited pool and did not seek legal advice from
a debtor's counsel (such as AIG's bankruptcy counsel or
independent bankruptcy counsel). As a result, there were many
options FRBNY evidently did not consider, including a combined
private/public rescue (which would have maintained some market
discipline), a loan conditioned on counterparties granting
concessions, and a short-term bridge loan from FRBNY to provide
AIG time for longer-term restructuring. Providing a full
government rescue with no shared sacrifice among the creditors
who dealt with AIG fundamentally changed the relationship
between the government and the markets, reinforcing moral
hazard and undermining the basic tenets of capitalism. The
rescue of AIG dramatically added to the public's sense of a
double standard--where some businesses and their creditors
suffer the consequences of failure and other, larger, better
connected businesses do not.
---------------------------------------------------------------------------
\534\ The Panel notes, however, that many parties benefitted from
the AIG rescue, and FRBNY, unlike a private entity, did not ask for any
kind of fee or consideration for the reduction in risk that occurred
due to the avoidance of bankruptcy.
---------------------------------------------------------------------------
The FRBNY's decision-making also suggest that it neglected
to give sufficient attention to the crucial need--more
important in a time of crisis than ever--for accountability and
transparency. In his testimony before the Panel, Mr. Baxter of
FRBNY commented that one of his take-away lessons from the
financial crisis is that ``we need to be more mindful of how
our actions can be perceived'' and that the policymakers ``need
to be more mindful of that and perhaps change our behavior as a
result of the perception.'' \535\ This perception, and, in
particular, FRBNY's failure to be more sensitive with respect
to potential conflicts of interest and the way in which the
public and members of Congress would view its actions, has
colored all the dealings between the government and AIG in the
eyes of the public.
---------------------------------------------------------------------------
\535\ Testimony of Thomas C. Baxter, supra note 215.
---------------------------------------------------------------------------
The omissions of FRBNY and Treasury pointed out above also
indicate that the government chose not to exploit its
negotiating leverage with respect to the counterparties. In
particular, it seems that some of the individuals involved in
the AIG rescue were relatively junior in terms of seniority, so
the active involvement of Secretary Paulson and President
Geithner in trying to negotiate concessions with their peers at
institutions who stood to lose most from an escalation of
financial panic and market dislocation might have made a
difference. It is possible that had individuals other than
those who stood to gain the most from an AIG rescue been at the
table in September 2008 (even recognizing the severe time
pressure that policymakers then faced), other potential
alternatives could have been developed. And by choosing a law
firm that had previously represented private parties in the
same matter and had strong ties to Wall Street, FRBNY at least
created the perception of being guided in its actions by
parties with an interest in a complete government rescue of
AIG's creditors.\536\
---------------------------------------------------------------------------
\536\ Written Testimony of Martin Bienenstock, supra note 307, at 4
(stating that ``it would be awkward for it to devise strategies to
obtain concessions'' from those very same institutions it routinely
represents).
---------------------------------------------------------------------------
The Panel asked several questions with respect to the
decisions made by the government in September.
i. Were all Private Sector Solutions Exhausted?
Before addressing the manner in which the government chose
to rescue AIG, it is worth asking whether all the private
options for rescue had in fact been exhausted. As discussed
above, at least several different private sector proposals were
contemplated in the days between September 12 and 16,
2008.\537\ The Panel discussed the issue with some of the
parties that had presented options to AIG in the period
preceding the rescue. While FRBNY and Treasury officials
remained hopeful that the private sector would formulate an
appropriate solution for AIG, all potential private sector
solutions eventually collapsed.
---------------------------------------------------------------------------
\537\ For a detailed discussion of the various private sector
solutions considered between September 12 and 16, 2008, see Section
C.1, supra.
---------------------------------------------------------------------------
At this time, however, other possible alternatives could
have also included a public-private hybrid solution built on
some government funding or guarantee combined with some private
sector funding. According to FRBNY, there was no attempt to do
such a hybrid approach because ``[t]here was no time'' and it
was also felt that ``that could be counterproductive, given
what we were seeing in the markets at the time.'' \538\
However, according to Mr. Willumstad, AIG had initially sought
$20 billion on the weekend spanning September 12, 2008 and
believed (at least initially) that he would be successful in
finding that amount through a combination of the New York State
Insurance Department's authorization to allow AIG to transfer
$20 billion in assets from its subsidiaries to use as
collateral for daily operations, a $20 billion loan from banks,
and $10 billion from private equity investors.\539\ Although
that target number grew to $40 billion within a day (in large
part due to the uncertainty as to what would happen in the
financial markets after Lehman's bankruptcy filing), Mr.
Willumstad had explained to President Geithner and Secretary
Paulson that AIG ``could probably raise $30 billion'' that
weekend, ``but the investors and New York State Insurance
Department would not go ahead unless they would be assured that
the company would survive after receiving that money.'' \540\
While FRBNY continued to assert that there would be no
government support for AIG up until it announced that it was
rescuing AIG, Mr. Willumstad believes that AIG had a verbal
commitment for approximately $30 billion from the private
sector, conditioned on FRBNY providing guarantees or some
alternative support mechanism to signal to the market
sufficiently that AIG would remain viable going forward.\541\
Based on Panel staff conversations with Scott Alvarez, general
counsel at the Federal Reserve Board, it is clear that the
Federal Reserve would not have been able to provide an open-
ended guarantee or blanket assurance to AIG's creditors that
AIG or its insurance subsidiaries would continue to be viable
or to operate as going concerns in the near or medium
term,\542\ but it could have done targeted guarantees or a
``capped'' guarantee to a private consortium loan in September
2008 (assuming adequate collateral) if it had properly explored
that approach.\543\ While the Federal Reserve (and the
taxpayers) would still have been liable (or at risk) for the
full amount of the guaranteed private loan or the guaranteed
AIG obligations, a major benefit of this approach is that the
Federal Reserve would not have had to provide the funds to AIG
initially.
---------------------------------------------------------------------------
\538\ Testimony of Thomas C. Baxter, supra note 215.
\539\ Testimony of Robert Willumstad, supra note 179.
\540\ Testimony of Robert Willumstad, supra note 179.
\541\ Testimony of Robert Willumstad, supra note 179.
\542\ This is because AIG would not have had sufficient collateral
for such an open-ended guarantee.
\543\ Panel staff conversations with Federal Reserve (May 28,
2010). Section 13(3) of the Federal Reserve Act requires that
assistance provided must be ``indorsed or otherwise secured to the
satisfaction of the Federal Reserve bank.'' 12 U.S.C. 343. Thus, the
amount of the guarantee would be ``capped'' by the value of available
or unencumbered assets that could be posted as collateral.
Without the proposed terms and conditions, it is difficult to say
whether the Federal Reserve could have authorized or FRBNY could have
provided a certain type of guarantee under Section 13(3). If the
insurance subs have liabilities of $1.9 trillion, and assets that
presumably at least match those liabilities (because state law requires
adequate coverage), and the Federal Reserve estimated the value of the
insurance subs was at least $85 billion as going concerns (but maybe
not much more), however, then a guarantee of a private obligation might
have been a feasible option.
As part of a hybrid public-private solution, AIG may have pledged
the same assets as collateral for both the private loan and the public
guarantee. In that case, the private creditors would have had to agree
to release collateral to FRBNY in the amount of any claims that they
asserted in relation to the public guarantee. In the alternative, the
private consortium or syndicate may not have required AIG to provide
collateral for the loan because the protection offered by the Federal
Reserve's guarantee provided sufficient security.
Internal FRBNY correspondence after FRBNY's provision of the
Revolving Credit Facility to AIG indicates that there was some general
discussion of guarantees, but the Federal Reserve did not believe it
had the authority to do so, but it might have been an option for
Treasury to consider. AIG Call Tonight, E-mail from Sarah Dahlgren,
senior vice president, Federal Reserve Bank of New York, to Timothy
Geithner, Thomas Baxter, and other FRBNY officials (Oct. 15, 2008)
(FRBNY-TOWNS-R1-209923).
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While Mr. Willumstad believes that this alternative ``would
have been much more attractive,'' \544\ it is not certain that
a deal could have been reached if the Federal Reserve Board and
FRBNY had taken this approach. It should also be noted that a
public-private hybrid solution might not have stabilized AIG.
AIG would still have been required to raise the capital from
the private parties to satisfy its liquidity needs. In the
event that the capital raised was in the form of debt rather
than equity, it may not have been able to avoid a ratings
downgrade, although, again, as discussed in more detail
below,\545\ FRBNY and Treasury could have played a more active
role in managing the reactions of the credit ratings agencies.
Credit ratings are based, in part, on the amount of leverage a
company has, and before acquiring capital through new debt, AIG
already had a large amount of debt or a high debt to equity
ratio. A guarantee could have provided partial or targeted
relief, and AIG's creditors would still have been able to
address any claims remaining after the government intervention
through bankruptcy or by other negotiations. A joint effort by
the government and private sector to support a struggling
financial services institution that had consolidated total
assets of more than $1 trillion might have also kept some
market discipline in the deal and sent a strong signal to the
markets at a time of great economic turmoil and uncertainty.
---------------------------------------------------------------------------
\544\ Testimony of Robert Willumstad, supra note 179.
\545\ See discussion in Section G.
---------------------------------------------------------------------------
Under the circumstances,\546\ it stands to reason that
FRBNY might have made a greater effort to save the system by
forming a broader private sector rescue coalition than the
group it assembled after the Lehman weekend (the actual
consortium of private bankers that was ultimately assembled
consisted of only two members--JP Morgan and Goldman Sachs--
whose efforts to syndicate the potential secured lending
facility among a number of large financial institutions appear
to have made little or no headway). Assuming the economy was
truly ``on the brink,'' as Secretary Paulson's recent memoir
attests, why was FRBNY's eleventh-hour rescue effort limited
only to a few key players? A broader group with more resources
might have had better odds of success and, given the stakes at
hand, it might have been worth it for FRBNY to solicit the
involvement of more players. Some firms had ample amounts of
cash during that period and the European banks that were AIG's
largest counterparties also had strong incentives (if not
purely a motivation based on their own self-interest) to help.
---------------------------------------------------------------------------
\546\ See discussion of extreme market dislocation in September
2008 in Section C.1.
---------------------------------------------------------------------------
While acknowledging that a private sector solution may not
have been likely to succeed given the combination of AIG's
escalating liquidity needs and increased concerns by potential
lenders about capital preservation in the wake of the Lehman
Brothers bankruptcy filing, the Panel notes that the upside of
a private sector rescue would have been two-fold and
significant. First, it would have saved billions of taxpayer
dollars and mitigated if not eliminated the serious moral
hazard and ``too big to fail'' concerns. Second, a successful
private sector rescue would have served as a very strong and
calming signal that the U.S. financial system was strong enough
to function without a full government bailout. The Panel also
notes that had private parties been involved they--and not the
government--could have managed much of the post-bailout
reorganization of the company.
ii. Was It Truly an All-or-Nothing Choice?
The government presents the decision to rescue AIG as an
all-or-nothing ``binary'' decision.\547\ In other words, the
government asserts that it was necessary to rescue AIG in its
entirety or let it fail in its entirety; it was not possible to
pick and choose which businesses or subsidiaries could be
saved. The Panel tested this assertion and considered whether
bankruptcy had to be an all-or-nothing option, in terms of the
entities covered, the obligations covered, or in terms of
timing: if a bankruptcy was not a real option in September
2008, was it later? \548\
---------------------------------------------------------------------------
\547\ Joint Written Testimony of Thomas C. Baxter and Sarah
Dahlgren, supra note 255, at 3 (stating that ``[i]n the early days of
the intervention, when we knew precious little about AIG, but knew that
it needed billions of dollars, we were truly facing a binary choice to
either let AIG file for bankruptcy or to provide it with liquidity.'');
FRBNY and Treasury briefing with Panel and Panel staff (Apr. 12, 2010).
\548\ In conversations with Panel staff, FRBNY and Treasury have
asserted that they considered bankruptcy as a possible option in the
months subsequent to their September 2008 decision to rescue AIG (and
it appears that this was under consideration at least until March
2009). See AIG Presentation on Systemic Risk, supra note 92 (detailing
the impact of an AIG failure on the U.S. Government's efforts to
stabilize the economy).
---------------------------------------------------------------------------
The Panel looked first at whether some parts of AIG could
have been permitted to fail. Since insurance companies cannot
file for bankruptcy under the U.S. Bankruptcy Code,
subsidiaries holding the vast majority of AIG's assets could
not have sought bankruptcy protection and might have been
subject to the specific regimes applicable to insurance
companies.\549\ The most obvious candidate to be forced into
bankruptcy, nonetheless, would have been AIGFP.\550\ It was the
cause of much of AIG's original distress and continuing
liquidity problems and was unlikely to have any value as a
going concern. Approximately $54 billion of AIGFP's debt,
however, was guaranteed by its parent, AIG.\551\ AIGFP's
bankruptcy would have triggered cross-default acceleration
provisions in AIG's own debt and resulted in AIG becoming
immediately liable to pay $65 billion of AIGFP debt and
approximately $36 billion of its own debt.\552\ It would have
thus pushed the parent itself into bankruptcy since it did not
have cash to meet these obligations. That bankruptcy might have
triggered the immediate seizure of many of AIG's insurance
subsidiaries (which represented any value that existed in the
AIG franchise) by state regulators.\553\ Exacerbating the
situation was the fact that many of the insurance companies had
interlocking holdings and intercompany borrowing
arrangements.\554\ The government asserted in interviews with
Panel staff that ``once one entity goes, the rest go.'' \555\
In these circumstances, it is difficult to see how anything
other than a bankruptcy of AIG's parent company would have been
possible.
---------------------------------------------------------------------------
\549\ For further discussion of the application of the U.S.
Bankruptcy Code to AIG, see Annex IV.
\550\ In making this assertion, the Panel does not imply that this
would have been an easy or controlled bankruptcy, however. The overall
complexity of AIGFP's business, its operations in multiple foreign
countries, and the impact of bankruptcy roles on swaps would have
combined to make an AIGFP bankruptcy extremely difficult.
\551\ AIG Form 10-Q for the Second Quarter 2008, supra note 177, at
96. The $54 billion included AIG's insurance subrogation liability to
insurance companies who paid out claims while standing in the shoes of
AIG. The actual subrogation value (which refers to circumstances in
which an insurance company tries to recoup expenses for a claim it paid
out when another party should have been responsible for paying at least
a portion of that claim) would have likely lowered the amount of
AIGFP's debt.
\552\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 116.
\553\ Panel staff conversation with Jay Wintrob, CEO of the
SunAmerica Financial Group (May 17, 2010). As discussed in Annex IV,
insurance companies are subject to their own resolution process in lieu
of bankruptcy; the term ``bankruptcy'' as used here is intended to
encompass that process at the state level.
\554\ For further details, see Section C.3
\555\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
---------------------------------------------------------------------------
The government does not contend that bankruptcy in
September 2008 was impossible, but that it was the much less
attractive of the two options that it considered possible. A
bankruptcy could have addressed many of AIG's problems: it
could have wiped out the old equity, limited losses, forced
losses on all creditors, and perhaps given the company the
chance to improve its prospects. The Panel does not take a
position on whether the government was correct to choose rescue
and acknowledges that this report is reviewing decisions made
under very stressful conditions, but offers several
observations on the decision and the justification offered for
that decision and asks whether the government considered all
the options that were available to a party with the enormous
bargaining power that being the lender of last resort brings.
While the government has claimed that the choice was binary
(either let AIG file for bankruptcy on September 16, 2008 or
step in to back AIG fully, which effectively meant it was
guaranteeing that all creditors would be paid in full), this
binary choice is too simplistic.
Bankruptcy law is designed to force creditors to accept
discounts or other losses under extant contracts. Without the
law to force AIG's creditors to accept discounts or other
losses, the Panel notes that whatever leverage the government
could have applied to get AIG's creditors to take less than
full payment was extra-legal and thus less certain to yield
results. But that leaves the question of whether the government
adequately used the negotiating leverage it had, outside of
bankruptcy, to persuade AIG's counterparties to accept some
losses, given the realities that AIG simply did not have the
money to pay all of them in full, and that the government knew
or should have known that keeping our financial system running
was already putting or was about to put enormous demands on
taxpayer resources and create systemic problems of its own.
Additionally, the Panel notes that the initial decision to
rescue AIG need not have been treated as permanent. FRBNY and
Treasury could have provided the RCF on a temporary bridge loan
basis in order to allow AIG to keep making collateral payments,
for example, with immediate plans to then go to Congress for
authority to allow a managed bankruptcy under some sort of
resolution authority. FRBNY and Treasury's arguments also seem
to assume that the government would or could not have taken
responsive actions to address some of the ``innocent victims''
(for example, employees relying on pension funds who would have
lost insurance in the event of an AIG bankruptcy). As
demonstrated by the bankruptcies of Chrysler and General
Motors, during which the government negotiated with the unions
and bond holders in its role as a post-petition lender,\556\
post-petition financiers have enormous leverage, and if the
money is being funded post-petition (as would have been the
case here), it could have been spent at its discretion. In
these circumstances, the government would have had a number of
alternatives on the table, and it could have used its huge
leverage arising from its post-financing position.
---------------------------------------------------------------------------
\556\ September Oversight Report, supra note 389, at 49-50
(discussing the government's provision of both pre- and post-petition
financing to Chrysler and GM as their financial conditions deteriorated
and the government's power and leverage as a DIP financier, on account
of its post-petition claim).
---------------------------------------------------------------------------
iii. Could the Government Have Negotiated Concessions from
AIG's Creditors?
Throughout this financial crisis, as in past crises, the
Federal Reserve and FRBNY, with the assistance or at least
acquiescence from Treasury, have used their leverage with
financial institutions, along with the institutions'
recognition of financial realities and their own self-interest,
to negotiate and reach compromises.\557\ By doing so, the
parties have been able to craft extra-legal compromises that
involve financial institutions taking on risk; that is,
financial institutions have realized potential or actual losses
so that the entire system continues to function in
extraordinary circumstances in a more or less orderly way.
There is no evidence, however, that after the early-morning
hours of September 16, 2008, the government made any effort to
do so with AIG. Time pressures, it is true, were great.
Moreover, this crisis involved not one failing institution, but
multiple institutions simultaneously near failure or in
unprecedented trouble.
---------------------------------------------------------------------------
\557\ Following the private-sector bailout of Long-Term Capital
Management in 1998, then-Chairman Alan Greenspan testified: ``Officials
of the Federal Reserve Bank of New York facilitated discussions in
which the private parties arrived at an agreement that both served
their mutual self interest and avoided possible serious market
dislocations. Financial market participants were already unsettled by
recent global events. Had the failure of LTCM triggered the seizing up
of markets, substantial damage could have been inflicted on many market
participants, including some not directly involved with the firm, and
could have potentially impaired the economies of many nations,
including our own.'' Written Testimony of Alan Greenspan, supra note
217.
---------------------------------------------------------------------------
On the other hand, it is important to ask whether the
government was in this time-pressured position in no small part
because of its own failure to organize and prepare themselves
effectively many months earlier.\558\ Earlier in 2008, the
Federal Reserve and FRBNY could have established teams to
monitor each easily identifiable financial institution that
might have found itself in trouble for the same reasons that
Bear Stearns collapsed, as well as teams to think more broadly
about problems that might be hidden from view. For example, the
governmental entities could have assembled teams to try to
determine the size of the CDS market and whether particular
institutions were on the hook for an outsized share of the
derivatives that the government was able to identify.\559\
While it is unclear whether this approach would have made a
difference in the end, it is certainly worth considering. In
2008, FRBNY examiners sought a meeting with the OTS to open a
dialogue with them about AIG and its operations and to discuss
issues that the FRBNY examiners had seen with respect to the
monoline financial guarantors.\560\ There is also some evidence
that Treasury (under the leadership of Steven Shafran, senior
adviser to Secretary Paulson) had, since the early summer of
2008, been looking into systemic risk in the financial sector
and coordinating between various agencies, with a specific
focus on Lehman Brothers.\561\ Nonetheless had the government
made earlier and broader efforts to obtain a more precise
picture of the looming danger at AIG, it might have used its
inherent negotiating leverage to great effect.\562\
---------------------------------------------------------------------------
\558\ For example, the government could have started preparing in
March 2008, when Bear Stearns' dire situation became apparent, or in
late 2007, when many large financial institutions incurred substantial
write-downs on mortgage-related assets, just to pick two timeframes.
The report of the bankruptcy examiner for Lehman Brothers indicates
that the SEC and FRBNY were conducting onsite monitoring of Lehman
beginning in March 2008. Report of Anton R. Valukas, court-appointed
bankruptcy examiner, In re Lehman Bros. Holdings, Inc., No. 08-13555,
at 1488-89 (JMP) (Bankr. S.D.N.Y. Mar. 11, 2010) (online at
lehmanreport.jenner.com/VOLUME%204.pdf) (``After March 2008 when the
SEC and FRBNY began onsite daily monitoring of Lehman, the SEC deferred
to FRBNY to devise more rigorous stress-testing scenarios to test
Lehman's ability to withstand a run or potential run on the bank. The
FRBNY developed two new stress scenarios: ``Bear Stearns'' and ``Bear
Stearns Light.'' Lehman failed both tests. The FRBNY then developed a
new set of assumptions for an additional round of stress tests, which
Lehman also failed. However, Lehman ran stress tests of its own,
modeled on similar assumptions, and passed. It does not appear that any
agency required any action of Lehman in response to the results of the
stress testing'').
\559\ For example, in 2007, as the housing market deteriorated, OTS
increased its surveillance of AIGFP and its portfolio of mortgage-
related credit default swaps. Among other things, OTS recommended that
AIGFP review its CDS modeling assumptions in light of worsening market
conditions and that it increase risk monitoring and controls. Beginning
in February 2008, in response to a material weakness finding in AIG's
CDS valuation process, OTS again stepped up its efforts to force AIG to
manage risks associated with its CDS portfolio. For further discussion
of OTS' supervisory actions with respect to AIG before the government's
rescue, see Section B.6, supra.
\560\ The Panel notes that this meeting eventually took place on
August 11, 2008.
\561\ Andrew Ross Sorkin, Too Big To Fail, at 216 (2009). It seems
possible that some of this monitoring dealt with AIG, though the Panel
has seen no evidence that it did. If there were such efforts with
respect to AIG, they likely would have been overshadowed over time as
Treasury increasingly focused on preparing for the possibility of a
Lehman bankruptcy.
\562\ As part of its negotiating leverage, the government could
have pointed to the fact that demands on taxpayer funds were not
infinite, and that failing to accept concessions might have yielded
worse results for the counterparties than taking a haircut.
---------------------------------------------------------------------------
The government should have had the foresight to collect
information earlier and begin the process of informing AIG's
creditors and counterparties, including financial institutions
and foreign governments, that no one should expect to emerge
from the situation unscathed. It is still not clear however,
that the government did all that it could, even in the little
time available, to convince AIG's creditors to accept less than
full compensation.
Until the afternoon of September 16, 2008, it was at least
possible for the government to suggest that it would let AIG
fail, as a means to demand concessions from AIG's
counterparties; this would have been a credible threat given
that the government had just let Lehman fail. For example, the
Federal Reserve could have conditioned its lending to AIG in
September 2008 by mandating that the counterparties either take
a haircut or face the risk of bankruptcy proceedings and the
associated uncertainty. There is also the possibility that the
Federal Reserve could have told the counterparties that it was
willing to make immediate settlement for a certain percentage
on the dollar, that it would permit AIG to default on all other
arrangements, and that a Chapter 11 bankruptcy would handle the
remaining debts.
The Panel also discussed with FRBNY and Treasury whether
some alternative to a rescue that paid off all of AIG's
obligations to its creditors and counterparties (and
particularly AIGFP's obligations) in full might have been
possible. While FRBNY acknowledges that it had the legal
authority to impose such conditions on its lending, it believes
that such constraints would have substantially impeded its
goals of assisting AIG so that it could meet its obligations as
they came due and serving as a reassurance that AIG would not
further destabilize the financial markets.\563\ FRBNY also
states that while such tactics have been used in certain
sovereign debt restructurings, ``they can be used there only
because sovereigns cannot go bankrupt, and only with months of
pre-planning.'' \564\
---------------------------------------------------------------------------
\563\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010). FRBNY states that ``[a]ny attempt to condition our lending
would have created further uncertainty in a time of panic as to which
of AIG's counterparties would get paid and which would be forced to
take substantial losses. One of our objectives was to calm market
participants, and uncertainty (and the allegations of favoritism that
surely would have followed) does not do that--it fuels fear.'' Joint
Written Testimony of Thomas C. Baxter and Sarah Dahlgren, supra note
255, at 6.
\564\ Joint Written Testimony of Thomas C. Baxter and Sarah
Dahlgren, supra note 255, at 6.
---------------------------------------------------------------------------
The Panel tested these assertions and considered whether it
might have been possible for FRBNY to condition its lending to
AIG on a requirement that the company obtain concessions from
some of its major creditors. While the government argues that
the bankruptcy threat was no longer viable after its initial
decision not to place AIG into bankruptcy, the evidence shows
that long after September 16, 2008, and indeed well into 2009,
the government was still considering the possibility of some
form of bankruptcy for at least part of AIG.\565\
---------------------------------------------------------------------------
\565\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010); FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); See AIG Presentation on Systemic Risk, supra note 92.
---------------------------------------------------------------------------
In his recent testimony before the Panel, Mr. Bienenstock
of Dewey & LeBoeuf asserted that the rescue of AIG could have
incorporated some ``shared sacrifice'' by certain of AIG's
creditors. In his view, for several reasons, it was ``very
plausible to have obtained material creditor discounts from
some creditor groups'' without undermining the government's
goals of preventing the further destabilization and potential
collapse of the financial system.\566\ First, according to Mr.
Bienenstock, since AIG was granting FRBNY a lien against all
available assets as security for its $85 billion RCF (and was
no longer permitted to borrow funds from its insurance company
subsidiaries effective September 22, 2008), creditors that
might have obtained a judgment for any subsequent default would
not necessarily have been able to collect.\567\ Second, since
AIG was current on its debt obligations, it was not going to
voluntarily file for bankruptcy, and any parties that might
have filed an involuntary bankruptcy petition against AIG would
have been unable to show that AIG was not paying its debts as
they came due.\568\ Third, FRBNY ``was saving AIG with taxpayer
funds due to the losses sustained by the business divisions
transacting business with these creditor groups, and a
fundamental principle of workouts is shared sacrifice,
especially when creditors are being made better off than they
would be if AIG were left to file for bankruptcy.'' \569\
Therefore, Mr. Bienenstock concludes, AIG was in a position to
convince its CDS counterparties to grant debt concessions.
---------------------------------------------------------------------------
\566\ Written Testimony of Martin Bienenstock, supra note 307, at
1.
\567\ Written Testimony of Martin Bienenstock, supra note 307, at
2.
\568\ Written Testimony of Martin Bienenstock, supra note 307, at
2. Mr. Bienenstock also describes how if creditors filed involuntary
bankruptcy petitions against AIG, they might have rendered themselves
liable for compensatory and punitive damages if the court found ``AIG
was generally paying its debts as they came due and the creditors had
been warned in advance of that fact.'' (citing 11 U.S.C. 303(i)(2)).
\569\ Written Testimony of Martin Bienenstock, supra note 307, at
3.
For example, the AIGFP CDS and securities lending counterparties
got $105.8 billion, which is a large portion of the overall $182.4
billion expended.
---------------------------------------------------------------------------
While it is unclear what the impact of any such concessions
would have been, given that they did not occur, the Panel notes
that certain potential ramifications might have occurred had
such negotiations been successful. Some potential ramifications
involve the rating agencies.
The ratings agencies assign a separate rating-type
designation to companies that have engaged in what is called a
``Distressed Exchange.'' Under published rating agency
criteria, a company's settlement of its obligations with
counterparties at a significant discount to what was due under
contract may be considered a ``Distressed Exchange.'' This
designation can have an adverse impact on a company's
ratings.\570\ Rating agency criteria set forth various factors
to be considered in assessing whether a particular transaction
will be deemed a Distressed Exchange.\571\ While the rating
agencies note that the impact of such exchange offers on
ratings generally depends on the particular facts and
circumstances of a situation, and say they cannot address
hypothetical situations definitively,\572\ several conclusions
can be drawn. For some of the rating agencies, there could be
in theory a finding that a Distressed Exchange has taken place
even if the counterparties technically accepted the offer
voluntarily, and no legal default occurred.\573\ The rating
committees, however, always consider various factors, such as
whether default, insolvency or bankruptcy in the near or medium
term would be likely without the exchange offer, in deciding
whether a selective default has occurred.\574\
---------------------------------------------------------------------------
\570\ For example, upon the completion of a ``Distressed
Exchange,'' Standard & Poor's lowers its ratings on the affected issues
to ``D,'' and the issuer credit rating is reduced to ``SD'' (selective
default).
\571\ According to Standard & Poor's criteria, a selective default
determination is based on the investor receiving less value than the
promise of the original securities and the settlement being distressed,
``rather than purely opportunistic.'' A ``Distressed Exchange'' occurs
where holders ``accept less than the original promise because of the
risk that the issuer will not fulfill its original obligations,'' and
also requires a ``realistic possibility of a conventional default
(i.e., the company could file for bankruptcy, become insolvent, or fall
into payment default) on the instrument subject to the exchange, over
the near to medium term.'' Upon the determination of a Distressed
Exchange, Standard & Poor's issues a separate credit rating of ``SD,''
or selective default, assuming the issuer continues to honor its other
obligations. Standard & Poor's Financial Services, General Criteria:
Rating Implications of Exchange Offers and Similar Restructurings,
Update (May 12, 2009) (online at www.standardandpoors.com/prot/ratings/
articles/en/us/?assetID=1245199775643) (hereinafter ``Standard and
Poor's Rating Criteria'') (free registration required). According to
Standard & Poor's, the selective default rating would have applied to
both the AIG parent and AIGFP. Panel staff conversations with Standard
& Poor's (May 13, 2010).
According to Moody's, ``[t]he two required and sufficient
conditions for an exchange offer to be deemed a distressed exchange are
1) the exchange has the effect of allowing the issuer to avoid default
and 2) creditors incur economic losses relative to the original promise
to pay as a result of the exchange.'' Furthermore, ``[e]xchanges made
by distressed issuers at discounts to par which have the effect of
allowing the issuer to avoid a bankruptcy filing or a payment default
(i.e., `distressed exchanges') are considered default events under
Moody's definition of default. However, since whether an issuer would
have defaulted absent an exchange is unobservable, the determination of
whether an exchange constitutes a default event is inherently a
judgment call.'' Moody's does not have separate symbols to use upon
finding that a Distressed Exchange has occurred, but instead
incorporates the occurrence into its ratings assessment. Moody's Global
Credit Policy, Moody's Approach to Evaluating Distressed Exchanges
(Mar. 2009) (hereinafter ``Moody's Approach to Evaluating Distressed
Exchanges'').
According to Fitch Ratings, a coercive debt exchange (which results
in a default) occurs when ``an issuer is essentially forced to
restructure its debt obligations in an effort to avert bankruptcy or a
liquidity crunch. By definition, this will cause a reduction in
contractual terms from the creditor's perspective . . .'' Fitch further
elaborates by stating that a coercive debt exchange must either involve
``an explicit threat of bankruptcy'' or ``a high probability of
bankruptcy or insolvency over the near term absent the exchange.''
Fitch Ratings, Coercive Debt Exchange Criteria (Mar. 3, 2009)
(hereinafter ``Coercive Debt Exchange Criteria'').
\572\ Written Testimony of Rodney Clark, supra note 80, at 6-7;
Panel staff conversations with Standard & Poor's (May 13, 2010); Panel
staff conversations with Moody's (May 19, 2010); Panel staff
conversations with Fitch Ratings (May 20, 2010).
\573\ Standard and Poor's Rating Criteria, supra note 571 (free
registration required); Moody's Approach to Evaluating Distressed
Exchanges, supra note 571.
\574\ Panel staff conversations with Standard & Poor's (May 19,
2010); Panel staff conversations with Moody's (May 19, 2010); Panel
staff conversations with Fitch Ratings (May 20, 2010).
---------------------------------------------------------------------------
The Panel notes that government-sponsored burden-sharing as
a condition of its lending would have been very different from
the usual situations addressed in the credit rating agency
criteria, so such an occurrence would have necessitated a
heightened level of scrutiny within the credit rating
agencies.\575\ Greater government involvement could have helped
to guide the rating agencies in this scrutiny in order to help
them understand the government intervention as a positive event
with respect to AIG's credit.
---------------------------------------------------------------------------
\575\ Panel staff conversations with Fitch Ratings (May 20, 2010).
---------------------------------------------------------------------------
The lack of very energetic efforts by senior Treasury and
FRBNY officials to assure the rating agencies that the
concessions were made solely out of a sense of equity and
fairness to the taxpayer may have meant that if the government
assistance had ``included negotiated settlements with either
AIGFP's derivative counterparties or AIG's debt holders at less
than 100 cents,'' the credit rating agencies would have
downgraded AIG's ratings to reflect a default.\576\ According
to Fitch Ratings, ``negotiated settlements at anything less
than 100 cents, especially if the offer is accepted because
Fitch believes that the counterparty fears (or is threatened)
it may receive less if it does not accept the offer, would be
viewed as a default under [its] criteria.'' \577\ This is
largely based upon the premise that ``[t]he promise of full
payment is the very essence of an investment grade credit
rating.'' \578\ A Distressed Exchange determination would have
likely had a negative impact on AIG's creditworthiness and
caused catastrophic consequences for the company, with further
collateral calls leading to the bankruptcy the government was
trying to avoid all along.\579\
---------------------------------------------------------------------------
\576\ Congressional Oversight Panel, Written Testimony of Keith M.
Buckley, group managing director, Global Insurance, Fitch Ratings, COP
Hearing on TARP and Other Assistance to AIG, at 5 (May 26, 2010)
(online at cop.senate.gov/documents/testimony-052610-buckley.pdf)
(hereinafter ``Written Testimony of Keith Buckley''); Congressional
Oversight Panel, Testimony of Rodney Clark, managing director of
insurance ratings, Standard & Poor's, COP Hearing on TARP and Other
Assistance to AIG (May 26, 2010) (hereinafter ``Testimony of Rodney
Clark'') (stating that ``we would consider a distressed payment of less
than what is owed to be a default or a selective default under our
ratings criteria.'').
\577\ Written Testimony of Keith Buckley, supra note 576, at 5.
\578\ Testimony of Jim Millstein, supra note 44, at 9.
\579\ The Panel notes that even if the downgrades had been short-
lived, the mere fact that the downgrades occurred would have triggered
the consequences that the government was trying to avoid. See Standard
and Poor's Rating Criteria, supra note 571 (free registration required)
(noting that ``[a]fter an exchange offer is completed, the entity is no
longer in default--similar to an entity that has exited from
bankruptcy. The `SA' issuer credit rating is no longer applicable--and
we change it as expeditiously as possible, that is, once we complete a
forward-looking review that takes into account whatever benefits were
realized from the restructuring, as well as any other interim
developments'').
---------------------------------------------------------------------------
Even if the concessions were not taken for the specific
purpose of allowing AIG to save money or liquidity (since that
might have been assured by FRBNY's lending facility), but,
rather, out of a sense of fairness to the taxpayers, Mr. Clark
of S&P, testified before the Panel that this would not have
precluded a determination that a ``distressed exchange'' had
occurred. The ratings committees would have looked at a
situation ``where AIG has significant funding, but isn't able
to use it to satisfy its financial obligations in whole, be it
for the CDSs or other obligations. We would have to form an
opinion; well, will that funding be available to future
financial obligations to pay them on time and in whole?'' \580\
It does not appear that any governmental agencies considered
that they could play a role in helping to form that opinion.
---------------------------------------------------------------------------
\580\ Testimony of Rodney Clark, supra note 576.
---------------------------------------------------------------------------
There are two other points to consider. First, it appears
that the government might have been able to structure the
concessions so as not to trigger a default by, for example,
requiring a discount that would have been less than
``significant.'' \581\ Second, had a distressed exchange
occurred, it is possible that AIG could have benefitted
financially, since the savings would have helped it to avoid
insolvency and reduce risk going forward (creating the
potential for higher ratings in the future). Nonetheless, the
ratings would have taken into account AIG's failure to pay in
accordance with the terms of its financial obligations, and any
subsequent benefit would have only been reflected
afterward.\582\ Mr. Bienenstock testified before the Panel
that, ``[i]ntuitively, it should be illogical that AIG would be
viewed as a lesser credit risk once it procured concessions
from creditors which would reduce the amount AIG needed to
borrow from FRBNY and would reduce further debt expense.''
\583\ Greater government guidance could have helped the credit
rating agencies focus on the end result, rather than the
process, of exchange.
---------------------------------------------------------------------------
\581\ For example, in conversations with Panel staff, Standard &
Poor's indicated that a discount that covers the time value of money
would not necessarily constitute a distressed exchange. Panel staff
conversations with Standard & Poor's (May 19, 2010). There is also the
argument that downgrades could have been avoided and moral hazard
concerns lessened if the discount was negotiated as a matter of
principle rather than as a way to significantly restructure the
underlying obligations of AIG under its CDS contracts.
\582\ Standard and Poor's Rating Criteria, supra note 571 (free
registration required); Moody's Approach to Evaluating Distressed
Exchanges, supra note 571 stating that ratings uplifts could occur
after the exchange ``[s]ince the reduction of debt at a substantial
discount to par often improves an issuer's ability to meet its
remaining debt obligations.''); Id. (stating that ``[f]ollowing the
completion of the exchange, the ratings of the stub instrument will be
reevaluated by a rating committee to reflect expected loss on a look
forward basis.''); Coercive Debt Exchange Criteria, supra note 571;
Testimony of Rodney Clark, supra note 576 (stating that ``it is true
that in many cases following a restructuring, following either a
distressed exchange or a series of distressed exchanges, that the
credit condition could be better than before the time of the
exchange.').
\583\ Written Testimony of Martin Bienenstock, supra note 307, at
4.
---------------------------------------------------------------------------
Ultimately, the government could have used its leverage to
attempt to negotiate concessions, but it failed to do so. The
potential impact of Secretary Paulson, President Geithner, and
Chairman Bernanke (individually or in tandem) discussing the
advantages of shared sacrifice with the counterparties, and, if
necessary, speaking to the rating agencies, seems to have been
overlooked by the government. If such powerful overtures had
been rejected, the names of the non-complying counterparties
could have been disclosed to the public. FRBNY and Treasury had
powerful non-financial tools at their disposal; they did not
use them.
iv. Would Bankruptcy Have Been as Bad as the Government
Claims?
If AIG had filed for bankruptcy, as discussed
elsewhere,\584\ the life insurance subsidiaries would not have
been included in that filing. The impact on the AIG parent
company and its non-insurance subsidiaries filing for
bankruptcy cannot be known with any certainty. The Panel notes,
however, that the survival of financial companies depends on
confidence in the marketplace. Parties will not trade with a
financial services company offering long-term products that is
facing financial trouble and uncertainty. Without sufficient
reassurances about AIG's ongoing viability, policyholders might
also have cashed in their life insurance policies as a form of
savings.\585\ Reputational harm might have led to the same
result and, in fact, AIG suffered significant policy
surrenders, even in the wake of the government's
assistance.\586\
---------------------------------------------------------------------------
\584\ For further discussion, see Section E.2 and C.4, supra.
\585\ The consensus among industry analysts is that once confidence
is lost in an insurance company like AIG, policyholders will pull their
policies, insurance agents will dissuade clients from purchasing
insurance policies from the company, and that, in effect, all the
insurance companies would have become ``run-off'' businesses. Panel
staff conversations with industry analysts. Warren Buffett maintains
that the property/casualty business would have gone into run-off, while
there would have been a disastrous run on the life insurance companies.
Panel staff conversation with Warren Buffett (May 25, 2010).
The events of the Great Depression are a useful comparison. There
were two financial holidays in 1933: the first was a full banking
holiday that shut down every bank in the United States for 10 days and
ushered in sweeping changes in banking regulation, and the second was a
partial life insurance holiday that suspended the payment of cash
surrender values and the granting of policy loans for a period of
roughly six months. During the Great Depression, insurance
policyholders substantially accelerated the rate at which they drew on
the savings and credit features of their life insurance contracts, and
with the banks closed or allowing withdrawals on only a restricted
basis, individuals turned to their life insurance for cash. These
circumstances caused the insurance companies, like the banks, to face
the possibility of a run that would force them into failure.
Although there may have been a shortage of market capacity with
respect to some of AIG's insurance lines (for example, some of its
specialized lines), and it therefore may have taken a while for
competition to replace some of AIG's business, industry analysts concur
that there was no shortage of market capacity in the industry with
respect to most other product lines (for example, its P&C and life
insurance businesses), meaning that those policyholders would have been
capable of finding coverage at other companies. Panel staff
conversations with industry analysts; Panel staff conversation with Jay
Wintrob, CEO of the SunAmerica Financial Group (May 17, 2010).
\586\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010) (stating that AIG suffered $5 billion of domestic life
insurance policy surrenders through the third quarter of 2009); Senate
Committee on Banking, Housing, and Urban Affairs, Written Testimony of
Testimony of Donald Kohn, supra note 245, at 11 (stating that ``general
economic weaknesses, along with a tendency of the public to pull away
from a company that it viewed as having an uncertain future, hurt AIG's
ability to generate new business during the last half of 2008 and cause
a noticeable increase in policy surrenders'').
---------------------------------------------------------------------------
While the Panel acknowledges that it is not certain what
would have happened to AIG's various insurance subsidiaries if
the parent company had filed, there are some general
conclusions that can be drawn. Since the state insurance
regulators had been closely monitoring the activities and
financial condition of AIG's insurance subsidiaries prior to
September 2008 and believed that they were solvent or
sufficiently capitalized, they would not necessarily have
changed their approach as a result of the parent's bankruptcy
filing.\587\ Since the first priority of the insurance
regulators is to protect the interests of policyholders, they
would have been concerned about the impact of the parent's
filing on the subsidiaries' books of business and the behavior
of policyholders (i.e., increased surrender activity and
decreased renewal rates). If the insurance regulators believed
that there was sufficient harm to the insurance subsidiaries or
that liquidity or insolvency concerns had emerged during the
course of the bankruptcy, they would have placed the relevant
insurance subsidiaries under heightened supervision or into
rehabilitation or liquidation. If a policyholder run had
developed, the insurance regulators had tools to prevent it.
Many insurance policies give the company management the ability
to place a six month hold on paying claims. If this were the
case, management could put this hold into place, possibly at
the request of the regulators. Alternatively, if the regulators
have taken the company into some form of supervision or
receivership, they may issue a directive to place a hold on
payment of claims for a period of time.\588\ Depending on the
form of the seizure, if the company were taken into
receivership, policyholders might experience delays in claims
payment well beyond a six month hold on payments.
---------------------------------------------------------------------------
\587\ Standard & Poor's, for example, testified before the Panel in
May 2010 that because ``the insurance subsidiaries' capital is
generally insulated by state insurance laws and regulations,'' an AIG
bankruptcy might have only had a ``marginal impact'' on AIG's insurance
subsidiaries, but that AIG's financial problems would have indirectly
impacted the creditworthiness of the insurance subsidiaries in two
ways: (1) the financial pressures at the parent would have made it
``less likely that AIG will be in a position to provide additional
capital to its subsidiaries in the event the subsidiaries suffer
investment losses of their own or otherwise require recapitalization;
and (2) ``overall reputational risk resulting from the parent company's
financial problems.'' Written Testimony of Rodney Clark, supra note 80,
at 6-7 .
\588\ Panel staff conversation with Texas Department of Insurance
(May 24, 2010).
---------------------------------------------------------------------------
There are several issues regarding the stability of AIG's
insurance subsidiaries in the event of the bankruptcy of the
parent company. First, there is at least some concern that a
number of the insurance subsidiaries may have been less solvent
than generally believed at the time--as seen by the amount of
government assistance they received to recapitalize and meet
their obligations.\589\ Second, while the seizure of the
insurance company subsidiaries would have resulted in claims on
state guarantee funds, given the large scope of AIG's
operations, it is unclear whether each state guarantee fund had
enough capital (or, where unfunded, access to capital) and what
steps they would have taken if there were a shortfall.\590\
State insurance regulators have the ability to ``ring-fence''
solvent insurance entities to shield them from the parent
entity's losses or bankruptcy in order to protect existing
policyholders. For its part, NAIC has emphasized that the state
guarantee system would typically allow for an orderly
disposition of policyholder claims. This view, however, is
premised on the fact that, ordinarily, when an insurance
company is placed into receivership, other companies would
likely either fill the void in the marketplace and/or purchase
their policies or groups of policies, which are typically
attractive assets (but this might not have occurred quickly in
the context of a global financial crisis). If there was a
shortfall, the state guarantee funds might have had to resort
to imposing higher assessments on other industry players,
pushing more liquidity out of the system at a time when there
was already a substantial liquidity crunch.\591\
---------------------------------------------------------------------------
\589\ Given that a substantial portion of certain companies' assets
were loans to the parent entity, intercompany funding, and ownership
interests in other AIG entities (which were typically treated as part
of their regulatory capital) it seems to be possible that the
subsidiaries may have been undercapitalized--particularly domestic life
insurance operations--and would have become destabilized upon the
parent's bankruptcy. State Insurance Regulation Wasn't the Problem,
supra note 408 (``If AIG had gone bankrupt, state regulators would have
seized the individual insurance companies. The reserves of those
insurance companies would have been set aside to pay policyholders and
thereby protected from AIG's creditors. However, * * * AIG's insurance
companies were intertwined with each other and the parent company.
Policyholders would have been paid, but only after a potentially
protracted delay. It would have taken time to allocate the companies's
[sic] assets''). For additional discussion of the government assistance
provided to the AIG insurance subsidiaries, see Section E.1, supra.
\590\ Panel staff conversation with Debra Hall, expert in insurance
company receiverships (May 14, 2010).
\591\ Panel staff conversation with Debra Hall, expert in insurance
company receiverships (May 14, 2010); David Merkel, To What Degree Were
AIG's Operating Insurance Subsidiaries Sound?, at 6 (Apr. 28, 2009)
(online at alephblog.com/ wp-content/uploads/ 2009/04/
To%20What%20Degree%20
Were%20AIG%E2%80%99s%20Operating%20Subsidiaries%20Sound.pdf)
(hereinafter ``AIG's Insurance Subsidiaries'').
---------------------------------------------------------------------------
It is also unlikely that consumers would have taken out new
insurance policies with AIG's insurance subsidiaries, further
impacting their revenue potential and destabilizing their
ongoing operations.\592\ While AIG has its own personnel
devoted to sales, its insurance policies are mainly distributed
through independent agents affiliated with broker-dealers.\593\
Due to suspensions by broker-dealers (getting closed out of
many of its distribution outlets) related to AIG's financial
risk and the losses that it incurred over the course of 2008
(and that occurred despite AIG's receipt of substantial
government assistance), AIG's ability to issue new insurance
policies was significantly curtailed between September 2008 and
March 2009.\594\ SunAmerica Financial, AIG's umbrella for its
life and retirement insurance companies, has estimated that it
lost between $2 and $3 billion in sales during this time
period.\595\ This demonstrates that AIG's insurance
subsidiaries incurred some loss even after the government's
rescue, but the amount would likely have been much larger had a
bankruptcy occurred. Third, it is unclear how the bankruptcy of
the AIG parent would have affected the ratings of the insurance
company subsidiaries.\596\
---------------------------------------------------------------------------
\592\ Panel staff conversations with industry analysts; Written
Testimony of Rodney Clark, supra note 80, at 6-7 (stating that ``it may
be more difficult for the subsidiaries to retain and attract new
customers where there is uncertainty surrounding the parent company--
particularly in light of a dampened demand for insurance and, more
significantly, marginal pricing'').
\593\ Panel staff conversation with Jay Wintrob, the CEO of the
SunAmerica Financial Group (May 17, 2010).
\594\ Panel staff conversation with Jay Wintrob, the CEO of the
SunAmerica Financial Group (May 17, 2010).; Senate Committee on
Banking, Housing, and Urban Affairs, Written Testimony of Testimony of
Donald Kohn, supra note 245, at 11 (stating that ``general economic
weaknesses, along with a tendency of the public to pull away from a
company that it viewed as having an uncertain future, hurt AIG's
ability to generate new business during the last half of 2008 and cause
a noticeable increase in policy surrenders'').
\595\ Panel staff conversation with Jay Wintrob, the CEO of the
SunAmerica Financial Group (May 17, 2010).
\596\ Written Testimony of Rodney Clark, supra note 80, at 6-8
(noting that while AIG's financial problems ``have no direct effect on
the solvency of its insurance subsidiaries, we believe the
creditworthiness of those subsidiaries is nevertheless indirectly
affected in two primary respects:'' (1) financial pressures at AIG
``generally make it less likely that AIG will be in a position to
provide additional capital to its subsidiaries in the event the
subsidiaries suffer investment losses of their own or otherwise require
recapitalization;'' and (2) ``overall reputational risk resulting from
the parent company's financial problems.''
---------------------------------------------------------------------------
These effects could have been mitigated if the government
stepped in to backstop or guarantee the insurance liabilities.
Such a guarantee program (as opposed to a guarantee of any
private rescue package), however, may have been impractical for
several reasons. First, the amounts of AIG's insurance policies
would have required a multi-trillion dollar government
guarantee (and it is unclear whether AIG would have had
sufficient collateral for the Federal Reserve to authorize such
a guarantee).\597\ Second, the lawyers for FRBNY did not
believe that section 13(3) or any other provision of the
Federal Reserve Act authorized the issuance of this type of
guarantee (as opposed to other types of guarantees that might
have been available, such as the guarantee of a private loan
discussed earlier).\598\ Third, there was the challenge of
ensuring that all 50 state insurance regulators would have
agreed not to seize their domiciled subsidiaries, and one
seizure could have led to a cascading effect of other seizures.
Finally, there would have been uncertainty as to who would
ultimately be responsible for the guarantee's administration.
Apart from the various business and legal issues associated
with a potential multi-trillion dollar government guarantee of
a private international company, it is not clear that such a
program, which has not been used before, would work. Panel
staff also asked the government if a guarantee for only certain
of AIG's domestic insurance subsidiaries was considered, and
the response was similar--that such a guarantee would likely
not have been feasible given that AIG's domestic life and
property & casualty insurance operations carried policies in
the trillions of dollars.\599\
---------------------------------------------------------------------------
\597\ In general, the Federal Reserve would only be able to issue a
guarantee pursuant to Section 13(3) if the guarantee was fully secured.
Therefore, the amount of the guarantee would be ``capped'' by the value
of available or unencumbered assets that could be posted as collateral.
For further detailed discussion of the Federal Reserve's Section 13(3)
authority, see Section C.4, supra.
\598\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010). In fact, based on further discussions with Scott Alvarez on
May 28, 2010, it may have been possible to work out a guarantee of the
insurance liabilities if adequate collateral could have been provided.
Such a guarantee, however, would have required significant interaction
with over 200 of AIG's domestic insurance regulators. These regulators
may have been constrained by existing local or state law regarding the
proper segregation of assets to satisfy outstanding insurance claims
(potentially requiring the regulators to amend local/state law before
they could agree to pledge the assets as collateral for a government
guarantee). Further, any solution would have required a coordinated
effort of all insurance regulators so that there would be uniform and
consistent treatment for AIG policyholders across the United States.
The Federal Reserve, FRBNY, and Treasury would have been further
constrained by the limited amount of time available to accomplish the
necessary tasks for a guarantee of the insurance liabilities.
\599\ FRBNY conversations with Panel staff (May 4, 2010).
---------------------------------------------------------------------------
A possible alternative to a guarantee could have been
direct lending to AIG's insurance company subsidiaries, which
might have been possible (and might also have allowed the
subsidiaries to maintain their credit ratings), but this would
have been highly complex for a company like AIG.\600\ According
to Mr. Clark of S&P, ``when you look at the literally hundreds,
when you start looking globally, of regulated and unregulated
subsidiaries of AIG, I think it would have been very difficult
to get money to all of those. In addition, you had cross-
guarantees between certain of the subsidiaries, both domestic
and foreign, which most often went back to insurance companies
regulated in New York or Pennsylvania, not always. It was a
very complicated web of relationships really just necessitated
by the complex global nature of the group.'' \601\
---------------------------------------------------------------------------
\600\ Testimony of Rodney Clark, supra note 576.
\601\ Testimony of Rodney Clark, supra note 576.
---------------------------------------------------------------------------
Given AIG's substantial issuance of commercial paper to
money market mutual funds, there was a real possibility that an
AIG bankruptcy could have had severe repercussions on both
money market funds \602\ and an already distressed commercial
paper market. Once a bankruptcy filing by Lehman Brothers
(which had $5 billion of commercial paper outstanding to money
market funds) resulted in the ``breaking of the buck'' on
September 16--the same day that the government rescued AIG--
investors started withdrawing funds from money market mutual
funds. As discussed above, however, AIG had issued $20 billion
of commercial paper--four times the amount of Lehman's
outstanding commercial paper. If a Lehman failure could cause
these investment vehicles to begin trading at a discount and
result in a wave of investor redemptions in prime funds and the
reinvestment of capital into government funds, it seems quite
plausible that an AIG failure would have further destabilized
these investments, reduced or halted credit availability for
corporations and financial institutions (even on a short-term
basis), and caused higher lending rates.\603\
---------------------------------------------------------------------------
\602\ A money market fund (MMF) is a type of mutual fund that
invests only in highly-rated, short-term debt instruments. Government
funds invest primarily in government securities like U.S. Treasuries,
while prime funds invest primarily in non-government securities such as
the commercial paper (i.e., short-term debt) of businesses. Investors
use MMFs as a safe place to hold short-term funds that may pay higher
interest rates than a bank account.
\603\ The Panel notes, however, that any such fallout could have
been prevented or mitigated by a government money market guarantee
program, and this seems very possible given that Treasury ultimately
announced such a program on September 19, 2008 (only three days after
the AIG rescue), but this alternative would have also exposed the
government to a substantial amount of risk.
---------------------------------------------------------------------------
The Panel notes that in a bankruptcy filing, virtually all
of the multi-sector CDO CDS counterparties would have
terminated as of the petition date and would have been entitled
to retain all previously posted cash collateral (which
essentially means their unsecured claim would become secured to
the extent of that collateral), hold onto the referenced CDOs
(for those that were not holding naked positions), or continue
the contract. Continuing collateral calls from the
counterparties after a bankruptcy filing would have been
unenforceable due to the automatic stay. Assuming that the
counterparties could not cover their positions by obtaining a
replacement derivative, they would have retained the right to
assert an unsecured claim against AIGFP for unrecovered
amounts, and these would have been resolved in bankruptcy
court. For those counterparties that still held the underlying
securities and were not fully hedged, they would have likely
faced the need to take the full risk of the reference
securities onto their books.\604\ This could have created a
domino effect across AIG's counterparties and the capital
markets, as those that had insufficient capital or liquidity to
offset that risk could have faced significant distress.\605\
While it is unclear whether this potentially substantial loss
of capital on the part of many entities would have been
destabilizing in itself, it is clear that a significant amount
of liquidity had already been drained out of the system in
September 2008, and the system would have had to dig itself out
of a bigger hole had AIG gone bankrupt. As Secretary Geithner
has noted, ``[t]he risk to the system from AIG's collapse is
not particularly reflected in the direct effects on its major
counterparties, the banks that bought protection from AIG . . .
What was significant for the system as a whole was the broader
collateral damage that would've happened in the event of
failure.'' \606\
---------------------------------------------------------------------------
\604\ The extent to which some of the CDS counterparties were
actually at risk is discussed below at Section D.4, infra.
\605\ Some of AIGFP's CDS counterparties assert that they were not
at risk to the credit consequences of an AIG default. No one has
asserted that they would not have been affected by the systemic impact
of an AIG default.
\606\ COP Hearing with Secretary Geithner, supra note 86.
---------------------------------------------------------------------------
The potential impact of an AIG bankruptcy can be guessed by
examining how the markets continued to deteriorate even after
AIG was rescued. As shown in Figure 22 below, the spread
between the London Interbank Offered Rate (LIBOR) and the
Overnight Index Spread Rate (OIS)--used as a proxy for fears of
bank bankruptcy--dramatically increased in September 2008 amid
the growing concerns of financial collapse. Former Federal
Reserve Chairman Alan Greenspan stated that the ``LIBOR-OIS
spread remains a barometer of fears of bank insolvency.'' \607\
In the immediate aftermath of the Lehman bankruptcy this spread
spiked to a level indicating actual illiquidity in the
interbank market--not merely a high cost for obtaining funds--
meaning that banks were not willing to lend to one
another.\608\ Prior to the beginning of the credit market
crisis in August 2007, the LIBOR-OIS spread was 10 basis
points. Following the failure of Bear Stearns, the Libor-OIS
spread increased to 83 basis points. The measure averaged 190.3
basis points through the final four months of 2008 and reached
its peak of 365 basis points on October 10, 2008 following the
collapse of Lehman Brothers. The LIBOR-OIS spread reflected the
contraction of liquidity that crippled the financial markets in
2007 and 2008.\609\
---------------------------------------------------------------------------
\607\ Federal Reserve Bank of St. Louis, What the LIBOR-OIS Spread
Says (2009) (online at www.research.stlouisfed.org/publications/es/09/
ES0924.pdf).
\608\ Federal Reserve Bank of St. Louis, What the LIBOR-OIS Spread
Says (2009) (online at www.research.stlouisfed.org/publications/es/09/
ES0924.pdf).
\609\ Federal Reserve Bank of St. Louis, The LIBOR-OIS Spread as a
Summary Indicator (2008) (online at www.research.stlouisfed.org/
publications/es/08/ES0825.pdf).
---------------------------------------------------------------------------

FIGURE 22: SPREAD BETWEEN THREE-MONTH LIBOR AND OVERNIGHT INDEX SWAP
RATE \610\

---------------------------------------------------------------------------
\610\ 90-day LIBOR less the 90-day OIS rate. An OIS is an interest
rate swap with the floating rate tied to an index of daily overnight
rates, such as the effective federal funds rate. At maturity, two
parties exchange, on the basis of the agreed notional amount, the
difference between interest accrued at the fixed rate and interest
accrued by averaging the floating, or index, rate. Investment Company
Institute, Report of the Money Market Working Group (Mar. 17, 2009)
(online at www.ici.org/pdf/ppr_09_mmwg.pdf).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Furthermore, as discussed above, AIG was heavily reliant on
commercial paper to fund its operations, a market that froze in
the fall of 2008. As Figure 23 illustrates, the total amount of
financial commercial paper outstanding declined by 16 percent
in September 2008, a reflection of the market's uncertainty
regarding financial companies.\611\ Interest rates for
overnight commercial paper shot up in September 2008. As Figure
24 shows, interest rates on relatively riskier investments such
as A2/P2 and asset-backed commercial paper increased by 142
percent and 179 percent respectively in September 2008. The
interest rates on comparatively less risky investments such as
AA nonfinancial and AA financial commercial paper increased by
56 percent and 34 percent during the same period. As noted
above, AIG had issued approximately $20 billion in commercial
paper--roughly four times the amount Lehman issued.\612\ Even
after AIG's receipt of substantial government assistance,
concerns regarding AIG's financial condition spread to the
money market funds, which were owners of the paper.\613\
---------------------------------------------------------------------------
\611\ Federal Reserve Data Download Program, supra note 317
(accessed May 28, 2010).
\612\ Federal Reserve Bank of New York, Presentation by Sandy
Krieger, executive vice president, Credit, Investment and Payment Risk
Group at the Federal Reserve Bank of New York, Understanding the
Response of the Federal Reserve to the Recent Financial Crisis, at 34
(Apr. 14, 2010).
\613\ Investment Company Institute, Report of the Money Market
Working Group, at 103 (Mar. 17, 2009) (online at www.ici.org/pdf/
ppr_09_mmwg.pdf) (``Concerns of money market fund investors about the
risk exposure of their money market funds and the ability of sponsors
of these funds to support them in the midst of a far-reaching financial
crisis led some large institutional investors in money market funds to
join the much broader run to Treasury securities, further overwhelming
the financial system's ability to accommodate this sudden and broad-
based change in the market outlook'').
---------------------------------------------------------------------------

FIGURE 23: FINANCIAL COMMERCIAL PAPER OUTSTANDING, SEASONALLY ADJUSTED
\614\

---------------------------------------------------------------------------
\614\ Federal Reserve Data Download Program, supra note 317
(accessed May 28, 2010).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

FIGURE 24: COMMERCIAL PAPER INTEREST RATES, 2008 \615\

---------------------------------------------------------------------------
\615\ Federal Reserve Data Download Program, supra note 317
(accessed May 28, 2010).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

As the financial crisis continued, spreads between yields
on one-month commercial paper of financial companies and
Treasury bills, an indicator of stress in money markets,
widened significantly (and would have likely widened even more
with an AIG bankruptcy), climbing to nearly 400 basis points at
one time.\616\
---------------------------------------------------------------------------
\616\ This metric measures the spread between 30-day AA financial
commercial paper rates and 1-month Treasury bonds. This spread reached
its peak on October 9, 2008 at 382 basis points. This metric averaged
24 basis point between July 31, 2001--the earliest possible point of
measurement--to January 1, 2008. Through the first nine months of 2008,
the metric averaged 98 basis points until a spike in October, 2008 when
the average for that month was 248 basis points. Federal Reserve Data
Download Program, supra note 317 (accessed June 7, 2010); U.S.
Department of the Treasury, Daily Treasury Yield Curve Rates
(Instrument: 1-month security) (online at www.ustreas.gov/offices/
domestic-finance/debt-management/interest-rate/
yield_historical_huge.shtml) (accessed June 7, 2010).
---------------------------------------------------------------------------
An AIG bankruptcy would likely have had significant
international consequences. Several large European banks, which
were exposed to AIG through CDSs that allowed them to hold less
capital than they would have otherwise held, may have become
under-capitalized as a result of a bankruptcy.\617\ This could
have led to serious regulatory consequences, including possible
seizure by regulators,\618\ and ripple effects on financial
markets. In addition, if one foreign insurance regulator had
decided to seize a foreign AIG insurance company, this could
have set off a wave of additional seizures in other countries,
because the likelihood that policyholders will be repaid
decreases as more and more assets are frozen.
---------------------------------------------------------------------------
\617\ See table of affected banks at Figure 21.
\618\ For further discussion of the impact on regulatory capital
swaps, see Sections B.3(a) and E.1 (Regulatory Capital Swap
Counterparties), supra.
---------------------------------------------------------------------------
Even if it were possible to do a Lehman-type resolution for
AIG by forcing the parent into bankruptcy and protecting the
U.S. insurance subsidiaries (perhaps through a backstop), the
vast reach and international aspects of this company would have
made a filing extremely difficult without a sufficiently
lengthy planning period.\619\ Substantial time would have been
needed to coordinate with the 200 foreign regulators and the
large number of parties that had significant agreements with
AIG,\620\ and the likelihood of a quick response would have
been slim.
---------------------------------------------------------------------------
\619\ Panel staff conversations with bankruptcy/restructuring
experts.
\620\ For example, there were at least 12 separate indentures (and
the government would have had to talk to the trustees under those
indentures) as well as a variety of other agreements. For further
discussion of these and other agreements, see Section E, supra. Even if
the government had started discussions with the regulators over the
weekend, it is likely that that still would not have been enough time.
---------------------------------------------------------------------------
Because of the FRBNY and Treasury decisions made on
September 16, 2008, we can never really know what would have
happened if AIG had filed for bankruptcy. The Panel concludes,
however, that an AIG bankruptcy could have risked such severe
financial disruptions that testing its consequences would have
been inadvisable. In a time of crisis, FRBNY and Treasury's
fundamental decision to provide support for AIG was probably
necessary (or at least a reasonable enough conclusion made
under great pressure); if that support had been provided in the
context of a bankruptcy, the outcome for AIG and markets would
have been very different.
v. Was Pre-Pack Bankruptcy an Alternative?
Finally, the Panel considered whether a pre-packaged
bankruptcy or some other kind of arranged and controlled
restructuring was possible on September 16, 2008 or
contemplated at this time. A pre-pack is a plan for
reorganization prepared in advance in cooperation with
creditors that will be filed soon after the petition for relief
under Chapter 11.\621\ The advantages to a pre-pack are that
the restructuring is not uncontrolled and there is an ability
to distinguish among creditors and rearrange commercial
contracts. For a number of reasons, this would not have been a
feasible or practical stand-alone alternative in September.
First, there was only a matter of hours to arrange a pre-
pack,\622\ not even weeks. With AIG running out of cash
quickly, the Reserve Primary Fund breaking the buck, and AIG's
commercial paper being four times the size of Lehman's, it
seems extremely unlikely that a pre-pack could have been
arranged in such a short time period as to prevent AIG's
immediate default and a complete run on the money market funds.
Second, while arranging a pre-pack is easier and has
traditionally worked well for debtors with a relatively small
number of creditors (for example, those having one credit
agreement or bonds issued under only one indenture), it is much
more difficult to conduct when a debtor like AIG--a large
worldwide enterprise--has a substantial number of creditors
with different types of claims. Third, AIG had more than 400
separate regulators, and more than 200 of them were overseas in
September 2008. From a logistical standpoint, trying to contact
all of these players to coordinate an arranged and controlled
bankruptcy in such a short amount of time was impracticable.
---------------------------------------------------------------------------
\621\ Pre-packaged bankruptcies can take various forms. Debtors
will often file prepackaged bankruptcies in order to shorten the
traditional process of confirming a reorganization plan and save the
company money for professional fees and other costs associated with
bankruptcy. The sooner the restructuring under Chapter 11 is completed,
the sooner the company can return focus to its core operations. Some of
these pre-pack reorganizations are extremely large, but can
nevertheless be accomplished in less than two months.
\622\ Even including the weekend, there would have not have been
enough time. Mr. Martin Bienenstock, partner and chair of the business
solutions and government department at Dewey & LeBoeuf, does ``not
believe any prepackaged chapter 11 plan for AIG was remotely possible
within the acutely short time available.'' Written Testimony of Martin
Bienenstock, supra note 307, at 1. See also Testimony of Jim Millstein,
supra note 44, at 4 (stating that ``prepackaged plans only have a
chance of success if there is sufficient time, before a company
defaults, to organize creditors into a negotiating committee, and to
negotiate and agree on a comprehensive restructuring plan which can be
implemented in an expedited proceeding before bankruptcy court'').
---------------------------------------------------------------------------
While a pre-pack around September 16, 2008 appears
problematic assuming FRBNY and Treasury had insufficient notice
of AIG's true financial health, in the event FRBNY and Treasury
had been fully aware of the issues earlier, a pre-pack would
have been a more workable option. It might have been possible
to complete a pre-pack (combined with a government-sponsored
bridge facility) over two or three months commencing in mid-
September if it were combined with a government-sponsored
bridge facility,\623\ and the Panel notes that the following
year pre-packs were effectively used in the support of the
automotive companies.\624\
---------------------------------------------------------------------------
\623\ According to Martin Bienenstock, chair of the Business
Solutions and Governance Department at Dewey & LeBoeuf LLP, if on
September 16, 2008, the government provided AIG with an $85 billion
bridge loan and sought to work out a pre-pack bankruptcy of AIG, the
odds of that being successful within 180 days would have been less than
10 percent. ``On the prepack, the reason I'm saying less than a 10
percent likelihood is, as a matter of right, any creditor can ask for
an examiner.. . . That can take months or years.'' Furthermore, if
everyone was not going to get paid in full in the bankruptcy
proceeding, then the chances of resolution within 180 days would have
even been slim. Congressional Oversight Panel, Testimony of Martin
Bienenstock, partner and chair of business solutions and government
department, Dewey & LeBoeuf, COP Hearing on TARP and Other Assistance
to AIG (May 26, 2010).
\624\ September Oversight Report, supra note 389, at 49-50.
---------------------------------------------------------------------------
vi. Did the Government Recognize the Consequences of its
Choice?
Senior officials of both the FRBNY and the Treasury have
stated, however, that significant negative consequences
resulted from their decision to rescue AIG. They have focused
on the perception that their intervention would be perceived as
a bailout of a ``too big to fail'' institution and, therefore,
raise substantial moral hazard concerns, especially since these
actions took place after the Federal Reserve had already
provided assistance to Bear Stearns in March 2008.\625\ The
government concluded, however, that such negative ramifications
were outweighed by the countervailing concern that taking no
action in the midst of a financial crisis might have served as
the catalyst for the next Great Depression. According to
Secretary Geithner, ``[o]ur job was to make a set of choices
among unpalatable, deeply offensive basic choices, and to do
what was best, we thought, for the country at that stage.''
\626\ The policymakers continue to emphasize that rescuing AIG
was a ``no brainer'' in context due to their conclusion that
the consequences of an AIG bankruptcy were far worse than those
resulting from the provision of liquidity to AIG.\627\ The
Panel recognizes that FRBNY and Treasury realized they were
making an unpalatable choice, but is not convinced they
recognized just how unpalatable that choice was--that is, they
had created a guarantee of the OTC derivatives market. The
implications of this decision are discussed in the Conclusion.
---------------------------------------------------------------------------
\625\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010); Joint Written Testimony of Thomas C. Baxter and Sarah
Dahlgren, supra note 255, at 3-4 (stating that the decision to lend
``was difficult because of the collateral consequence, the moral hazard
resulting from AIG's rescue.''). While policymakers do not recall
whether discussions took place concerning actions that could have
mitigated the moral hazard concern during the decision-making that led
up to the AIG rescue, they acknowledge the significance of the issue
and do not pretend that the moral hazard price was not contemplated.
According to at least one staff memo that was circulated on September
14, 2008, moral hazard was noted as a negative of lending to AIG. E-
mail from Alejandro LaTorre, vice president, Federal Reserve Bank of
New York, to Timothy F. Geithner, president, Federal Reserve Bank of
New York, and other Federal Reserve Bank of New York officials (Sept.
14, 2008) (FRBNYAIG00496-499) (with attached memo).
\626\ Congressional Oversight Panel, Questions for the Record for
Treasury Secretary Timothy Geithner (Dec. 10, 2009) (online at
www.cop.senate.gov/documents/testimony-121009-geithner-qfr.pdf).
\627\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010).
---------------------------------------------------------------------------
The Panel also recognizes that the government was faced
with a deepening financial crisis, and its attention was on a
number of troubled institutions besides AIG in the course of
just a few days. Given this context, the government took
actions that it thought would facilitate rapid intervention in
the midst of deteriorating economic conditions. Nonetheless, if
the government concluded that it could not impose conditions on
its assistance once it had decided to backstop AIG with
taxpayer funds, or that other possible rescue alternatives were
unattractive or impracticable, then it had an obligation to
fully explain why it decided what it did, and especially why it
was of the opinion that all AIG's creditors and counterparties
would receive all amounts they were owed. In addition, while
the Panel acknowledges the number of complex issues and
troubled institutions that policymakers were concerned with at
the time, it appears that the government was neither focused on
nor prepared to deal with the AIG situation. By placing a
tremendous amount of faith in the assumption that a private
sector solution would succeed in resolving AIG, the government
had no legitimate alternative on the table once that assumption
turned out to be incorrect. In its assessment of government
actions to deal with the current financial crisis, the Panel
has regularly called for transparency, accountability, and
clarity of goals. These obligations on the part of the
government do not vanish in the midst of a financial crisis. In
fact, it is during times of crisis, when difficult decisions
must be made, that a full accounting of the government's
actions is especially important.

2. Securities Borrowing Facility: October 2008

In the 15 days between September 16 and October 1, AIG drew
down approximately $62 billion of the $85 billion RCF, and a
substantial component of this amount was used to settle the
redemptions arising from securities lending counterparties'
return of those securities to AIG.\628\ The fact that FRBNY had
to resort to an additional credit facility so soon after the
initial intervention (coupled with the facility's effect of
allowing AIG to use the remaining amounts under the RCF for
other purposes) suggests that none of the parties, including
FRBNY, had a complete grasp of AIG's need for additional
capital. Given the scope of the continued economic and market
deterioration, however, it would have been very difficult for
anyone to calculate with exact precision the impact of a
worsening financial crisis on AIG's balance sheet.
---------------------------------------------------------------------------
\628\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); Federal Reserve Report on Restructuring, supra note 329, at
4; Board of Governors of the Federal Reserve System, Minutes of Board
Meeting on American International Group, Inc.--Proposal to Provide a
Securities Lending Facility (Oct. 6, 2008) (hereinafter ``Minutes of
Federal Reserve Board Meeting'').
---------------------------------------------------------------------------
As discussed above, credit rating agencies made early
contact with FRBNY to emphasize that the $85 billion RCF was
problematic because of the impact it had on AIG's balance
sheet, and indicated that additional downgrades were likely if
FRBNY did not address the continuing collateral calls stemming
from AIG's securities lending and AIGFP CDS portfolios.\629\ As
a result, FRBNY spent a significant amount of time trying to
develop alternative solutions to avoid further downgrades.\630\
As discussed above, $62 billion of the RCF had been drawn down
by October 1. While the drawdowns were expected, they also
demonstrated the substantial liquidity pressures placed on AIG
due to the ongoing withdrawal of counterparties from the
securities lending program and the likelihood that additional
securities borrowing counterparties would decide not to renew
their positions with AIG. These concerns were compounded by the
continued deterioration in the market. Given these
circumstances, a primary benefit of the SBF was to reduce the
pressure on AIG to liquidate the RMBS portfolio.\631\
---------------------------------------------------------------------------
\629\ House Committee on Oversight and Government Reform, Testimony
of Timothy F. Geithner, secretary, U.S. Department of the Treasury, The
Federal Bailout of AIG (Jan. 27, 2010) (publication forthcoming)
(noting that while the initial $85 billion revolving credit facility
``helped stem the bleeding for a time,'' ``given the massive losses AIG
faced, and given the force of the storm moving across the global
financial system, it was not enough. And we had to work very quickly
almost from the beginning to design and implement a broader, more
permanent restructuring'').
\630\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
\631\ Given the financial crisis and the depressed real estate
market, had AIG liquidated its RMBS portfolio at that time, the sales
would have likely occurred at significantly depressed prices.
---------------------------------------------------------------------------
By November 2008, AIG borrowed approximately $20 billion
under the SBF. While the creation of this additional facility
exposed FRBNY to further potential losses, advances made under
the facility were with recourse to AIG. As discussed in more
detail below, FRBNY received enhanced credit protection in
these securities.\632\
---------------------------------------------------------------------------
\632\ Minutes of Federal Reserve Board Meeting, supra note 628. For
further discussion of the ML2 facility and its current value, see
Section D.3, infra.
---------------------------------------------------------------------------
As FRBNY has noted, the SBF was not designed to be a
permanent solution.\633\ While it may have made the company
more leveraged temporarily, it was designed as a short term
response to credit rating agency concerns about the liquidity
pressures the AIG parent continued to face from its RMBS
securities lending portfolio. It appears, therefore, to have
achieved its immediate goals of helping stabilize AIG's
liquidity situation in the near term and preserving the value
of its insurance subsidiaries.
---------------------------------------------------------------------------
\633\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010); Minutes of Federal Reserve Board Meeting, supra note 628;
RMBS Solution: AIG discussion document (Oct. 30, 2008) (FRBNY-TOWNS-R1-
205305) (stating that the ``FRBNY $37.8 B sec lending program was
initiated as a stop-gap liquidity measure to address the liquidity
drain from sec lending terminations''). The primary reasoning offered
by FRBNY for why this was not designed to be a permanent solution was
that FRBNY could not continue to function as a ``RMBS lender of last
resort'' on an indefinite basis.
---------------------------------------------------------------------------

3. The TARP Investment and First Restructuring: November 2008

The period between late October and early November marked
the first of several occasions in which the government had to
weigh providing continued support for AIG against letting all
or part of it fail. The enactment of EESA on October 3, 2008,
provided government policymakers with a potentially more
flexible set of tools for addressing AIG's problems in November
than was available to them in the initial rescue of AIG in
September. EESA created the TARP which included the ability to
use equity and asset guarantees \634\ to support troubled
financial institutions and allowed for lending without the more
restrictive collateral requirements that the Federal Reserve is
required to meet under Section 13(3).
---------------------------------------------------------------------------
\634\ See November Oversight Report, supra note 411, at 40-43
(describing section 102 of EESA, which requires the Secretary, if he
creates the TARP, also to ``establish a program to guarantee troubled
assets originated or issued prior to March 14, 2008, including
mortgage-backed securities.'').
---------------------------------------------------------------------------
This was also a juncture at which the government considered
whether there was a cheaper and more efficient resolution
mechanism for AIG, including a surgical or partial bankruptcy
such as a ``pre-pack,'' but ultimately rejected any form of
bankruptcy.\635\ Between September and November, AIG continued
to face liquidity pressures from its CDS and securities lending
portfolios. As discussed above, AIG was expected to report a
sizeable loss for the third quarter of 2008, and the four
leading credit rating agencies had notified FRBNY of their
concern that the RCF made the company overleveraged and did not
adequately address its liquidity pressures. Given these
concerns, the rating agencies suggested the strong likelihood
of further downgrades if these issues were left unaddressed.
---------------------------------------------------------------------------
\635\ Testimony of Thomas C. Baxter, supra note 215; Testimony of
Scott G. Alvarez, supra note 639. It is worth noting that since the
prior AIG intervention had occurred before the passage of EESA, it was
not until this time that TARP funds specifically, rather than
government funds generally, became implicated.
---------------------------------------------------------------------------
Having already provided AIG with the $85 billion line of
credit as well as the subsequent SBF, the calculus of the
government's decision-making focused on either the
restructuring of the terms of its assistance or facing the risk
of losing a part or the whole of its investment if AIG were to
face downgrades and the renewed possibility of bankruptcy.
AIG's earning statement was due to be released on November 10.
Continuing to lend money to AIG so it could meet its
obligations would have led to further downgrades and placed the
company on the verge of bankruptcy. The government decided that
November 10 had become the effective deadline for restructuring
its assistance. The government has stated that its interactions
with the rating agencies in the six weeks between September 16
and early November 2008 were an iterative process; \636\ during
regular conversations between the government and the rating
agencies, the rating agencies evaluated the potential solutions
offered by the government and offered feedback. Before the
government announced the restructuring of its assistance, it
ensured that the rating agencies had reviewed the set of
solutions being offered.
---------------------------------------------------------------------------
\636\ FRBNY conversations with Panel staff (May 4, 2010); Panel
staff conversations with Standard & Poor's (May 19, 2010); Panel staff
conversations with Moody's (May 19, 2010); Panel staff conversations
with Fitch Ratings (May 20, 2010).
---------------------------------------------------------------------------
The November restructuring of the AIG assistance
illustrates how the government's initial decision to rescue AIG
in September constrained all of its subsequent decision-making.
In conversations with the Panel and its staff, government
officials have emphasized their belief that it would be very
poor policy and precedent for the government to vacillate in
its decision-making, especially with respect to actions taken
to avert economic collapse in the midst of a financial crisis.
Later in the process, it was not just the credibility of the
AIG investment that was at stake, but, in addition, all of
TARP's Capital Purchase Program (CPP) and the implication that
the large financial institutions that received government
assistance were systemically important. A sudden change in
course with respect to AIG would have called into question the
government's intention to stand behind major TARP
recipients.\637\ In the government's view, then, the actions
taken in September 2008 determined the trajectory of government
policy: having decided to rescue AIG on September 16, 2008, the
government concluded that it was very difficult and
impracticable for it to reverse its course and let AIG
fail.\638\
---------------------------------------------------------------------------
\637\ See Congressional Oversight Panel, January Oversight Report:
Exiting TARP and Unwinding its Impact on the Financial Markets, at 5
(Jan. 14, 2010) (online at cop.senate.gov/documents/cop-011410-
report.pdf) (hereinafter ``January Oversight Report'') (noting that
``the TARP has raised the long-term challenge of how best to eliminate
implicit guarantees. Belief remains widespread in the marketplace that,
if the economy once again approaches the brink of collapse, the federal
government will inevitably rush in to rescue financial institutions
deemed too big to fail.''); November Oversight Report, supra note 411,
at 4 (noting that ``the government's broader economic stabilization
effort may have signaled an implicit guarantee to the marketplace: the
American taxpayer would bear any price, and absorb any loss, to avert a
financial meltdown'').
\638\ FRBNY and Treasury briefing with Panel and Panel staff (May
11, 2010).
---------------------------------------------------------------------------
At this point, FRBNY and Treasury had enough time to
collect information on AIG and reflect, on the basis of their
due diligence, about the various ways to shape government
assistance to AIG, that would have been more effective,
efficient, and less costly than the course the government
ultimately followed. The potential cost of delay depends on the
value of the collateral provided to the government.
As indicated elsewhere, there was a difference of opinion
between the private bankers and the government about the value
of the collateral provided by the stock of AIG's insurance and
related subsidiaries. The possible variance took several forms.
First, there is a simple disagreement about what the
subsidiaries were worth as going concerns. Second, a valuation
could have reflected the fact that AIG's default--and
conversion of the collateral--would have resulted in a probable
bankruptcy of AIG, in turn causing seizure of the insurance
companies by their respective regulators; even if that had not
happened, a bankruptcy would have potentially placed the
insurance subsidiaries in a ``run-off'' mode, when few new
policies were purchased, policies that could be cashed in were
cashed in, and assets were preserved simply to pay claims when
due. Moreover, even if the collateral theoretically retained
sufficient value to cover the loan, the bankruptcy process
would have delayed realization of that value for some, perhaps
a substantial, period of time, until conclusion of the
bankruptcy process, and the value of the collateral could
itself have changed during the interim. At each point in the
timeline these considerations become more difficult to assess.
In any event, FRBNY and Treasury decided to continue on the
course they had first elected in September. Mr. Alvarez of the
Federal Reserve Board testified before the Panel that the RCF
``did not prevent the private sector from subsequently coming
in and restructuring AIG, making another loan, and taking us
out of the position. That--that was always a possibility. Our
loan did not remove that possibility.'' \639\ It appears,
however, FRBNY and Treasury did not make serious efforts to
engage with private sector participants at this time (or any
time post-September 2008) to assess the level of interest (if
any) in a public-private hybrid or some other package of
assistance that would have reduced the government's exposure
and retained some private party discipline.
---------------------------------------------------------------------------
\639\ Congressional Oversight Panel, Testimony of Scott G. Alvarez,
general counsel, Board of Governors of the Federal Reserve System, COP
Hearing on TARP and Other Assistance to AIG (May 26, 2010) (hereinafter
``Testimony of Scott G. Alvarez'').
---------------------------------------------------------------------------
The Panel notes that the creation in November 2008 of a
more durable capital structure for AIG had several practical
consequences.\640\ First, by avoiding bankruptcy and further
downgrades, the government's restructuring provided AIG with
more time and greater flexibility to sell assets. At a time
when AIG likely could not have obtained anything other than
fire sale prices for its assets, the restructuring protected
the interests of the government and taxpayers by improving the
company's negotiating position by allowing AIG to hold off on
selling assets until market conditions improved. Second, once
Treasury expended TARP funds, the government's calculus
changed, since Treasury, in its role as the primary manager of
TARP, is obligated to protect taxpayer interests, promote
transparency, and foster accountability. Since the Federal
Reserve is not as politically accountable as Treasury, it is
likely that the Federal Reserve's goals are at least somewhat
different from those of Treasury. Third, since Treasury's TARP
investments are junior to the RCF and AIG's other senior debt,
the return of the taxpayers' TARP investment (as well as its
value) are dependent upon the company's viability going
forward. While Treasury's direct involvement in AIG stemming
from this first TARP investment did not by itself result in a
transfer of risk to the public since the Federal Reserve's
source for its $85 billion line of credit was the government's
ability to print money, a primary implication of Treasury's
preferred stock purchase in AIG was that the government
acquired an increased interest in the viability and success of
the institution in which it invested, which might color any
future decisions concerning AIG.\641\
---------------------------------------------------------------------------
\640\ For a detailed discussion of tensions inherent in the capital
structure, see Section G, infra.
\641\ See further discussion of the dynamics of Treasury equity
positions and Federal Reserve loans to AIG in Section G. This stake is
presumably greatest in a case like AIG--where the government has a lot
to lose, since it committed to provide a total of $182.3 billion to the
company since September 2008.
---------------------------------------------------------------------------

4. Maiden Lane II

The creation of the ML2 facility in combination with the
creation of the ML3 facility (discussed below) allowed FRBNY to
achieve the goal of avoiding rating downgrades and their
negative consequences. As a result of the ML2 transaction,
AIG's remaining exposure to losses from its U.S. securities
lending program was limited to declines in market value prior
to closing and its $1 billion of funding.\642\ While the
purchases transferred a substantial amount of risk to FRBNY,
which is charged with managing those assets for the benefit of
the U.S. taxpayer, the Panel notes that two factors combine to
mitigate that risk.
---------------------------------------------------------------------------
\642\ BlackRock Financial Management, Inc., Proposed Structure for
Sec Lending RMBS Vehicle (Maiden Lane II) (Nov. 2008) (FRBNY-TOWNS-R1-
163661) (noting that the objectives of the ML2 transaction should
include minimizing the cash drain on the AIG parent and minimizing the
capital hit to AIG).
---------------------------------------------------------------------------
First, while the possibility that these securities might
decline in value below their purchase price (causing the asset
pool to be ``underwater'' and for the government's stake to be
``out of the money'') and the portfolio exposes FRBNY to credit
and concentration risk, these concerns are counterbalanced by
FRBNY's substantially discounted purchase price \643\ and
FRBNY's right to share in 83 percent of the upside.\644\
Further, the government believes there could be a significant
upside on its holdings in ML2 (perhaps as much as $15-20
billion if securities return to par).\645\ This upside
potential also makes it more likely that AIG will repay the
remainder of FRBNY's senior debt (RCF).
---------------------------------------------------------------------------
\643\ FRBNY purchased RMBSs with a face value of $39.3 billion for
a total price of $19.5 billion.
\644\ See discussion of residual values for ML2 in Section D.3,
supra.
\645\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
---------------------------------------------------------------------------
Second, FRBNY has the ability to hold the securities for
some time; it does not face liquidity pressures to sell at fire
sale prices. FRBNY engaged BlackRock to do a valuation analysis
of the securities, including an investigation of cash flows
under various scenarios, and BlackRock determined that the
securities would realize more value if they could be held over
a longer period of time.\646\
---------------------------------------------------------------------------
\646\ FRBNY and Treasury briefing with Panel and Panel staff (Apr.
12, 2010).
---------------------------------------------------------------------------
The ML2 transactions form a critical element of the larger
AIG intervention and, therefore, play an instrumental role in
the return on the government's investment. The government's
stake in ML2 is currently ``in the money.'' \647\
---------------------------------------------------------------------------
\647\ For further discussion please, see section D.3, supra.
---------------------------------------------------------------------------

5. Maiden Lane III

As discussed above, even after the government's rescue in
September 2008, collateral calls with respect to AIGFP's CDS
portfolio were absorbing liquidity and threatening further
ratings downgrades, which would have required even more
collateral to be posted.\648\ AIG operated under the assumption
that it had two potential courses of action: keep the CDSs (and
keep making the collateral calls) or try to get rid of them;
defaulting on them was not an option, since it would likely
have led to bankruptcy.\649\
---------------------------------------------------------------------------
\648\ The threat posed by the continuing collateral calls began
immediately after the rescue. Briefing by Sara Dahlgren, executive vice
president, Federal Bank of New York to Panel staff (May 11, 2010).
\649\ Some of AIG's standard derivatives documentation--such as its
Master Agreement with Goldman contained cross-default language
providing that certain defaults between the counterparties (or certain
of their affiliates) would cause amounts due and payable under the
Master Agreement to become due and payable. Such provisions can have a
cascade effect, and can complicate negotiations of individual
contracts. Testimony of Jim Millstein, supra note 44 (stating: ``Any
creditor with the right to declare a cross-default could have brought
the house of cards down.''). See also Section G.1, supra.
---------------------------------------------------------------------------
Continuing to pay out on the collateral calls, however, was
not a workable option; only $24 billion remained undrawn on the
RCF, and it was doubtful that that sum would cover anticipated
further collateral calls prompted by the ratings downgrades
that would have resulted from AIG's earnings release about to
be published on November 10; moreover, this would have added to
an already considerable debt burden.\650\ In response, AIG
attempted to negotiate cancellation of the CDSs in exchange for
a cash payment, continuing to negotiate throughout
October.\651\ Since these negotiations were not succeeding,
FRBNY asked BlackRock Solutions to develop options for
disposing of the CDSs. In consultation with the government and
its advisors, BlackRock presented three alternatives, two of
which (discussed in more detail above) FRBNY felt would not
work.\652\
---------------------------------------------------------------------------
\650\ Briefing by Thomas C. Baxter, general counsel, Federal
Reserve Bank of New York, to Congressional Oversight Panel (May 12,
2010) (noting some of the counterparties expressed a preference to
continuing the position and continuing to take the collateral).
\651\ Testimony of Thomas C. Baxter, supra note 319.
\652\ See Section D, supra.
---------------------------------------------------------------------------
At least one of the two alternatives that was rejected by
the FRBNY is worth further exploration. As explained in Section
D. 4., rather than purchasing the underlying CDOs, the FRBNY
could have stepped into AIGFP's position and guaranteed the
performance of the CDS contracts that AIGFP had written on the
selected cash CDOs that ultimately were acquired by ML3. This
could have been accomplished by using a special purpose vehicle
like ML3 to purchase the CDSs written by AIGFP, rather than the
underlying CDOs held by AIGFP's counterparties. The assumption
by the government of AIG's obligations under their CDS
contracts, and the consequent increased assurance of
performance under the CDSs, would presumably have been very
valuable to the counterparties and may have allowed FRBNY to
obtain agreement to forego further collateral postings under
those contracts.
Admittedly, government officials would have had to overcome
several obstacles to achieve this result. One is the financing
for the SPV. As discussed above, the Federal Reserve can only
lend under section 13(3) if there is collateral sufficient to
protect it from losses.\653\ Collateral for an FRBNY loan to
the SPV would have been an issue as the CDSs may have been seen
as open-ended liabilities (even with the termination of further
collateral postings) and too difficult to value as collateral
under the Section 13(3) authority.\654\ Most of the other
assets that AIG might have used as collateral had already been
pledged in support of the Revolving Credit Facility.
Nevertheless, it is possible that the Federal Reserve could
have used some combination of the CDS contracts in the SPV and
other unpledged holdings of AIG to provide the collateral
needed for the Federal Reserve to authorize a Section 13(3)
loan. Alternatively, it is possible that the Federal Reserve
could have received expanded guarantee authority at the time
TARP was passed or shortly thereafter if the proper groundwork
had been laid. It appears that there was some consideration
given to using TARP to provide a guarantee; in the end, TARP
was not used for this purpose.
---------------------------------------------------------------------------
\653\ For further discussion of collateral demands under Section
13(3) of the Federal Reserve Act, see Section C.4.b of this report.
\654\ Id.
---------------------------------------------------------------------------
A further complication relates to the ability of AIGFP to
assign its CDS contracts to a new legal entity. The argument
that any assignment or assumption of the CDS contracts would
have been very difficult in this instance is probably unlikely
as standard language (often modified) in CDS contracts requires
counterparties not to arbitrarily delay or withhold consent to
such an assignment of interest.\655\ Here again, in light of
the superior credit position of the SPV that would be stepping
in to take over the CDS contracts, the counterparties would
likely have been agreeable to such assignment of their
contracts. Had this alternative SPV been successfully put in
place, then to the degree that prior collateral calls
associated under the CDS contracts had resulted from downgrades
in AIG's credit rating, the government would have been able to
recapture that portion of the collateral postings as a result
of the fact that the issuer of the CDS contracts--the SPV--
would now be a AAA rated governmental entity.
---------------------------------------------------------------------------
\655\ The International Swaps and Derivatives Association (ISDA)
Master Agreement between Goldman Sachs International and AIGFP (GSI
ISDA), dated as of August 19, 2003, provides for transfer without
consent to affiliates of equivalent credit-worthiness; other
assignments require the consent of the protected party.
---------------------------------------------------------------------------
As noted in Section D, the current value of the ML3
holdings is well in excess of the loan from the FRBNY and also
exceeds the sum of the loan plus the AIG investment in ML3.
Appreciation of the assets of ML3 produces income to the FRBNY
and, in turn, to the Federal Reserve System. If, as in the
alternative, an FRBNY owned SPV had assumed the issuer position
of the CDS contracts, then appreciation of the underlying CDO's
would likewise have been recaptured in the form of returned
collateral from the CDS counterparties. In this respect, the
government would have benefited from appreciation of the CDO's
under either approach.
While acknowledging the difficulties involved in pursuing
the government assumption of the contracts option, the Panel
believes that the attention given to this alternative to ML3
was wholly inadequate, particularly in light of the advantages
such an arrangement might have provided both with respect to
avoiding any requirement to pay off CDO owners in full at the
outset with government resources and with respect to the
recapture of collateral by virtue of the government's superior
credit rating.
The alternative, which FRBNY actually chose, was to create
an SPV to purchase the CDOs at par from AIG's counterparties in
exchange for cancelling the CDSs. These purchases could have
been effected at something less than the face value of the CDS
less the collateral already received. This did not, however,
happen. FRBNY has given a number of reasons for closing out the
CDSs at their face value minus the collateral paid out: \656\
---------------------------------------------------------------------------
\656\ See Panel meeting with Federal Reserve Bank of New York
officials (Apr. 12, 2008); SIGTARP Quarterly Report to Congress, supra
note 369, at 30. See also Testimony of Thomas C. Baxter, supra note
319.
---------------------------------------------------------------------------
After the government had made it clear in
September that it was going to stand behind AIG, the threat of
an imminent AIG bankruptcy had effectively been removed. Any
threat of a default (anything less than payment of the full
amount due on the CDSs) amounted to a threat of bankruptcy,
which, once the government had indicated it would support AIG,
would not be taken seriously.\657\
---------------------------------------------------------------------------
\657\ See March Oversight Report, supra note 492, at 84-87.
---------------------------------------------------------------------------
FRBNY was concerned that threatening default would
introduce doubt in the capital markets about the resolve of the
government to stand behind its commitments, which would
adversely affect the stability of the capital markets,
reintroducing the systemic risk it had sought to quell.\658\
---------------------------------------------------------------------------
\658\ See March Oversight Report, supra note 492, at 84-87
(discussing Treasury's concerns that having committed to backstop the
stress-tested banks, of which GMAC was one, it could not allow GMAC to
file for bankruptcy without undermining its own credibility).
---------------------------------------------------------------------------
FRBNY was also concerned about the reaction of the
rating agencies to attempts to pay less than the full amount
due on the CDSs, which could have led to further downgrades on
AIG's credit rating.\659\
---------------------------------------------------------------------------
\659\ See Section F.1(b)(iii), supra (discussing ``selective
default ratings''). See also Written Testimony of Rodney Clark, supra
note 80.
---------------------------------------------------------------------------
There was little time, significant execution risk
and the possibility of significant harm if the transaction was
not affected by November 10.\660\
---------------------------------------------------------------------------
\660\ Briefing by Federal Reserve Bank of New York and the U.S.
Department of the Treasury to the Congressional Oversight Panel and
Panel staff (Apr. 12, 2010 and May 11, 2010).
---------------------------------------------------------------------------
While by November the government had seriously undermined
its own leverage, it may have had more leverage than it
thought. The government believed that it could not threaten
bankruptcy of AIG, because it had already decided against it in
September. The markets, however, were not so sure. CDS spreads
on AIG had widened, indicating that market participants were
not convinced that the government was going to stand behind
AIG.\661\
---------------------------------------------------------------------------
\661\ AIG's CDS spreads on September 12 and 16, and on November 7
were 858 basis points, 2413 basis points, and 2924 basis points,
respectively, the last of which was an overall high. Data accessed
through Bloomberg Data Service (accessed June 3, 2010).
---------------------------------------------------------------------------
Any concessions had to be voluntary. This point is key--
non-consensual payments at less than par would have triggered
cross-defaults, causing a default under all agreements between
AIG and the counterparty (and, in some circumstances,
affiliates of AIG and the counterparty), and thus pushed AIG
into the bankruptcy that the government had taken such great
pains to avoid. The government's negotiating stance was that it
had to treat all parties equally. At least one counterparty
indicated that it would be open to a concession only if other
counterparties would agree to the same concession.\662\ Other
counterparties, however, indicated in discussions with the
Panel staff that they neither knew nor cared what other
counterparties had been offered or were willing to accept, and
that they were negotiating for themselves alone.\663\ This
again suggests that FRBNY imposed unnecessary constraints on
itself for public policy reasons. If other counterparties had
separately agreed to varying degrees of concession, the
holdouts could have been ``named and shamed'' as the only ones
unwilling to make concessions and thus been more incentivized
to come to an agreement.
---------------------------------------------------------------------------
\662\ The counterparty was the Swiss bank UBS, which agreed to
accept a 2 percent haircut provided the other counterparties did as
well. SIGTARP Report on AIG Counterparties, supra note 246, at 15.
\663\ Panel staff discussions with CDS counterparties (May 10-16,
2010).
---------------------------------------------------------------------------
FRBNY did make some attempts to negotiate with the CDS
counterparties. It prepared talking points and briefing
packages for the relatively low-level FRBNY officials who dealt
with the counterparties.\664\ These talking points emphasized
the significant benefits that the counterparties had received
by reason of the rescue of AIG and stabilization of the
financial markets, and the moral obligations that the
counterparties thus owed. The Panel staff has spoken to some of
the counterparties about the nature of these negotiations. It
seems that their nature varied. Some counterparties
characterized them as genuine commercial negotiations in which
they were forced to fight fiercely for their rights; others
described more desultory attempts.\665\
---------------------------------------------------------------------------
\664\ Briefing by BlackRock Solutions, to Federal Reserve Bank of
New York (Nov. 5, 2008) (FRBNYAIG-192338, 192382, 192392, 192402).
\665\ Panel staff discussions with CDS counterparties (May 10-16,
2010).
---------------------------------------------------------------------------
Societe Generale was the largest counterparty and owned the
reference securities.\666\
---------------------------------------------------------------------------
\666\ Some of the counterparties are reported to have ``naked'' CDS
positions; i.e., they did not own (or have contracts with parties
owning) the reference securities. The Panel has been unable to confirm
the extent to which this assertion is correct, and the basis upon which
those assertions are made are not entirely clear. To the extent this
was true with respect to any particular counterparty, they would not
have been at risk to a loss of value in those reference securities.
Admittedly, upon termination of the contracts they would have lost out
on the opportunity to make more money if there were a subsequent
decrease in value of the reference securities. (The values of the
reference securities could have gone in either direction, however, with
consequent repayment of collateral received, and they have subsequently
recovered some value; if the counterparty thought that valuations had
bottomed out, it would be doubly happy to close out the contract and
retain the collateral received.) The calculations and negotiating
stance of a party that does not hold the underlying reference
securities are necessarily different from those of a party that enters
into the CDS as a hedge for securities it actually owns, and a party
that is not at risk to the reference securities has more negotiating
power.
---------------------------------------------------------------------------
Goldman Sachs, the second largest counterparty, has stated,
and has reaffirmed to the Panel, that it was not exposed to AIG
counterparty credit risk--the risk that a protection seller
will be unable to make a payment due under a CDS--in the event
of an AIG bankruptcy.\667\ This does not mean that Goldman had
no exposure to AIG: for example, had Goldman agreed to make
concessions on closing out its AIG CDSs, it would have
experienced losses to the extent of those concessions, since
those losses would not be covered by any of its hedges. A two
percent concession on the notional value of Goldman's ML3
assets would have been $280 million.
---------------------------------------------------------------------------
\667\ Panel correspondence with Goldman Sachs (May 14, 2010).
---------------------------------------------------------------------------
Goldman's chief financial officer, David Viniar, stated
that in purchasing CDS protection from AIG, ``we served as an
intermediary in assisting our clients to express a defined view
on the market. The net risk we were exposed to is consistent
with our role as a market intermediary rather than a
proprietary market participant.'' \668\ If true, however, this
statement does not in and of itself mean that risk was
completely mitigated, because the relationship between the
contracts meant Goldman was still on the hook to its own
clients. If AIG had failed, Goldman would have been exposed to
its own clients to the entire extent of the notional amount of
the CDSs it had written, and its ability to do so would have
depended on the strength of its own hedges and its negotiating
position vis-a-vis its own counterparties. The Panel notes that
Goldman has declined to supply the Panel with the identities of
its own counterparties or any documentation with respect to
those relationships. It has similarly declined to provide
information with respect to the providers of its own hedges on
AIG.\669\
---------------------------------------------------------------------------
\668\ See Thomson Street Events, GS-Goldman Sachs Conference Call
to Answer Questions from Journalists and Clarify Certain Misperceptions
in the Press Regarding Goldman Sachs' Trading Relationship with AIG, at
7 (Mar. 20, 2009) (hereinafter ``Goldman Sachs Conference Call'').
However, since Goldman has declined to provide evidence of its
relationships with its own counterparties, the Panel was unable to
confirm this assertion. In the book, The Big Short, author Michael
Lewis describes these counterparties as including Goldman Sachs itself
(which sold bonds to its customers created by its own traders so that
they could bet against them), hedge fund managers such as Steve Eisman
of FrontPoint Partners, and stock market investor Michael Burry. See
Michael Lewis, The Big Short: Inside the Doomsday Machine, at 76-77
(2010).
\669\ Goldman has provided the Panel with quantitative data with
respect to its hedges, but has provided no details with respect to the
institutions that provided those hedges. Similarly Goldman has provided
no details or documentation with respect to its own counterparties. The
Panel does not presently have the ability to assess Goldman's
negotiating position with respect to its counterparties. Data provided
by Goldman to Panel (May 26, 2010).
---------------------------------------------------------------------------
Goldman, however, had two types of protection against the
failure of AIG.
The terms of the CDSs in effect with AIG provided that AIG
had to put up cash collateral in the event of a downgrade in
AIG's credit ratings, AIGFP's credit ratings, or a decrease in
the market value of the reference CDOs.\670\ On November 7,
2008, the amount of cash collateral posted with respect to
Goldman's ML3 CDOs was approximately $8.2 billion (with an
additional $1.2 billion claimed but not yet paid).\671\
---------------------------------------------------------------------------
\670\ The International Swaps and Derivatives Association (ISDA)
Master Agreement between Goldman Sachs International and AIGFP (GSI
ISDA), dated as of August 19, 2003, provides for a variable threshold,
which is essentially an amount of uncollateralized exposure provided
for in the ISDA Master Agreement. (The ISDA Master Agreement and the
Threshold are described in greater detail in Annex III.) The Threshold
for each started at $125 million, and was reduced by $25 million
(meaning that the counterparty would have to post collateral in the
amount of $25 million) for each ratings downgrade. At BBB (S&P) or Baa2
(S&P), the agreement would terminate. AIG parent was AIGFP's credit
support provider and Goldman Group was GSI's credit support provider.
The GSI ISDA was amended in April, 2004 to provide that Goldman Group,
GSI, and AIGFP would each have a threshold amount of $50 million, but
AIG parent's threshold amount (meaning, the amount that GSI was willing
to bear, uncollateralized, from AIG parent) was $250 million. However,
these amounts could vary depending on the terms in the confirmation.
For example, several transactions under the GSI ISDA calculated
``exposure'' as a function of the market value and outstanding
principal balance of the reference obligation combined with a threshold
that varied by a percentage based on the credit rating of the seller
(AIGFP). Goldman's contract called for a calculation of ``exposure'' on
each business day and concurrent collateral calls. According to
Goldman, its MTM process was more rigorous than other counterparties',
leading to collateral dispute with AIG.
\671\ Data provided to the Panel by Goldman Sachs (May 24, 2010);
see also SIGTARP Report on AIG Counterparties, supra note 246.
---------------------------------------------------------------------------
Additionally, Goldman informed the Panel that it had
purchased CDS protection against an AIG failure over the course
of 2007 and 2008 from ``all the large financial institutions
around the U.S. and outside the U.S.'' \672\ on AIG in amounts
sufficient to cover Goldman's exposure to AIG.\673\ According
to Goldman, these CDS positions were collateralized, with
collateral exchanged on a daily basis.\674\ (Goldman was so
well hedged, in fact, that the protection it bought on AIG
netted it a gain over time, according to Mr. Viniar.) \675\ The
positions had termination dates ranging from 2008 and 2018, but
the great majority of these positions terminated in 2012 or
2013.\676\
---------------------------------------------------------------------------
\672\ See Goldman Sachs Conference Call, supra note 668, at 7.
\673\ See Goldman Sachs Conference Call, supra note 668, at 2, 7,
16-17. Whether these hedges would, ultimately, have been successful in
perfectly hedging Goldman dollar-for-dollar depends on the triggers--
for a ``plain vanilla'' CDS, likely AIG's bankruptcy or default under
various agreements--and the protection seller's role in the event of an
AIG default. For a perfect hedge, the protection seller would have
stepped into AIG's role, and provided identical protection to that
provided under the defaulted AIG CDS. Even a less precise hedge,
however, would have substantially reduced Goldman's exposure, and
market participants confirmed to Panel staff that Goldman's hedges were
consistent with market practice.
\674\ Senate Homeland Security, Permanent Subcommittee on
Investigations, Testimony of David Viniar, chief financial officer,
Goldman Sachs, Wall Street and the Financial Crisis: The Role of
Investment Banks. (Apr. 27, 2010) (online at hsgac.senate.gov/public/
index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=f07ef2bf-914c-494c-
aa66-27129f8e6282). As of November 6, 2008, Goldman held approximately
$8.2 billion of cash collateral posted with respect to Goldman's ML3
CDOs (with an additional $1.2 billion claimed but not yet paid). Data
provided by Goldman to Panel (May 26, 2010).
\675\ See Goldman Sachs Conference Call, supra note 668, at 7. Mr.
Viniar noted that the gain was ``not particularly material.''
\676\ Data provided by Goldman to Panel (May 26, 2010).
---------------------------------------------------------------------------
Goldman states that it had nothing to lose. Either AIG
would close out its position at par as set forth in the
contract, or it would default, and Goldman would keep the
collateral that had already been posted by AIG and Goldman's
AIG CDS counterparties.\677\ As Mr. Viniar stated in March
2009:
---------------------------------------------------------------------------
\677\ Goldman has provided data to the Panel which, assuming they
are accurate, back up Goldman's claims that by reason of the collateral
it held, it was not at credit risk to AIG in November 2008 and that the
amount to which it was exposed by reason of an AIG failure was exceeded
by the collateral already held from AIG and the providers of third
party hedges. Data provided by Goldman to Panel (May 26, 2010).

In the middle of September, it was clear that AIG
would either be supported by the government and meet
its obligations by making payments or posting
collateral, or it would fail. In the case of the
latter, we would have collected on our hedges and
retained the collateral posted by AIG. That is why we
are able to say that whether it failed or not, AIG
would have had no material direct impact on Goldman
Sachs.\678\
---------------------------------------------------------------------------
\678\ Goldman Sachs, Overview of Goldman Sachs' Interaction with
AIG and Goldman Sachs' Approach to Risk Management (Mar. 20, 2009)
(online at www2.goldmansachs.com/our-firm/on-the-issues/viewpoint/
archive/aig-summary.html).

As regards to AIG credit risk, the position that Goldman
describes is that of the classic ``empty creditor'' \679\
(assuming the accuracy of its statements) indifferent between
bankruptcy and bailout, but hostile to negotiated concessions.
However, in light of the government's concerns with respect to
the impact of AIG's failure, which Goldman must have shared, it
would be slightly disingenuous for Goldman to say that it was
truly neutral on this point.\680\ The point is, however, that
Goldman believed that this would not happen. The government had
signaled in September that AIG was too big to fail, and from
that it could be inferred that AIG would be supported through
its current liquidity crisis. On that basis, Goldman could
refuse to make concessions until the clock ran out.\681\
---------------------------------------------------------------------------
\679\ The ``Empty Creditor'' theory posits that CDS may create so-
called ``empty creditors'' whose interests are skewed in favor of
bankruptcy rather than in the continuation of the debtor and who may
accordingly push the debtor into inefficient bankruptcy or liquidation.
See Patrick Bolton and Martin Oehmke, Credit Default Swaps and the
Empty Creditor Problem at 1-2 (Nat'l Bureau of Econ. Research, Working
Paper No 15999) (May 2010) (online at www.nber.org/papers/w15999.pdf)
(citing Hu and Black, Debt, Equity, and Hybrid Decoupling: Governance
and Systemic Risk Implications, European Financial Management, 14, 663-
709 (stating that ``Even a creditor with zero, rather than negative,
economic ownership may want to push a company into bankruptcy, because
the bankruptcy filing will trigger a contractual payout on its credit
default swap position'') and Equity and Debt Decoupling and Empty
Voting II: Importance and Extensions, University of Pennsylvania Law
Review, 156(3), 625-739).
\680\ See Thomson Street Events, GS-Goldman Sachs Conference Call
to Answer Questions from Journalists and Clarify Certain Misperceptions
in the Press Regarding Goldman Sachs' Trading Relationship with AIG, at
7 (Mar. 20, 2009) (Viniar acknowledges disruption of AIG failure on the
financial markets, conf call page 8, ``quite dramatically''). Goldman
states it had ``no material credit exposure'' to AIG; it does not argue
that it would have been unaffected by AIG's failure. Goldman Sachs
decline in equity value and increase in credit default swap spreads,
while marked, were not exceptional when compared to other financials,
such as Morgan Stanley and Credit Suisse. Data accessed through
Bloomberg Data Service (accessed June 3, 2010).
\681\ Goldman has also raised the issue of its responsibilities to
its shareholders which by then included the U.S. government not to make
a loss. It is quite likely that any voluntary concessions would have
triggered shareholder suits--on the grounds that the Goldman board's
actions in agreeing to concessions in contracts for which they were
theoretically fully hedged and collateralized would have improperly
reduced the value of the CDSs for Goldman. See Jiong Deng, Building an
Investor-Friendly Shareholder Derivative System in China, at 351
(Summer 2005) (online at www.harvardilj.org/attach.php?id=35). Whether
the extraordinary circumstances under which Goldman would have agreed
to such concessions would have affected the success of the shareholder
suit is unknowable.
---------------------------------------------------------------------------
It is unknowable whether if, instead of sending relatively
junior people to negotiate, senior government officials could
have used the government's bully pulpit to obtain a better
result, either with the counterparties or with the credit
rating agencies whose downgrades were anticipated. Certainly
there was a significant time constraint, cited by Mr. Baxter of
FRBNY.\682\ But in light of concerns that these negotiations
would themselves endanger AIG's credit rating, and the view
expressed at the most senior levels of FRBNY that the attempt
was likely doomed to failure,\683\ it is hard to escape the
conclusion that FRBNY was just ``going through the motions.''
---------------------------------------------------------------------------
\682\ Testimony of Thomas C. Baxter, supra note 319.
\683\ COP Hearing with Secretary Geithner, supra note 86, at 81.
---------------------------------------------------------------------------
The identities of the CDO CDS counterparties were not
disclosed until several months after the event.\684\ TARP
Special Inspector General Neil Barofsky has referred to an
ongoing inquiry with respect to the manner in which the
decision to disclose was made, and in its most recent quarterly
report to Congress, SIGTARP has made reference to ongoing
investigations related to its audit of FRBNY's decision to pay
certain AIG counterparties at par.\685\ SIGTARP has indicated
that if no charges result from its investigation, it intends to
issue a report detailing its findings.\686\
---------------------------------------------------------------------------
\684\ SIGTARP Report on AIG Counterparties, supra note 246.
\685\ SIGTARP Quarterly Report to Congress, supra note 369, at 19.
\686\ Richard Teitelbaum, Barofsky Says Criminal Charges Possible
in Alleged AIG Coverup, Bloomberg News (Apr. 28 2010) (online at
www.bloomberg.com/apps/news?pid=20601208&sid=aVHMZwNcj2B0).
---------------------------------------------------------------------------

6. Additional Assistance and Reorganization of Terms of Original
Assistance: March and April 2009

While the additional restructuring of the government's
assistance to AIG in March and April 2009 indicates that the
company continued to be severely destabilized by capital and
liquidity pressures, these actions also illustrate how the
structure of the government's assistance had to be adjusted on
a continuous basis due to changing circumstances. AIG's
sizeable loss in the fourth quarter of 2008, coupled with the
likelihood of additional rating downgrades, presented the
government with another choice: whether to do nothing and face
the risk of downgrades, bankruptcy, and the loss of a portion
or the whole of its then outstanding investment, or restructure
its assistance in order to stabilize AIG over the long term. As
with the November restructuring, the government's decision-
making remained sharply constrained and influenced by its
September decision to avert a bankruptcy (and its desire to not
vacillate during a time of crisis), but was also shaped in part
by a further consideration of whether there was a cheaper and
more efficient mechanism to resolve AIG, including some kind of
arranged and controlled bankruptcy.
The government's approach has largely remained focused on
preventing the detrimental effect on market confidence that
would result if it were to not deliver on its promise to
provide financial assistance, as well as on preserving the
value of its investment.\687\ Treasury's commitment to provide
total equity support to AIG of up to $69.8 billion exposed the
taxpayers to additional risk, and the March 2009 restructuring
(which likely benefitted AIG's existing common stockholders),
deprived taxpayers of compulsory quarterly dividend payments,
since Treasury exchanged its cumulative preferred stock for
noncumulative preferred stock. On balance, it appears that the
government made a calculation that the long-term benefits of
restructuring its assistance in order to facilitate divestiture
of its assets, maintain credit ratings, and maximize the
likelihood of repayment outweighed any short-term monetary
gains, such as those that would be acquired through the payment
of dividends. While the government's public statements
announcing the restructuring measures explicitly reference that
an orderly restructuring would ``take time and possibly further
government support, if markets do not stabilize and improve,''
\688\ the terms and the amount of government assistance to AIG
since March and April 2009 remain unchanged.
---------------------------------------------------------------------------
\687\ Senate Committee on Banking, Housing, and Urban Affairs,
Written Testimony of Donald Kohn, supra note 245, at 3 (stating that
``[o]ur judgment has been and continues to be that, in this time of
severe market and economic stress, the failure of AIG would impose
unnecessary and burdensome losses on many individuals, households and
businesses, disrupt financial markets, and greatly increase fear and
uncertainty about the viability of our financial institutions. Thus,
such a failure would deepen and extend market disruptions and asset
price declines, further constrict the flow of credit to households and
businesses in the United States and in many of our trading partners,
and materially worsen the recession our economy is enduring'').
\688\ Treasury and the Federal Reserve Announce Participation in
Restructuring, supra note 518.
---------------------------------------------------------------------------
Instead of Treasury committing an additional $29.8 billion
of TARP funds to AIG in March and April 2009, this also would
have been another point when FRBNY and Treasury could have
sought private sector financing, or some type of public-private
hybrid form of assistance. While it does not appear that such
efforts were made, it is important to recognize that this was
another place when FRBNY and Treasury could have acted
differently.
Perhaps most significantly, the Panel notes that the
restructuring measures taken in March and April 2009 illustrate
how the government, for the first time, began to prioritize an
orderly restructuring process for AIG, as seen in the explicit
separation of the major non-core businesses of the future AIG--
AIA and ALICO. Together with the measures taken in September
and November 2008, these actions provide tangible evidence of
the government's commitment to the orderly restructuring of AIG
over time. Given the scope of the government's assistance to
AIG, the Panel finds that an orderly restructuring process is
both a critical long-term solution for the company and a
lynchpin of AIG's ability to repay its substantial government
assistance.

7. Government's Ongoing Involvement in AIG

To repay its debt and reduce its degree of financial risk,
AIG instituted a wind-down of AIGFP and a divestiture process
to sell business units in September 2008. Since that time,
AIGFP has been focused on unwinding its riskiest books and
estimates that the majority of the wind-down will be completed
by the end of 2010, provided the markets remain stable. In his
December 2009 testimony before the Panel, Secretary Geithner
asserted the company's new board and management are ``working
very hard and effectively'' at strengthening AIG's core
insurance business while reducing the AIGFP portfolio.\689\
According to FRBNY, the entirety of AIG's restructuring is not
at the government's behest, but is driven by the disposition
plan in place when FRBNY rescued the company in September
2008.\690\ This restructuring plan, which focuses on
consolidating and downsizing AIG to focus on several core
property & casualty and life insurance business units, has also
guided the company's plans to repay gradually the government
assistance through these asset sales and dispositions.
---------------------------------------------------------------------------
\689\ COP Hearing with Secretary Geithner, supra note 86, at 69.
\690\ FRBNY conversations with Panel staff (May 4, 2010).
---------------------------------------------------------------------------
Since the Federal Reserve does not have statutory
supervisory authority over AIG or its subsidiaries (as it does
for bank holding companies or state chartered member banks), it
functions as a creditor, and its rights are governed by the
credit agreement for the RCF. As Chairman Bernanke has stated,
``[h]aving lent AIG money to avert the risk of a global
financial meltdown, we found ourselves in the uncomfortable
situation of overseeing both the preservation of its value and
its dismantling, a role quite different from our usual
activities.'' \691\ As creditor, FRBNY monitors the
implementation of AIG's restructuring and divestiture plan and
participates as an observer in the corporate governance of
AIG.\692\ FRBNY uses its rights as creditor to work with AIG
management ``to develop and oversee the implementation of the
company's business strategy, its strategy for restructuring,
and its new compensation policies, monitors the financial
condition of AIG, and must approve certain major decisions that
might reduce its ability to repay its loan.'' \693\ As an
ongoing condition of the RCF and to support its role as
creditor, FRBNY established an on-site staff of approximately
25 people to monitor AIG's use of cash flows and its progress
in pursuing its restructuring and divestiture plan. This
internal team was supplemented by over 100 employees from the
Bank of New York Mellon, investment bankers from Morgan
Stanley, and outside legal counsel from Davis Polk & Wardwell
LLP.\694\ FRBNY has indicated that in the months since
September 2008, the role and function of the on-site monitoring
team has changed, with separate teams having been established
to monitor liquidity and the core business units that are
central to AIG's operations going forward, and with regular
ongoing communications between the teams.\695\ FRBNY's on-site
monitoring team works closely with Treasury's AIG team, and
there are frequent meetings and regular communication between
Treasury, FRBNY, and senior executives at AIG. While FRBNY's
on-site team's size is approximately the same now as it was in
September 2008, FRBNY's recruitment of individuals with
investment banking and insurance expertise has allowed it to
reduce the size of its external assistance.\696\
---------------------------------------------------------------------------
\691\ Written Testimony of Ben Bernanke, supra note 481, at 4.
\692\ While Federal Reserve banks have boards of directors which,
by statutory construct, include bank executives and bank shareholders,
they play a limited role in the Reserve bank's operations and function
largely in an advisory capacity. The boards of directors of Reserve
banks serve to make observations on the economy and markets, make
recommendations on monetary policy, and ratify the Reserve bank's
budget, internal controls, policies, procedures, and personnel matters.
Consistent with the Federal Reserve Act, however, the boards do not
exercise a role in the regulation, supervision, or oversight of banks,
bank holding companies, or other financial institutions.
\693\ Senate Committee on Banking, Housing, and Urban Affairs,
Written Testimony of Donald Kohn, supra note 245, at 6.
\694\ FRBNY conversations with Panel staff (May 6, 2010).
\695\ FRBNY conversations with Panel staff (May 6, 2010).
\696\ FRBNY conversations with Panel staff (May 6, 2010).
---------------------------------------------------------------------------
The Federal Reserve Board also oversees FRBNY's ongoing
administration of the credit facilities for AIG authorized
under section 13(3).\697\ A team of Board staff regularly
reviews developments affecting AIG with the FRBNY team charged
with ensuring compliance with the terms of the credit
agreements, monitoring AIG's liquidity and financial condition,
and reviewing its restructuring plan. In turn, the Board staff
team provides regular updates to Board members and senior
agency staff about significant AIG developments. The Board
staff also consults regularly with the Treasury team that
oversees the TARP investments in AIG.
---------------------------------------------------------------------------
\697\ Testimony of Scott G. Alvarez, supra note 639, at 15-16.
---------------------------------------------------------------------------
Together with the trustees of the Series C Trust, the
Federal Reserve, FRBNY and Treasury have worked with AIG to
recruit a substantially new board of directors and new senior
management (including a new chief executive officer, a new
chief risk officer, a new general counsel, and new chief
administrative officer).\698\
---------------------------------------------------------------------------
\698\ Testimony of Jim Millstein, supra note 44, at 2. The Series C
Trustees have elected 11 of the 13 existing board members. The two
remaining directors were nominated and elected by Treasury, pursuant to
the terms of its Series E and Series F Preferred share holdings.
---------------------------------------------------------------------------
The Panel also discusses the Special Master's involvement
with respect to AIG, his rulings on executive compensation
regarding AIG and the impact of those rulings on the company's
competitive position in Section J.1.

8. Differences between the Treatment of AIG and Other Recipients of
Exceptional Assistance

During Secretary Geithner's testimony before the Panel in
April 2009, he said that where Treasury provides exceptional
assistance,\699\ ``it will come with conditions to make sure
there is restructuring, accountability, to make sure these
firms emerge stronger in the future.'' \700\ As with the
automotive companies (but unlike Citigroup and Bank of America,
other recipients of exceptional assistance), some of AIG's
management has been replaced at the government's behest.\701\
The government, and Treasury in particular, also seem to have
taken on an active role with respect to planning and strategy
at AIG, but not with respect to Citigroup and Bank of America.
However, Treasury has not required AIG to submit a forward-
looking viability plan, nor was AIG forced into bankruptcy.
(This is why AIG's shareholders retain whatever value is left
in their shares). Additionally, while Citigroup shareholders
have been diluted, AIG shareholders have seen their positions
severely diluted (if not nearly wiped out) by the government.
This is also in contrast to the treatment of automotive company
shareholders, who were wiped out completely.\702\ While
Treasury may have the power to dilute the other shareholders,
it lost the power to eliminate them legally in the absence of
bankruptcy proceedings. Because there was no bankruptcy, as
discussed in Section E above, creditors of AIG were protected,
unlike some creditors of the automotive companies. The parties
that fared particularly well from the government's intervention
in AIG include those stakeholders who would have lost
everything or something on their position, but for the
government's rescue. The government's actions, therefore,
ensured that many parties that would have received nothing in a
bankruptcy were not wiped out.
---------------------------------------------------------------------------
\699\ Recipients of ``exceptional assistance'' are those companies
receiving assistance under the SSFI, the TIP, the Asset Guarantee
Program, the Automotive Industry Financing Program, and any future
Treasury program designated by the Secretary as providing exceptional
assistance. Recipients of exceptional assistance currently include AIG,
Chrysler, Chrysler Financial, GM, and GMAC (since renamed Ally
Financial).
\700\ Congressional Oversight Panel, Testimony of Timothy F.
Geithner, secretary, U.S. Department of the Treasury, COP Hearing with
Treasury Secretary Timothy F. Geithner, at 40 (Apr. 21, 2009) (online
at www.cop.senate.gov/documents/transcript-042109-geithner.pdf).
\701\ The Panel recognizes that Citigroup and Bank of America have
made significant changes in their management team on their own since
early 2009.
\702\ If Treasury were to convert its preferred shares in AIG
(which looks increasingly possible), the other shareholders would be
diluted beyond their already substantial dilution.
---------------------------------------------------------------------------
The perception that AIG received unique treatment is
deepened by the fact that AIG was the sole recipient of TARP
funding under Treasury's SSFI, which was later renamed the AIG
Investment Program (AIGIP). During late 2008 and early 2009--
the same period when AIG received substantial government
assistance--Bank of America and Citigroup also received
multiple rounds of government assistance against a backdrop of
imminent insolvency. In addition to receiving $25 billion in
funding under the TARP's CPP, Citigroup received $20 billion in
TARP funds through the Targeted Investment Program (TIP); it
also benefitted from a loss-sharing agreement on a pool of
assets that Citigroup identified as some of its riskiest
assets, and which was initially valued at up to $306 billion,
under a TARP initiative known as the Asset Guarantee Program
(AGP). For its part, Bank of America received $15 billion in
CPP funds (which was supplemented by another $10 billion under
the same program following the closing of its acquisition of
Merrill Lynch in January 2009), $20 billion in TARP funds
through the TIP, as well as a loss-sharing agreement on a pool
of assets that was initially valued at approximately $118
billion but was never finalized.\703\ It seems puzzling,
however, that the SSFI program, which was established in the
fall of 2008 ``to provide stability and prevent disruptions to
financial markets from the failure of institutions that are
critical to the functioning of the nation's financial system,''
was not used to assist the other ``systemically significant''
institutions that were also placed on life support, including
Bank of America and Citigroup. This also suggests that the
government shied away from labeling some of the largest banks
as ``failing institutions'' even as it was trying to prop them
up.\704\
---------------------------------------------------------------------------
\703\ The Panel notes that Bank of America repaid all of its TARP
assistance and Citigroup repaid its $20 billion in TIP assistance and
terminated the loss-sharing agreement in December 2009.
\704\ With respect to the financial health of Citigroup in late
October and November 2008, Treasury has stated ``[d]ue to the
deterioration in confidence, there was concern that, without government
assistance, Citigroup would not be able to obtain sufficient funding in
the market over the following days,'' and that ``a failure to act to
reestablish confidence in Citigroup by providing additional liquidity
and an asset guarantee program would have had a significant adverse
effect on U.S. and global financial markets.'' Congressional Oversight
Panel, Responses to Questions for the Record for Assistant Secretary
Herbert M. Allison, Jr., at 3 (Mar. 4, 2010) (online at cop.senate.gov/
documents/testimony-030410-allison-qfr.pdf).
---------------------------------------------------------------------------
But while there are some differences in treatment with
respect to AIG and other recipients of exceptional assistance,
the Panel also notes that there are some key similarities in
the government's treatment of AIG and Citigroup.
As with Citigroup, AIG has undergone substantial corporate
restructuring and consolidation, but these changes have been
largely driven by internal corporate decision-making and have
not occurred at the government's behest. It appears that at
least some of AIG's asset disposition plan and focus on its
core operations, including the significant wind-down of AIGFP
and emphasis on property & casualty and life insurance
businesses, preexisted the government's assistance to AIG.\705\
Citigroup's asset sales and focus on its core operations,
including worldwide retail banking, investment banking, and
transaction services for institutional clients, resulted from
its first quarter 2009 internal restructuring, when it
reorganized itself into Citicorp and Citi Holdings.
---------------------------------------------------------------------------
\705\ E-mail from Patricia Mosser, senior vice president, Federal
Reserve Bank of New York, to Scott Alvarez of Federal Reserve Board of
Governors, among others (Sept. 13, 2008) (FRBNYAIG00508) (referencing
that AIG's medium-term plan was to sell approximately ``$40 billion of
high quality assets, largely life insurance subsidiaries in the US and
abroad to raise capital/cash needed to fill the hole. Such a sale of
assets would amount to AIG selling approximately 35 to 40% of the
company'').
---------------------------------------------------------------------------
In addition, there appear to be some similarities, at least
preliminarily, with respect to how the government intends to
dispose of its TARP investments in Citigroup and AIG. In
February 2009, Treasury announced that it would convert up to
$25 billion of its preferred stock holdings in Citigroup into
common stock, which would provide additional tangible common
equity for Citigroup. On June 9, 2009, Treasury agreed to terms
to exchange its CPP preferred stock for 7.7 billion shares of
common stock priced at $3.25 per share (for a total value of
$25 billion) and also agreed to convert the form of its TIP and
AGP holdings.\706\ In addition, on July 30, Treasury exchanged
its $20 billion of preferred stock in Citigroup under the TIP
and its $5 billion investment in the AGP from preferred shares
to trust preferred securities (TruPS). The conversion allowed
Citigroup to strengthen its capital base by improving its
tangible common equity ratio--a key measure of bank solvency--
to 60 percent. Pursuant to a pre-arranged written trading plan,
Treasury intends to fully dispose of its 7.7 billion common
shares of Citigroup over the course of 2010, subject to market
conditions.
---------------------------------------------------------------------------
\706\ On July 23, 2009, Treasury, along with both public and
private Citigroup debt holders, participated in a $58 billion exchange,
which resulted in the conversion of Treasury's $25 billion CPP
investment from preferred shares to interim securities to be converted
to common shares upon shareholder approval of a new common stock
issuance. The $25 billion exchange substantially diluted the equity
holdings of existing Citigroup shareholders and was subject to
shareholder approval on September 2, 2009.
---------------------------------------------------------------------------
In a similar fashion, during a recent interview, AIG Chief
Executive Officer Robert Benmosche pointed to Treasury's
conversion of preferred to common shares with respect to its
Citigroup holdings as one possible government exit strategy
from AIG.\707\ Treasury will likely consider such a conversion
as it plans and executes its AIG exit strategy.
---------------------------------------------------------------------------
\707\ Jamie McGee, AIG Less Reliant on U.S., on Path to Repaying
Bailout, CEO Says, Bloomberg News (Apr. 2, 2010) (online at
www.bloomberg.com/apps/news?pid=20601109&sid=az0bouW0eHus).
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G. Assessment of the Roles of Treasury and the Federal Reserve

Although Treasury had no regulatory authority to intervene,
no failed financial institution resolution authority that might
have provided an alternative to bankruptcy, and no fiscal
capacity to finance a rescue of AIG in September 2008, Treasury
clearly was closely involved in the discussions about the
appropriate policy response to the unfolding AIG crisis.
Notwithstanding their lack of formal authority to intervene,
the Secretary and the President could be expected to be held
accountable for the consequences of an AIG failure on the
American economy. Likewise, the Federal Reserve Board Chairman
and FRBNY President clearly would not have wanted to act
without coordinating closely with Treasury and the White House.
But in the absence of formal Treasury authority to act, the
Federal Reserve Board and FRBNY, were necessarily the lead
organizations in responding to the crisis.
FRBNY is owned by its member banks, not the federal
government. It routinely acts as the agent of the Federal
Reserve Board and System in financial market transactions.
Although its purchases of securities are usually financed by
the creation of money, not tax collections or borrowing, such
money creation is undertaken by the government exercising its
authority as sovereign. In that respect FRBNY was using the
``taxpayer resources'' of the federal government when it
extended an $85 billion line of credit to AIG in September
2008. Although Treasury officials from the Bush Administration
were unwilling to speak to the Panel in connection with this
report, discussions with FRBNY officials confirm that policy
officials negotiating with AIG at the time recognized that U.S.
taxpayers and not the privately owned FRBNY should receive
compensation for the value of the financial assistance being
provided to AIG. Consequently, FRBNY required that convertible
preferred stock with a value of 77.9 percent of the common
stock of AIG be issued to ``the United States Treasury,'' a
reference to the general fund of the U.S. government, rather
than Treasury.\708\ A trust agreement was created to manage
Treasury's equity holdings and address the U.S. government's
corporate governance role created by this equity position.\709\
This arrangement reflects both the absence of authority (at
that time) for the Secretary or Treasury to hold the equity,
and the inappropriateness of having the central bank of the
United States owning and managing the majority of the equity in
a very large financial institution.
---------------------------------------------------------------------------
\708\ The Federal Reserve banks are separate legal entities which
operate under the general supervision of the Board of Governors of the
Federal Reserve System. Federal Reserve Act Sec. 4, 12 U.S.C. 341
(2006). All banks in the United States are required to be stockholders
of the Federal Reserve bank in the region in which the banks are
located. 12 U.S.C. 282. The Board of Governors is authorized to
exercise general supervision over the Federal Reserve banks. Federal
Reserve Act Sec. 11 , 12 U.S.C. 248(i) (2006). In addition, the Board
is empowered to delegate functions other than those relating to
establishing monetary and credit policies to the Federal Reserve banks.
Id. at Sec. 248(k).
\709\ Panel staff interview with FRBNY General Counsel Thomas
Baxter (May 7, 2010). For further discussion of the considerations
involved in determining whether a trust arrangement would be advisable,
see the Panel's September report. September Oversight Report, supra
note 389, at 88-91.
---------------------------------------------------------------------------
Even with the enactment of EESA and Treasury's resulting
ability to use TARP funds, Treasury continued to accede to a
strong role for the Federal Reserve. The actions of FRBNY in
using SPVs (ML2 and ML3) to buy AIG's illiquid RMBS and to
unwind derivative positions, when Treasury could have used TARP
resources to accomplish the same objectives, seem particularly
noteworthy. Part of the reason for this arrangement may have
been that by this time FRBNY was in a far superior position to
act, given its extensive ongoing involvement with resolving the
AIG crisis from the outset, whereas Treasury was only beginning
to get staff in place in early November. Treasury may also have
been agreeable to FRBNY's lead role in light of the fear at
that time that a $700 billion TARP could prove inadequate for
the multitude of problems that might have needed to be
addressed.
At the same time, the heavy reliance upon the Federal
Reserve to take actions of an executive leadership and fiscal
character raises questions as to what was lost in terms of
accountability and transparency. The Federal Reserve's mission
is to conduct monetary policy, and it is not well suited to
incurring multi-billion dollar obligations of taxpayer
resources. In fairness, the leadership of the Federal Reserve
may rightly note that its actions in the case of the rescue of
AIG were undertaken to fill a void in the government's ability
to act, and it did not seek and would have gladly declined the
role it played had the executive branch been able to play the
role that circumstances demanded.
As discussed above, the Federal Reserve supported AIG
through collateralized loans whereas Treasury made investments
and loans for which it received preferred stock (convertible to
common in most cases). This means that here, as with the
``ring-fenced'' assets guarantee to Citigroup and other TARP
assistance transactions in which Treasury and the Federal
Reserve have acted jointly, the Federal Reserve is in the
senior or more protected position in the event of losses on the
government's loans and investments in assisted institutions.
Presumably use of this structure results from the combination
of the Section 13(3) limitation on the Federal Reserve's form
of assistance, the more flexible options available to Treasury
using the TARP, and--at least in this instance--the fact that
the Federal Reserve acted first. To avoid being in a lower
repayment position, Treasury would have needed to extend
secured loans to AIG--despite the adverse impact this would
have had on AIG's balance sheet and its classifications by the
ratings agencies. In that case, Treasury's exposure to losses
in the event of default would have been a function of the
quality of its collateral and not the higher priority of the
Federal Reserve's position. In this respect, the fact that
Treasury actually took a lower relative priority of repayment
position means that Treasury's use of TARP resources has
effectively protected the Federal Reserve. It also raises the
prospect that Treasury may be more risk averse in its
management direction and oversight of AIG than the Federal
Reserve may be inclined to be. The Panel notes that Treasury
and Federal Reserve staff acknowledge the potential differences
in incentives here but insist that they in fact act in close
coordination and that in practice their interests are
completely aligned.
There is also the interesting question about what would
happen if AIG fails despite the assistance of both the Federal
Reserve and Treasury or had failed during the period when only
the Federal Reserve had provided assistance to that firm. How
would large losses on the RCF, the SBF and the ML2 and ML3 have
affected the Federal Reserve System's consolidated balance
sheet? As the Congressional Budget Office (CBO) has recently
noted, the Federal Reserve has generated sharply increased
remittances to Treasury since the onset of the financial crisis
as its expanded balance sheet and lending programs are
producing a surge in earnings.\710\ Nevertheless, the
extraordinary size of the assistance provided to AIG means that
there could have been losses large enough to have had wiped out
the Federal Reserve's earnings for some period. The Federal
Reserve has never run a loss and its capital surplus at the end
of 2009 stood at over $50 billion. But its exposure to AIG and
other financial rescue programs are unprecedented and
policymakers may want to give more consideration as to how any
possible losses should be managed in the current episode and
any future financial crisis.
---------------------------------------------------------------------------
\710\ Congressional Budget Office, The Budgetary Impact and Subsidy
Costs of the Federal Reserve's Actions During the Financial Crisis, at
4-5 (May 2010) (online at cbo.gov/ftpdocs/115xx/doc11524/05-24-
FederalReserve.pdf) (hereinafter ``CBO Study'').
---------------------------------------------------------------------------
The actions of the Federal Reserve in the AIG rescue also
serve to illustrate the importance of established procedures
for executing financial transactions in the federal government.
Such actions are made transparent through a formal budget
process involving both the President and the Congress, which
must explicitly authorize beforehand--and, in many cases,
separately appropriate funds to cover--the fiscal transactions
undertaken in the executive branch. Use of the Federal Reserve
to undertake key transactions without such prior approval by
the President and the Congress, as occurred in the case of AIG,
while convenient to both the Federal Reserve and Treasury at
the time, may have sacrificed longer-term accountability and
transparency. Treasury's use of the TARP has been and continues
to be held up to close scrutiny and subject to multiple
oversight mechanisms, of which the Panel's reports and hearings
are but one example. While the Federal Reserve has provided a
large amount of reporting and information concerning its
actions during the crisis, comparable oversight is not mandated
by statute in the case of the actions of the Federal
Reserve.\711\
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\711\ On May 20, 2009, subsequent to the major events discussed in
this report, the Helping Families Save Their Homes Act was enacted.
Among other provisions, this Act provides expanded authority to the
Government Accountability Office to audit the actions taken by the
Federal Reserve under Section 13(3) of the Federal Reserve Act during
the financial crisis. See Helping Families Save Their Homes Act of
2009, Pub. L. No. 111-22, Sec. 801(e).
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H. Current Government Holdings and Their Value

AIG's outlook remains uncertain. While the potential for
the Treasury to realize a positive return on its significant
assistance to AIG has improved over the past 12 months, it
still appears more likely than not that some loss is
inevitable. The long-term horizon for a full government exit,
with attendant equity market and company operating risks,
further clouds this outlook. The size of any loss is unknowable
at present and is, of course, dependent on a host of external
factors. It is also dependent on the various inputs used to
calculate the government's investment in the firm, such as the
value of the Series C equity stake, forgone interest and
dividend payments, and the ML2 and ML3 vehicles. Both AIG and
Treasury, however, have generally expressed varying degrees of
optimism on repayment prospects. AIG expects to fully repay its
obligations to the government, while Treasury is generally
hopeful that the government can ultimately recoup a significant
portion of its investment.\712\ In any case, both parties share
an interest in bringing an end to the government's involvement
with AIG as soon as possible.
---------------------------------------------------------------------------
\712\ Congressional Oversight Panel, Testimony of Jim Millstein,
chief restructuring officer, U.S. Department of the Treasury,
Transcript: COP Hearing on TARP and Other Assistance to AIG (May 26,
2010) (publication forthcoming) (``[I]t seems very likely that the $83
billion dollars of outstanding Fed support will be paid in full.
Similarly, at current market prices, the common stock that the Series C
represents has value. The Treasury Department has $49 billion dollars
outstanding in Series E and F Preferred. And as I said in my testimony,
the recovery on that will depend on the performance of the remaining
businesses and how those businesses are valued in the market at the
time''); Congressional Oversight Panel, Testimony of Robert Benmosche,
president and chief executive officer, American International Group,
Inc., Transcript: COP Hearing on TARP and Other Assistance to AIG (May
26, 2010) (publication forthcoming) (``I believe that we will pay back
all that we owe the U.S. Government. And I believe at the end of the
day, the U.S. Government will make an appropriate profit'').
---------------------------------------------------------------------------
While the Panel recognizes the danger in a prolonged
investment strategy, political expediency should not trump the
opportunity for taxpayers to realize as much value as possible
from their investment.\713\ Thus, the Panel cautions against a
rapid exit in the absence of clearly defined parameters for
achieving the maximum risk-adjusted return to the taxpayer.
Nonetheless, given the significant equity market and company
execution risks involved in a long-term, back-end-loaded exit
strategy, the Panel believes that the government's exposure to
AIG should be minimized (and shifted to private shareholders)
where possible via accelerated sales of a small minority of the
government's holdings, provided this can be done with limited
harm to the share price. In this sense, the interests of AIG's
government and private shareholders are aligned, as the
taxpayer is best served by enhancing value before a broader
exit strategy via the public markets can be executed.
---------------------------------------------------------------------------
\713\ Broader costs to the economy and the competitive landscape
stemming from the protracted government ownership of a large for-profit
company, while outside the scope of this report, should also be
addressed in the government's risk/reward calculus, whenever possible.
---------------------------------------------------------------------------
This section and Section I below outline the value of the
government's AIG holdings and potential scenarios for recovery.
There is a debate in the marketplace about AIG's valuation, and
thus the potential for taxpayers to see a return on their
investment. The Panel's analysis outlines various valuation and
exit scenarios, and their consequent impact on the recovery
value of the government's investments. A rigorous valuation
analysis of AIG is beyond the scope of the Panel's mandate, so
this analysis focuses on the key factors informing the debate
on AIG's valuation and the potential for the government to
monetize its investment under various scenarios.

1. Market's View of AIG's Equity

Trading at $34.07 per share, the equity market currently
values AIG at $22.8 billion.\714\ While down considerably from
the firm's peak split-adjusted share price of $1,456, the stock
is trading above the lows witnessed in late 2008 and early
2009.\715\ AIG currently trades at almost five times its lowest
closing price of $7 on March 9, 2009.\716\ For the year-to-date
period, the stock price is up approximately 14 percent.\717\
Not surprisingly, this rebound over the prior 15 months or so
has coincided with increased optimism concerning the potential
for the government to recoup a significant portion of its
investment. In the meantime, the share price remains volatile,
befitting a stock with a limited public market floatation and
elevated interest among short sellers.\718\ Figure 25
illustrates the precipitous decline in AIG's stock price
through early 2009, followed by its more recent improvement.
---------------------------------------------------------------------------
\714\ AIG's market capitalization is based on a total of 668
million common shares outstanding, which includes both the 135 million
existing common shares and the government's Series C stock held in
trust. These shares have not yet been converted into common stock, but
conversion at some point is almost certain. Most analysts therefore
include these shares in calculating AIG's equity market capitalization.
AIG's closing stock price was $34.07 as of June 7, 2010. Bloomberg
(accessed June 7, 2010).
\715\ Adjusted for 1 for 20 reverse stock split.
\716\ Bloomberg (accessed June 7, 2010).
\717\ Panel staff calculation from Bloomberg data (accessed June 7,
2010).
\718\ The government's 79.8 percent stake of the diluted shares
outstanding do not trade in the public market. According to Bloomberg,
the float is 117.25 million shares (accessed June 7, 2010).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

According to market participants, many institutional
investors believe that there is too much uncertainty to take a
position on the outlook for AIG shares. The firm's limited
public float and government ownership are additional
complicating factors.\720\ For those who are taking a position,
the key debate focuses on the capacity for shareholders to
realize any residual value should AIG succeed in repaying the
government.\721\
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\720\ Few actively-managed investment funds own sizable long
positions in AIG shares. The top five shareholders, outside of the U.S.
government are: Fairholme Capital Management, which holds a long
investment on approximately 6 percent of AIG shares; Starr
International, Hank Greenberg's company, which owns 2 percent; and two
index funds, Vanguard Group Inc. and State Street Corp., which own 1.5
percent in the aggregate. Including the U.S. government's holdings,
these six holders account for almost 90 percent ownership of
outstanding AIG shares. Fairholme Capital Management, LLC, Schedule 13G
Statement of Acquisition of Beneficial Ownership by Individuals (Apr.
12, 2010) (online at www.sec.gov/Archives/edgar/data/5272/
000091957410002876/d1087362_13g.htm); Fairholme Capital Management,
LLC, Form 13F for Quarterly Period Ending March 31, 2010 (May 14, 2010)
(online at www.sec.gov/Archives/edgar/data/1056831/ 000105683110000003/
submisson.txt); Starr International Co., Inc., Form 4 Statement of
Changes in Beneficial Ownership of Securities (Apr. 28, 2010) (online
at www.sec.gov/Archives/edgar/data/5272/000114036110017797/ xslF345X03/
doc1.xml); Vanguard Group Inc., Form 13F for Quarterly Period Ending
March 31, 2010 (May 6, 2010) (online at www.sec.gov/Archives/edgar/
data/102909/ 000093247110002093/march2010vgi.txt); State Street Corp.,
Form 13F for Quarterly Period Ending March 31, 2010 (May 17, 2010)
(online at www.sec.gov/Archives/edgar/data/93751/ 000119312510121662/
d13fhr.txt); Data accessed through Bloomberg Data Service.
\721\ There are few recent publicly available valuation analyses of
AIG. Citations are limited to publicly available analyst reports and do
not include Panel staff conversations with a broader universe of market
participants, including sell-side and buy-side analysts. For a
published, relatively bullish analysis of this type, see, e.g., UBS
Investment Research, Potential Pluses & Minuses = Neutral (Apr. 28,
2010) (hereinafter ``UBS Analysis''). For a published, relatively
bearish analysis of this type, see, e.g., Keefe, Bruyette & Woods, An
Update on AIG (Apr. 27, 2010) (hereinafter ``Keefe, Bruyette & Woods
Analysis'').
---------------------------------------------------------------------------
In this context, some analysts have suggested that the
government may choose to grant AIG concessions in order to
mitigate potential losses on its investment. Although AIG
claims that it does not need concessions to repay the
government, this is not universally believed and in fact has
not been the case to date. For example, the government has both
formally (in agreeing to less onerous financing terms on three
separate occasions) \722\ and informally (by forgoing dividend
payments on preferred shares) sought to mitigate the financial
strain on AIG.
---------------------------------------------------------------------------
\722\ The government restructured AIG's debt on three separate
occasions: 1) November 10, 2008; 2) March 2, 2009; and 3) April 17,
2009. Generally these restructurings were conducted in order to
mitigate the company's debt burden and prevent additional credit
downgrades from the ratings agencies. For a detailed discussion of
these debt restructurings, see Section D.2-5, supra.
---------------------------------------------------------------------------
While one could argue that such moves amounted to
``backdoor concessions,'' AIG's fragile financial position
works against a hard-line stance by the company's principal
shareholder. The government's decision to forgo its right to
non-cumulative dividends on its preferred equity stake equates
to a nominal forfeiture of just under $5 billion annually.\723\
Jim Millstein, chief restructuring officer at Treasury,
asserted at the Panel's May 26, 2010 hearing that AIG's
earnings are currently ``insufficient to support a preferred
dividend.'' \724\ In any case, given that the government owns
nearly 80 percent of the diluted shares outstanding (assuming
conversion of the Series C)--or over 90 percent if the E and F
preferred shares are exchanged for common stock--capital
retained by AIG to stabilize its business should ultimately
accrue to its largest shareholder.
---------------------------------------------------------------------------
\723\ Treasury is entitled to non-cumulative cash dividends at a
rate of 10 percent per annum on its $49.1 billion in Series E and F
preferred shares.
\724\ Testimony of Jim Millstein, supra note 44.
---------------------------------------------------------------------------
Although the prospect of additional concessions has been
openly debated by market participants, the Panel sees little
evidence that the Administration, Congress, or the public would
or should support such a strategy in the absence of compelling
and clear-cut evidence that it was in the best interest of the
taxpayer. Treasury officials have strongly asserted that
additional concessions are unnecessary and not in the
offing.\725\
---------------------------------------------------------------------------
\725\ Testimony of Jim Millstein, supra note 44. Mr. Millstein
stated that the Panel ``can be certain'' that the government will not
grant AIG any concessions, such as forgiving its debt, when the
government exits its position in AIG. Panel staff briefing with Jim
Millstein, chief restructuring officer, U.S. Department of the Treasury
(May 17, 2010).
---------------------------------------------------------------------------
Bullish investors take the view that AIG, provided it has
the time to maximize the value of its core operations, can
repay the government and have sufficient value to build a long-
term franchise. These investors see the valuations offered for
AIA and ALICO (albeit, in the case of AIA, ultimately
withdrawn) as supportive of their outlook. They also believe
that rising industry-wide valuations in the context of an
improving economy will continue to support their investment
strategy. A more measured pace to forthcoming asset sales--as
opposed to a fire-sale approach--increases the value of the
call option on AIG shares, according to one market
participant.\726\ This stance is to some extent backstopped by
the belief among some market participants that the government
will either forgive or restructure a portion of AIG's debt, to
help facilitate its independence from government support.
---------------------------------------------------------------------------
\726\ Panel staff conversations with market participants.
---------------------------------------------------------------------------
Bearish investors, on the other hand, believe that the math
simply does not work. They assert that the government is
unlikely to offer concessions with respect to the company's
outstanding debt and that, even if AIG succeeds in paying off
the government, it does not have sufficient franchise value to
support the current stock price. This view is reinforced by a
more skeptical take on the underlying strength of AIG's
operations, with most critical investors citing potential
problems arising from legacy mismanagement, such as low reserve
ratios and the potential for the unraveling of intercompany
linkages, impacting the holding company's debt financing needs.
Accordingly, many bearish investors believe that AIG has a
negligible or negative net worth, a view that AIG contests (see
footnote below for AIG rebuttal to claims of one bearish
analyst).\727\ The current 12-month price target consensus
among analysts, including those with a relatively positive
view, is $23, well below the stock's recent trading range of
$30 to $45 per share.\728\
---------------------------------------------------------------------------
\727\ See Keefe, Bruyette & Woods Analysis, supra note 721;
Congressional Oversight Panel, Testimony of Clifford Gallant, managing
director of property and casualty insurance research, Keefe, Bruyette &
Woods, COP Hearing on TARP and Other Assistance to AIG (May 26, 2010).
In conversations with Panel staff on June 5, 2010, Brian Schreiber,
AIG's senior vice president of strategic planning, disputed certain
aspects of Mr. Gallant's April 27, 2010 report (and subsequent
testimony). Among the items highlighted, AIG asserts that the report
(1) understates the company's pro forma book value by excluding the
value of the E/F preferred shares (on a converted basis); (2)
overstates the company's leverage and debt load by including Treasury's
E/F preferred shares in this category; (3) excludes the earnings of
several AIG subsidiaries, including the Japan-based Star and Edison
life insurance companies; and (4) calculates valuation based on
assigning below-market multiples to Q4 2009 earnings streams, which AIG
claims may not accurately represent the earnings power of the firm.
\728\ Bloomberg (accessed June 7, 2010). Trading range covers
period of April 1, 2010 to June 7, 2010.
---------------------------------------------------------------------------

2. Residual Value of AIG: The Parameters of Debate

The key parameters of the debate regarding AIG's value
reflect estimates regarding its residual value. As outlined in
Figure 26 below, the company owes the government $100.8
billion: \729\ $26.1 billion for the RCF,\730\ $25.6 billion
for FRBNY's interest in the AIA and ALICO SPVs, and $49.1
billion for the TARP preferred stock (which conceivably could
be removed from the liabilities column if exchanged for common
equity). AIG also has $43.9 billion of private debt
outstanding. The company's total obligations are thus $144.7
billion.\731\ AIG's announced asset sales are expected to yield
about $55 billion in proceeds, reducing the company's
obligations to the government to about $47 billion and its
total obligations to roughly $90 billion.\732\ Analysts
estimate that Chartis, AIG's domestic property & casualty
insurance group, and SunAmerica, its domestic life insurance
group, together would command a valuation in the range of $45
billion-$60 billion, which would leave a gap of approximately
$35 billion-$40 billion to reach par.\733\ Thus, the value of
AIG's core franchise, plus the remaining assets slated for
sale, and AIG's stake in ML2 and ML3 must exceed the balance
owed to the government and private bondholders to suggest any
residual value to the company's equity. This is shown in Figure
26 below, which represents AIG's obligations less estimated
asset sale proceeds. (This analysis excludes the Trust's Series
C equity stake, which is currently valued at $18.2 billion. As
these shares did not represent a direct outlay by the
government, the value of this investment represents something
of a wild card in calculating potential returns to the
government.)
---------------------------------------------------------------------------
\729\ This total reflects only the government's investment in AIG
itself, and does not include FRBNY's investments in the Maiden Lane
entities.
\730\ Federal Reserve H.4.1 Statistical Release, supra note 342
(accessed June 4, 2010).
\731\ American International Group, Inc., Form 10-Q for the
Quarterly Period Ended March 31, 2010, at 5, 82 (May 7, 2010) (online
at www.sec.gov/Archives/edgar/data/5272/000104746910004918/
a2198531z10-q.htm) (hereinafter ``AIG Form 10-Q for the First Quarter
2010'').
\732\ AIG's President and CEO Robert Benmosche indicated that AIG
intends to use the sale proceeds to repay FRBNY. Testimony of Robert
Benmosche, supra note 28. The Panel assumes that AIG will use the sale
proceeds to completely repay FRBNY for both its preferred interest in
AIA and ALICO and the Revolving Credit Facility.
\733\ See, e.g., UBS Analysis, supra note 721, at 3; Keefe,
Bruyette & Woods Analysis, supra note 721, at 2.

FIGURE 26: CALCULATION OF AIG RESIDUAL FRANCHISE VALUE
[Dollars in billions]
------------------------------------------------------------------------------------------------------------------------------------------------
AIG Obligations
FRBNY:
FRBNY Revolving Credit Facility........................ $26.1
Preferred Interest in AIA and ALICO.................... 25.6
------------
Total.................................................. 51.7
Treasury:*
TARP Series E Preferred................................ 41.6
TARP Series F Preferred................................ 7.5
------------
Total.................................................. 49.1
Total Obligations to Government............................ 100.8
Other Debt:
AIG Private Debt \734\................................. 43.9
------------
Total Obligations to Government & Private Sector........... 144.7
Assets Slated for Sale
AIA.................................................... 32.5
ALICO.................................................. 16.2
Other Completed and Pending Asset Sales................ 6.1
------------
Total Value of Assets Slated for Sale...................... 54.8
Total Obligations of AIG................................... 144.7
Total Value of Assets Slated for Sale...................... -54.8
------------
Residual Franchise Value* (amount all other assets must be 89.9
worth for AIG to have positive net worth).................
------------------------------------------------------------------------
*Note: TARP Series E/F Preferred could potentially be exchanged for
equity, reducing AIG's obligations and producing a lower Residual
Franchise Value.
\734\ See Figure 32. Analyst estimates of AIG's private debt vary
widely. Some analysts do not include the ``match funded'' debts of
AIG's Matched Investment Program (MIP) or fully-collateralized debt
within AIGFP, while other analysts include one or both of these
instruments, in addition to certain debt within subsidiaries,
including all or a portion of the debts of AIGFP that are guaranteed
by the parent company. COP analysis includes the ``Debt Issued by
AIG'' from AIG's financial statements, which includes the MIP and
AIGFP match funded debts, but not the AIGFP debts guaranteed by AIG.
This yields a figure of $43.9 billion for private debt, which is
approximately in the middle of the range of recent analyst estimates.

Whether the company's remaining assets are worth more than
$90 billion is an open question, although the role of the
government in this process, and how it might seek to recoup its
investment, which is discussed below, helps to inform this
analysis.\735\ The primary variables in calculating AIG's
residual value are outlined below in Figure 27, which provides
a baseline overview of three potential valuation scenarios for
key AIG components. These scenarios--base, bull, and bear--
reflect inputs with respect to the value of AIG's core and non-
core operations and investments, conditions in the insurance
industry, the health of the capital markets, legacy AIGFP asset
valuations, and the company's potential return from its equity
contribution to ML3. As the differing views in the market
underscore and the scenarios below illustrate, there is
significant room for debate on the value of AIG's core and non-
core assets, and the company's corresponding ability to repay
the government. It is likely that there are also fundamental
differences in assumptions among investors, AIG, and the
government about the company's core earnings potential
(reflecting differences between current versus ``expected''
earnings assumptions) and the application of valuation
multiples, since current industry multiples (including AIG's
absolute and relative valuation) are meaningfully below
historical averages.
---------------------------------------------------------------------------
\735\ However, the government will not likely play a role in
collecting taxes from AIG for an extended period, given that as of
March 31, 2010, AIG reported a net deferred tax asset of $8.2 billion,
which can be used as an offset of future income tax expense and
represents an amount deemed more likely than not to be realized. AIG's
net deferred tax asset valuation incorporates the effect of deferred
tax liabilities, the carryforward periods for any net operating loss
carryforwards (of which AIG had $35.2 billion as of December 31, 2009
and which carryforward 20 years from the date incurred), and certain
transactions expected to be completed in future periods. American
International Group, Inc., Form 10-Q for the Quarterly Period Ended
March 31, 2010, at 80-81 (May 7, 2010) (online at www.sec.gov/Archives/
edgar/data/ 5272/000104746910004918/a2198531z10-q.htm). AIG Form 10-K
for FY09, supra note 50.
---------------------------------------------------------------------------
The ``Total vs. Residual Value'' line in Figure 27 below
compares the total value of AIG's core and non-core businesses
to the Residual Franchise Value from Figure 26 above. Excluding
the $49 billion from the Series E/F preferred, which may be
exchanged for equity in the future, yields positive values in
all three scenarios, versus a negative base scenario if the
Treasury's preferreds are included in AIG's obligations.

FIGURE 27: BULL/BEAR/BASE SCENARIO FOR AIG VALUATION VS. RESIDUAL VALUE
\736\
[Dollars in billions]
------------------------------------------------------------------------
Base Bull Bear
Assets Scenario Scenario Scenario
------------------------------------------------------------------------
AIG Core Operations (Chartis/ $49 $61 $36
SunAmerica)...........................
Non-Core Assets (ILFC, AGF, ML3, etc.)* 24 30 18
--------------------------------
Total Value........................ $72 $91 $54
========================================================================
Total vs. Residual Value............... (18) (0) (36)
Total vs. Residual Value (excl. Series 31 49 13
E/F)..................................
------------------------------------------------------------------------
* Note: Excludes AIA and ALICO
\736\ Inputs for base valuations reflect a compilation of sell-side and
buy-side analysts' estimates. Base values for AIG Core Operations and
Non-Core Potential Sales are the average of estimates provided by UBS,
KBW, and two buy-side investors. UBS Analysis, supra note 721, at 3;
Keefe, Bruyette & Woods Analysis, supra note 721, at 10. Bull and Bear
scenarios illustrate base case scenarios by 25 percent in each
direction.

This analysis yields a range of values from $(21) billion
to $10 billion versus residual value. The exclusion of the
preferred obligations produces positive values in the three
scenarios, ranging from $13 billion to $49 billion.

3. Administration and CBO Subsidy Estimates

Market estimates of the residual value of AIG generally
imply a more favorable recovery rate in comparison with the
subsidy estimates published by the CBO and OMB. The CBO's
current estimate of the subsidy cost for the AIG portion of the
TARP is $36 billion.\737\ The OMB's most recent estimate is $50
billion.\738\ Treasury published a TARP financial update on May
21, 2010 showing that the Administration now estimates that
TARP will lose $45.2 billion overall on its TARP investments,
including its numerous non-AIG investments.\739\ CBO, OMB and
Treasury all assume that the full $69.8 billion in TARP funding
that has been committed to AIG will fully be utilized, although
only $49.1 billion has actually been disbursed to date. The
Federal Reserve is not included in the federal budget, but CBO
recently estimated a subsidy cost of $2 billion for the Federal
Reserve's RCF for AIG at the time the loan was extended
(September 16, 2008). While CBO did not produce a current
subsidy estimate, the fact that they now estimate that the RCF
will produce $12 billion in interest income with minimal losses
and that ML2 and ML3 investments will generate $4 billion in
income implies that the government will realize a net gain from
the Federal Reserve's financial transactions with AIG.\740\
Consequently, it is possible that the Fed will make a profit on
its support of AIG while Treasury endures a loss.
---------------------------------------------------------------------------
\737\ Congressional Budget Office, Report on the Troubled Asset
Relief Program--March 2010, at 3 (Mar. 2010) (online at www.cbo.gov/
ftpdocs/112xx/doc11227/03-17-TARP.pdf).
\738\ Office of Management and Budget, Budget of the U.S.
Government, Fiscal Year 2011, Analytical Perspective, Chapter 4, at 39-
40 (online at www.whitehouse.gov/omb/budget/fy2011/assets/budget.pdf)
(accessed June 9, 2010).
\739\ U.S. Department of the Treasury, Summary Tables of Troubled
Asset Relief Program (TARP) Investments as of March 31, 2010, at 1 (May
21, 2010) (online at www.financialstability.gov/docs/
TARP%20Cost%20Estimates%20-%20March%2031%202010.pdf). See also U.S.
Department of the Treasury, Projected TARP Costs Reduced by $11.4
Billion (May 21, 2010) (online at www.financialstability.gov/latest/
pr_05212010b.html).
\740\ CBO Study, supra note 710, at 13-14.
---------------------------------------------------------------------------
The TARP subsidy calculations of both agencies make use of
market data for traded financial instruments of AIG, such as
subordinated debt and preferred stock, to calculate market
expectations and implied loss rates on the TARP investment.
CBO's methodology involves analyzing preferred stock price data
for AIG and the risk premium that appears to be reflected in
that data. The risk premium is further analyzed to estimate an
implied loss rate probability embedded in that premium. The
resulting subsidy rate of 52 percent, which reflects potential
losses as well as other factors, is then applied to the total
funding available ($69.8 billion) to produce the subsidy
estimate of $36 billion.
OMB's subsidy estimate is based upon a methodology
developed in coordination with Treasury's Office of Financial
Stability. It uses price data for AIG subordinated debt and
adjusts that data to reflect the lower priority position of AIG
preferred shares relative to subordinated debt. The adjustment
used for the 2010 Budget was based upon the relative prices for
subordinated debt and preferred stock of an institution that
was in a similarly stressed situation at the time of the
estimate, namely the CIT Group. For the 2011 Budget subsidy
rate, the adjustment was based upon market data for Citigroup
stock and debt. Similar to CBO, OMB used the resulting adjusted
prices for AIG preferred stock to produce derived market
implied loss rates and resulting credit subsidy rates of 83
percent for 2010 and 62 percent for 2011.
The Credit Reform Act of 1990 requires OMB to continue
using its initial subsidy estimate--in this case from the 2010
Budget published in May 2009--for obligated funds until these
funds have actually been disbursed.\741\ Because most of the
funds obligated for AIG Series F preferred stock purchases had
not been disbursed by the time that the Administration's 2011
Budget was published in February 2010, OMB and Treasury were
required to use their earlier 2009 estimates for a substantial
portion of their latest subsidy estimate. Hence, OMB's most
recent subsidy cost estimate of $50 billion incorporates a
blend of the subsidy rate calculations over two years. This in
large part accounts for the different subsidy estimates of the
two agencies as they otherwise use similar methodologies based
upon market data for AIG debt and preferred stock.
---------------------------------------------------------------------------
\741\ Federal Credit Reform Act of 1990 (FCRA), 2 U.S.C. 661
(1990).
---------------------------------------------------------------------------

I. Exit Strategies

This section provides an overview of Treasury's exit
strategy and the corresponding effort by AIG to improve its
business operations, which will factor heavily in both the
timing and amount of funds Treasury will recover from its
investment. Section I.1 outlines the key challenges facing
Treasury as it looks ahead to monetizing its investment in AIG.
Section I.2 addresses AIG's current restructuring efforts, the
pace and success of which will weigh heavily on the outcome for
the taxpayer. Section I.3 highlights Treasury's exit plan and
its outlook on AIG's restructuring process, recent earnings,
and near-term business risks that could delay the current
timetable.
Despite some recent challenges, both AIG and Treasury
believe that it is likely that the company will be able to
fully repay FRBNY in 2010, which is senior to the company's
TARP obligations. More significantly, both the company and
Treasury have grown increasingly confident in recent months
regarding the possibility (in the case of Treasury) or the
expectation (in the case of AIG) of full repayment of
Treasury's assistance.\742\ Ultimately, the outlook for
taxpayers is contingent on the long-term prospects for AIG, and
the ability of the current management team to produce strong
operating results ahead of the commencement of an expected exit
strategy by Treasury in 2011.\743\ Market observers and
government officials generally agree that Mr. Benmosche's
target for annualized earnings of approximately $8 billion
would constitute sufficiently strong earnings (core earnings
within AIG's primary ongoing P&C and Life Insurance businesses
are currently approximately $6 billion, annualized for first
quarter 2010 results).\744\ In addition, a more transparent
company structure would help facilitate access to the capital
markets, allowing AIG to emerge as a stand-alone investment
grade insurance company capable of repaying the government's
investment.\745\
---------------------------------------------------------------------------
\742\ Although Treasury is clearly more confident versus the year-
ago period, recent complications associated with the AIA transaction as
well as a more challenging capital markets backdrop have perhaps
justified a more calibrated assessment of the factors impacting the
potential for full repayment. Testimony of Jim Millstein, supra note
44; Testimony of Robert Benmosche, supra note 28.
\743\ Testimony of Jim Millstein, supra note 44 (``[T]he objective
of the restructuring plan is to restructure AIG's balance sheet and
business profile so that it can maintain this status on its own,
thereby permitting the government to monetize the taxpayers'
investment'').
\744\ Includes General Insurance (Chartis), Domestic Life Insurance
& Retirement Services, and Foreign Life Insurance & Retirement
Services. AIG Form 10-Q for the First Quarter 2010, supra note 731, at
114.
\745\ Testimony of Robert Benmosche, supra note 28 (``[W]e have a
company that can earn between $6 and $8 billion dollars after taxes * *
* we want very clear discreet businesses that we can see what they are,
where we can see their financials. And therefore, we can go to the
capital markets for that insurance company''); Testimony of Jim
Millstein, supra note 44 (Mr. Benmosche is an ``experienced insurance
executive...h[e] is confiden[t] that he can get Chartis and SunAmerica
Financial to an $8 billion dollar net after tax earning. If he can do
that, we're going to be paid in full'').
---------------------------------------------------------------------------

1. Overview

Figure 28 below outlines the current market value of the
government assets to be unwound in conjunction with an exit
from AIG. The government has expended $100.8 billion in total
direct assistance to AIG (excluding investment in ML2 & ML3),
but its current investment value is $119 billion, reflecting
the additional value of the Series C shares. Assuming FRBNY is
paid in full, Treasury's subordinate position represents $49.1
billion in preferred debt securities (Series E & F), and
includes the value of the Series C shares (which fluctuates
based on the share price of AIG), a $67.3 billion investment
value.\746\
---------------------------------------------------------------------------
\746\ $67.3 billion assumes $49.1 billion for preferreds and $18.2
billion for Series C shares (based on conversion and sale at AIG's
current market value of $34.07 per share as of June 7, 2010).

FIGURE 28: SUMMARY OF GOVERNMENT INVESTMENTS IN AIG \747\
[Dollars in billions]
------------------------------------------------------------------------
Estimated
Assets Value
------------------------------------------------------------------------
FRBNY:*
FRBNY Revolving Credit Facility........................ $26.4
Preferred Interest in AIA and ALICO.................... 25.6
Treasury:
TARP Series E Preferred................................ 41.6
TARP Series F Preferred................................ 7.5
TARP Series E Warrants................................. 0.0
TARP Series F Warrants................................. 0.0
Series C Shares (Held in Trust):
Series C Convertible Preferred......................... 18.2
------------------------------------------------------------------------
* Note: This table does not include ML2 and ML3.
\747\ Value of FRBNY Revolving Credit Facility as of May 27, 2010.
Series C valuation adjusted for equity market value as of June 7,
2010.

Until very recently, AIG had intended to repay FRBNY's
investment with proceeds from the sale of its Asian
subsidiaries, AIA and ALICO. On June 2, 2010, the announced
sale of the larger of these two entities, AIA, to the British
insurance giant Prudential for $35.5 billion,\748\ was
cancelled due to differences over price (discussed further in
Section I.3). Nevertheless, Treasury officials have indicated
to the Panel that they believe that AIG will be able to realize
value equivalent to the $35.5 billion negotiated sale price
through an alternate strategy, perhaps involving an IPO on the
Hong Kong Stock Exchange.\749\ However, there is a higher risk
premium to this strategy given the potential for equity market
and AIA operating risks (although operating results have
improved in recent quarters) to weigh on an IPO valuation and
subsequent secondary offerings to fully dispose of AIG's
ownership interest.
---------------------------------------------------------------------------
\748\ AIG Statement on $85 Billion Secured Revolving Credit
Facility, supra note 501.
\749\ Panel staff conversation with Jim Millstein, chief
restructuring officer, U.S. Department of the Treasury (June 2, 2010).
An AIA IPO was reportedly AIG's original divestiture strategy prior to
the Prudential offer, and now appears to be the likely scenario since
the planned sale to Prudential collapsed. See Andrew Peaple, AIA Needs
Polishing Before IPO, Wall Street Journal (June 2, 2010) (online at
online.wsj.com/article/
SB10001424052748703561604575281771117418324.html?mod=WSJ_Heard_LEFTTopNe
ws).
---------------------------------------------------------------------------
Full repayment of Treasury's TARP investment and charting a
course for a viable long-term strategy will demand additional
actions that are not completely clear. Media reports and
Treasury conversations with Panel staff affirm that the company
intends to outline a more coherent strategy to repay its
government assistance in the near future.\750\ Assuming the
ALICO sale is finalized and an IPO or other strategic action
for AIA is clarified in the third or fourth quarter of 2010, it
is probably fair to assume that an exit strategy will emerge
before 2011. Treasury candidly acknowledged the necessity for
AIG to move forward with unveiling a strategy in the coming
months.\751\ Working from the assumption that Treasury expects
to recoup a substantial portion of its $49.1 billion cost basis
(with full realization of its current investment value of $67.3
billion an aspirational target), it is likely that Treasury
will seek to convert its preferred interest into common equity
shares (consistent with AIG boosting its balance sheet to
support an investment grade credit rating), and then pursue a
strategy aimed at selling the stake in the public markets over
an extended time horizon. An exit that is perceived as overly
hasty risks creating a run on the stock, as shareholders try to
get out before the government converts its preferred stake to
common equity, in order to avoid massive dilution.\752\
---------------------------------------------------------------------------
\750\ Panel staff conversations with Jim Millstein, chief
restructuring officer, U.S. Department of the Treasury (May 17, 2010
and June 2, 2010). See also Joann S. Lublin and Serena Ng, Board Panel
at AIG Hires Rothschild, Wall Street Journal (May 12, 2010) (online at
online.wsj.com/article/
SB10001424052748703565804575238760116921430.html).
\751\ Panel staff conversation with Jim Millstein, chief
restructuring officer, U.S. Department of the Treasury (June 2, 2010).
\752\ Panel staff discussions with Treasury officials, AIG
executives, and stock analysts did not yield a consensus as to what
extent the market is pricing in the potential for significant dilution
in AIG shares. Market clarity on this front is hindered by the stock's
very limited public float.
---------------------------------------------------------------------------
a. The Long Good-Bye
The baseline approach is for Treasury to seek to exit AIG
over several years. The model for this approach will likely be
Citigroup.\753\ A conversion of the preferred shares into
common equity may prove more difficult for Treasury to execute
with AIG, though, given AIG's publicly traded float of $4
billion and a government equity stake that could conceivably
amount to approximately $70 billion (full conversion of Series
C, E & F at current market prices).\754\ Thus, absent a capital
raise by AIG to repay Treasury directly, a protracted wind-down
of Treasury's stake seems inevitable.\755\ Presumably, some
amount of Series C sales will commence ahead of the exchange of
Treasury's E and F preferred shares for common equity in order
to improve liquidity and avoid the government's stake in AIG
moving above 80 percent.\756\
---------------------------------------------------------------------------
\753\ The government's investment in Citigroup and the subsequent
exit strategy is discussed in Section F.8, supra. The Panel's January
2010 report contains a discussion of the government's Citigroup exit
strategy, including the monetization of the preferred shares under the
TARP Capital Purchase Program (CPP). See January Oversight Report,
supra note 637, at 34-64.
On December 22, 2009, Citigroup repaid $20 billion in TARP funds it
received under the TIP. Citigroup issued $20.5 billion of new debt and
equity to raise money to repurchase Treasury's $20 billion of TruPS
through the selling of $17 billion of new common stock and issuing $3.5
billion of other debt and equity. Office of the Special Inspector
General for the Troubled Asset Relief Program, Quarterly Report to
Congress, at 73 (Jan. 30, 2010) (online at www.sigtarp.gov/reports/
congress/2010/January2010_Quarterly_Report_to_Congress.pdf)
(hereinafter ``SIGTARP Quarterly Report to Congress'').
On July 30, 2009, Treasury agreed to exchange $25 billion in
Citigroup preferred shares it had received under the Capital Purchase
Program (CPP) for 7.7 billion shares of common stock priced at $3.25
per share. U.S. Department of the Treasury, Exchange Agreement dated
June 9, 2009 between Citigroup Inc. and United States Department of the
Treasury, at Schedule A (June 9, 2009) (online at
www.financialstability.gov/docs/agreements/08282009/
Citigroup%20Exchange%20Agreement.pdf). On March 29, 2010 Treasury
announced its intention to sell the 7.7 billion in common shares in an
``orderly and measured fashion'' over the course of 2010, subject to
market conditions. U.S. Department of the Treasury, Treasury Announces
Plan to Sell Citigroup Common Stock (Mar. 29, 2010) (online at
www.financialstability.gov/latest/pr_03282010.html).
On May 26, 2010, Treasury completed a sale of 19.5 percent of its
holdings of Citigroup common stock. Treasury sold 1.5 billion shares
for approximately $6.2 billion. U.S. Department of the Treasury,
Treasury Announces Plan to Continue to Sell Citigroup Common Stock (May
26, 2010) (online at www.financialstability.gov/latest/
pr_05262010b.html).
\754\ As mentioned above, the Series C shares are convertible into
common stock, while the E and F shares are not. Nevertheless, the
exchange of the E and F shares for an equivalent dollar amount of
common shares is a likely exit strategy. References to ``conversion''
hereafter refer both to the conversion of C shares and the exchange of
E and F shares.
\755\ On December 9, 2009, Bank of America repaid $45 billion in
TARP funds ($25 billion from the Capital Purchase Program (CPP) and $20
billion from the TIP. Bank of America repurchased its preferred shares
using capital it raised in a securities offering plus excess cash it
generated through normal business operations. In the securities
offering, Bank of America raised a total of $19.3 billion in the
securities offering by selling 1.29 billion shares (equivalent to
common equity) for $15 each. SIGTARP Quarterly Report to Congress,
supra note 753, at 55.
\756\ See note 265, supra, for an explanation of why the government
chose an ownership percentage of just under 80 percent.
---------------------------------------------------------------------------
Although neither AIG nor Treasury has announced a timeline
for the government's exit, assuming Treasury converts its
preferred shares to common equity by early 2011, Treasury will
likely remain a significant shareholder in AIG through 2012 as
it sells down its stake over the next 12 months or so. This
protracted timeline, of course, involves substantial equity
market risk and will rely heavily on AIG building a sustainable
franchise value over the medium term in order to support an
increased supply of shares on the market (AIG's strategy and
operations are examined in more detail in Section I.2 below).
b. The Mechanics and Key Variables of Treasury's Likely
Baseline Exit Strategy
This baseline approach could conceivably yield a broad
array of outcomes, depending on the equity market conditions
and the residual value of the AIG franchise (as outlined in
Section H.1 and H.2 above, with business outlook addressed in
Section I.2 below). Mathematically, the key variable that will
dictate the value realized by the government is not the price
that Treasury converts its preferred stake into common equity,
but rather the stock performance of the common shares
subsequent to this conversion (although legacy shareholders are
of course less diluted at a higher conversion price by the
government). In order to recover its full investment, it is
vital that Treasury be able to sell at or near the conversion
price. By nature, this involves a period of considerable risk
to Treasury's investment between conversion and sale.
Strictly speaking, aside from the impact of increased
dilution for legacy shareholders, the price at which the E and
F shares are converted is irrelevant, since the conversion is
based on the dollar amount of Treasury's investment, $49.1
billion, rather than a fixed number of shares. For example,
Treasury would receive twice as many new common shares at a
conversion price of $18 as it would at $36. Similarly, the
proceeds would be the same if the stock drops 50 percent after
conversion at $36 versus a similar decline following conversion
at $18.
A stable stock price over the next 18 months would yield
$49 billion to the government from the E and F shares (equal to
its $49 billion investment), assuming full conversion and the
forthcoming sale of common shares at equivalent share prices.
However, should AIG's share price subsequently collapse by 50
percent on the weight of dilution and uninspiring operating
results from any price point following the conversion into
common equity, Treasury would only see $25 billion in value
from the E and F shares, $24 billion shy of its investment.
Importantly, these scenarios do not reflect the value of
the Series C shares, which are fully tethered to the current
value of the share price. Unlike the E and F shares, the C
shares convert into a fixed number of common shares--
approximately 533 million shares representing 79.8 percent
ownership of AIG. In an ideal world, proceeds from the C
shares, which were obtained at no cost to the taxpayer, will
help Treasury recover its full investment and perhaps more.
Thus, sales of the Series C shares at the conversion prices
outlined below could conceivably yield anywhere from $3 billion
to $20 billion in additional proceeds, helping mitigate the
impact of a potential decline in the post-conversion share
price of the preferreds.\757\
---------------------------------------------------------------------------
\757\ Treasury is aware of the trade-offs and challenges involved
in maximizing the value between the Series C and the E and F shares.
See Testimony of Jim Millstein, supra note 44 (``[M]arket conditions
may change before the trustees have the opportunity to sell that stock.
And the very selling of that stock, given how much they have, will put
significant downward selling pressure on the price of AIG's common
stock'').
---------------------------------------------------------------------------
Figure 29 shows the effects of three variables on the
baseline exit strategy: (1) conversion of the E and F preferred
shares to common at $36, $18, and $6 price points, (2)
subsequent performance of the common shares following
conversion (flat, down 50%, and down 75%), and (3) the exit
value realized for the Series C shares ($36, $18, and $6).

FIGURE 29: GOVERNMENT EXIT STRATEGY RETURN POTENTIAL
[$ Billions except stock price data]
------------------------------------------------------------------------
E/F Stock Price at Conversion
--------------------------------------
$36.00 $18.00 $6.00
------------------------------------------------------------------------
Stock Price at Sale:*
Flat......................... $49 $49 $49
Down 50%..................... 25 25 25
Down 75%..................... 12 12 12
Memo: Series C Value............. 20 10 3
------------------------------------------------------------------------
* Note: Data illustrates the impact on the government's investment from
a change in the price of AIG common stock after the conversion of the
E/F shares to common stock and sale of the resulting common.

Clearly, the manner in which the government exits these
investments, and the market's reaction to this exit, will help
determine the value that the government realizes. An investment
horizon with an extended duration is probably the most
conservative strategy, as it maintains optionality, while
providing a clear path for recouping the government's
investment. However, such an approach also entails significant
market and operational risks over an extended period of time.
Given these risks, the Panel believes that Treasury should
explore options aimed at accelerated sales of smaller portions
of its stake sooner rather than later, to help mitigate longer-
term equity market risks, and transfer some of the risk from
the taxpayer to the public markets.
c. Potential Fallback Options if Outlook Deteriorates
Alternatively, should Treasury's confidence in a full
payback waver, other options could include (1) strategic
actions aimed at breaking up the company and pursuing selective
bankruptcies of non-core and cash-draining businesses as
necessary, or (2) a restructuring of the government's
assistance to AIG to expedite an exit and preserve a minimal
amount of franchise value. These approaches would involve the
realization that AIG does not offer a sufficient stable of
assets to create the requisite value to repay Treasury's
investment. While the Panel is not advocating either of these
scenarios (as the underlying fundamentals of the company do not
appear to warrant such an aggressive approach at this
juncture), a break-up or a partial restructuring in bankruptcy
or through congressionally mandated resolution authority should
be revisited in the future should AIG prove to be effectively
insolvent.
Should equity market conditions or AIG's corporate
performance substantially deteriorate, Treasury may conclude
that the best approach involves a more aggressive break-up
strategy and/or strategic bankruptcies of certain business
lines. A separate or complementary approach could involve
relegating unprofitable subsidiaries to bankruptcy in order to
spare the holding company the cost of subsidizing their
operations in the future. This would alleviate some of the
financial pressures on the company (and by extension, the
taxpayer), particularly for operations that require significant
external funding and may have limited potential sale value.
ILFC and AGF may fall into this category.\758\ Under this
approach, the government could avoid indirectly subsidizing
money-losing subsidiaries and their creditors, as is currently
the case, if the subsidiaries could be put into bankruptcy
without affecting other operations or the holding company. This
approach could not be applied to AIGFP and other subsidiaries
whose obligations have been guaranteed by the holding company.
One potential counterweight to this strategy is that selective
bankruptcy for certain AIG subsidiaries might lead to a credit
ratings downgrade of the holding company and key insurance
subsidiaries, which would severely damage AIG's operations and
its ability to raise capital to repay the government.\759\
Accordingly, this strategy would require the acquiescence of
the rating agencies, which could prove problematic, given the
expectation that holding companies do not let downstream
subsidiaries default on their debt.
---------------------------------------------------------------------------
\758\ See discussion in Section I(2)(d) below on outlook for key
business units, including ILFC and AGF.
\759\ ``The credit rating of AIG is an essential factor in
establishing the competitive position of its insurance subsidiaries
because it provides a measure of the insurance subsidiaries' ability to
meet obligations to policyholders, maintain public confidence in the
insurance companies' products, facilitate marketing of products, and
enhance the companies' competitive positions. AIG's credit rating is
derived from the performance of all its subsidiaries. If one subsidiary
files for bankruptcy, this would adversely impact AIG's rating and
would ultimately impact the insurance subsidiaries' businesses and
credit ratings as well. Selective bankruptcy would likely result in
policyholders and potential customers losing confidence in the
viability of AIG's insurance subsidiaries, leading to increased policy
cancellations or termination of assumed reinsurance contracts, which
would prevent the companies from new offering products and services.
Moreover, a downgrade in AIG's credit ratings may, under credit rating
agency policies concerning the relationship between parent and
subsidiary ratings, result in a downgrade of the ratings of AIG's
insurance subsidiaries.'' AIG Form 10-K for FY09, supra note 50, at 20.
See also Standard & Poor's briefing with Panel staff (May 1, 2010).
---------------------------------------------------------------------------
If AIG appears to have a negative net worth, more drastic
actions may make sense. AIG could spin off its valuable assets,
such as Chartis and SunAmerica, by taking them public and
seeding the companies with their own share bases. Proceeds from
these transactions could then be used to pay off as much of the
government investment as possible. Since this may not be enough
to fully repay the government, the holding company, with the
remaining bad assets and liabilities, could then be put through
bankruptcy without affecting the policyholders or other clients
of AIG. AIG's common equity, including anything left of the
government's equity stake, would be made worthless. Private
bondholders would likely take substantial losses, since most of
the corporate value would have already been stripped away. If
AIG is insolvent and the stock is worthless anyway, this
strategy could salvage as much value as possible and place
government interests before those of other creditors. It would
also help motivate the employees of the spun-off firms, again
helping to maximize value. This strategy would require a
healthy market backdrop in order to facilitate investor
interest in the spin-offs.
Another stop-gap option, but potentially many times more
problematic for obvious reasons, is a reworking of the
government's Series C equity stake.\760\ The logic, according
to several market participants, behind reducing the hurdle for
paying back the government's investment is that--if losses are
inevitable--a smaller piece of a bigger pie may be preferable
to a bigger piece of a smaller pie. In practice, this approach
would involve less dilution for non-government equity holders,
which would in turn increase the value of the government's
preferred stake when converted into equity. This higher equity
price, however, would involve a substantial opportunity cost,
as the government would forfeit its current holdings,
representing a 79.8 percent stake in the company, with a value
of approximately $18 billion, in the hope that this concession
would drive a higher equity valuation following the conversion
of its $49.1 billion preferred stake.
---------------------------------------------------------------------------
\760\ Instead of giving up equity, the government could also
restructure the entire basis of its involvement in AIG to something
less onerous to the company. There is some precedent for this, since
the Series D preferred was exchanged for Series E, which has terms that
are more favorable to AIG. This would be less of a true exit strategy,
than something akin to a bad debt workout, and would likely be
influenced by the expectation that the government was poised to
ultimately take a loss. This strategy would keep the government
involved in AIG for some time to come.
---------------------------------------------------------------------------
However, there are several complications to this approach
beyond the front-loading of political and headline risks that
would likely greet an announcement of this nature. For one, the
conversion of the preferred shares would entail significantly
higher execution risks vs. the potential break-up options
discussed above. The longer duration of such a transaction and
the uncertain outlook for AIG's equity market valuation could
potentially magnify downside risks. Additionally, it is
difficult to imagine that the AIG Credit Facility Trustees, who
administer the Series C shares, would be keen to go along with
such a strategy, unless a meaningful loss in their holdings was
otherwise inevitable. That said, if such a transaction were to
materialize, the endorsement of the Trustees, bound by a
fiduciary duty to the taxpayer, could help counteract
accusations that any concession amounted to a subsidy from the
taxpayer to private sector equity and debt holders.

2. AIG's Plans for Return to Profitability

As the analysis above indicates, Treasury is unlikely to
exit AIG until the company provides evidence to the market that
it is capable of functioning as a standalone investment grade
entity, absent government support. Accordingly, until such a
date, the value of Treasury's investment is subject to
significant and protracted operational risks, in addition to
underlying equity market conditions.\761\ A key variable in
taxpayers recouping their investment pivots on the ability of
AIG to execute on its strategy of maximizing the value of non-
core assets and producing improved operating results in its
core businesses, paving the way for the firm to access the
capital markets independent of government support.\762\
---------------------------------------------------------------------------
\761\ Testimony of Jim Millstein, supra note 44 (``Whether Treasury
ultimately recovers all of its investment or makes a profit, will in
large part depend on the company's operating performance and market
multiples for insurance companies at the time the government sells its
interest'').
\762\ Testimony of Robert Benmosche, supra note 28.
---------------------------------------------------------------------------
a. Evolving Strategy
The company's strategy is of course largely informed by the
need to repay the government's $100.8 billion in assistance.
AIG is seeking to balance asset sales and risk reduction with a
credible and focused ongoing business strategy. This strategy
has been some time in the making, as difficult market
conditions and management turnover may have frustrated earlier
efforts at charting a course for repaying the taxpayer prior to
Mr. Benmosche's arrival at the firm in August of 2009.
In the wake of the government's rescue in the fall of 2008,
the math simply did not provide a way forward for the company
(and, as became evident in the subsequent months, for the
government). The terms of the government's rescue and the
market backdrop provided little hope of a full recovery, beyond
seeking to mitigate the magnitude of expected losses on the
government's assistance and to reduce the systemic risk posed
by the company.\763\ Potential buyers in the insurance sector
suffered through significant valuation declines, dampening
their appetite for acquisitions of AIG's most marketable
assets. Cash purchases were of course problematic during this
period, owing to the dearth of available funding, even to
highly rated borrowers. Against this backdrop, core operating
fundamentals of key insurance businesses suffered amidst the
deteriorating market environment, further clouding the mergers
and acquisitions outlook.
---------------------------------------------------------------------------
\763\ In this respect, the government was very much like a bank
seeking to mitigate its losses on a mortgage foreclosure. In turn, a
better market backdrop creates a pathway to value maximization as
opposed to loss mitigation.
---------------------------------------------------------------------------
Thus, a greatly improved market backdrop and a longer-term
investment mentality on the part of AIG's principal shareholder
have facilitated a strategy aimed at repaying the government
and cultivating a sustainable independent business strategy.
The key components of AIG's recovery strategy are asset sales,
risk reduction, and a renewed focus on longer-term business
growth objectives. Specifically, in addition to asset sales,
the firm is focused on strengthening its global property &
casualty franchise and its domestic life insurance and
retirement services operations, while continuing to manage down
the firm's legacy exposure within AIGFP. In the meantime, there
are currently many balls up in the air, given the pending sales
of ALICO and other assets, the need for an alternate
disposition plan for AIA, uncertain prospects and financing
challenges for ILFC and AGF, and remaining residual AIGFP
exposures in an adverse market backdrop. Additionally, the
company must continue to make progress on streamlining its
operations and untangling the cross-linkages throughout its
vast operations. In turn, greater transparency into individual
business lines will help facilitate more beneficial terms from
the capital markets for financing core operations as well as
facilitating the sale of non-core businesses at more attractive
valuations. As noted, Treasury has stated that it expects the
company to articulate an updated strategy in the next few
months.\764\
---------------------------------------------------------------------------
\764\ Panel staff conversation with Jim Millstein, chief
restructuring officer, U.S. Department of the Treasury (June 2, 2010).
---------------------------------------------------------------------------
As discussed in Section D.4, the fair value of the holdings
of ML3 ($23.7 billion) is currently well in excess of the
balance of the FRBNY loan outstanding to that SPV ($17.3
billion) and the underlying CDOs remaining in the SPV may well
continue to appreciate. But it is important to recognize the
economic value of the assistance provided to the counterparties
at the time that the Maiden Lane acquisitions of the CDOs were
completed. This assistance did not consist merely of the $24.3
billion share of the $29.3 billion that ML3 paid in November
and December 2008 to acquire those CDOs. The terms of those
sales to ML3 also provided the counterparties with the right to
keep the $35 billion in collateral that AIGFP had posted up to
that time under the CDS contracts that were extinguished when
ML3 was created. Given the government's approximately 80
percent stake in AIG, it is at least arguable that the loss of
AIG's $35 billion in collateral provided another $28 billion in
government assistance to the ML3 counterparties.\765\ Hence,
from this perspective, more than $52 billion of the $62 billion
par value received by those counterparties was direct or
indirect government assistance, assistance which it is highly
unlikely that ML3 will ever fully recover despite the rebound
in the value of the CDOs since the time they were initially
acquired by the SPV.
---------------------------------------------------------------------------
\765\ the government's power to unilaterally demand that CDS
counterparties return collateral to AIG may have been limited,
presumably the full backing of the government for these contracts would
have backstopped AIG's credit rating at a higher level, providing a
foundation for the company to recover some part of the posted
collateral as the reference CDOs recovered in value. See discussion in
Section F.5.
---------------------------------------------------------------------------
b. The Future AIG
Putting this all together, AIG--under management and the
government's baseline scenario--is likely to be a much
different company in 2011 or 2012, with a core business in
property and casualty insurance, supported by a domestic life
and retirement services operation. These businesses today
produce approximately $53 billion in revenue and $6 billion in
pre-tax earnings, annualized for first quarter 2010
results.\766\ After the company's restructuring and asset sales
are complete, the vast majority of AIG's businesses will be
housed within its global property-casualty and commercial
insurance operation, which has been rebranded as Chartis, and
its domestic life insurance and retirement services segment,
rebranded as SunAmerica. It is expected that Chartis and
SunAmerica will constitute the vast majority of AIG's revenue
going forward, with the balance of company revenue coming from
certain non-core operations. Figure 30 below shows the expected
future business structure of AIG.
---------------------------------------------------------------------------
\766\ Includes General Insurance (Chartis), Domestic Life Insurance
& Retirement Services, and Foreign Life Insurance & Retirement
Services. AIG Form 10-Q for the First Quarter 2010, supra note 731, at
114.

FIGURE 30: AIG FUTURE BUSINESS STRUCTURE
----------------------------------------------------------------------------------------------------------------
Life Insurance &
General Insurance (Chartis) Retirement Services Financial Services Asset Management
(SunAmerica)
----------------------------------------------------------------------------------------------------------------
Function
----------------------------------------------------------------------------------------------------------------
Property/casualty insurance.......... Rebranded as Chartis... Capital markets........ Investment advisory
Commercial/industrial insurance...... Individual and group Consumer finance....... Brokerage
Speciality insurance................. life insurance Insurance premium Private banking
Reinsurance.......................... products. finance. Clients include AIG
Retirement services.... Aircraft leasing....... subsidiaries,
Annuities.............. institutional and
Domestic operations individual investors
rebranded as
SunAmerica.
----------------------------------------------------------------------------------------------------------------
Key Subsidiaries to be Retained
----------------------------------------------------------------------------------------------------------------
American Home Assurance Co........... Lexington Insurance Co. AIG Financial Products AIG Investments
Chartis Overseas..................... American General Life (AIGFP) (but in a AIG SunAmerica Asset
American International Underwriters Insurance Co. largely in-house Management
Insurance Co. VALIC.................. treasury/risk AIG Advisor Group
American International Reinsurance SunAmerica Annuity..... management function).
Co. (AIRCO). Western National.......
American General Life
and Annuity.
----------------------------------------------------------------------------------------------------------------
Asset Sales (Completed/Pending/Potential)
----------------------------------------------------------------------------------------------------------------
Remaining Portion of Transatlantic American Life Insurance Most of AIGFP's assets. AIG Investments--
Holdings. Co. (ALICO). AIG Consumer Finance international asset
American International Group (AIGCFG). management operations
Assurance Co. (AIA). International Lease AIG Private Bank
Nan Shan Life.......... Finance Corp..
American General
Finance (AGF).
----------------------------------------------------------------------------------------------------------------

c. Which Businesses Are Being Continued or Sold and Why?
Since receiving government assistance, AIG has either
completed or announced asset sales representing 29 percent of
the firm's total assets, representing at $66 billion in gross
proceeds.\767\ Current management is targeting several smaller
incremental sales or divestitures that could ultimately bring
total asset sales to more than 35 percent of legacy operations,
a reduction in comparison to the aims of the previous
management team, which had targeted the sale of businesses
constituting 65 percent of the company.\768\
---------------------------------------------------------------------------
\767\ Although these figures include the announced but since
withdrawn sale of AIA to Prudential, an alternative disposition plan
for this asset is likely to be announced in the coming months.
\768\ GAO Report, supra note 18, at 42.
---------------------------------------------------------------------------
For 2010, AIG is focused on executing the previously
announced sales of its international life insurance operations,
AIA and ALICO, often described as two of the company's crown
jewels. The growth profile and strong profitability of these
overseas life insurance businesses, in comparison with the more
cyclical property & casualty arm, bolstered their
attractiveness to potential buyers. Additionally, the property
& casualty business was viewed as a better source of cash flow
to the parent, given the annual payment streams generated by
its customer base.\769\
---------------------------------------------------------------------------
\769\ Panel staff conversation with Brian Schreiber, senior vice
president, AIG Strategic Planning (Apr. 23, 2010). Life insurance
policies are generally long-term contracts whereas many property and
casualty policies are renewed on an annual basis.
---------------------------------------------------------------------------
Barring a shift in the company's strategy, additional asset
sales by AIG are unlikely to raise significant new sums of
money, given that the company has already announced the sales
of the big ticket items. Among businesses that are either in
run-off mode, considered non-core, or may be slated for sale,
ILFC and AGF appear to be the more prominent--although any sale
is unlikely to move the needle meaningfully in terms of
generating incremental cash to repay the government. Valuations
for these two assets are likely to be tempered by the
challenges within the aircraft leasing and low-income consumer
credit market, respectively. Not coincidentally, these
businesses are also the most reliant on the wholesale funding
market, which is difficult for AIG to access under present
circumstances. Additionally, some smaller properties, such as
Star/Edison in Japan, may be put back on the market after
failing to attract a buyer the first time around.
AIG's aircraft leasing business, ILFC, continues to be
hampered by broader economic conditions as well as a meaningful
increase in financing costs. In the near term, AIG is seeking
to sell aircraft portfolios to raise needed cash, although
these sales often entail relinquishing the desirable aircraft
within the fleet, which increases the remaining portfolio's
average fleet age and lowers operating margins.\770\ AIG will
likely exit this business when doing so is practical. In the
meantime, there are few potential buyers for the entire fleet,
necessitating piecemeal portfolio sales. Similar to ILFC, AGF
is battling a challenging macroeconomic environment,
exacerbated by rising funding costs. Given this backdrop, one
could probably fairly characterize these businesses in their
current state as depreciating assets.
---------------------------------------------------------------------------
\770\ In April 2010, ILFC entered into an agreement with Macquarie
Aerospace Limited to sell 53 aircraft with an aggregate book value of
approximately $2.3 billion, which is expected to generate approximately
$2 billion in gross proceeds during 2010. AIG Form 10-Q for the First
Quarter 2010, supra note 731, at 12. In May 2010, AIG announced that it
hired Mr. Henri Courpron as the new ILFC chief executive officer. AIG
Statement on $85 Billion Secured Revolving Credit Facility, supra note
501.

FIGURE 31: AIG ASSET SALES AS OF JUNE 7, 2010 \771\
[Dollars in millions]
----------------------------------------------------------------------------------------------------------------
Announced
Buyer Target Name Announcement Date Deal Value
----------------------------------------------------------------------------------------------------------------
Public Shareholders \772\................ AIA Group Ltd.............. TBA........................ $32,500
MetLife Inc.............................. American Life Insurance 3/7/2010................... 15,545
Company.
Investor group........................... Nan Shan Life Insurance Co. 10/12/2009................. 2,150
Ltd..
Zurich Financial Services AG............. 21st Century Insurance 4/16/2009.................. 1,900
Group (U.S. personal lines
automobile insurance
business).
Wintrust Financial Corp.................. Assets of A.I. Credit Corp. 7/28/2009.................. 747
Munchener Ruckversicherungs.............. HSB Group, Inc............. 12/21/2008................. 666
Pacific Century Group.................... Portion of investment 9/5/2009................... 500
advisory and asset
management business.
BMO Financial Group...................... AIG Life Holdings (Canada), 1/13/2009.................. 311
ULC.
Aabar Investments PJSC................... AIG Private Bank Ltd....... 12/1/2008.................. 254
UBS AG................................... Commodity index business of 1/19/2009.................. 150
AIG Financial Products
Corp..
Top Ten Total............................ 54,722
Others................................... 590
----------------------------------------------------------------------------------------------------------------
Total................................ $55,313
----------------------------------------------------------------------------------------------------------------
\771\ SNL Financial; AIG Form 10-Q for the First Quarter 2010, supra note 731, at 19; AIG Form 10-K for FY09,
supra note 50, at 40, 47, 119; AIG Form 10-K for FY08, supra note 47, at 6, 63.
\772\ Recent press reports indicate the likely disposition strategy for AIA Group is now an IPO. $32.5 billion
figure represents the mid-range estimate of the possible value.

d. Key Business Challenges
For the most part, market observers with whom the Panel
staff spoke were quick to stress the positive attributes of
many of AIG's insurance assets.\773\ While it is unclear to
what extent AIG has compromised underwriting quality and
pricing to help mitigate the unique challenges faced by the
company in the current competitive environment, recent data
support the resiliency of the firm's market share in core
operations, particularly within Chartis (outlined in more
detail below).\774\ AIG's management asserts that rebranding
efforts and enhanced distribution platforms for its products
should begin to contribute positively to the company's
growth.\775\
---------------------------------------------------------------------------
\773\ Panel staff conversations with sell-side and buy-side
investors.
\774\ Panel staff briefing with Robert Schimek, chief financial
officer, Chartis (Apr. 23, 2010).
\775\ Panel staff briefing with Robert Schimek, chief financial
officer, Chartis (Apr. 23, 2010).
---------------------------------------------------------------------------
There is some debate, however, among analysts with respect
to the health of AIG's core franchise, with under-reserving for
insurance claims most often cited as a potential drag on future
earnings.\776\ Loss provisioning across the industry was
described by one market participant as ``more art than
science.'' In particular, several market observers raised
questions regarding AIG's long-term provisioning practices
across its core businesses.\777\ AIG has assured the Panel that
its insurance subsidiaries have adequate reserves, and stated
that its auditors and insurance regulators would not allow it
to under-reserve.\778\ Several market experts were also quick
to note that market share and revenue growth within the
insurance industry can be finessed on a near-term basis by more
lenient underwriting standards and generous pricing
initiatives, the evidence of which may take several years to
materialize in financial results. One market observer relayed
complaints he has heard that AIG may be undercutting
competitors by as much as 30 percent on the price of property &
casualty insurance, though AIG, Treasury, and GAO have disputed
this allegation.\779\ These alleged pricing practices raise
questions about the impact of government backing on both risk
taking within AIG and on the business dynamics facing AIG's
competitors.
---------------------------------------------------------------------------
\776\ For further discussion of the financial condition of the
insurance company subsidiaries at the time of the government's
intervention in AIG, see Section E.2 (AIG Insurance Company
Subsidiaries), supra.
\777\ For a detailed discussion, see Section B.4, supra.
\778\ Panel and staff briefing with AIG CFO David Herzog, chief
financial officer, AIG (May 17, 2010 and June 4, 2010).
\779\ See Testimony of Jim Millstein, supra note 44; House
Financial Services, Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises, Written Testimony of Orice M.
Williams, director, Financial Markets and Community Investment,
Government Accountability Office, American International Group's Impact
on the Global Economy: Before, During, and After Federal Intervention,
at 16 (Mar. 18, 2009) (online at www.house.gov/apps/list/hearing/
financialsvcs_dem/gao_-_williams.pdf) (``[S]ome of AIG's competitors
claim that AIG's commercial insurance pricing is out of line with its
risks but other insurance industry participants and observers disagree.
At this time, we have not drawn any final conclusions about how the
assistance has impacted the overall competitiveness of the commercial
property/casualty market'').
---------------------------------------------------------------------------
More broadly, some investors voiced skepticism that the
current management team is capable of overcoming what they
viewed as significant legacy institutional practices that
cultivated an array of cross-linkages throughout the firm. In
particular, a legacy of intercompany funding arrangements
(discussed in greater detail in Section B.4(d)), and how the
unwinding of these arrangements may impact the holding
company's debt load, is another area that skeptical analysts
contend could impact value realization. Accordingly, AIG's
outstanding debt load and certain valuation assumptions could
be subject to potential revision given that AIG may need to
borrow more from FRBNY's loan facility, particularly as cross-
segment lending arrangements expire, and private sector debt
matures.
The table below highlights a conservative estimate of the
company's current obligations. Given that AIG has provided
financial assistance to subsidiaries whose debt is not
guaranteed by the parent company, such as AGF and International
Lease Finance Corporation (ILFC), the full liability could be
greater. Since the start of 2010, AIG has drawn down more than
$5.3 billion in additional funds from the RCF, raising concerns
among some market participants about the scope of the holding
company's debt obligations, given that some of these funds were
used to renew expiring subsidiary credit lines.\780\
---------------------------------------------------------------------------
\780\ Federal Reserve H.4.1 Statistical Release, supra note 2.
Federal Reserve H.4.1 Statistical Release, supra note 342.

FIGURE 32: TOTAL DEBT OUTSTANDING \781\
[Dollars in millions]
------------------------------------------------------------------------
03/31/10 12/31/2009 03/31/09
------------------------------------------------------------------------
Debt Issued by AIG:
FRBNY Credit Facility $27,400 $23,435 $47,405
(secured)...................
Notes and bonds payable...... 9,457 10,419 11,221
Junior subordinated debt..... 11,699 12,001 11,520
Junior subordinated debt 5,880 5,880 5,880
attributed to equity units
\782\.......................
Loans and mortgages payable.. 427 438 370
MIP matched notes and bonds 12,642 13,371 13,953
payable \783\...............
Series AIGFP matched notes 3,868 3,913 4,296
and bonds payable \784\.....
--------------------------------------
Total AIG Debt................... 71,373 69,457 94,645
Total AIG Private Debt........... 43,973 46,022 47,240
Debt Guaranteed by AIG:..........
Commercial paper and other 2,285 2,742 6,747
short-term debt.............
GIA.......................... 8,353 8,257 10,716
Notes and bonds payable...... 1,916 2,029 3,538
Loans and mortgages payable.. 825 1,022 1,981
Hybrid financial instruments. 1,706 1,887 1,257
--------------------------------------
Total AIGFP Debt................. 15,085 15,937 24,239
AIG Funding commercial paper..... -- 1,997 5,509
AIGLH notes and bonds payable.... 798 798 798
Liabilities connected to trust 1,339 1,339 1,299
preferred stock.................
--------------------------------------
Total debt issued or $88,595 $89,528 $126,490
guaranteed by AIG...........
------------------------------------------------------------------------
\781\ AIG Form 10-Q for the First Quarter 2010, supra note 731, at 103;
AIG Form 10-Q for the First Quarter 2009, supra note 367, at 64.
\782\ Upon each of the stock purchase dates of AIG's mandatory
convertibles, AIG's obligations will be met with through a successful
remarketing of the debt portion of the equity units, or upon a failed
remarketing, through the surrendering of the outstanding debentures to
satisfy the stock purchase contract portion of the equity units.
\783\ Debt maturities for the MIP are expected to be funded through cash
flows generated from invested assets, as well as the sale or financing
of the asset portfolio's in the program. However, mismatches and the
timing of cash flows of the MIP, as well as any short falls do to
impairments of MIP assets, would need to be funded by AIG parent. In
addition, as a result of AIG's restructuring activities, AIG expects
to utilize assets from its non-core businesses and subsidiaries to
provide future cash flow enhancements and help the MIP meet its
maturing debt obligations.
\784\ Approximately $813 million of AIGFP debt maturities through March
31, 2011 are fully collateralized, with assets backing the
corresponding liabilities; however mismatches in the timing of cash
inflows on the assets and outflows with respect to the liabilities may
require assets to be sold to satisfy maturing liabilities.

For his part, Mr. Benmosche asserts that near-term
fluctuations in AIG's borrowing from the RCF reflect short-term
variances in the company's cash flows and are not indicative of
an underlying appetite for increased government assistance.
While he predicted further ups and downs in the firm's RCF
balance as AIG taps its government credit line to meet its
funding needs as legacy debt matures, he believes AIG's cash
flows will eventually stabilize, allowing the firm to begin to
repay its obligations. That said, the key yardstick for
progress on this front will be when the firm is able to raise
funding from private sources at attractive and sustainable
levels of interest.\785\
---------------------------------------------------------------------------
\785\ Testimony of Robert Benmosche, supra note 28.
---------------------------------------------------------------------------
e. Overview of Core Insurance Businesses
Based on core operating data in the lead-up to the crisis,
AIG's life insurance and property & casualty subsidiaries--as
measured by Return on Equity (ROE)--either performed on par or
exceeded key industry benchmarks.
Life Insurance. AIG has historically produced ROEs
of 15 percent in its life insurance business. This compares
favorably to 13-14 percent ROEs for the industry, though recent
returns have been impacted by a more challenging market
backdrop, with AIG underperforming the industry's 10-12 percent
ROE during the 2008-2009 period. AIG's global life insurance
returns have traditionally benefitted from its leading foothold
in overseas markets, particularly in Asia (although these
businesses are now in the process of being sold), where pricing
and growth were considered more favorable than in the U.S.
market. Within the United States, AIG's life insurance
operations benefited from its vast scale, which helped the
company offset less favorable growth and pricing trends in
comparison to its overseas operations.
Property & Casualty. Percentage returns for AIG's
property & casualty business, historically in the mid-teens,
have also declined in recent years (less than 10 percent in
2008-2009). According to market participants, AIG's relative
historic outperformance in this business was boosted by its
product diversity and innovative underwriting, which provided a
pipeline of higher-margin contracts. And consistent with the
size of its platform, AIG benefited from better cost leverage
in its operations. As noted above, several critics claim that
AIG's returns, particularly in recent years, have benefitted
from underreserving for future payouts, a practice that would
presumably lower future returns when loss rates on legacy
contracts exceed the reserve cushion.
Figure 33 below outlines trailing 5-year ROEs for AIG's
legacy U.S. life and P&C businesses. (Note that returns are
lower than the historical results outlined above, given the
absence of AIG's more profitable overseas operations, including
its Asian life businesses (which are being sold) and the
company's overseas P&C business lines (which will remain under
the Chartis umbrella).

FIGURE 33: AIG U.S. LIFE INSURANCE AND PROPERTY & CASUALTY ROE, 2005-
2009 \786\

---------------------------------------------------------------------------
\786\ The underlying data for this graph pertains to return on
equity (ROE) for AIG's U.S. Life and Property & Casualty insurance
subsidiaries. The historical ROEs for the Property & Casualty
subsidiary was provided by A.M. Best. The historical ROEs for the Life
Insurance subsidiary was accessed through SNL Financial data service.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Figure 34 below outlines market share data for the core
U.S. life and P&C business. While AIG's U.S. P&C market share
has remained fairly stable during the 2008-2009 period, life
insurance has declined measurably. The relative performance
disparity is not necessarily surprising given the variance in
contract terms. P&C contracts are generally renewed annually,
whereas life customers can terminate their policies at will,
making the life business more sensitive (at least on a short-
term basis) to AIG's recent challenges.\787\
---------------------------------------------------------------------------
\787\ AIG Form 10-K for FY09, supra note 50, at 109 (``AIG expects
that negative publicity about AIG during the fourth quarter of 2008 and
the first nine months of 2009, AIG's previously announced asset
disposition plan and the uncertainties related to AIG will continue to
adversely affect Life Insurance & Retirement Services operations for
the remainder of 2009, especially in the domestic businesses. In
addition, AIG's issues have affected certain operations through higher
surrender activity, primarily in the U.S. domestic retirement fixed
annuity business and foreign investment-oriented and retirement
products. Surrender levels have declined from their peaks in mid-
September of 2008 and have begun to stabilize and return to pre-
September 2008 levels for most products and countries'').
---------------------------------------------------------------------------

FIGURE 34: AIG U.S. LIFE INSURANCE AND PROPERTY & CASUALTY MARKET
SHARE, 2005-2009 \788\

---------------------------------------------------------------------------
\788\ The underlying data for this graph pertains to the
consolidated market share of AIG's U.S. Life and Property & Casualty
insurance subsidiaries in their respective markets. Data accessed
through SNL Financial data service.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

However, business retention and growth trends have improved
in recent quarters for AIG's U.S. life insurance operations,
with business retention for the first quarter of 2010 the best
since September 2008 (although, given the depth of AIG's
problems in the aftermath of initial government assistance, it
would be surprising if retention did not begin to improve in
recent quarters).\789\
---------------------------------------------------------------------------
\789\ Congressional Oversight Panel, Written Testimony of Robert
Benmosche, president and chief executive officer, American
International Group, Inc., COP Hearing on TARP and Other Assistance to
AIG, at 12 (May 26, 2010) (online at cop.senate.gov/documents/
testimony-052610-benmosche.pdf).
---------------------------------------------------------------------------
In the context of AIG's strategic outlook, the near-term
operating environment for its core ongoing insurance businesses
remains challenging. Summarizing from AIG's 2009 10-K.\790\
---------------------------------------------------------------------------
\790\ AIG Form 10-K for FY09, supra note 50, at 39-40.
---------------------------------------------------------------------------
Domestic Life Insurance & Retirement Services:
Closely levered to improving economic and market backdrop,
these businesses are expected to benefit from rebranding and
improved distribution channels, as well as a reduction in low-
yielding excess liquidity as a result of a more stable market
backdrop.
General Insurance (Chartis): Pricing and ratable
exposures (value and number of policies outstanding, influenced
by asset values and economic growth) are both expected to
decline in 2010, consistent with industry-wide expectations.
Figure 35 below shows the ratios of payments to
policyholders and operating expenses compared to premiums
earned by AIG's property & casualty insurance business. This
``Combined Ratio'' highlights the total of these costs compared
to premiums (i.e., the lower the ratio the better). This ratio,
which excludes investment activities, is a good barometer of
the absolute and relative health of the business, although
trends vary based on the underlying business cycle. With a few
exceptions, AIG has generally reported a Combined Ratio below
its peer group average. In 2009, however, AIG's Combined Ratio
of 108 percent compared to an industry average of 101 percent.
This increase could be partially a cyclical reserve build,
exacerbated by recent challenges unique to AIG.

FIGURE 35: UNDERWRITING COST RATIOS \791\

---------------------------------------------------------------------------
\791\ AIG Form 10-K for FY09, supra note 50, at 74. AIG combined
ratios prior to 2007 and average industry combined ratios accessed
through SNL Financial data service.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

f. Success in Winding Down AIGFP Positions; how much of
AIGFP's Operations will be Continued?
AIG plans to exit the ``vast majority of the risk'' within
AIGFP by year-end 2010. Public disclosure regarding the unit's
holdings and Panel staff conversations with management indicate
that this wind-down process has moved ahead at a rapid
pace.\792\ The process has been aided by the improved market
backdrop, with higher asset values and a healing credit market
helping to maintain--and in some cases increase--the
portfolio's value, in addition to facilitating sales. Further,
given the current management team's desire to avoid disposing
of assets at fire-sale prices, the economics from this process
have also benefited from a longer time horizon (in the context
of a recovery in many asset classes) and strengthened
negotiating position.\793\
---------------------------------------------------------------------------
\792\ AIGFP Chief Operating Officer Gerry Pasciucco briefing with
Panel staff (Apr. 23, 2010).
\793\ Testimony of Robert Benmosche, supra note 28; AIGFP Chief
Operating Officer Gerry Pasciucco briefing with Panel staff (Apr. 23,
2010).
---------------------------------------------------------------------------
AIG's outstanding trade positions declined by 54 percent in
2009. The notional amount of non-credit derivatives exposure
fell by 49 percent in 2009, while credit derivatives declined
39 percent during the year; overall, the firm's derivatives
portfolio declined by 41 percent, from $1.6 trillion to $941
billion. The pace of declines continued in the first quarter of
2010, with notional amounts in the credit book down an
incremental 26 percent, and overall trade positions declining
by 11 percent.

FIGURE 36: WIND-DOWN OF AIGFP'S PORTFOLIO, THIRD QUARTER 2008 TO FIRST
QUARTER 2010 \794\

---------------------------------------------------------------------------
\794\ American International Group, Inc., The Restructuring Plan:
AIG Financial Products Corp. Unwind Progress (online at
www.aigcorporate.com/restructuring/windownofFP.html) (accessed June 9,
2010). Due to FAS 161, FP is changing its methodology for computing
notional, leading to a slight increase of previously reported values
for Q3 (actual $1.9b) and Q4 2009 (actual $1.6b). The notional amount
of derivatives outstanding for the first quarter of 2010 is $755.4
billion.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

While the company has sought to balance overly hasty exits
from certain positions with a desire to reduce significantly
AIGFP's risk exposures in an expedited manner, the underlying
bias has been to dispose of assets as quickly as possible
whenever possible. While difficult to verify (beyond the
reduced volatility in quarter-over-quarter results), management
asserted to Panel staff that this process has targeted the most
complex risk first, which would suggest that its remaining
exposures are not tainted by a ``survivor's bias.'' \795\ And
from a systemic risk standpoint, as exposures have been sold or
otherwise hedged, the capital markets portfolio's exposure to
market volatility has declined approximately 80 percent since
year-end 2008.\796\ The number of trading counterparties has
declined approximately 43 percent during this period.
---------------------------------------------------------------------------
\795\ AIGFP Chief Operating Officer Gerry Pasciucco briefing with
Panel staff (Apr. 23, 2010).
\796\ AIG presentation to COP, ``AIG Financial Products Corp.
Unwind Progress.'' AIGFP's ``Gross Vega'', the sum of all individual
positions' absolute exposures as if each position is not hedged, has
declined from $1.30 billion to $0.22 billion, as of the first quarter
of 2010.
---------------------------------------------------------------------------
Accordingly, this reduction in exposure and counterparties,
as well as the improved market backdrop, has significantly
diminished--but not yet eliminated--AIGFP's vulnerability to a
severe market disruption.\797\ The company noted that AIGFP's
exposure to cash calls from counterparties due to a downgrade
of its credit ratings declined from $20 to $22 billion at the
beginning of 2009 to approximately $4 billion today.\798\
---------------------------------------------------------------------------
\797\ Jim Millstein described the goal in his May 26, 2010
testimony before the Panel: AIGFP's ``risk profile will need to be
reduced to the level where potential losses are inconsequential to the
parent company's financial condition. More specifically, investors must
be satisfied that AIGFP does not pose a substantial threat to the
Company's liquidity position, even in times of stress.'' Testimony of
Jim Millstein, supra note 44, at 9-10.
\798\ Testimony of Robert Benmosche, supra note 28; AIG Form 10-Q
for the First Quarter 2010, supra note 731, at 158.
---------------------------------------------------------------------------
Figure 37 below provides a more detailed view of the
evolution of AIGFP's CDS portfolio, outlining the composition
and losses from 2007 through the first quarter of 2010. AIGFP
recorded a positive valuation gain in 2009 of $1.4 billion vs.
a loss of $28.6 billion in 2008. Tighter credit spreads were no
doubt a key factor in the modest gain, although the size of
AIGFP's book declined dramatically following the cancelation of
multi-sector CDS contracts associated with the ML3
transaction.\799\ Even so, these results reflected losses
within the legacy remnants of the much reduced multi-sector CDS
portfolio ($669 million in 2009 vs. $25.7 billion in 2008). The
negative impact of these legacy exposures was offset, however,
by a positive swing in AIGFP's corporate CDO book ($1.9 billion
gain in 2009 vs. $2.3 billion loss in 2008). First quarter 2010
results reflected a modest valuation gain of $119 million
across the entire credit portfolio.\800\ Since 2008, the
biggest reductions have been achieved in the firm's regulatory
capital swap portfolio, as would be expected given the relative
size of this portfolio and the nature of the underlying
contracts.\801\
---------------------------------------------------------------------------
\799\ AIG Form 10-K for FY09, supra note 50, at 38.
\800\ AIG Form 10-Q for the First Quarter 2010, supra note 731.
\801\ See the discussion of regulatory capital swaps in Section
B.3.

FIGURE 37: AIGFP CDS PORTFOLIO, 2007 TO FIRST QUARTER OF 2010 \802\
[Dollars in millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Net Notional Amount Unrealized Valuation Gain (Loss)
-----------------------------------------------------------------------------------------------
FY Ending 12/31 Q1 (3/31) FY Ending 12/31 Q1 (3/31)
-----------------------------------------------------------------------------------------------
2007 2008 2009 2010 2007 2008 2009 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Regulatory Capital:
Corporate loans......................................... $229,313 $125,628 $55,010 $41,993 -- -- -- --
Prime residential mortgages............................. 149,430 107,246 93,276 65,844 -- -- $137 $33
Other................................................... -- 1,575 1,760 1,552 -- $(379) 35 6
Total............................................... 378,743 234,449 150,046 109,389 -- (379) 172 39
Arbitrage:
Multi-sector CDOs....................................... 78,205 12,556 7,926 7,574 (11,246) (25,700) (669) 158
Corporate debt/CLOs..................................... 70,425 50,495 22,076 16,367 (226) (2,328) 1,863 (7)
Total............................................... 148,630 63,051 30,002 23,941 (11,472) (28,028) 1,194 151
Mezzanine Tranches...................................... 5,770 4,701 3,478 3,104 -- (195) 52 (71)
Grand Total......................................... $533,143 $302,201 $183,526 $136,434 $(11,472) $(28,602) $1,418 $119
--------------------------------------------------------------------------------------------------------------------------------------------------------
\802\ Form 10-K for FY09, supra note 50, at 130; AIG Form 10-K for FY07, supra note 41; AIG Form 10-Q for the First Quarter 2010, supra note 731.

Looking ahead, AIG is not anticipating a swift exit from
the balance of its positions within AIGFP, given that in many
instances the risk/reward calculus favors holding certain
assets to maturity.\803\ For example, AIGFP's regulatory
capital book is expected to substantially roll off in the next
12 months, as European financial institutions transition from
the Basel I regulatory capital framework. AIG is confident that
it will not have to make any payments associated with potential
triggers or the expiration of these contracts.\804\
Additionally, other assets and hedges are byproducts of the
insurance operations of the firm, and will not be wound down,
absent a change in the underlying nature of AIG's insurance
business.
---------------------------------------------------------------------------
\803\ Panel conversation with AIGFP COO Gerry Pasciucco briefing
with Panel staff (04/23/10);
\804\ AIG Form 10-K for FY09, supra note 50, at 27 (``Given the
current performance of the underlying portfolios, the level of
subordination and AIGFP's own assessment of the credit quality of the
underlying portfolio, as well as the risk mitigants inherent in the
transaction structures, AIGFP does not expect that it will be required
to make payments pursuant to the contractual terms of those
transactions providing regulatory capital relief'').
---------------------------------------------------------------------------
AIG's management asserts that AIGFP is effectively on the
verge of entering run-off mode status in 2010, a phase that
will require significantly less expertise to manage what is
expected to be a portfolio across credit and non-credit asset
classes of several thousand positions, in comparison to about
14,000 today and 44,000 at the end of September 2008.\805\
Ultimately, the aim is to absorb the remaining portfolio into
AIG. Ultimately, this business is expected to evolve into the
treasury function of a financial company, a cost center (as
opposed to a profit center) tasked with managing the capital
markets exposures and funding needs of the overall business.
---------------------------------------------------------------------------
\805\ AIGFP COO Gerry Pasciucco briefing with Panel staff (Apr. 23,
2010); Testimony of Jim Millstein, supra note 44.
---------------------------------------------------------------------------

FIGURE 38: NUMBER OF AIGFP'S TRADE POSITIONS, THIRD QUARTER 2008 TO
FIRST QUARTER 2010

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

3. Treasury's Plan for Exit

Consistent with other investments in financial
institutions, Treasury describes itself as a ``reluctant
shareholder'' in AIG, forgoing its ability to become involved
in the company's day-to-day operations.\806\ Further, Treasury
maintains that it will divest its holdings as soon as
practicable; \807\ in its view, monetizing the investments in
AIG on behalf of the taxpayer will take time. In addition,
Treasury has a junior preference--below FRBNY--in recouping
funds from AIG; thus, while recent news surrounding the sale of
AIA and ALICO increases the likelihood of the FRBNY credit
facility being paid back in full, some uncertainty continues to
surround Treasury's investment.\808\ As of May 27, 2010, AIG
and its affiliated entities' total obligations to FRBNY and
Treasury were as follows:
---------------------------------------------------------------------------
\806\ See Testimony of Jim Millstein, supra note 44, at 1; House
Oversight and Government Reform Committee, Joint Written Testimony of
Jill M. Considine, Chester B. Feldberg, and Douglas L. Foshee,
trustees, AIG Credit Facility Trust, AIG: Where is the Taxpayer Money
Going, at 5 (online at oversight.house.gov/images/stories/documents/
20090512165555.pdf); Written Testimony of Herb Allison, supra note 396,
at 5.
\807\ See Testimony of Jim Millstein, supra note 44, at 1; AIG
Credit Facility Trust Agreement, supra note 377. See also January
Oversight Report, supra note 637, at 28-32 (discussing Treasury's exit
strategy for the disposal of assets held in relation to TARP). Written
Testimony of Herb Allison, supra note 396, at 5.
\808\ See further discussion of the relationship between Treasury
and FRBNY in Section G.

FIGURE 39: OUTSTANDING GOVERNMENT ASSISTANCE TO AIG (AS OF MAY 27, 2010)
\809\
[Dollars in billions]
Fed Revolving Credit Facility (outstanding principal)...... $26.1
Treasury Investment (SSFI)/AIGIP........................... 41.6
------------
Total.................................................. 67.7
Maiden Lane III (amount outstanding and accrued interest).. 16.6
Maiden Lane II (amount outstanding and accrued interest)... 14.9
------------
Total.................................................. 31.5
Subtotal............................................... 99.2
Equity Capital Facility (drawdown)......................... 7.5
------------
Current Exposure........................................... 106.7
Preferred Interest in AIA and ALICO SPVs................... 25.6
------------
Total Exposure......................................... 132.3
Fed........................................................ 83.2
Treasury................................................... 49.1
------------
Total.................................................. 132.3
(31.5)
------------
Assistance on AIG's Balance Sheet.......................... $100.8
------------------------------------------------------------------------
\809\ Treasury Transactions Report, supra note 2, at 18; Board of
Governors of the Federal Reserve System, Factors Affecting Reserve
Balances (H.4.1) (online at www.federalreserve.gov/Releases/H41/
Current/) (hereinafter ``Federal Reserve H.4.1 Statistical Release'')
(accessed June 2, 2010).

As illustrated above, certain investments in AIG do not
require the company to either repurchase preferred shares at a
particular liquidation preference or pay back drawdowns of
capital facilities. These vehicles include both ML2 and ML3, as
well as Series C convertible preferred stock, which is being
held in the AIG Credit Facility Trust for the benefit of the
U.S. Treasury. Loans extended to ML2 and ML3 are secured by the
underlying assets in the portfolio and do not represent a
direct obligation of AIG. The preferred stock, which is
convertible into approximately 80 percent of AIG's common
shares outstanding, is managed through a trust, as discussed
above.\810\
---------------------------------------------------------------------------
\810\ See Section D.6(b), supra.
---------------------------------------------------------------------------
The government's current plan, a ``hold'' strategy, which
appears to be the objective of Treasury and the Federal
Reserve, may have several advantages.\811\ First, realizing the
intrinsic value of CDOs and RMBS purchased by ML2 and ML3 will
likely take time, given the difficulties in obtaining
reasonable prices for these types of assets.\812\ Second, a
more patient approach may increase AIG's ability to repay its
obligations to the federal government as economic conditions
continue to improve. ``The slower approach to restructuring
could help AIG to generate more favorable values from its
business portfolio than would be the case under rushed asset
sales,'' Moody's Investors Service has noted.\813\ Third, in
early 2010 Mr. Benmosche cautioned that corporate earnings will
likely remain subject to ``continued volatility'' as the
company continues its restructuring process. While 2010 first
quarter earnings were much improved, it may be somewhat
premature to conclude that the earnings volatility that
occurred in 2009 is no longer a concern because claims relating
to catastrophes such as the ones that the company faces from
the earthquake in Chile, the explosion of an oil rig in the
Gulf of Mexico and unrealized gains (losses) from its
securities portfolios present near-term risks. This point is
highlighted by the fact that the net loss attributable to AIG
in the fourth quarter of 2009 was $8.9 billion. This came after
the company posted net income of $1.8 billion and $455 million
in the previous two quarters. As Figure 40 below shows, a true
earnings trend has yet to emerge.
---------------------------------------------------------------------------
\811\ A ``hold'' strategy does not necessarily imply that the
government intends to hold its investments over the long-term but
rather that the Federal Reserve and Treasury will dispose of these
assets as soon as practical.
\812\ FRBNY stated that this equity interest ``has the potential to
provide a substantial financial return to the American people should
the $85 billion loan, as anticipated, provide AIG with the intended
breathing room to execute a value-maximizing strategic plan.'' Federal
Reserve Bank of New York, Statement by the Federal Reserve Bank of New
York Regarding AIG Transaction (Sept. 29, 2008) (online at
www.newyorkfed.org/newsevents/news/markets/2008/an080929.html).
\813\ See Moody's Investors Service, Issuer Comment: Moody's Sees
AIG Holding its Ground Through 3Q09 (Nov. 9, 2009).

FIGURE 40: AIG NET INCOME/(LOSS)
[Dollars in millions]
----------------------------------------------------------------------------------------------------------------
Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010
----------------------------------------------------------------------------------------------------------------
$(7,805) $(5,357) $(24,468) $(61,659) $(4,353) $1,822 $455 $(8,873) $1,451
----------------------------------------------------------------------------------------------------------------

While the restructuring process is under way, it remains to
be seen if this is the best course of action for AIG and U.S.
taxpayers. In a recent interview, Mr. Benmosche stated that
``the most important thing is to raise enough money so that we
can pay back the Federal Reserve.'' \814\ He goes on to suggest
after the closing of the AIA and ALICO sales, formal talks
could begin with the government over an exit, and cited the
next 12 to 18 months as the period in which many issues would
be addressed.\815\ As discussed above, the withdrawal of
Prudential's offer to purchase AIA delays this timetable.
---------------------------------------------------------------------------
\814\ Karan Iyer, Report: Benmosche Says AIG on Track to Repay
Government, SNL Financial (Apr. 3, 2010) (online at www.snl.com/
interactivex/article.aspx?Id=10978787&KPLT=2).
\815\ Id.
---------------------------------------------------------------------------
When other goals that the company set forward for 2010 have
been reached, such as closing the sales of Nan Shan and ALICO,
the rate at which the government can decrease its exposure may
become clearer, but will continue to depend upon the future
profitability of AIG's core property & casualty insurance, and
to a lesser extent, its domestic life and retirement services
businesses. As discussed in Section I.2(d), AIG's property &
casualty insurance business is in the midst of a soft market,
and questions persist with respect to the adequacy of its
reserves.
In 2009, broad market and credit conditions prevented
Treasury and AIG's management from articulating a credible
government exit strategy from AIG. That may be changing,
however. In total, Treasury has invested approximately $49
billion in the insurer. Recent comments by the CEO and
government officials indicate that a framework for Treasury to
divest its holdings in the company could come later this year.
This would be consistent with recent reports indicating that a
board panel has hired Rothschild as an independent financial
advisor, in addition to the advisors management has hired to
aid in the restructuring efforts. Treasury also owns warrants
in AIG; and although Treasury has not articulated how those
warrants would be disposed of, one option would be the approach
taken with financial institutions under the CPP.
It remains to be seen whether the failure to close the AIA
sale with Prudential diminishes the underlying value of the
asset--investment banks advising AIG maintain that an IPO would
result in an enterprise value greater than Prudential's revised
offer of $30.4 billion--but the failure to close does delay the
timing in which FRBNY is paid back. In turn, the timetable by
which Treasury is paid back is pushed further into the future.

J. Executive Compensation

1. General \816\

It is not surprising that the large group of companies that
AIG owned (with an employee complement of over 100,000) \817\
would have many different compensation arrangements. The
company told SIGTARP that, as of March 2009, it had
``approximately 630 compensation plans,'' \818\ involving
bonuses, retention awards, and deferred compensation schemes.
Some plans covered employees of AIG itself and others covered
employees of the subsidiaries.\819\
---------------------------------------------------------------------------
\816\ Parts a and b of this discussion are based upon a SIGTARP
report released in October 2009. Office of the Inspector General for
the Troubled Asset Relief Program, Extent of Federal Agencies'
Oversight of AIG Compensation: Varied and Important Challenges Remain
(Oct. 14, 2009) (SIGTARP-10-002) (online at www.sigtarp.gov/reports/
audit/2009/Extent_ of_Federal_Agencies%27_Oversight
_of_AIG_Compensation _Varied_and_Important_Challenges
_Remain_10_14_09.pdf) (hereinafter ``SIGTARP Report on Oversight of AIG
Compensation'').
\817\ Data indicate that the AIG group of companies had 106,000
employees as of June 30, 2009. SIGTARP Report on Oversight of AIG
Compensation, supra note 816, at 7 note 7.
\818\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 7.
\819\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 7.
---------------------------------------------------------------------------
Historically, the structure and management of AIG's
compensation plans were decentralized, and no approval of plan
grants or terms at the company's subsidiaries was required at
the holding company level. That fact made it hard for
government officials, and for AIG officials themselves,
initially to comprehend the scope, ongoing cost, coverage, and,
even more important, the amounts payable under those plans. The
difficulties were compounded by the incompatibility of AIG's
information systems.

2. Initial Government Involvement

The FRBNY review of AIG's financial and management issues,
which started in early October 2008, led to its concern about
AIG's pending and future compensation plans, especially
liabilities for payments of $1 billion in the nearly nine
months following the installation of the RCF. That concern led
to the reduction of the company's 2008 bonus pool by 30 percent
compared to 2007. FRBNY has played a continuing role in working
with the company on its overall compensation programs, and has
become the most informed of those agencies involved in the
rescue on AIG compensation issues.
Treasury imposed specific compensation restrictions as part
of its TARP investment. These restrictions applied to 57 then-
senior employees. They limited golden parachute payments,
placed a ceiling on 2009 incentive compensation of 3.5 percent
of 2008 base salary plus bonus, placed a ceiling on the size of
senior executive bonus pools based on 2006-07 pools, and
restricted payments of bonuses or cash awards out of TARP
funds.\820\ SIGTARP found, however, that ``Treasury essentially
relied on what it was told [about AIG's compensation
arrangements] . . . and did not conduct direct oversight of
AIG's executive compensation prior to March 19, 2009.'' \821\
---------------------------------------------------------------------------
\820\ See American International Group, Inc., Fixed Rate Cumulative
Perpetual Preferred Stock Offering, at section 4.10 (Nov. 25, 2008)
(online at www.financialstability.gov/docs/agreements/
AIG_Agreement_11252008.pdf) (outlining the securities purchase
agreement between AIG and Treasury).
\821\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 22.
---------------------------------------------------------------------------
FRBNY, on the other hand, even in the formal credit
agreement creating the RCF, made no effort to condition future
assistance on compensation restrictions for AIG senior
management. Although such restrictions were arguably
unnecessary after June 2009--when Treasury's executive
compensation rules were placed in effect--no effort comparable
to that undertaken by Treasury was made beforehand, despite the
Reserve bank's superior knowledge of AIG's compensation
arrangements. Whether or not the agreements were legally
binding, it is not uncommon to renegotiate compensation
packages as a condition of providing financing for a company.

3. The AIGFP Retention Payments

In 2007 and 2008, AIGFP changed some of its compensation
arrangements to create retention award agreements for employees
whose deferred compensation had lost value because of AIG's
financial reversals. According to AIG, the agreements, which
provided for a total of approximately $475 million to be
distributed over two years, were designed not to reward
employees for their performance, but instead to keep employees
in place so that they could ``wind down the complex trades and/
or continue AIGFP's general operations.'' \822\
---------------------------------------------------------------------------
\822\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 12.
---------------------------------------------------------------------------
In March 2009 AIG paid approximately $168 million in
retention awards payments to roughly 400 AIGFP employees. (The
remaining amounts are payable in 2010.) The payments, not
surprisingly, generated much public criticism, both in Congress
and the Administration. (Apparently, FRBNY learned of the AIGFP
retention programs in November 2008, but did not tell Treasury
about them until the end of February 2009.) SIGTARP concluded
that ``Treasury's failure to discover the scope and scale of
AIG's executive compensation obligations, in particular at
AIGFP, potentially resulted in a missed opportunity to avoid
the explosively controversial events and created considerable
public and Congressional concern over the retention payments.''
\823\ At the same time, however, SIGTARP found that government
and private lawyers--who reviewed the employment contracts on
behalf of AIG, the FRBNY, and the Treasury Department--had
concluded that the contracts were binding and that AIG was
required by law to make the retention payments. But one of the
conditions of Treasury's Equity Capital Facility was an
agreement by AIG to pay a $165 million commitment fee within
five years to Treasury on account of the retention agreement
awards.\824\
---------------------------------------------------------------------------
\823\ See, e.g., Testimony of Edward Liddy, supra note 91, at 3
(``[I]t is regrettable that we have even reached this point. When the
press first reported about the AIG Financial Products retention bonuses
in late January, I called Mr. Liddy to express my concerns that paying
out such sums to the very division that engaged in the risky behavior
that warranted the government's bailout would rightly incite a public
outcry * * * Unfortunately, my sound advice went unheeded, the company
hid behind legal technicalities, and the public outcry that I predicted
happened: AIG has become the subject of considerable public scorn, and
the public's interest in providing ongoing, sustainable support to
repair our struggling financial system has plummeted.'').
\824\ U.S. Department of the Treasury, Securities Purchase
Agreement, Dated as of April 17, 2009, Between American International
Group, Inc. and United States Department of the Treasury, at Section
1.2 (Apr. 17, 2009) (online at www.financialstability.gov/docs/
agreements/Series.F.Securities.Purchase.Agreement.pdf).
---------------------------------------------------------------------------
The retention payments raise three difficult issues. The
first is one of policy, namely whether the need to retain
employees who understood and could unwind AIGFP's CDS trades to
reduce AIG's continuing liabilities, outweighed the need to
clean house at AIGFP. The second is why FRBNY did not push
AIGFP to renegotiate the agreements, especially since AIGFP was
the company whose operations had led to the crisis at the
company. The third is the failure of FRBNY to tell Treasury
about the retention program for more than three months and to
consider the way to deal with the payments.

4. The Special Master

Like all recipients of TARP assistance, AIG is subject to
both statutory \825\ and regulatory \826\ executive
compensation standards. In general, the rules apply to AIG's
``top 5 most highly paid executives'' \827\ and various other
employees.\828\ The rules (and the rules relating to the
Special Master, discussed immediately below) apply until the
date ``no obligation arising from the . . . assistance . . .
remains outstanding.'' \829\
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\825\ The statutory standards are found in EESA section 111. The
text of section 111 in force after February 17, 2009 is contained in
section 7001 of the American Recovery and Reinvestment Act, Pub. L. No.
111-5 (Feb. 17, 2009) (``ARRA''), which almost completely recast, and
toughened, the original EESA language, EESA Sec. 111(a)(5). The fact
that an institution's stock warrants remain outstanding does not in
itself require continuation of the compensation restrictions. However,
section 111 also applies during the period of the actual federal
``ownership'' of the common stock of a TARP recipient. See 31 CFR
Sec. 30.2.
\826\ The regulatory standards are found in the Interim Final Rule,
entitled ``TARP Standards for Compensation and Corporate Governance.''
31 CFR Sec. Sec. 30.0-30.17 (June 15, 2009) (online at
ecfr.gpoaccess.gov/cgi/t/text/text-
dx?c=ecfr;sid=00de395363b27bcc941de94d3b128136;rgn=div5;
view=text;node=31%3A1.1.1.1.28;idno=31;cc=ecfr).
\827\ EESA Sec. 111(a)(1). The five executives, called ``senior
executive employees,'' must each be an individual ``whose compensation
is required to be disclosed under the Securities Exchange Act, ``and
non-public company counterparts.'' Id.
\828\ As set out in EESA section 111(b)(3)(A-F), they include:
exclusion, for senior executive officers of compensation incentives to
take ``unnecessary risks''; a required ability by the institution to
recover (or ``clawback'') ``bonus, retention, or incentive
compensation, for senior executive officers and the institution's 20
next most highly-compensated employees, ``based on statements of
earnings, revenues, gains, or other criteria . . . later found to be
materially inaccurate;'' prohibition of any plan whose terms would
``encourage manipulation of earnings . . . to enhance the compensation
of any of its employees;) of compensation; a prohibition on golden
parachute payments to a senior executive officer and any of the
institution's next 5 most highly-compensated employees; a requirement
that bonuses, incentive awards, or incentive compensation, for, in the
case of an institution of AIG's size, senior executive officers and the
next 20 most highly-compensated employees, except through ``long-term
restricted stock'' that (i) cannot ``fully vest'' while obligations
arising from TARP assistance are outstanding, and (ii) has a value no
greater than one-third of the individual's total annual compensation. ;
and creation of an independent compensation committee of the
institution's board of directors to review compliance with the
foregoing standards. (As a company listed on the New York Stock
Exchange, AIG was already required to have an independent compensation
committee of its board of directors.) An institution's board is also
required to adopt a strict policy limiting ``perquisites,'' EESA
section 111(d). Finally, Treasury must review any bonuses and other
compensation paid to the senior executive officers and the next most
highly paid employees of each entity that receives TARP assistance
before February 17, 2009, to determine if the bonuses are (i)
inconsistent with the purposes of section 111, (ii) inconsistent with
the TARP, or (iii) contrary to the public interest. In any case in
which Treasury makes that determination, it must ``seek to negotiate''
with both the institution and the recipient of the compensation for
``appropriate reimbursements to the government.'' EESA section 111(f).
\829\ EESA section 111(a)(5). The fact that an institution's stock
warrants remain outstanding does not in itself require continuation of
the compensation restrictions. Id. However, section 111 also applies
during the period of the actual federal ``ownership'' of the common
stock of a TARP recipient. See 31 CFR Sec. 30.2.
---------------------------------------------------------------------------
Under Treasury's implementing regulations, AIG's
compensation arrangements are subject to an additional set of
more restrictive rules. Because AIG is one of the companies
deemed to have received ``exceptional financial assistance,''
\830\ it is one of the companies subject to the jurisdiction of
the Special Master for TARP Executive Compensation, Kenneth R.
Feinberg, for the same period as that in which the general
rules apply.\831\ The Special Master, who is appointed by the
Treasury Secretary,\832\ must (i) agree to the amount and type
of compensation to be paid to AIG's 25 most senior executives,
and (ii) fix parameters for setting compensation for other
individuals whom relevant SEC rules classify as AIG executive
officers, and for the company's next 100 most highly-paid
employees.
---------------------------------------------------------------------------
\830\ The term ``exceptional financial assistance'' means any
financial assistance provided under the SSFI, the TIP, the Automotive
Industry Financing Program, and any new program designated by the
Secretary as providing exceptional financial assistance. 31 CFR
Sec. 30.1.
\831\ For 2009, AIG was one of seven companies subject to the
approval requirement; Bank of America, Chrysler, Chrysler Financial,
Citigroup, General Motors, and GMAC were the others. The number shrunk
to five for 2010, because Bank of America and Citigroup repaid the TARP
assistance that had placed them in the group of institutions subject to
the mandatory approval rules. On May 17, 2010, Treasury announced that
Chrysler Financial had exited the TARP after its parent company,
Chrysler Holding, repaid an outstanding loan of $1.9 billion. On May
14, 2010. As a result, that company is also no longer required to
comply with the TARP executive compensation restrictions, for periods
after May 14; Treasury staff has indicated that the rules do not permit
the company to adjust its post-repayment compensation to make up for
amounts that might have been paid or earned, but for the relevant caps,
for the period before repayment.
\832\ Mr. Feinberg is a Washington lawyer whose specialty is
mediation, resolution of multi-party claims, and administration of
settlement funds. He was, for example, Special Master of the September
11th Victims Compensation Fund, Special Master in the Agent Orange,
asbestos, Dalkon shield and DES (pregnancy medication) cases,
administrator for the Memorial Fund created after the shootings at
Virginia Tech and the fund created by the settlement of SEC claims
against AIG (arising from pre-2008 conduct), and, on behalf of several
insurance companies, manager of resolution of claims disputes arising
from Hurricane Katrina claims. Feinberg was appointed Special Master in
June 2009.
---------------------------------------------------------------------------
The Special Master reviewed the company's compensation
proposals and made a determination of appropriate compensation
levels (i.e., those levels that he would approve). In his
review, he applied the following standards:\833\ (i) base cash
salary should not exceed $500,000 except in ``appropriate cases
for good cause shown,'' (ii) executives should receive the bulk
of their compensation in the form of units of ``restricted
stock,'' (iii) total compensation should be comparable to total
compensation for similarly situated employees in similar
companies, (iv) employees could be eligible for long-term
incentive awards if they achieve certain performance
objectives, and (iv) all incentive compensation had to be
subject to a ``clawback'' if it were subsequently discovered
that it was paid on the basis of materially inaccurate
information.\834\
---------------------------------------------------------------------------
\833\ Letter from Kenneth R. Feinberg, special master for TARP
executive compensation, U.S. Department of the Treasury, to Robert
Benmosche, president and chief executive officer, American
International Group, Inc., Proposed Compensation Payments and
Structures for Senior Executive Officers and Most Highly Compensated
Employees (Oct. 22, 2009) (online at www.treas.gov/press/releases/docs/
20091022%20AIG%20Letter.pdf). He also applied similar standards in
reviewing the compensation structures of covered employees 26-100 in
both 2009 and 2010. The standards are consistent with those applied to
the other institutions within the Special Master's jurisdiction.
\834\ The general executive compensation rules limit executive
compensation to no more than 1/3 of an employee's total compensation
and require that it be paid in restricted stock, that is, stock whose
vesting and ultimate sale are extended over time. The ``clawback''
provision is also part of the general rules.
---------------------------------------------------------------------------
Due to employee turnover, the Special Master set the
compensation of only 13 senior AIG executives for 2009 and 22
such executives for 2010. For 2009, the highest compensation
figure approved for the ``Top 25'' employees was $10.5 million
and the lowest was $100,000. For 2010, the highest was $10.5
million, and the lowest was $312,500.\835\ In addition, the
Special Master sought to recoup a portion of March 2009
retention awards. After AIGFP employees satisfied their pledge
to return $45 million of the retention payments they received
in 2009, the Special Master permitted AIG to pay these
employees ``non-cash compensation'' in 2010. He also determined
that with only one exception, all AIGFP executives who received
retention awards in 2010 would have their 2010 salaries frozen
at the levels he set in 2009.\836\
---------------------------------------------------------------------------
\835\ FRBNY has worked with Treasury and the Special Master, to
some extent, especially by providing information based on its knowledge
of AIG's compensation arrangements and practices.
\836\ U.S. Department of the Treasury, Letter from Kenneth R.
Feinberg, Proposed Compensation Payments and Structures for Senior
Executive Officers and Most Highly Compensated Employees, at A10
(``Covered Employees 1-25'') (Mar. 23, 2010) (online at
www.financialstability.gov/docs/
20100323%20AIG%202010%20Top%2025%20Determination%20(3-23-10).pdf).
---------------------------------------------------------------------------
An illustration of the Special Master's approach is
provided by the level of compensation he approved for Mr.
Benmosche, who became AIG's CEO in mid-2009. Staff of the
Special Master's office has cited several factors to support
that figure: (i) Mr. Benmosche was new to the company and had
in no way been involved in the conditions that led to the
company's difficulties, (ii) Mr. Benmosche was an experienced
insurance executive, (iii) a certain compensation level was
necessary to attract the sort of experienced individual willing
to tackle a situation such as AIG's, (iv) that level was in the
range of what is paid to individuals holding comparable
positions at comparable companies, and, perhaps most important,
(v) $7.5 of the $10.5 million in Mr. Benmosche's package was
composed of long-term equity that will have value only if his
efforts were successful.
The company allegedly has chafed against the determinations
of the Special Master in some cases, and a few senior
executives have left the company because of proposed limits on
their compensation.\837\ The Chairman's Message at the
beginning of the 2009 AIG Annual Report notes that:

\837\ On December 11, 2009, The New York Times reported that five
of AIG's top executives, including general counsel Anastasia Kelly, had
exercised a ``right to severance'' afforded to them by a company
executive plan that permitted them to claim severance if their pay and
responsibilities were reduced. At least three of the five subsequently
withdrew their claims. Mary Williams Walsh and Louise Story, A.I.G.
General Counsel Set to Depart Over Pay, The New York Times (Dec. 10,
2009) (online at dealbook.blogs.nytimes.com/2009/12/11/aig-general-
counsel-is-set-to-depart-amid-talks-on-pay/).

The Board has been intently focused on . . . dealing
with the pay guidelines and restrictions imposed by the
Special Master, who has ultimate authority over a
number of major compensation decisions. While we can
pay the vast majority of people competitively, on
occasion, these restrictions and his decisions have
yielded outcomes that make little business sense. For
example, in some cases, we are prevented from providing
market competitive compensation to retain some of our
own most experienced and best executives. This hurts
the business and makes it harder to repay the
taxpayers.\838\
---------------------------------------------------------------------------
\838\ American International Group, Inc., AIG 2009 Annual Report,
at 2 (Feb. 26, 2009) (online at www.aigcorporate.com/investors/
2010_April/2009AnnualReport.pdf) (emphasis added).

The SIGTARP Executive Compensation Report reports that
``AIG documents indicate that dozens of Directors and Officers
have resigned across the Commercial Insurance, Worldwide Life
Insurance, Investments, and Financial Products businesses.''
\839\ The losses are apparently ``especially acute'' at AIGFP,
but the Report does not indicate how many of the affected
individuals were subject to the Special Master's
determinations.\840\
---------------------------------------------------------------------------
\839\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 19.
\840\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 20.
---------------------------------------------------------------------------
The Special Master has generally rejected such assertions
from the companies under his jurisdiction. In testimony before
the House Committee on Financial Services on February 25, 2010,
he stated:

I'm dubious about that claim. Now, I will say this,
first, the determinations we have made were only made
last October, last December. We don't see any exit of
individuals from these companies.
Whatever individuals were exiting these companies, I
suggest exited long before compensation determinations
were made by this office. There were quite a few
vacancies when I took over this assignment. But I don't
see exiting. We have to take that into account. It
certainly impacts our decisions on compensation. But
I'm rather dubious about that claim.\841\
---------------------------------------------------------------------------
\841\ House Committee on Financial Services, Testimony of Kenneth
R. Feinberg, special master for TARP executive compensation, U.S.
Department of Treasury, Compensation in the Financial Industry--
Government Perspectives (Feb. 25, 2010) (online at www.house.gov/apps/
list/hearing/financialsvcs_dem/hr_021810.shtml). One of the principles
governing the Special Master's work is to the need to retain
competitiveness to permit repayment of TARP assistance. 31 CFR
Sec. 30.16(b)(1)(ii) (``The compensation structure, and amount payable
where applicable, should reflect the need for the TARP recipient to
remain a competitive enterprise, to retain and recruit talented
employees who will contribute to the TARP recipient's future success,
and ultimately to be able to repay TARP obligations.'').
---------------------------------------------------------------------------

5. Effect on AIG's Future

Analysts and rating agencies have cited executive turnover
as one cause for concern about the future strength of AIG.
FRBNY apparently shares this concern.\842\
---------------------------------------------------------------------------
\842\ SIGTARP Report on Oversight of AIG Compensation, supra note
816, at 19.
---------------------------------------------------------------------------
AIG divisional management, in conversations with Staff, has
provided a mixed assessment of government compensation
constraints, indicating that this is more of an issue at the
firm-wide or holding company level. A firm-wide manager
described the issue as a ``huge time sink'' for senior managers
and asserted that there is no question that the company has
seen executives depart as a result of the compensation
constraints. Another firmwide manager acknowledged that AIG had
lost some people but had also managed to hold on to a lot more.
And, again, only the most senior and well-paid employees of AIG
are subject to the Special Master's jurisdiction. Chartis, for
example, has very few such employees. In any case, retention of
key employees is likely to pivot on the perceived long-term
direction of the firm.
The fixing of salary levels at a company in AIG's situation
is not easy. Still, AIG is supported largely by public funds.
The Panel continues to hold the view, expressed in its GMAC
report, that the appropriate and necessary levels of
compensation for executives of companies that depend on federal
assistance for their operation raises significant unanswered
questions.

K. Conclusion

1. AIG Changed a Fundamental Market Relationship

By providing a complete bailout that called for no shared
sacrifice among AIG and its creditors, FRBNY and Treasury
fundamentally changed the rules of America's financial
marketplace.
U.S. policy has long drawn a distinction between two
different types of investments. The first type is ``safe''
products, such as checking accounts, which are highly regulated
and are intended to be accessible to even unsophisticated
investors. Banks that offer checking accounts must accept a
substantial degree of regulatory scrutiny, offer standardized
features, and pay for FDIC insurance on their deposits. In
return, the bank and its customers benefit from an explicit
government guarantee: within certain limitations, no checking
account in the United States will be allowed to lose even a
penny of value.
By contrast, ``risky'' products, which are more loosely
regulated, are aimed at more sophisticated players. These
products often offer much higher profit margins for banks and
much higher potential returns to investors, but they have never
benefited from any government guarantee. The risks--and the
rewards--have always been borne solely by private parties.
Before the AIG bailout, the derivatives market appeared to
fall cleanly in the second category. Yet by bailing out AIG and
its counterparties, the federal government signaled that the
entire derivatives market--which had been explicitly and
completely deregulated by Congress through the Commodities
Futures Modernization Act \843\--would now benefit from the
same government safety net provided to fully regulated
financial products. In essence, the government distorted the
marketplace by transforming highly risky derivative bets into
fully guaranteed transactions, with the American taxpayer
standing as guarantor.
---------------------------------------------------------------------------
\843\ For a further discussion of AIG's regulatory scheme, see
Section B.2, supra.
---------------------------------------------------------------------------
The Panel believes that the moral hazard problem unleashed
by making whole AIG's counterparties in unregulated,
unguaranteed transactions has turned out to be a key act in
undermining the credibility of America's system of financial
regulation and the credibility of the specific efforts at
addressing the financial crisis that followed, including the
entirety of the TARP program.

2. The Powerful Role of Credit Rating Agencies

It is clear from the analysis in this report that
considerations about credit rating agencies were central to
FRBNY's, and later Treasury's, decisions to assist AIG, and
shaped many of the decisions that had to be made during the
course of the rescue. Indeed, it is no exaggeration to say that
concerns about rating downgrades drove government policy in
regard to AIG.
As the market's most widely followed judges of financial
soundness, credit rating agencies wield immense power, whether
they consciously use it or not. In this case, government
decisionmakers felt compelled to follow a particular course of
action out of a justifiable fear of what credit rating agencies
might do if they acted otherwise. The fact that this small
group of private firms was able to command such deference from
the federal government raises questions about their role within
the marketplace and how effectively and accountably they have
wielded their power.

3. The Options Available to the Government

FRBNY and Treasury justify AIG's extraordinary bailout by
saying that they faced a ``binary choice'' between allowing AIG
to fail, which would have resulted in chaos, or rescuing the
entire institution, including all of its business partners. The
Panel rejects this reasoning. The evidence suggests that
government had more than two options at its disposal, and that
some of the alternatives would not have resulted in the payment
in full of the counterparties and other AIG creditors.
In interviews and meetings with participants on all sides
in these events, the Panel has identified a key decision point:
the period between Sunday afternoon, September 14, 2008, and
Tuesday morning, September 16, 2008. This was the period during
which FRBNY sought to encourage a private effort to lend
sufficient funds to AIG to address its liquidity crisis, while
at the same time trying to determine what the consequences
would be of the bankruptcy of AIG's holding company. Secretary
Geithner characterized the decision as to whether or not to
press JPMorgan and Goldman Sachs further to support AIG as an
existential decision, showing both the importance and the
difficulty of that moment.
The key events in this effort at a private sector solution
began with the convening of a meeting at FRBNY at 11 a.m on
Monday, September 15, 2008, led on the lender side by
representatives of JPMorgan Chase and Goldman Sachs.
Representatives from Morgan Stanley, who was retained to assist
the government, were also present. President Geithner helped
open the meeting and indicated that FRBNY expected the parties
to find a private sector solution for AIG, which at that point
involved lending AIG approximately $75 billion. While the
meeting continued for some time, and the parties to the meeting
left with a commitment to keep working, by late afternoon
President Geithner had concluded the chances of their putting
together a private sector rescue package were slipping.
Early in the morning on September 16, 2008, an attorney for
JPMorgan Chase contacted FRBNY and informed FRBNY that JPMorgan
Chase and Goldman Sachs would be unable to put together a
rescue plan for AIG. It appears no further efforts were made to
pursue a private sector solution, or to pursue a mixed FRBNY-
private sector solution. In particular, there were no efforts
by FRBNY to speak to the CEOs of JPMorgan Chase or Goldman
Sachs about the urgency of crafting a private sector solution
for AIG.
The Panel is concerned that the government put the effort
to organize a private AIG rescue in the hands of only two
banks--banks with severe conflicts of interest as they would
have been among the largest beneficiaries of a taxpayer
bailout. By failing to bring in other players, the government
neglected to use all of its negotiating leverage. There is no
doubt that a private rescue would have been difficult, perhaps
impossible, to arrange, but if the effort had succeeded, the
impact on market confidence would have been extraordinary, and
the savings to taxpayers would have been immense.
Further, even after the Federal Reserve and Treasury had
decided that a public rescue was the only choice, they still
could have pursued options other than paying every creditor and
every counterparty at 100 cents on the dollar. Arrangements in
which different creditors accept varying degrees of loss are
common in bankruptcy proceedings or other negotiations when a
distressed company is involved, and in this case the government
failed to use its significant negotiating leverage to extract
such compromises. As Mr. Bienenstock of Dewey & LeBoeuf
testified to the Panel, ``FRBNY was saving AIG with taxpayer
funds due to the losses sustained by the business divisions
transacting business with these creditor groups, and a
fundamental principle of workouts is shared sacrifice,
especially when creditors are being made better off than they
would be if AIG were left to file bankruptcy.'' As such, ``it
was very plausible to have obtained material creditor discounts
from some creditor groups as part of that process without
undermining its overarching goal of preventing systemic
impairment of the financial system and without compromising the
Federal Reserve Board's principles.''
The Panel believes that FRBNY's approach was driven by
three considerations.
The first consideration was a matter of central banking
philosophy: was it the role of FRBNY to attempt to use all the
tools at its disposal to induce entities it regulated to do
something they did not want to do in the interests of systemic
stability? The Panel believes that FRBNY at that moment did not
see such inducement as its role. The Panel believes that in
such a crisis, with the stability of the financial system and
the integrity of the regulatory system in jeopardy, that
FRBNY's role was to do just that: to ensure that those private
parties that benefited from the stability of the financial
system would contribute to its preservation.
The second consideration was moral hazard. The key actors
in FRBNY, as well as Chairman Bernanke, have all expressed
their sense that AIG deserved to fail, that rescuing AIG
created a moral hazard problem for other large firms. The Panel
believes the Federal Reserve System fully and properly
considered this downside to rescuing AIG. However, AIG was not
the only financial market participant rescued by the AIG
bailout. As noted above, however, the Federal Reserve's rescue
of AIG also rescued AIG's counterparties, and the Panel does
not believe that this aspect of the moral hazard problem was
given proper weight.
The third consideration, and a potentially decisive one all
by itself, was the question of whether there was enough time to
work further on a private sector solution or a mixed public-
private solution, as well as a related question as to whether
any private sector institution or group of institutions was
strong enough in the midst of an accelerating crisis to
participate on the scale necessary. The record appears to be
clear that in the absence of outside funding AIG would have
been insolvent by the end of the day on September 16, 2008. In
the end, FRBNY provided immediate funding that night.
Ultimately, it is impossible to stand in the shoes of those
who had to make decisions during those hours, to weigh the
risks of accelerated systemic collapse against the profound
need for the financial firms that FRBNY was rescuing along with
AIG to share in the costs and the risks of that rescue, and to
weigh those considerations not today in an atmosphere of
relative calm, but in the middle of the night in the midst of a
financial collapse. All the Panel can do is observe the costs
to the public's confidence in our public institutions from the
failure to share the burden of the AIG rescue with AIG's
counterparties in the financial sector.

4. The Government's Authorities in a Financial Crisis

The Federal Reserve and Treasury have explained the
haphazard nature of the AIG rescue by noting that they lacked
specific tools to handle the collapse of such a complex,
multisector, multinational financial corporation. To some
extent this argument is a red herring: the relevant authorities
should have monitored AIG more closely, discovered its
vulnerability earlier, and sought any needed new authorities
from Congress in advance of the crisis. Even after AIG began to
unravel, the Federal Reserve and Treasury could have used their
existing authority more effectively.
Even so, it is worth noting that the government has no
well-defined legal process to wind down a company like AIG in
the same way that it winds down banks through the FDIC
resolution process or nonfinancial companies through
bankruptcy. As a result, the Federal Reserve and Treasury had
to repurpose powers that were originally intended for other
circumstances, leading to a bailout that was improvised,
imperfect, and in many ways deeply unfair.
It is similarly worth noting that OTS approached AIG from a
bottom-up perspective, focused primarily on ensuring that no
harm would be done to the thrift, as opposed to taking a top-
down approach that reviewed the overall safety and soundness of
the holding company. Given that AIG's thrift represented well
under 1 percent of the holding company's assets, this approach
seems misguided at best and raises questions about whether this
is the most effective way to review complex companies and their
systemic risks.

5. Conflicts

The rescue of AIG illustrates the tangled nature of
relationships on Wall Street. People from the same small group
of law firms, investment banks, and regulators appear in the
AIG saga (and many other aspects of the financial crisis) in
many roles, and sometimes representing different and
conflicting interests. The lawyers who represented banks trying
to put together a rescue package for AIG became the lawyers to
FRBNY, shifting sides in a matter of minutes. Those same banks
appear first as advisors, then potential rescuers, then as
counterparties to several different kinds of agreements with
AIG, and ultimately as the direct and indirect beneficiaries of
the government rescue. Many of the regulators and government
officials (in both Administrations) are former employees of the
entities they oversee or that benefited from the rescue.
These links have led to many allegations that the rescue
was orchestrated in order to assist friends and former
colleagues of those leading the rescue. Although Panel staff
has spent significant time reviewing hundreds of thousands of
pages of documents from the time of the rescue, to date they
have found no evidence of any such concerted effort. It is
nonetheless indisputable that the friends and former colleagues
of those who directed the AIG rescue are among the many
beneficiaries of the rescue.
The government has justified its decision to draw from a
limited pool of lawyers and advisors by citing the need for
expertise from Wall Street insiders familiar with AIG. Even so,
the government entities should have recognized that at a time
when the American taxpayers were being asked to bear
extraordinary burdens, they had a special responsibility to
ensure that their actions did not undermine public trust by
failing to address all potential conflicts and the appearance
of conflicts that could arise. The need to address conflicts
and the appearance of conflicts, by government actors,
counterparties, lawyers and all other agents involved in this
drama, was treated largely as a detail that could be subjugated
to the primary goal of keeping the financial system up and
running. This was wrong.
Even setting aside concerns about actual or apparent
conflicts of interest, the limited pool of people involved in
AIG's rescue raises a broader concern. Everyone involved in
AIG's rescue had the mindset of either a banker or a banking
regulator. The discussions did not include other voices that
might have brought different ideas and a broader view of the
national interest. It is unsurprising, then, that the American
public remains convinced that the rescue was designed by Wall
Street to help fellow Wall Streeters, with less emphasis given
to protecting the public trust.
The Panel recognizes that government officials were
confronting an immediate crisis and had to act in haste. Yet it
is at moments of crisis that the government has its most acute
obligation to protect the public interest by avoiding even the
appearance of impropriety. As Mr. Baxter of FRBNY told the
Panel, ``If we should go through this again, we [would] need to
be more mindful of how our actions can be perceived. The lesson
learned for me personally here is that we need to be mindful of
that and perhaps change our behavior as a result of the
perception, not the actuality.''
ANNEXES

Annex I: Where the Money Went

Annex II: Detailed Timeline of Events Leading up to the Rescue of AIG

Annex III: What are Credit Default Swaps?

Annex IV: Legal Authorities

Annex V: Securities Lending

Annex VI: Details of Maiden Lane II Holdings

Annex VII: Details of Maiden Lane III Holdings

Annex VIII: Comparison of Effect of Rescue and Bankruptcy

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

ANNEX II: DETAILED TIMELINE OF EVENTS LEADING UP TO THE RESCUE OF AIG

Mid to late 2007:

AIG:

Texas Department of Insurance discovers during an
examination that AIG's life insurance subsidiaries' securities
lending program had been purchasing RMBS with the cash
collateral. The insurance regulators instruct AIG to unwind the
program. They inform the regulators of AIG's other life
insurance subsidiaries.
In November 2007, at the AIG Supervisory College,
the Texas Department of Insurance informs OTS and the other
non-insurance regulators of the securities lending issue.

Mid-July through August 2008:

AIG:

AIG CEO Robert Willumstad reviews AIG's businesses
and measures to address the liquidity concerns in AIG's
securities lending portfolio and the ongoing collateral calls
with respect to AIGFP's CDS portfolio.
--AIG asks a number of investment banking firms to
discuss possible solutions to these issues.
--In late August, AIG engages JP Morgan to assist in
developing alternatives, including a potential
additional capital raise.
FRBNY records reflect that Mr. Willumstad has one
conversation with FRBNY President Geithner regarding possible
access to the Federal Reserve's discount window.
On August 11, OTS holds an introductory meeting
with FRBNY at FRBNY's request. FRBNY examiners had long sought
such a meeting with the OTS to open a dialogue with them about
AIG and its operations, and to discuss issues that the FRBNY
examiners had seen with respect to the monoline financial
guarantors. An OTS examiner attends on behalf of OTS.
Mr. Willumstad announces plans to hold an investor
meeting on September 25, 2008 to present the results of his
review.
At the end of August, the credit rating agencies
advise Mr. Willumstad of their plans to reassess AIG's ratings
(even though they had previously agreed to wait).

Early September 2008:

AIG:

AIG faces increasing stress on its liquidity due
to securities lending requirements and cash collateral demands
from its AIGFP CDS portfolio.
AIG meets with representatives of the major rating
agencies to discuss Mr. Willumstad's strategic review as well
as the liquidity issues arising from AIG's securities lending
program and AIGFP's CDS portfolio.
September 7, 2008: Fannie Mae and Freddie Mac are placed
into government conservatorship.
September 8-12, 2008: AIG
AIG's common stock price declines from $22.76 to
$12.14.
The company reports that as of July 31, 2008, S&P,
Moody's, and Fitch had placed its senior long-term debt on
negative outlook.
Mr. Willumstad meets with S&P, Moody's, and Fitch,
and they all but announce that they would be downgrading AIG in
the very near future.
September 9, 2008: Mr. Willumstad calls President Geithner
and asks to meet with him. In a short meeting, they discuss the
potential for AIG to become a primary dealer in order to gain
access to the Federal Reserve's discount window. President
Geithner tells Mr. Willumstad that AIG does not meet the
requirements to be a primary dealer and that he will get back
to him.
September 11, 2008: President Geithner notifies Secretary
Paulson and Chairman Bernanke that Lehman Brothers is unlikely
to open for business on Monday, September 15, 2008.
September 12, 2008: AIG
S&P places AIG on CreditWatch with negative
implications and notes that upon completion of its review, it
could affirm the company's current rating of AA- or lower the
rating by one to three notches.
AIG understands that both S&P and Moody's would
re-evaluate AIG's ratings early in the week of September 15.
AIG's subsidiaries, ILFC and AGF, are unable to
replace all of their maturing commercial paper with new
issuances of commercial paper. Therefore, the AIG parent
advances loans to them to meet their commercial paper
obligations.
Mr. Willumstad and other senior AIG officials meet
with some private equity investors over lunch to discuss the
serious challenges AIG is facing.
Mr. Willumstad calls President Geithner at FRBNY
to inform him that the company is facing potentially fatal
liquidity problems. Mr. Willumstad's concerns are two-fold:
(1) AIG had lent out investment-grade securities for
cash collateral, which was invested in illiquid MBSs.
Consequently, AIG would not be able to liquidate its
assets to meet the demands of its counterparties.
(2) AIG is facing a downgrade in its credit rating
the next week, perhaps coming as soon as Monday,
September 15. Depending on the severity of the
downgrade, it would prompt additional collateral calls
ranging between $13 billion to $18 billion.
Mr. Willumstad meets with private equity investors
and investment bankers during the course of the day.
AIG's common stock price falls from $22.76 on
September 8 to $12.14 on September 12.
AIG's general counsel and CFO call the New York
Insurance Department to inform it of its liquidity problem, and
to ask for assistance.
Later that day, FRBNY analysts come to AIG to look
into, discuss, and ask questions about liquidity issues arising
from the AIGFP portfolio.
Mr. Willumstad informs President Geithner that he
needs to raise $20 billion, and with the advice of its
financial advisor JPMorgan Chase, the company sets out to raise
$20 billion over the weekend (in order to allow AIG to meet its
obligations as they came due in anticipation of collateral
calls related to looming downgrades).
Mr. Willumstad calls Warren Buffett during the
evening, who apparently expresses some interest in some of
AIG's businesses if they were for sale, but does not want to
invest in the AIG parent because it is ``too complicated.''
During the evening an FRBNY employee emails
William Dudley and others at FRBNY about ``panic'' at hedge
funds about AIG: ``I am hearing worse than [Lehman.] Every bank
and dealer has exposure to them . . . People I heard from worry
they can't roll over their funding. . . . Estimate I hear is 2
trillion balance sheet.''
Staff from FRBNY (along with staff from the
Federal Reserve Board of Governors who participated by
telephone) met with AIG senior executives on Friday. At this
meeting, AIG stated that it had $8 billion cash in its holding
company, and if there was no downgrade, enough liquidity to
last for the next two weeks. AIG estimated that it might have
to pay out $18.6 billion over the next week if, as expected,
its ratings were downgraded the following week. A description
of this meeting was sent to President Geithner, Dudley, and
others, late Friday night.
On Friday, AIG informed Treasury and the New York
state insurance regulators of its severe liquidity problems,
principally due to increasing demands to return cash collateral
under its securities lending program and collateral calls on
AIGFP's CDS portfolio.
On Friday, President Geithner called together
representatives of 12 major financial institutions to
participate in discussions regarding a private-sector
consortium rescue for Lehman Brothers at a meeting that began
at 6:45 p.m. and continued through the weekend. On Friday, the
financial institutions discussed committing funds to finance
$40 billion of Lehman's real estate assets. Over the course of
the weekend, the institutions did commit to financing.
Barclays, however, was no longer prepared to complete the
purchase.
September 13-14, 2008: AIG
Mr. Willumstad, along with his CFO, Vice Chairman,
and JPMorgan Chase bankers held a call with FRBNY staff and BOG
staff to update them on the status of the company's efforts to
address its liquidity needs. At this point, Mr. Willumstad is
fairly optimistic that assistance from New York State is
forthcoming (in the form of New York State authorization for
AIG to transfer $20 billion in liquid assets from its
subsidiaries to use as collateral for daily operations). AIG
said it had a plan over the next six to 12 months to sell
approximately $40 billion in assets, including domestic and
foreign life insurance subsidiaries; these assets equaled 35-40
percent of the company. AIG said that in addition to the
aforementioned assistance from the New York State Insurance
Department, it needed bridge financing, and was interested in
tapping Federal Reserve lending facilities. Federal Reserve
officials who were on the call got the impression that AIG had
not approached private financial institutions about obtaining
this financing, likely because AIG felt that it would be turned
down. The phone call also included a discussion of the Federal
Reserve's emergency lending authority under Section 13(3) of
the Federal Reserve Act. The Federal Reserve officials stated
that 13(3) lending would send a negative signal to the market,
and told AIG that they ``should not be particularly
optimistic,'' given the history and hurdles of 13(3) lending.
Treasury, Federal Reserve, New York State
Insurance Department and other experts meet to consider how to
respond to AIG's problems and determine if it is systemically
important (while aware that the private sector was already
working on a solution to AIG's liquidity problems). State
insurance regulators provide information on the condition of
AIG's insurance subsidiaries, including the potential impact of
RMBS portfolio losses on the subsidiaries' capital base.
The New York Insurance Department has a conference
call with AIG on Saturday morning, and then goes to AIG's
offices where they spend the remainder of the weekend where
they can provide assistance and expedite any needed regulatory
actions.
AIG accelerates the process of attempting to raise
additional capital and discusses capital injections and other
liquidity measures with private equity firms, sovereign wealth
funds, and other potential investors. AIG also meets with
Blackstone Advisory Services LP to assist in developing
alternatives, including a potential additional capital raise.
However, once AIG concludes that it needs $40 billion by
Saturday evening (the increased estimate is partly based on the
increasing likelihood of a Lehman bankruptcy, which would
substantially increase the pressure on AIG due to additional
collateral calls and a likely decline in the value of its
investment portfolio), investors lose interest because they do
not think it would be a sound investment given AIG's financial
condition.
By Saturday evening, Mr. Willumstad concludes that
the only solution is for the government to guarantee AIG's
balance sheet through a loan or line of credit. Mr. Willumstad
calls President Geithner at FRBNY during the evening and
estimates that AIG needs $40 billion, twice the amount he had
mentioned earlier.
--To raise this amount, Mr. Willumstad notes that he
needs government support. Geithner says that this would
not be possible.
On Sunday, Christopher Flowers, founder of the
private equity firm J.C. Flowers & Company proposes that his
firm and Allianz (the German insurance company) buy AIG for $2
a share (they propose to acquire the assets of the subsidiaries
but seek to be insulated from the liabilities of the parent).
Flowers and Allianz would each contribute $5 billion in new
capital, but Flowers' offer is conditioned on receiving
government support, New York State authorization for AIG to
transfer $20 billion in assets from its subsidiaries to use as
collateral for daily operations, and the replacement of AIG's
top management with Allianz executives.
--Mr. Willumstad does not believe the proposal is
credible.
Sunday mid-day, staffers at FRBNY were preparing
to brief President Geithner on the pros and cons of providing
AIG access to the Federal Reserve's Discount Window, ``this is
to inform [Geithner] in his discussions with Chairman Bernanke
w/r/t the option and impact of lending to AIG.''
At 3:49 p.m. on Sunday, President Geithner (and
other FRBNY officials) receive a staff memo describing the pros
and cons of lending to AIG, a spreadsheet provided by AIG
detailing the firms with the largest exposures to AIG (that was
not complete as it dealt only with derivatives and lending
exposures), and a presentation describing what FRBNY knows on
AIG subsidiaries based on publicly available information.
On Sunday afternoon/evening, Mr. Willumstad
returns to FRBNY and tells the regulators that he is out of
ideas and that without government support, the company would
not survive.
Also on Sunday evening, FRBNY officials meet with
JPMorgan Chase, AIG's financial advisor, and no AIG
representatives are present.
Late Sunday night, President Geithner felt that
``it still seemed inconceivable that the Federal Reserve could
or should play any role in preventing AIG's collapse.''
September 15, 2008:
Bank of America/Merrill Lynch: Bank of America announces
its intent to purchase Merrill Lynch for $50 billion
Lehman Brothers: Lehman Brothers files for Chapter 11
bankruptcy protection

Money Market Mutual Funds:

According to Secretary Geithner's 1/27/10 House
Oversight testimony, an escalating bank run and broad
withdrawal of funds from money market funds starts on Sunday
evening, September 14-15, 2008, severely disrupting the
commercial paper market.
Reserve Primary Fund (which had increased its
purchases of Lehman securities from November 2007 through the
summer of 2008 and held $785 million in Lehman short-term debt,
meaning that 1.2 percent of its assets were in Lehman debt, by
September 2008) contacts FRBNY to express concern about
Lehman's effect on the money market industry and on the Primary
Fund.
--That morning, the Primary Fund faces $5.2 billion
in redemption requests, and these increase to $16.5
billion by the early afternoon.
--By the end of the day, redemption orders for the
Reserve Primary Fund total $25 billion.
By early afternoon, State Street, the fund's
custodian bank, calls to report that the huge number of
redemptions caused the Primary Fund's account to be overdrawn,
and the bank is suspending overdraft privileges. Investors
seeking to withdraw funds could not immediately access their
money.

AIG:

Just after midnight and into the early morning,
FRBNY staff consider whether AIG could receive support from the
FHLB as a backstop for the insurance subsidiaries.
During the morning, President Geithner calls Mr.
Willumstad to advise him that he has asked JPMorgan Chase and
Goldman Sachs to lead a private consortium effort to assist
AIG.
FRBNY staff meets and discusses systemic risks
posed by the possible bankruptcy of AIG (bank exposures,
implications for the insurance subsidiaries, and wider economic
knock-on effects).
As of Monday morning, FRBNY staff was pushing a
private sector solution.
At 11:30 a.m., Mr. Willumstad and other AIG
officials, at the request of President Geithner, meets with
representatives of Goldman Sachs, JPMorgan, Morgan Stanley, the
New York State Insurance Department, FRBNY, and Treasury at
FRBNY to discuss the creation of a $75 billion secured lending
facility to be syndicated among a number of large financial
institutions. President Geithner says that there would be no
government help, meaning that there has to be an industry and
private solution.
--Goldman Sachs and JPMorgan immediately begin the
financing attempt.
--Mr. Willumstad, along with Dan Jester from
Treasury, calls the credit rating agencies to ask them
to delay downgrading AIG, to no avail.
--After the meeting, Mr. Willumstad and other AIG
officials return to AIG and prepare for a bankruptcy
filing.
AIG is again unable to access the commercial paper
market for its primary commercial paper programs, AIG Funding,
ILCF, and AGF. AIG advances loans to ILFC and AGF to meet their
funding obligations.
AIG experiences returns under its securities
lending programs which lead to cash payments of $5.2 billion to
securities lending counterparties.
In the late afternoon, S&P downgrades AIG's long-
term debt rating by three notches, and Moody's and Fitch
downgrade AIG's long-term debt rating by two notches, causing
AIG to need to post additional collateral.
--As a result, AIGFP estimates that it needs more
than $20 billion to fund additional collateral demands
and transaction termination payments in a short period
of time.
--Due to the downgrades, AIG has 48 hours under its
contracts to post collateral. This means that AIG would
run out of cash by Wednesday, September 17, default on
its obligations, and be placed into bankruptcy.
--(By the end of September, AIG had drawn down $61
billion on the Federal Reserve's RCF, due to the impact
of the downgrades, changes in market levels, and other
factors).
Traders, aware of AIG's mounting collateral calls
and the ongoing meetings at FRBNY, unload their stock. AIG's
common stock price falls to $4.76 per share (a 61 percent drop
in one day).
New York Governor David Paterson (acting on the
recommendation of New York State Superintendent of Insurance
Eric Dinallo) authorizes AIG to transfer $20 billion in assets
from its subsidiaries to use as collateral for daily
operations. In exchange, the parent company will give the
subsidiaries less-liquid assets.
According to Mr. Willumstad, AIG is largely out of
business by the evening.
September 16, 2008:

AIG:

At 1:44 a.m., President Geithner receives a staff
memo weighing the pros and cons of a proposal to temporarily
reinsure AIGFP's stable value wraps so that AIGFP could be
unwound in a manner that contains the negative economic and
psychological impact on plan participants. This would require
an act of Congress.
At 2 a.m., FRBNY officials receive word that AIG's
plans for the secured lending facility with Goldman Sachs and
JPMorgan fail. The FRBNY knew as of this time that there was no
viable private sector solution to AIG's liquidity problems.
At 3:13 a.m., FRBNY staff forward to President
Geithner and other FRBNY officials receive a memo that assesses
the systemic impact of an AIG bankruptcy, how the bankruptcy
process might unfold, and the impact of an AIG failure on
financial counterparties, market liquidity, and related
spillover effects. The memo concludes that it ``could be more
systemic in nature than Lehman due to the retail dimension of
its business . . . [that] intervention needs to insulate the
retail activities (inc. those in the parent, like stable value
wraps) in a way that inspires confidence among the public to
avoid a potential crisis of confidence. Coordination issues
among state regulators could make this difficult.''
FRBNY, Treasury, and Federal Reserve officials
present their assessment of the AIG situation to the Federal
Reserve Board at a meeting that began at 8 a.m., which
authorizes FRBNY to provide liquidity to AIG in the form of an
$85 billion revolving credit facility under Section 13(3) of
the Federal Reserve Act.
Mr. Willumstad calls President Geithner during the
morning to inform him of his plans to draw down the remaining
AIG credit lines that morning (because it could not make the
required representations to its lenders), but President
Geithner advises him not to do so. Nonetheless, Mr. Willumstad
authorizes the draw-downs.
The downgrades coupled with the sharp decline in
AIG's common stock price to $4.76 on the previous day (and the
fear of an anticipated AIG bankruptcy) result in counterparties
withholding payments from AIG and refusing to transact with AIG
even on a secured short-term basis, resulting in AIG being
unable to borrow in the short-term lending markets.
To provide liquidity, both ILFC and AGF draw down
on their existing revolving credit facilities, resulting in
borrowings of approximately $6.5 billion and $4.6 billion,
respectively.
At 11 a.m., President Geithner calls Mr.
Willumstad and tells him that he is working on a solution and
will get back to him.
Insurance regulators notify AIG that it will no
longer be permitted to borrow funds from its insurance company
subsidiaries under a revolving credit facility that AIG
maintains with certain of its insurance subsidiaries acting as
lenders. Subsequently, the insurance regulators require AIG to
repay any outstanding loans under that facility and to
terminate it. (The intercompany facility is terminated
effective September 22, 2008).
AIG requests to draw on its $15 billion line of
credit. JPMorgan was the lead agent on the line and held
approximately $800 million of exposure. FRBNY staff following
whether line is funded, if other participant banks invoke MAC
clause, and how it affects other exposures and collateral
requirements for AIG.
At 2 p.m., FRBNY calls Mr. Willumstad and asks him
to send a group of AIG attorneys over to FRBNY.
At approximately 3:30 p.m., the FRBNY sends AIG
the terms of a secured lending agreement that it is prepared to
provide. AIG anticipates an immediate need for cash in excess
of its available resources. (Those liquidity problems (and
AIG's actual draws on the Federal Reserve's RCF) went from $0
to $14 billion on September 16th, to $28 billion by the end of
the next day, and to almost $40 billion by the end of the
week).
At 4:42 p.m., President Geithner and Secretary
Paulson call Mr. Willumstad and outline the terms of FRBNY's
secured lending agreement. Mr. Geithner advises him that he has
two choices: accept the terms or file for bankruptcy. Secretary
Paulson tells Mr. Willumstad that there is ``no negotiation''
and that ``this is the only offer.''
Secretary Paulson also notes that another
condition is that Mr. Willumstad would be replaced (AIG
subsequently elects Edward M. Liddy as chairman and CEO). While
President Geithner and Secretary Paulson push Mr. Willumstad to
get an answer quickly (largely because of the impact on the
capital markets), Mr. Willumstad tells them the AIG Board will
have to review and make a decision on its own.
At Board meeting that starts at 5 p.m. and lasts
several hours, AIG's Board of Directors approves borrowing from
FRBNY based on a term sheet that sets forth the terms of the
secured credit agreement and related equity participation.
At 6 p.m., Secretary Paulson and Chairman Bernanke
conduct a briefing on the AIG rescue for House and Senate
leadership in Senator Majority Leader Reid's conference room.
Mr. Willumstad calls FRBNY at 8 p.m. to notify
them of the AIG Board's acceptance.

Money Market Mutual Funds:

Redemption requests at the Reserve Primary Fund
reach $24.6 billion by 9 a.m.
By 3:45 p.m., total redemption requests reach
about $40 billion, and FRBNY declines to provide assistance in
meeting shareholder redemptions.
The net asset value of shares in the Reserve
Primary Money Fund falls below $1 as of 4 p.m., primarily due
to losses on Lehman Brothers commercial paper and medium-term
notes.
Money market redemption requests reach $33.8
billion (compared with a total of $4.9 billion for the entire
previous week).
September 17, 2008:
Secretary Paulson has a conversation with Jeffrey Immelt,
CEO of General Electric, who tells him that the capital markets
are ``very bad'' and that the commercial paper markets are
under significant stress.
The cost of buying default protection against Morgan
Stanley and Goldman Sachs had soared overnight.

Money Market Mutual Funds:

Putnam announces that it would close and liquidate
the $12.3 billion Institutional Prime Money Market Fund, even
though it does not own any Lehman or AIG securities and
maintains its one dollar share value.
Investors liquidate $169 billion from prime funds
and reinvest $89 billion into government funds between
September 15 and September 17.
Yields on 3-month Treasury notes dip below zero as
investors seek the safety of short-term Treasury bonds.
Dow Jones average drops 449 points, falling 7 percent in
only 3 days of trading.
At 6 p.m., Chairman Bernanke meets with Federal Reserve
Vice Chairman Donald Kohn and Federal Reserve Governor Kevin
Warsh, Mr. Alvarez of the Federal Reserve Board, and
Spokesperson Michelle Smith (with President Geithner and
Secretary Paulson conferencing in via phone). Chairman Bernanke
concludes that they ``have to go to Congress and get some
authority.''
September 18, 2008:
After consulting with Treasury and Federal Reserve staff as
well as President Bush and Vice President Cheney, Secretary
Paulson, Chairman Bernanke, and SEC Chairman Christopher Cox
meet with House and Senate leadership in Speaker Pelosi's
conference room for 90 minutes, requesting the ``authority to
spend several hundred billion.''
SEC announces a temporary emergency ban on short selling in
the stocks of 799 financial stocks.
September 19, 2008:
Troubled Asset Relief Program: Treasury submits draft
legislation to Congress for authority to purchase troubled
assets.
Federal Reserve announces plans to purchase federal agency
discount notes (short-term debt obligations issued by Fannie
Mae, Freddie Mac, and Federal Home Loan Banks) from primary
dealers.
During the evening, Morgan Stanley's CFO receives a call
from the head of the firm's Tokyo office, reporting that
Mitsubishi U.F.J., a large Japanese bank, is interested in
negotiating a stake. (Morgan Stanley ultimately sells 21
percent of the company to Mitsubishi for $9 billion).

Money Market Mutual Funds:

Federal Reserve announces the creation of the
Asset-Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility (AMLF) to extend non-recourse loans at the
primary credit rate to U.S. depository institutions and bank
holding companies to finance their purchase of high-quality
asset-backed commercial paper from money market mutual funds.
Treasury announces a temporary guarantee program
that would make available up to $50 billion from the Exchange
Stabilization Fund to guarantee investments in participating
money market mutual funds.
By September 19, withdrawal requests had climbed
to 95 percent of the Reserve Primary Fund's $62 billion
portfolio, necessitating approval from the SEC to delay
redemption payments beyond the seven-day requirement.
September 20, 2008: A Chinese delegation, led by Gao
Xiqing, the vice chairman of the C.I.C., arrives in NY to meet
with Morgan Stanley executives.
September 21, 2008: Federal Reserve approves applications
of Goldman Sachs and Morgan Stanley to become bank holding
companies.
September 22, 2008: AIG enters into the Fed Credit
Agreement (for the RCF provided on September 16) in the form of
a 2-year secured loan and a Guarantee and Pledge Agreement with
FRBNY.
September 23, 2008: Goldman Sachs announces that Mr.
Buffett is buying $5 billion of preferred stock.
September 24, 2008: Goldman Sachs raises another $5 billion
in a public offering of common stock.
September 25, 2008: Washington Mutual is closed by OTS and
taken over by the FDIC.
September 29, 2008: The House votes down EESA legislation,
and the Dow Jones industrial drops 778 points.
October 3, 2008: Congress passes EESA and President Bush
then signs it into law.
October 7, 2008: Federal Reserve creates the CPFF.
October 8, 2008: Federal Reserve and other central banks
lower short-term rates.
Ongoing Activities: Federal Reserve expanded the scope and
scale of its swap lines with central banks in order to provide
liquidity in U.S. dollars to overseas markets (September 18,
2008; September 24, 2008; September 26, 2008; October 14, 2008;
October 29, 2008).
ANNEX III: WHAT ARE CREDIT DEFAULT SWAPS?

A. Credit Default Swaps Generally

Credit default swaps (CDSs) are privately-negotiated
bilateral contracts that obligate one party to pay another in
the event that a third party cannot pay its obligations.\844\
In essence, the purchaser of protection pays the issuer of
protection a fee for the term of the contract and receives in
return a promise that if certain specified events occur, the
purchaser of protection will be made whole. If a credit event
\845\ does not occur during the term of the contract, the
issuer will have no obligation to the purchaser and retains the
fees paid. If a credit event occurs during the term of the
contract, the contract is settled--either by cash, in which the
parties agree on a market value for the reference obligation,
or by physical settlement, in which the protection seller
provides the ``deliverable obligations'' specified by the
contract--and the purchaser of protection discontinues the
payment. The term of the contract is negotiable, and although
five years is the most common term, maturities from a few
months to ten years or more are possible. Fees are usually paid
quarterly and are expressed in basis points per annum on the
notional amount of the CDS.\846\ Providers of protection credit
are dominated by banks and insurance companies, while banks,
security houses, and hedge funds are the predominant protection
buyers.\847\ Among these parties, CDS dealers maintain matched
books, whereby protection sold and protection bought are
balanced, and net exposure can be low.\848\ These dealers are
typically large, global banks, and they try to profit from the
spreads between buying and selling protection.\849\ Because a
dealer is in the middle of a transaction, the success of the
dealer's hedge is dependent on relative parity between the
protection bought and the protection sold. Figure 41 shows an
example of such a hedge.
---------------------------------------------------------------------------
\844\ International Swaps and Derivatives Association, AIG and
Credit Default Swaps (Nov. 2009) (online at www.isda.org/c_and_a/pdf/
ISDA-AIGandCDS.pdf) (hereinafter ``ISDA Paper on AIG and Credit Default
Swaps'').
\845\ Credit events are typically constructed around the issuer of
the reference obligation, and can include bankruptcy, failure to pay,
acceleration of payments on the issuer's obligations, default on the
issuer's obligations, restructuring of the issuer's debt, and similar
events. Written Testimony of Robert Pickel, supra note 38, at 1.
\846\ The notional amount is the amount of protection provided by
the CDS: for example, if a party enters into a CDS to purchase
protection on a $100 million exposure, the notional amount would be
$100 million. William K. Sjostrum, Jr., The AIG Bailout, Washington and
Lee Law Review, Vol. 66, at 943 (Nov. 9, 2009) (online at
papers.ssrn.com/sol3/
papers.cfm?abstract_id=1346552) (hereinafter ``Sjostrum Law Review
Article''). Although notional amount is often used to describe CDS
exposure, it is not a precise description of the actual exposure of an
entity under a CDS. The price of protection also depends on the
riskiness of the underlying obligation and increases as the risk
associated with the underlying obligation increases. See House
Committee on Agriculture, Written Testimony of Erik Sirri, director,
Division of Trading and Markets, U.S. Securities and Exchange
Commission, The Role of Credit Derivatives in the U.S. Economy, 110th
Cong. (Oct. 15, 2008) (online at www.sec.gov/news/testimony/2008/
ts101508ers.htm) (hereinafter ``Written Testimony of Erik Sirri'').
\847\ Francis A. Longstaff, Sanjay Mithal, and Eric Neis, Corporate
Yield Spreads: Default Risk Or Liquidity? New Evidence from the Credit
Default Swap Market, Journal of Finance, Vol. 60, No. 5, at 2216-17
(Oct. 2005) (online at ksuweb.kennesaw.edu/dtang/CRM/
LongstaffMithalNeis2005JF_YieldSpreads.pdf).
\848\ ISDA Paper on AIG and Credit Default Swaps, supra note 844.
\849\ See Sjostrum Law Review Article, supra note 846, at 943;
Written Testimony of Erik Sirri, supra note 846. Some, but not all of
these parties are regulated entities. Banks, investment banks and
investment companies are regulated entities, although insurance
companies are subject to state regulation in the U.S. and hedge funds
are at present minimally regulated. For a list of ISDA members, see
International Swaps and Derivatives Association, Membership (online at
www.isda.org/membership/isdamemberslist.pdf) (accessed June 8, 2010).
---------------------------------------------------------------------------

FIGURE 41: CREDIT DEFAULT SWAPS

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

CDSs are built around a debt reference security or a pool
of reference securities--called the reference obligation or
obligations--and are memorialized by a standardized agreement
prepared by the International Swaps and Derivatives Association
(ISDA). These agreements, known as ISDA Master Agreements, set
forth a variety of terms pursuant to which CDS counterparties
can choose the events and terms that will govern their
transactions.\850\ The Master Agreement sets forth not only the
payment terms and credit events for a given CDS but also
establishes the general relationship between the parties,
including events of default and termination events for the
Master Agreement between the parties.\851\ Transactions are
commonly documented pursuant to either a ``1992 Multicurrency
Cross-Border ISDA Master Agreement'' (the 1992 Agreement) or a
``2002 ISDA Master Agreement'' (the 2002 Agreement).\852\ Each
of these agreements consists of preprinted standard provisions
and a schedule. While the Master Agreements remain in their
standard pre-printed form, the parties may use the schedule to
make elections and vary any of the provisions in the Master
Agreement.\853\ In addition to the Master Agreement and the
schedule, each transaction under a Master Agreement is
separately memorialized by a confirmation. According to ISDA,
the confirmation of a transaction evidences that transaction,
and each transaction is incorporated into the ISDA Master
Agreement.\854\ The Master Agreement provides that in the event
of a disagreement between the terms of the schedule and the
Master Agreement, the schedule shall govern, and in the event
of a disagreement between the confirmation and the schedule,
the confirmation shall govern with respect to the particular
transaction.\855\ The ISDA documentation also includes a
``credit support annex'' (CSA) that, if used, governs
collateral arrangements and requirements between the parties.
The CSA provides for a variety of calculations that determine
the collateral taker's ``exposure,'' which is a technical term
that sets forth the amount payable from one party to another if
all transactions under the relevant ISDA Master Agreement were
being terminated as of the time of valuation, calculated using
estimates at mid-market of the amounts that would be paid for
replacement transactions.\856\ After a credit event, CDSs can
be cash-settled or physically-settled. If the CDS is
physically-settled, it will specify ``deliverable obligations''
(usually pari passu with the reference obligations) that the
protection seller is required to buy at par from the protection
buyer. If the CDS is cash-settled, the parties agree on a
market value for the reference obligation.\857\ After an event
of default or termination event under the relevant master
agreement, the entire relationship governed by that master
agreement will close out, meaning that the agreement will
terminate and amounts owed under the contract will be
paid.\858\ Parties may also (and often do) write multiple
contracts under a single master, and if they can use `` close-
out netting'' (whereby a variety of contracts can be set off
against each other), all transactions under that ISDA Master
Agreement are viewed as a single agreement between the
counterparties.\859\
---------------------------------------------------------------------------
\850\ Written Testimony of Robert Pickel, supra note 38, at 1.
\851\ Those events of default in the preprinted ISDA Master
Agreement are: failure to pay or deliver; breach of agreement; credit
support default; misrepresentation; default underspecified transaction;
cross default; bankruptcy; and merger without assumption. Termination
events in the preprinted ISDA Master Agreement are illegality; tax
event; force majeure (only in the 2002 Agreement); tax event upon
merger; credit event upon merger; and additional termination event.
Parties may vary or to supply the standardized terms, or may
incorporate other events. International Swaps and Derivatives
Association, Market Review of OTC Derivative Bilateral
Collateralization Practices, at 9 (Mar. 1, 2010) (online at
www.isda.org/c_and_a/pdf/Collateral-Market-Review.pdf) (hereinafter
``Market Review of OTC Derivative Bilateral Collateralization
Practices'').
\852\ Most of AIG's CDSs were documented pursuant to the 1992
Agreement.
\853\ Market Review of OTC Derivative Bilateral Collateralization
Practices, supra note 851, at 9.
\854\ International Swaps and Derivatives Association, Frequently
Asked Questions, at No. 31 (online at www.isda.org/educat/faqs.html#31)
(hereinafter ``ISDA Frequently Asked Questions'') (accessed June 8,
2010).
\855\ See International Swaps and Derivatives Association, 1992
Agreement and 2002 Agreement, at Section 1b (Inconsistency) (copies of
Master Agreements provided by ISDA).
\856\ As described further below, AIG's CSA would ultimately prove
critical to AIG's melt-down. In the calculation of the CSA,
``exposure'' is combined with the Independent Amounts (a lump sum
payable) and then the Threshold, the uncollateralized amount discussed
further herein, is subtracted. Market Review of OTC Derivative
Bilateral Collateralization Practices, supra note 851, at 11.
ISDA also provides a variety of other standardized documents, such
as definitions. The Master Agreement is typically governed by New York
State or English law, because New York and London are the primary
trading centers for CDSs. The same version of the Master Agreement
would be used for both jurisdictions. The credit support annex,
however, differs depending on whether it is the New York form or the
English form. See Edmund Parker and Aaron McGarry, The ISDA Master
Agreement and CSA, Butterworths Journal of International Banking and
Financial Law (Jan. 2009) (online at www.mayerbrown.com/publications/
article.asp?id=8431&nid=6) (hereinafter ``ISDA Master Agreement and
CSA'').
\857\ Sjostrum Law Review Article, supra note 846, at 949. If the
protection buyer does not have the securities, it must obtain them in
the market.
\858\ International Swaps and Derivatives Association, The
Importance of Close-Out Netting, ISDA Research Notes, No. 1 (2010)
(online at www.isda.org/researchnotes/pdf/Netting-ISDAResearchNotes-1-
2010.pdf) (hereinafter ``The Importance of Close-Out Netting'').
\859\ ISDA Frequently Asked Questions, supra note 854, at No. 31
(accessed June 8, 2010); The Importance of Close-Out Netting, supra
note 858.
---------------------------------------------------------------------------
While the ISDA Master Agreement is a common framework used
by institutions for initiating, documenting, and closing out
CDS contracts, there can be substantial variation in the actual
terms of contracts.\860\ There are approximately 800 member
institutions--all sophisticated market players--registered with
ISDA,\861\ and as noted above, some of these are dealers that
take different sides of the same trade.\862\ CDSs can also be
used for multiple purposes, including hedging, speculation, and
arbitrage.\863\ Accordingly, although the ISDA Master
Agreement--the CDS base documentation--is theoretically
standardized, as the contracts are privately negotiated among
sophisticated parties for various reasons, terms can vary
greatly. Further, CDSs are not listed on any exchange, and are
traded in the over-the-counter market between large financial
institutions without any required documentation or
recordkeeping to track who traded, how much, and when.\864\ As
a result, not only is variation among the CDS agreements
substantial but the market overall is also opaque. The lack of
transparency is further compounded by documentation problems
that have repeatedly plagued the CDS market. For example, a
2007 GAO report described backlogs of confirmations and poorly
documented assignments of CDS contracts, compounded by
overreliance on manual systems.\865\ Similarly, after the
Lehman bankruptcy, a variety of ISDA documentation difficulties
came to light. These included the tendency of some parties to
enter into derivative transactions without actually signing a
Master Agreement first.\866\
---------------------------------------------------------------------------
\860\ Navneet Arora, Priyank Gandhi and Frances A. Longstaff,
Counterparty Credit Risk and the Credit Default Swap Market (Jan. 2010)
(online at v3.moodys.com/microsites/crc2010/papers/
longstaff_counterparty.pdf) (hereinafter ``Counterparty Credit Risk and
the Credit Default Swap Market'').
\861\ Counterparty Credit Risk and the Credit Default Swap Market,
supra note 860.
\862\ Written Testimony of Erik Sirri, supra note 846.
\863\ Sjostrum Law Review Article, supra note 846. CDSs can play a
similar role in the market to bond insurance, which began as municipal
bond insurance but during the 1990s expanded to encompass insurance on
a variety of complex products. See House Financial Services,
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises, Written Testimony of Eric Sirri, director, Division of
Trading and Markets, U.S. Securities and Exchange Commission, The State
of the Bond Insurance Industry, 110th Cong. (Feb. 14, 2008) (online at
www.house.gov/apps/list/hearing/financialsvcs_dem/ht021408.shtml).
Insurance products, however, are regulated, unlike the credit default
swap market, which generally reduces flexibility.
\864\ Written Testimony of Erik Sirri, supra note 846.
\865\ U.S. Government Accountability Office, Credit Derivatives
Confirmation Backlogs Increased Dealers' Operational Risks, but were
Successfully Addressed after Joint Regulatory Action (Jun. 2007) (GAO-
07-716) (online at www.gao.gov/new.items/d07716.pdf).
\866\ See ISDA Master Agreement and CSA, supra note 856.
---------------------------------------------------------------------------
Although CDSs are used, in many cases, to decrease exposure
to a given credit default risk, entering into a CDS necessarily
increases an institution's exposure to counterparty credit
risk. Counterparty credit risk is the risk that the seller of
the protection will be incapable or unwilling to make payment
due under a closed CDS contract after a credit event.
Typically, in order to minimize or mitigate counterparty credit
risk, the CDS may include a CSA that requires the posting of
collateral from the protection seller to the protection
buyer.\867\ Collateral postings and margin calls are negotiated
between the parties. According to ISDA, 97 percent of trades in
credit derivatives are covered by collateral arrangements, and
over three quarters of all derivatives of any type are
collateralized.\868\ As noted above, however, the wide
variation among terms in CDSs means that the parties are not
obligated to collateralize CDSs and there are no particular
commercial terms that need to be established. Fundamentally,
collateralization terms are commercial and credit-risk-
management decisions subject to negotiation between the
parties.\869\
---------------------------------------------------------------------------
\867\ Sjostrum Law Review Article, supra note 846.
\868\ Market Review of OTC Derivative Bilateral Collateralization
Practices, supra note 851, at 7.
\869\ Market Review of OTC Derivative Bilateral Collateralization
Practices, supra note 851, at 7.
---------------------------------------------------------------------------

B. AIG's Credit Default Swaps

AIG has been described as ``unique'' among large CDS market
participants inasmuch as its book consisted almost completely
of ``sold'' protection: AIG, unlike a dealer, did not hold
offsetting positions in CDSs.\870\ Because its models
anticipated that none of the particular underlying reference
securities on which AIG wrote protection would ever cause a
credit event, AIG anticipated that the CDSs it wrote would
expire, and AIGFP would pocket the premiums without further
obligation.\871\ AIG wrote CDSs on Super Senior, ``high
grade,'' and mezzanine tranches of multi-sector CDOs. These
CDOs were securities with a pool of underlying assets that
included mortgages from multiple sectors, including residential
mortgages, commercial mortgages, credit card receivables, and
other similar assets. Some of these assets were sub-prime
mortgages, which deteriorated at substantially higher rates
than were accounted for in AIG's model.\872\
---------------------------------------------------------------------------
\870\ ISDA Paper on AIG and Credit Default Swaps, supra note 844.
\871\ Sjostrum Law Review Article, supra note 846. See also House
Committee on Agriculture, Written Testimony of Henry Hu, Allan Shivers
Chair in the Law of Banking and Finance, University of Texas School of
Law, The Role of Credit Derivatives in the U.S. Economy (Oct. 13, 2008)
(online at agriculture.house.gov/testimony/110/h81015/Hu.pdf).
\872\ Sjostrum Law Review Article, supra note 846. The vast
majority of these were physically-settled contracts, which obligated
the counterparty to deliver the reference obligation at close-out.
---------------------------------------------------------------------------
Although the deterioration in the credit quality of the
CDOs caused the estimated spreads on the CDSs written on those
CDOs to widen and resulted in unrealized losses for AIG, it was
the collateral posting obligations embedded in the CDSs that
caused AIG to begin to experience a liquidity crunch.\873\
According to AIG's quarterly report for the period ended
September 30, 2009, counterparties' collateral calls against
AIGFP related to the multi-sector CDO portfolio were largely
driven by deterioration in the market value of the reference
obligations, and the large majority of its obligations to post
collateral were associated with arbitrage transactions relating
to multi-sector CDOs.\874\ As discussed above,
collateralization provisions are almost universal for credit
derivatives, although the terms of any given credit support
annex are privately negotiated among counterparties. For many
of AIG's multi-sector CDS contracts, the collateral required
was determined based on the change in value of the underlying
cash security representing the super senior risk layer subject
to credit protection, rather than on the changing value of the
derivative. Accordingly, AIG could be obligated to post
collateral based not on a widening spread for the CDS itself,
but rather on price changes in the underlying reference
security.\875\
---------------------------------------------------------------------------
\873\ Sjostrum Law Review Article, supra note 846.
\874\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 118.
\875\ AIG Form 10-Q for Third Quarter 2008, supra note 23.
---------------------------------------------------------------------------
In addition to these collateralization provisions keyed to
the value of the reference obligation, however, many of AIG's
contracts also contained a ``ratings trigger.'' A ``ratings
trigger'' in a CSA creates an obligation to post additional
collateral in the event that the party affected experiences a
ratings downgrade. Ratings triggers are not particular to AIG
CDS contracts: in a recent ISDA survey, almost all market
participants reported using ratings triggers when computing
their Threshold, which is the amount of exposure a party is
willing to bear uncollateralized. ISDA states that market
participants often specify the Threshold as a fixed amount,
although Thresholds may decrease (and accordingly reduce
exposure) with decreases in credit rating.\876\
---------------------------------------------------------------------------
\876\ AIG has no information as to whether its rating triggers were
common in the market, and it noted that when it was involved in these
deals, it was generally a thin market. It is therefore difficult to
determine whether AIG's CSAs were unusual. As described further below,
other market participants require triggered Thresholds.
---------------------------------------------------------------------------
AIG broke down its description of its collateral calls into
(1) regulatory capital transactions; (2) arbitrage portfolio
for multi-sector CDOs; and (3) arbitrage portfolio for
corporate debt/CLOs. AIG's ratings triggers were complex and
varied from contract to contract,\877\ but some or many of them
contained various requirements to post collateral in the event
of ratings triggers, and in its survey ISDA identifies the
variable threshold as a particular issue for AIG.\878\ For its
regulatory capital transactions subject to a CSA, the majority
of the contracts used formulae unique to each transaction or
counterparty that depended on credit ratings (including AIG's
credit ratings and, occasionally, the ratings of notes that
were issued with respect to different tranches of the
transaction), loss models from rating agencies, or changes in
spreads on certain credit indices (although they did not depend
on the value of any underlying reference obligation).\879\ For
some of AIG's regulatory capital contracts, AIG was required to
enter into a CSA in the event its credit rating dropped below a
specified threshold, and after September 2008 AIG was required
to implement a CSA or alternative collateral arrangement for a
majority of the regulatory capital transactions for which it
was obligated to put a CSA in place if its ratings
dropped.\880\ For its multi-sector CDO arbitrage portfolio,
AIG's calculation of exposure modified the standard CSA
provisions and substituted instead a formula based on the
difference between the net notional amount of the transaction
and the market value of the relevant underlying CDO security
(as opposed to the replacement value of the transaction).\881\
The arbitrage portfolio also required transaction-specific
thresholds, which varied based on the credit ratings of AIG
and/or the reference obligations.\882\
---------------------------------------------------------------------------
\877\ Sjostrum Law Review Article, supra note 846.
\878\ Market Review of OTC Derivative Bilateral Collateralization
Practices, supra note 851, at 7.
\879\ AIG Form 10-K for FY07, supra note 41.
\880\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 119.
\881\ Replacement value is an alternative form of valuing the
amounts due under a closed-out contract that the 2002 Agreement added
to the measures in the 1992 Agreement. See Mayer Brown Rowe & Maw, 2002
ISDA Master Agreement, at 1 (2002) (online at www.mayerbrown.com/
publications/article.asp?id=332&nid=6) (``If transactions under the
1992 Agreement are terminated following an Event of Default or a
Termination Event, a close-out amount is calculated in accordance with
the payment measure elected by the counterparties. The two optional
payment measures in the 1992 Agreement are Market Quotation and Loss. A
new payment measure, `Replacement Value,' has been developed to replace
both of these existing methods. This new measure incorporates many
aspects of both existing methods of calculating the early termination
payment while seeking to give the Non-defaulting Party discretion and
flexibility in determining the value of any terminated transactions
(subject always to the requirement of good faith and commercial
reasonableness)''). See generally International Swaps and Derivatives
Association, 2005 ISDA Collateral Guidelines (2005) (online at
www.isda.org/publications/pdf/2005isdacollateralguidelines.pdf).
\882\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 119.
According to AIG, the multi-sector CDO portfolio includes 2a-7 Puts,
pursuant to which holders of securities are required, in certain
circumstances, to tender their securities to the issuer at par. AIG's
contracts provide that if an issuer's remarketing agent is unable to
resell the securities so tendered, AIGFP must (except under certain
circumstances) purchase the securities at par. At both March 31, 2010
and December 31, 2009, there was $1.6 billion net notional amount of
2a-7 Puts issued by AIGFP outstanding. AIG Form 10-Q for the First
Quarter 2010, supra note 731, at 55.
---------------------------------------------------------------------------
According to its quarterly report, as of September 30, 2008
the collateral calls derived largely from counterparties
relating to multi-sector CDOs, and to a lesser extent, with
respect to regulatory capital relief purposes and in respect of
corporate debt/CLOs.\883\ Since most of the collateral posting
requirements that befell AIG starting in June, 2007 derived
from the difference between the notional amount of the CDS and
the market value of the reference obligation,\884\ is worth
noting that the ratings triggers were not the proximate cause
of the initial collateral calls. Rather, the collateral calls
resulted from the significant and substantial deterioration in
the value of the reference obligations around which the CDSs
were built. The ratings triggers, however, came in to play when
AIG was already struggling, and magnified its difficulties.
AIG's variable thresholds were not necessarily unique to AIG,
although AIG has since been identified as an object lesson for
the procyclical dangers of credit-rating triggered collateral
posting requirements. Through such ratings triggers, an
individual institution's efforts to reduce its exposure to a
struggling counterparty can have significant systemic
effects.\885\
---------------------------------------------------------------------------
\883\ AIG Form 10-Q for Third Quarter 2008, supra note 23, at 119.
\884\ Sjostrum Law Review Article, supra note 846.
\885\ Bank for International Settlements, The Role of Margin
Requirements and Haircuts in Procyclicality, at 11 (Mar. 2010) (online
at www.bis.org/publ/cgfs36.pdf?noframes=1) (``While triggers can
effectively protect creditor interest against idiosyncratic shocks,
they exacerbate procyclicality when the counterparty involved is
systemically important and faces financial distress. This was
forcefully demonstrated when the credit rating of the insurance company
AIG was downgraded, triggering significant amounts of collateral
payments that ultimately were met through government intervention'');
Market Review of OTC Derivative Bilateral Collateralization Practices,
supra note 851, at 45.
(``Recommendation 10: The use of credit-based Thresholds that
reduce as credit ratings decline or credit spreads widen should be
carefully considered. Parties that elect to use these elements in
collateral arrangements should recognize that they may have a
ratcheting effect that reduces credit risk to one party while
simultaneously increasing liquidity demands on the other party if the
latter suffers credit deterioration. Accordingly, both parties should
ensure that they have in place appropriate monitoring to (a) detect and
respond to credit deterioration in their counterparty and (b) forecast
and manage the liquidity impact of their own credit deterioration.
Alternatively, the use of fixed thresholds and/or frequent margin calls
should also be considered, and all collateral structures should be
considered in the context of guarantees and other credit risk mitigants
that may be available.'')
---------------------------------------------------------------------------
Since September 2008, AIG has been in the process of
unwinding AIGFP's CDS contracts. As of November 17, 2009, AIG's
total CDS exposure had fallen about 32 percent since the end of
2008, from $302 billion to $206 billion.\886\ In the quarter
ended March 31, 2010, AIG reported that it continued to wind
down its CDS portfolio. Among other things, its regulatory
capital portfolio shrank according to its terms: these
contracts as part of their terms and after could be terminated
by counterparties at no cost to AIGFP after regulatory events
such as the implementation of Basel II.\887\ The arbitrage
portfolio is composed of CDSs with long-term maturities, and at
present AIG is unable to predict or estimate when the final
payments will be made.\888\ AIG is, functionally, either
attempting to sell its positions or is allowing them to expire
according to their terms. Some of its positions are such that
it will be unable to sell them--for example there is no market
for the regulatory capital hedges--and AIGFP must therefore
allow them to expire according to their terms or close them out
if a credit event occurs.
---------------------------------------------------------------------------
\886\ SIGTARP Report on AIG Counterparties, supra note 246, at 25.
\887\ AIG Form 10-Q for the First Quarter 2010, supra note 731, at
55.
\888\ AIG Form 10-Q for the First Quarter 2010, supra note 731, at
57.
ANNEX IV: LEGAL AUTHORITIES

A. The Bankruptcy Rules That Would Have Applied to AIG

Generally, when a company files for bankruptcy, its
creditors will be subject to an automatic stay or an injunction
that prevents the creditors from taking further action to
collect on their debts.\889\ Thus, the debtor's assets will be
protected while negotiations take place with creditors.
Creditors will be grouped by their level of priority, and
creditors of the same priority level will receive equal
treatment under the bankruptcy plan.\890\ Often, unsecured
creditors will be forced to take substantial discounts on what
they are owed, and equity holders lose the entire value of
their investments. Creditors can request relief from the
automatic stay in certain situations such as foreclosing on
collateral if the creditor is fully secured or offsetting
certain obligations with the debtor.\891\ If a
creditor has received favorable treatment while the debtor was
insolvent (generally assumed within 90 days of the bankruptcy
filing), the bankruptcy trustee will be able to undo this
favorable treatment through various avoidance actions such as
preferential transfer, constructive fraudulent conveyance, and
actual fraudulent conveyance actions.\892\ The trustee also has
the power to assume or reject executory contracts (i.e.,
contracts in which the parties have not completed performance)
and to ignore contractual provisions that allow for
modification or termination of contractual rights or
obligations based on the debtor's financial condition or
bankruptcy filing.\893\ These provisions, among others, provide
a legal structure for the orderly reorganization or liquidation
of businesses in need of bankruptcy protection. However, the
complex structure of AIG combined with a variety of provisions
in the United States Bankruptcy Code giving additional
protection or favorable treatment to the counterparties to
AIG's various financial instruments would have complicated the
bankruptcy process for AIG.
---------------------------------------------------------------------------
\889\ See 11 U.S.C. 362(a). It should be noted that the overall
bankruptcy structure presented in this paragraph applies to both
Chapter 7 and Chapter 11 of the Bankruptcy Code.
\890\ See 11 U.S.C. 507.
\891\ See 11 U.S.C. 362(d), 553(a).
\892\ See, e.g., 11 U.S.C. 547 (providing that the trustee may
avoid preferential transfers), 548 (providing that the trustee may
avoid fraudulent transfers).
\893\ 11 U.S.C. 365(e)(1).
---------------------------------------------------------------------------
U.S. bankruptcy courts do not have jurisdiction over all
types of debtors and would not have had jurisdiction over all
of AIG's companies or subsidiaries. The AIG corporate structure
includes a parent company and at least 223 subsidiaries that
engage in a wide range of business activities in over 130
countries or jurisdictions. These activities include domestic
and foreign insurance-related activities, the issuance of
commercial paper to finance operations, mortgage lending, and
the structuring and sale of a variety of standard and
customized financial products (e.g., CDSs or securities
lending).\894\ AIG's domestic insurance companies, bank,
foreign insurance companies, and other foreign companies
without sufficient ties to the United States would not be able
to seek protection under U.S. bankruptcy law.\895\ This
complicates a potential bankruptcy filing for AIG in two ways.
First, AIG would have to ascertain which of its companies could
file a bankruptcy petition, presumably Chapter 11
(reorganization) rather than Chapter 7 (liquidation), and then
decide which of its companies would do so.\896\ This can be an
intensive and time consuming process and would involve a
careful analysis of the corporate structure, financial
condition of each company or subsidiary, the existence of
intercompany lending arrangements or guarantees, the applicable
law, the likely outcome of the bankruptcy filing, and the
practical consequences of such a filing on current or future
consumers, suppliers, creditors, and investors. Second, AIG
would have to consider the impact of a bankruptcy filing on the
subsidiaries that did not or could not file, their various
regulators, the relevant markets (e.g., capital markets or the
derivatives market), and the general public.
---------------------------------------------------------------------------
\894\ See GAO Report, supra note 18.
\895\ See 11 U.S.C. 109(a) (requiring debtors to have a U.S.
connection), (b)(2) (excluding domestic insurance companies and certain
banks from Chapter 7), (b)(3) (excluding foreign insurance companies
from Chapter 7), (d) (making these Chapter 7 exclusions applicable to
Chapter 7).
\896\ The decision of which subsidiaries would file for bankruptcy
is done on an entity-by-entity basis and requires board resolution. If
the subsidiary is wholly owned by the parent company, this decision
will be influenced by the parent company because the parent company
appoints the board of directors.
---------------------------------------------------------------------------
The impact of a bankruptcy filing on the insurance
subsidiaries could provide particular concern because of the
size of AIG's insurance business and the potential impact on
its various policyholders. And, there is at least some concern
that a number of the insurance subsidiaries were not
sufficiently capitalized to handle the liquidity pressures from
the securities lending program on their own.\897\ There is some
uncertainty as to what would have happened to AIG's various
insurance subsidiaries if the parent company had filed;
however, a few general conclusions can be drawn. Upon filing,
the insurance regulators would not necessarily have changed
their approach to AIG's insurance subsidiaries. The insurance
regulators had been monitoring the activities and financial
condition of the insurance subsidiaries prior to September 2008
and believed that they were solvent or sufficiently
capitalized.\898\ The insurance regulators would have been
concerned about the impact of the filing on the subsidiaries'
books of business and would have monitored the behavior of
policyholders such as heightened surrender activity for life
insurance policyholders and decreased renewal rates for
shorter-term commercial and property insurance policies.\899\
However, it is likely that the insurance regulators would have
seized the insurance subsidiaries, or put them under a stricter
form of supervision, regardless of their financial condition in
order to more effectively protect the subsidiaries from the
bankruptcy process.\900\
---------------------------------------------------------------------------
\897\ AIG's Insurance Subsidiaries, supra note 591, at 6. For
additional discussion of the government assistance provided to the AIG
insurance subsidiaries, see Section E. The insurance subsidiaries
received capital contributions from the parent company to offset
realized losses from the sale of RMBS as part of the securities lending
transactions ($5 billion), to maintain capital surplus levels upon
unrealized losses in the RMBS investments, and to make up the shortfall
in securities lending arrangements when collateral levels were below
100 percent ($434 million). Panel conference call with Texas Department
of Insurance (May 24, 2010).
\898\ Conference call with the National Association of Insurance
Commissioners and representatives from the New York, Pennsylvania, and
Texas insurance departments (Apr. 27, 2010). The supervisors have
informed the Panel staff that they would not necessarily have seized
the subsidiaries and mentioned the Chapter 11 reorganization of Conseco
Inc. in 2003 as a practical example of a holding company bankruptcy
that did not necessitate insurance regulator intervention. Panel staff
conversation with Texas Department of Insurance (May 24, 2010); Panel
staff conversation with NAIC (Apr. 27, 2010).
\899\ Current insurance customers may have been concerned about
their policies, deciding to take their business elsewhere or taking out
the cash surrender value of their life insurance policies. And, the
insurance subsidiaries may not have been able to attract new customers
because of fear about the subsidiary's financial condition or the
ability to make contractual insurance payments.
\900\ If the AIG insurance subsidiary was solvent at the time of
the filing, the supervisor would choose to first closely watch and
monitor its position. Panel staff call with New York Insurance
Department (June 3, 2010). It is likely, however, that the supervisor
would seize even the healthy subsidiaries in order to protect them from
the bankruptcy. Panel staff conversation with Jay Wintrob, the CEO of
the SunAmerica Financial Group (May 27, 2010). If the regulators had
placed the insurance subsidiaries into some form of rehabilitation,
they would have had more power in the bankruptcy (e.g., by exercising
additional regulatory authority to operate, reorganize, or liquidate
the subsidiaries), and they would have been able to more fully assess
the financial condition of the subsidiaries because of greater access
to their books and records. But see Panel staff call with New York
Insurance Department (June 3, 2010) (the regulators would not have
seized the subsidiaries because they were well capitalized).
---------------------------------------------------------------------------
Because insurance is regulated by the states, each state
could have slightly different legal processes for taking
greater oversight or control of its insurance subsidiaries. For
example, in Texas, the Commissioner of Insurance has the option
of placing a company under supervision.\901\ Supervision does
not involve an actual seizure of the company, but it provides
the Commissioner with greater powers to direct the actions of
the company ``without immediate resort to the harsher remedy of
receivership.''\902\ In the case of AIG, supervision would have
been confidential.\903\ Once the Commissioner has put a company
under supervision, it may later be converted to
receivership.\904\ If the Commissioner determines that a
receivership is appropriate, then he or she may put the company
into receivership by commencing a delinquency proceeding in
Texas state court.\905\ Texas has other tools in its arsenal.
For example, the Commissioner can take action against a company
whose financial condition is ``hazardous,'' requiring it to
increase its capital and surplus.\906\
---------------------------------------------------------------------------
\901\ Tex. Ins. Code Ch. 441; 28 Tex. Admin Code Sec. 8. A
conservatorship under Texas law is similar, but imposes more stringent
requirements on the Commissioner. For example, supervision is ex parte,
but conservatorship requires notice and hearing or consent by the
company.
\902\ Tex. Ins. Code Ch. 441.001(f).
\903\ It is confidential when there is the protection of a guaranty
fund. Tex. Ins. Code Ch. 441.201(f). AIG might have been required by
auditors, ratings agencies, or disclosure laws to disclose a
supervision.
\904\ Tex. Ins. Code Ch. 443.057(8).
\905\ Tex. Ins. Code Ch. 443.005, 443.057. Texas law provides 22
grounds under which the Commissioner files for rehabilitation or
liquidation. These grounds include impairment, insolvency, and when the
``insurer is about to become insolvent.'' Tex. Ins. Code Ch. 443.057.
\906\ Tex. Ins. Code Ch. 404.003; 404.053.
---------------------------------------------------------------------------
The New York Insurance Department has 15 grounds for
putting a domestic insurance company into rehabilitation or
liquidation.\907\ These grounds include insolvency.\908\ If the
New York Superintendent needed to put a solvent subsidiary into
rehabilitation to protect it from actions taken in a
bankruptcy, he or she could do so by finding ``after
examination, [the insurer] to be in such condition that its
further transaction of business will be hazardous to
policyholders, creditors, or the public.''\909\ In order to put
a company into rehabilitation, the superintendent, represented
by the attorney general, will need to get a court order.\910\
---------------------------------------------------------------------------
\907\ NY Ins. Code Sec. 7402.
\908\ NY Ins. Code Sec. 7402(a).
\909\ NY Ins. Code Sec. 7402(e).
\910\ NY Ins. Code Sec. 7417.
---------------------------------------------------------------------------
The state insurance regulators would have worked with each
other as well as with the bankruptcy court, company management,
and bankruptcy counsel to ensure that actions taken during the
parent company's bankruptcy would not adversely affect the
insurance subsidiaries (actively participating in bankruptcy
hearings and filing relevant court orders). For example, the
insurance regulators would have to approve the taking of
material amounts from the insurance subsidiaries (cash or other
assets) or the purchase of the insurance subsidiary by a third
party. The regulators would have unwound the securities lending
agreements and brought the insurance subsidiaries' share of the
collateral in the investment pool onto their balance sheet.
During the course of the bankruptcy, if the regulators believed
that there was sufficient harm to the insurance subsidiaries or
that liquidity or insolvency concerns had emerged, they would
place the relevant insurance subsidiaries under heightened
supervision or into conservation, rehabilitation, or
liquidation, if they had not yet done so. In the worst case
scenario, the regulators would have seized the insurance
subsidiaries, ceased paying the surrender values of life
insurance policies (stopping a run on the life insurance
companies, if one had developed), sealed off the company, and
preserved the assets to pay off the liabilities.
Seizure of the insurance subsidiaries could have caused
protracted delays in paying claims to policyholders. In the
past, smaller insurance receiverships have taken up to 10 to 20
years to pay all claims. It could also have caused significant
stress to other, solvent insurance companies. When an insurance
company goes into receivership, claims that cannot be paid out
of the company are paid by the state guarantee fund. State
guarantee funds are funded through assessments on the solvent
insurance companies in the state. These assessments have annual
caps that, based on AIG's size, likely would have been hit,
requiring additional assessments the following year. These
assessments could have caused substantial strain on these
solvent insurance companies.\911\
---------------------------------------------------------------------------
\911\ Panel staff conversation with industry experts (May 14,
2010).
---------------------------------------------------------------------------
If the parent company of AIG and some of its eligible
subsidiaries decided to file a bankruptcy petition, the
bankruptcy laws would not have protected AIG from heightened
liquidity problems, the almost complete loss of value of its
derivative portfolio, the loss of key sources of short-term
funding, or the loss of assets that had been posted as
collateral prior to the bankruptcy filing. In general,
bankruptcy is fundamentally different for financial companies
whose business relationships and financial transactions depend
on trust or confidence. For this reason, a bankruptcy filing
would have been a death warrant for AIG as a financial company
because neither financial institutions nor others will do
business with a company if they fear that default is a
possibility. Further, the Bankruptcy Code includes a number of
safe harbors that would have exempted counterparties to various
``financial instruments''--defined broadly to include AIG's
CDSs and repurchase agreements--from the automatic stay, the
prohibition on modifying or terminating contracts based on a
bankruptcy filing, and various avoidance actions related to
pre-bankruptcy collateral transfers.\912\
---------------------------------------------------------------------------
\912\ See 11 U.S.C. 362(b)(6), (b)(7), (b)(17), (b)(27), (o)
(exempting various financial participants or holders of commodities
contracts, forward contracts, securities contracts, repurchase
agreements, swap agreements, and master netting agreements from the
automatic stay); 11 U.S.C. 555, 556, 559, 560, 561, 553, 365(e)(1)
(providing that counterparties to securities contracts, forward
contracts, commodities contracts, repurchase agreements, swap
agreements, and master netting agreements cannot be prevented from
exercising any contractual right to liquidate, terminate, or accelerate
their contracts or from offsetting or netting out any termination
value, payment amounts, or other obligations); 11 U.S.C. 546(e)-(g),
(j) (providing that the trustee cannot avoid transfers made in relation
to securities contracts, commodity contracts, forward contracts,
repurchase agreements, swap agreements, and master netting agreements
based on sections 544 (strong arm provision), 545 (statutory liens),
547 (preferences), or 548(a)(1)(B) and 548(b) (constructive fraudulent
transfers); 11 U.S.C. 548(c), (d)(2) (impairing the trustee's ability
to bring actual fraudulent transfer actions by protecting
counterparties to the extent that they gave value and providing that
transfers related to margin payments or transfers related to
repurchase, swap, and master netting agreements are always for value).
For definitions of these terms, see 11 U.S.C. 101(22A) (defining
``financial participant''), (25) (defining ``forward contract''), (26)
(defining ``forward contract merchant''), 47 (defining ``repurchase
agreement''), 46 (defining ``repo participant''), 53B (defining ``swap
agreement''), 53C (defining ``swap participant''), 38A (defining
``master netting agreement''), 38B (defining ``master netting agreement
participant''). The bankruptcy court in the Lehman Brothers case has
recently clarified that this option has temporal limitations or must be
exercised ``fairly contemporaneously with the bankruptcy filing'' and
that the safe harbors only protect those actions listed in the
provisions. See Wilbur F. Foster, Jr., Adrian C. Azer, and Constance
Beverly, Court Explores Termination Rights Under Bankruptcy Code
Section 560, Pratt's Journal of Bankruptcy Law, at 505-506 (Nov./Dec.
2009).
---------------------------------------------------------------------------
In combination, these provisions would have cut off AIG's
top-level overnight or short-term funding through repurchase
agreements. If AIG had filed for bankruptcy, the counterparties
to these derivative instruments would have called their loans,
rather than allowing them to roll over (similar to a revolving
credit line), and would have withdrawn funds or seized
collateral.\913\ And, the counterparties to AIG's CDS
agreements would have terminated or closed out their contracts
(terminating their payment obligations), seized any collateral
posted prior to the filing, attempted to purchase replacement
positions, and asserted a claim for any deficiency or
unrecovered amounts. The deficiency claims asserted by the
counterparties, if any, would have been subject to the discount
negotiated for unsecured creditors in the bankruptcy plan.
---------------------------------------------------------------------------
\913\ See 11 U.S.C. 362(b)(7), (b)(27); 11 U.S.C. 553, 559, 561.
---------------------------------------------------------------------------
Although bankruptcy proceedings would have provided a legal
mechanism to reorganize or liquidate the AIG parent company and
its derivative portfolio, such proceedings would not have
addressed the potential impact on its insurance subsidiaries,
their regulators, or their customers. Bankruptcy proceedings
also would not have addressed the impact of AIG's filing (or
general default on its obligations) on the counterparties to
its various derivative contracts or to the financial system as
a whole. All of the counterparties to AIG's derivative
contracts would have closed out their contracts creating some
level of market panic as the counterparties attempted to
mitigate their damages by seizing previously posted collateral,
selling securities, or purchasing replacement positions and as
the counterparties adjusted their financial statements to
properly reflect newly calculated risk levels or asset values.
However, such external considerations are outside the scope of
the bankruptcy law. The extent to which an AIG filing would
have destabilized the capital markets and whether the markets
would have been able to recover from such a filing in a timely
manner or without severe disruptions is unclear. However, it is
clear that there was no resolution authority in place that
could manage both the resolution of AIG and the systemic
consequences of an AIG failure.

B. Section 13(3) of the Federal Reserve Act

Section 13(3) of the Federal Reserve Act provides three
express limitations on the Federal Reserve's emergency lending
authority: (1) the Board of Governors must determine that
unusual and exigent circumstances exist, by the affirmative
vote of at least five members, (2) the loans must be secured to
the satisfaction of the Federal Reserve Bank, and (3) the
Federal Reserve Bank authorized to make the loans must have
obtained evidence that adequate credit was not available from
other banking institutions.\914\
---------------------------------------------------------------------------
\914\ 12 U.S.C. 343. For additional explanation of Section 13(3),
see Section C.4.
---------------------------------------------------------------------------
In general, the Federal Reserve and FRBNY satisfied these
three express limitations when providing assistance to AIG in
the form of four credit facilities: the RCF, SBF, ML2, and ML3.
The Board of Governors authorized each of the facilities after
determining that unusual and exigent circumstances existed by
the affirmative vote of at least five members, meeting the
first prong.\915\ The Board authorized the general structure or
terms of the facilities and the maximum amounts that could be
borrowed from FRBNY. FRBNY also reviewed the assets being
pledged as collateral for adequacy and determined that the
collateral secured the facilities to its satisfaction, meeting
the second prong.\916\ Finally, FRBNY used the authorization
provided by the Board of Governors to finalize the specific
terms and to enter into the facilities after verifying that
adequate credit was not available to AIG from other banking
institutions, meeting the third prong.\917\ Where necessary,
the Federal Reserve and FRBNY relied on their legal authority
to take actions that were incidental to their lending
authority. For example, FRBNY relied on its incidental powers
to require the equity kicker of 79.9 percent of AIG's stock
(given to Treasury), to set up the SPVs for the Maiden Lane
facilities, and to accept preferred equity in AIA and ALICO in
partial forgiveness of AIG's outstanding obligations.\918\ The
following discussion will provide an analysis of the Board's
decision regarding the general structure of the facilities as
well as the adequacy of the collateral accepted as security.
---------------------------------------------------------------------------
\915\ See Federal Reserve Press Release, supra note 266; Federal
Reserve Press Release, supra note 320; Federal Reserve Press Release
Announcing Restructuring, supra note 330; Treasury and the Federal
Reserve Announce Participation in Restructuring, supra note 518; Board
of Governors of the Federal Reserve System, Minutes: Financial
Markets--Extension of credit to American International Group, Inc.
(Sept. 16, 2008), Board of Governors of the Federal Reserve System,
Minutes: American International Group, Inc.--Proposal to provide a
securities lending facility (Oct. 6, 2008).
\916\ Panel staff conversation with Federal Reserve Board staff
(May 27, 2010).
\917\ Panel staff conversation with Federal Reserve Board staff
(May 27, 2010).
\918\ Panel staff conversation with Federal Reserve Board staff
(May 27, 2010).
---------------------------------------------------------------------------
The structure of the revolving credit facility fits most
neatly into the Federal Reserve's Section 13(3) lending
authority. Section 13(3) authorizes the Federal Reserve to
``discount . . . notes, drafts, and bills of exchange.'' \919\
The term ``discount'' has been interpreted broadly to refer to
any purchase of paper (or essentially any advance of funds in
return for a note) with previously computed interest.\920\ The
RCF provided for the advance of funds by FRBNY to AIG in return
for an interest-bearing note or credit agreement.\921\ The
quality of the assets pledged as collateral to secure the
facility and the requirement that AIG ``gift'' almost 80
percent of its stock to Treasury as an ``equity kicker''
(pursuant to its incidental powers) raise more difficult
questions.
---------------------------------------------------------------------------
\919\ 12 U.S.C. 343.
\920\ Panel staff conversation with Federal Reserve Board staff
(May 27, 2010). See also Small and Clouse (2004) (stating that Section
13(3) provides virtually no restrictions on the form a credit
instrument must take in order to be eligible for discount because the
terms ``notes, drafts, and bills of exchange'' include most forms of
written credit instruments); Board of Governors of the Federal Reserve
System, Federal Reserve Bulletin, at 269 (Mar. 1958) (providing that
``the judicial interpretations of the word `discount' show that the
term is used very broadly. In practice the term `bank discount' is
applied broadly to transactions by which a bank computes interest in
advance so that there is the possibility of compound interest, and it
seems that any purchase of paper is a `discount' in that sense since it
permits such advance computation and compounding.''). The purchase of
paper--including notes, promissory notes, drafts, and bills of
exchange--recourse or non-recourse--does not necessarily have to be at
an amount less than the principal amount of the paper. Id.
\921\ FRBNY provided funds to AIG in return for a series of demand
notes until FRBNY and AIG entered into a Credit Agreement that
established the credit facility (the existing demand notes were
canceled and the amounts due were transferred to the facility). See
Board of Governors of the Federal Reserve System, Report Pursuant to
Section 129 of the Emergency Economic Stabilization Act of 2008:
Secured Credit Facility Authorized for American International Group,
Inc. on September 16, 2008, at 4 (online at www.federalreserve.gov/
monetarypolicy/files/129aigseccreditfacility.pdf) (hereinafter
``Federal Reserve Report Pursuant on Secured Credit Facility Authorized
for AIG''). For additional information on the Revolving Credit
Facility, see Section D.1.
---------------------------------------------------------------------------
FRBNY accepted the unencumbered assets of AIG, including
AIG's stock in its regulated insurance subsidiaries, as
collateral for the $85 billion credit facility.\922\ The
Federal Reserve relied on information collected by the private
consortium (that attempted but ultimately failed to provide
capital to AIG) and on a third-party evaluation to estimate the
value of the pledged assets.\923\ Although reasonable minds can
certainly differ on the value of a company or its assets,
especially a company as complicated as AIG with market
conditions as disrupted as they were, there are some aspects of
an AIG asset valuation worth noting.
---------------------------------------------------------------------------
\922\ See Federal Reserve Press Release, supra note 266; Federal
Reserve Report Pursuant on Secured Credit Facility Authorized forAIG,
supra note 921, at 5-7. For additional information on the Revolving
Credit Facility, see Section D.1. It should be noted that the assets
pledged as collateral did not include securities loaned by the
insurance subsidiaries to various counterparties (the counterparties
owned the loaned securities), the RMBS purchased with the cash
collateral from the counterparties to the securities lending agreements
(they were encumbered and thus unable to provide security), or the CDOs
or underlying reference securities to CDS contracts issued by AIG (they
were owned or intermediated by the CDS counterparties).
\923\ Morgan Stanley, which had been hired as an advisor to FRBNY,
provided information on the value of the potential collateral to the
private consortium. Ernst & Young advised the Federal Reserve Board and
FRBNY on the valuation of potential collateral. The latter evaluation
was completed before the credit agreement was signed, but not before
the Federal Reserve announced the Revolving Credit Facility on
September 16 and the first overnight loans were made. The overnight
loans made before the credit agreement was signed were secured by AIG
securities that the Reserve Bank valued as satisfactory for the amount
of credit extended (roughly $37 billion). Panel staff conversation with
Federal Reserve Board staff (June 8, 2010); Panel staff conversation
with Federal Reserve Board staff (May 27, 2010); Federal Reserve Report
Pursuant on Secured Credit Facility Authorized for AIG, supra note 921,
at 4.
---------------------------------------------------------------------------
Although FRBNY determined that the $85 billion RCF was
secured to its satisfaction, only days before a private sector
consortium apparently concluded that AIG did not have
sufficient assets to secure a $75 billion loan.\924\ In
addition, the valuation of some of the assets--including the
stock in AIG's insurance subsidiaries--may have been higher
because of the Federal Reserve's support to AIG. The Federal
Reserve was entitled to take into account the impact of its
intervention on the value of the collateral it was taking. In
the event that AIG later defaulted, however, the consequences
that the government was trying to avoid (bankruptcy of the
parent company, seizure of the insurance subsidiaries, or both)
may have occurred, driving down the value of the insurance
subsidiaries (and the stock in the insurance subsidiaries that
were pledged as collateral to secure the RCF).
---------------------------------------------------------------------------
\924\ Although both the Federal Reserve and the private consortium
were evaluating assets of AIG, it is not clear whether they were
evaluating the exact same assets or collateral package. For additional
discussion of the private sector consortium, see Sections C.1 and C.2.
---------------------------------------------------------------------------
The requirement that AIG provide an ``equity kicker'' in
return for the RCF (as part of its incidental powers) is also
unique as a requirement for government or central bank
assistance. Although ``equity kickers'' are common requirements
in commercial loans--and the requirement to provide 79.9
percent of AIG stock was one of the proposed terms for the
private consortium--such ``equity kickers'' are not common for
central banks and have never before been required by the
Federal Reserve as a condition for a loan.\925\
---------------------------------------------------------------------------
\925\ Panel staff conversation with Federal Reserve Board staff
(May 27, 2010).
---------------------------------------------------------------------------
Like the $85 billion RCF, the subsequent $37.8 billion SBF
fits neatly into the Federal Reserve's lending authority under
Section 13(3). As part of this facility, FRBNY can replace
existing securities lending counterparties of AIG.\926\ If the
counterparties wish to exit the program, FRBNY will borrow the
investment grade debt obligations from AIG that had been loaned
to those counterparties (the borrowed obligations serving as
collateral for the transaction) in return for cash collateral
``with an interest rate of 100 basis points above the average
overnight repo rate offered by dealers on the relevant
collateral type.'' \927\ Further, in comparison to the assets
pledged as collateral for the RCF, the assets pledged as
collateral for the SBF are less risky and more easily valued,
including only investment grade debt obligations such as
corporate debt obligations, agency pass-through certificates,
and obligations of foreign and local governments. As mentioned
above, these assets were not eligible to be pledged as
collateral for the RCF because they had already been loaned to
the securities lending counterparties.\928\
---------------------------------------------------------------------------
\926\ For additional information on AIG's securities lending
program, see Section B.3 and Annex V, and for additional information on
the Securities Borrowing Facility, see Section D.1.
\927\ Securities Borrowing Facility for AIG, supra note 264, at 3.
Broken down, securities lending agreements have two parts: (1) the
borrower purchases the securities (in this case fixed income debt
obligations) from the lender for a certain price (in this case cash
collateral ``with an interest rate of 100 basis points above the
average overnight repo rate offered by dealers on the relevant
collateral type'') and (2) the borrower agrees to sell and the lender
agrees to purchase equivalent securities for the same price as the
original transfer upon the demand of either party. In addition to the
debt obligations pledged as collateral, the advances were made with
recourse to AIG (providing additional security for the loans).
\928\ Securities Borrowing Facility for AIG, supra note 264, at 3.
---------------------------------------------------------------------------

3. Maiden Lane II

The ML2 facility provides a less straightforward fit with
the Federal Reserve's authority under Section 13(3) because of
its more complicated structure. FRBNY created a wholly-owned
SPV (ML2). The Federal Reserve authorized FRBNY to loan up to
$22.5 billion to the SPV under a senior note (and AIG loaned $1
billion to the SPV under a subordinated note). The SPV then
purchased RMBS from AIG insurance subsidiaries (related to the
securities lending program) at their fair market value as of
October 31, 2008.\929\
---------------------------------------------------------------------------
\929\ Federal Reserve Report on Restructuring, supra note 329, at
5, 7-8. For additional discussion of the ML2 facility, see Sections D.3
and F.4.
---------------------------------------------------------------------------
The Federal Reserve Board staff explained that FRBNY
created the SPV using its incidental powers for practical
purposes. The SPV provided a convenient structure to segregate
the RMBS assets and make the ML2 facility more transparent (by
making it easier to identify the owner of the assets and to
generally control, value, audit, and report on the assets).
Thus, placing the assets into the SPV was ``incidental'' to
purchasing those assets at a discount.\930\ Technically, an SPV
is a ``person,'' even if wholly owned by the bank that created
it (in this case, FRBNY); thus, it could be the recipient of a
loan under Section 13(3). In substance, however, FRBNY was
lending money to itself under Section 13(3) and then using the
funds to purchase RMBS.\931\ The Federal Reserve Board staff
further explained that you can ``look through'' the SPV to see
that FRBNY was discounting the RMBS assets. Each RMBS was
itself a promissory note or debt obligation so FRBNY was
essentially purchasing a note or debt obligation at a discount
(a practice that fits more neatly under its 13(3) lending
authority).\932\
---------------------------------------------------------------------------
\930\ Panel staff conversation with Federal Reserve Board staff
(May 27, 2010). It should be noted that the RMBS assets in ML2 are
consolidated onto the Federal Reserve's balance sheet (so the SPV
structure was not used as a means to achieve an off balance sheet
transaction with AIG.
\931\ FRBNY loaned to ML2 under a senior note. The loan accrued
interest (at a rate of 1-month LIBOR plus 100 basis points) and was
fully secured by the RMBS portfolio. The loan was non-recourse, meaning
that payment could only be collected from the RMBS assets. Panel staff
conversation with Federal Reserve Board staff (May 27, 2010); Federal
Reserve Report on Restructuring, supra note 329, at 7
\932\ The RMBS were third party notes; third parties were required
to make payments to AIG. AIG sold this payment stream to FRBNY.
---------------------------------------------------------------------------
The Federal Reserve Board staff characterized this loan as
a ``haircut'' because FRBNY loaned $19.5 billion in cash in
return for RMBS with a par value of $40 billion (a haircut of
around 50 percent). This loan, however, did not require a
``haircut'' in the normal sense of the term. The securities
lending counterparties were not required to take a haircut or
make concessions; AIG paid these counterparties in full with
the help of the funds provided by FRBNY. The fact that the par
value of the RMBS (which served as collateral for the loan) was
almost twice the amount of the loan supports the Board's
conclusion that the loan was overcollateralized.

4. Maiden Lane III

The 13(3) analysis of the ML3 facility is more complicated
because in ML3, FRBNY purchased the debt obligations from the
counterparties to AIG's CDS contracts, rather than from AIG or
its subsidiaries.\933\ Even though the termination of the CDS
contracts and the purchase of the CDOs from the CDS
counterparties benefited AIG (an institution that could not
obtain credit from alternative banking institutions), ML3 did
not involve a loan to AIG or a purchase of notes or debt
obligations owned by AIG. ML3 involved a loan to an SPV wholly
owned by the FRBNY or a purchase of notes or debt obligations
from CDS counterparties of AIG (institutions that likely could
obtain adequate credit from other banking institutions). Thus,
whether one respects the separate corporate status of the SPV,
or looks through the SPV, the purchases were made for the
benefit of, but not from, institutions that were otherwise
unable to obtain credit, unless one regards the SPV itself as
being unable to do so.
---------------------------------------------------------------------------
\933\ The 13(3) analysis for ML3 is otherwise similar to the ML2
analysis. FRBNY created a wholly-owned special purpose vehicle or SPV
(ML3). FRBNY then loaned up to $30 billion to the SPV under a senior
note (and AIG loaned $5 billion to the SPV under a subordinated note).
The SPV purchased CDOs from the CDS counterparties at their market
value as of October 31, 2008. Like the RMBS purchased by ML2, the CDOs
were promissory notes or debt obligations. And, FRBNY's loan to ML3 was
overcollateralized; FRBNY loaned $24.3 billion to ML3 in return for
CDOs with a par value of $62 billion. For additional discussion of the
terms and reasons for the ML3 facility, see Section D.4. See also
Federal Reserve Report on Restructuring, supra note 329, at 8-9.
---------------------------------------------------------------------------
Even so, however, one can see the structure in one of three
ways: as a third party agreement to benefit AIG (a purchase of
a discounted note ``for'' AIG, which is all the statute
requires), a restructuring of the original loan made by the
Federal Reserve using its incidental powers to buttress section
13(3), or a purchase by an SPV that could not otherwise obtain
credit (an admittedly weak characterization).
ANNEX V: SECURITIES LENDING

Securities lending was developed as a means for investors
to maintain a long position in a stock while enhancing the
stock's ability to generate profit. Securities lenders are
usually large institutional investors such as mutual funds,
pensions, endowments, and insurance companies. Securities
borrowers may be hedge funds, broker-dealers, or trading desks.
The borrowed securities are most often used to cover a short
sale but may be used for other types of arbitrage or balance
sheet management.
In a typical securities lending transaction, the owner
lends the security to the borrower in exchange for a fee.\934\
The borrower must also post collateral, often cash amounting to
102 to 105 percent of the market value of the security on the
day it is lent. While the security is on loan, the borrower
holds title to the security and its voting rights. In reality,
the security is often sold by the borrower immediately and the
proceeds from the sale used as the collateral. That is, the
security is lent and sold, and the proceeds posted as
collateral as one nearly simultaneous transaction.
---------------------------------------------------------------------------
\934\ This is often accomplished through an agent, who may also
hold and manage the collateral on behalf of the lender.
---------------------------------------------------------------------------
The lender may use the collateral for investments and may
take as its fee a percentage of the profits made from such
investments. As the value of the loaned security fluctuates,
the collateral held by the lender may be adjusted to reflect
the value of the security plus the additional 2 to 5 percent
margin--if the value of the security increases, the borrower
must post more collateral; if the value falls, the lender
returns a portion of the collateral. To repay the loan and
claim the collateral, the borrower must give the lender the
same number and type of security that was borrowed. The primary
risk to a borrower is therefore the possibility that the
security will increase in value and the borrower will have to
buy replacement securities at a price higher than the original
securities were sold.
Lenders usually invest the borrower's collateral in
overnight investments or in other low-risk securities. There is
a chance, however, that a lender will make an imprudent
investment and lose some of the collateral's value. In that
case, the lender will have to make up the difference between
the investment's current value and the collateral owed to the
borrower. In some cases, the lender may be unable to return the
collateral upon request and may therefore become indebted to
the borrower. Additionally, if the collateral is invested in
securities whose value falls rapidly, the lender may face a
double bind: it must return a large portion of the collateral
but it may find the market for the securities in which the
collateral is invested has lost significant liquidity, making
it difficult to sell the investments and redeem the
collateral.\935\
---------------------------------------------------------------------------
\935\ This appears to be what happened to at least one securities
lender in the wake of Lehman's failure and the near-collapse of AIG in
late 2008. BP Corp. North America, Inc. v. Northern Trust Investments,
N.A., 2008 WL 5263695 (N.D. Ill., Dec. 16, 2008).
---------------------------------------------------------------------------
Until the credit crunch of late 2008, securities lending
was viewed as a low-risk activity; since the start of the
current crisis, that view has come into question.
ANNEX VI: DETAILS OF MAIDEN LANE II HOLDINGS

Description of Holdings

ML2 was formed to acquire non-agency (i.e., not eligible
for purchase by Fannie Mae and Freddie Mac) RMBS from the
reinvestment pool of the securities lending portfolio of
several regulated U.S. insurance subsidiaries of the American
International Group, Inc. (the ``AIG Subsidiaries''). At the
time (Q4 2008), 47.1 percent of the securities were rated AAA;
52 percent of the face value of the securities had subprime
collateral.

Valuation of Holdings as of December 2008

On December 12, 2008, ML2 purchased from the AIG subs non-
agency RMBS with an approximate fair value of $20.8 billion,
determined as of October 31, 2008. The purchase was financed
with a $19.5 billion loan from FRBNY, $1.0 billion purchase
price payable to the AIG subsidiaries, and a $0.3 billion
adjustment due to changes between the announcement and
settlement date. The $20.8 billion fair value determination
relies largely on Levels 2 and 3 mark to market accounting
(GAAP) methodology. Level 2 relies upon quoted prices for
similar securities to those being valued. Level 3 employs
model-based techniques that use assumptions not observable in
the market, including option pricing models and discounted cash
flow models.

Valuation of Holdings--Latest Estimate

On May 27, 2010 the net portfolio holdings of ML2 was $15.9
billion and the outstanding principal amount of the loan
extended by FRBNY plus accrued interest was $14.8 billion.

FIGURE 42: SECURITIES SECTOR DISTRIBUTION FOR ML2 \936\

---------------------------------------------------------------------------
\936\ Credit and Liquidity Programs and the Balance Sheet, supra
note 324.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

FIGURE 43: SECURITIES RATING DISTRIBUTION FOR ML2 \937\

---------------------------------------------------------------------------
\937\ Credit and Liquidity Programs and the Balance Sheet, supra
note 324.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

ANNEX VII: DETAILS OF MAIDEN LANE III HOLDINGS

Description of Holdings

ML3 was formed on October 14, 2008, to acquire asset-backed
(ABS) collateralized debt obligations (CDOs) from certain
third-party counterparties of AIGFP. The acquisition took place
in two stages: the first on November 25, 2008 and the second on
December 18, 2008. The majority of the CDOs were categorized as
high grade CDOs; CDOs backed by commercial real estate,
mezzanine CDOs, and other ABS made up the remaining portion. On
December 31, 2008, the ratings composition of ML3 was the
following: AAA (18.1%), AA+ to AA- (27.0%), A+ to A- (9.0%),
BBB+ to BBB- (12.6%) and BB+ and Lower (33.2%).

Valuation of Holdings as of December 2008

The fair value of the assets as of year-end 2008 was $26.7
billion. The fair value of the FRBNY Senior Loan was $24.4
billion. These fair values were determined based largely upon
Level 3 mark to market accounting methodology.

Valuation of Holdings--Latest Estimate

On May 27, 2010, the net portfolio holdings of ML3 were
$23.4 billion while the FRBNY outstanding principal loan amount
plus accrued interest was $16.6 billion.

FIGURE 46: SECURITIES SECTOR DISTRIBUTION FOR ML3 \938\

---------------------------------------------------------------------------
\938\ Credit and Liquidity Programs and the Balance Sheet, supra
note 324.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

FIGURE 47: SECURITIES RATING DISTRIBUTION FOR ML3 \939\

---------------------------------------------------------------------------
\939\ Credit and Liquidity Programs and the Balance Sheet, supra
note 324.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

ANNEX VIII: COMPARISON OF EFFECT OF RESCUE AND BANKRUPTCY

FIGURE 50: SECURITIES LENDING COUNTERPARTIES
------------------------------------------------------------------------
Bankruptcy Rescue Difference
------------------------------------------------------------------------
Collateral Status: Overcollateralized
------------------------------------------------------------------------
AIG insurance subsidiaries would SL CPs received The financial
remain liable to SL CPs for any cash collateral result would have
unpaid obligations. payments (either been the same if
through the AIG parent
collateral calls company had filed
or upon for bankruptcy or
termination) in as a result of
full, on demand, the rescue.
or at the However, the SL
termination of CPs were better
AIG's SL program. off as a result
The impact on the of the rescue
SL CPs is the because they did
same regardless not have to sell
of whether the the lent
funds were securities
provided to AIG (incurring
through the related costs and
Federal Reserve expenses) to
credit facilities satisfy the
or the ML2 amount of unpaid
transaction. obligations.
AIG parent company would not
provide further capital to
provide liquidity to SL
collateral pools or to offset
insurance subsidiary losses
from the sale of impaired
assets (RMBS) (guarantees would
likely be rejected in
bankruptcy and downstream
payments would likely stop,
unless creditors and DIP
believed it would maximize
value of stock in insurance
subsidiaries).
If AIG subsidiaries were unable
to provide cash collateral (for
collateral calls or early
termination payments), SL CPs
could sell the lent securities
to satisfy any unpaid
obligations (and use any excess
to pay reasonable costs and
expenses).
------------------------------------------------------------------------
Collateral Status: Undercollateralized
------------------------------------------------------------------------
AIG insurance subsidiaries would
remain liable to SL CPs.
AIG parent company would not SL CPs received SL CPs received
provide further capital to cash collateral more as a result
provide liquidity to SL payments (either of the rescue
collateral pools or to offset through than they would
the insurance subsidiaries' collateral calls have received if
losses from the sale of or upon the AIG parent
impaired assets (RMBS) to termination) in company had filed
satisfy required collateral full, on demand, for bankruptcy.
payments. or at the The SL CPs did
termination of not have
AIG's SL program. sufficient
The impact on the collateral to
SL CPs is the satisfy any
same regardless unpaid
of whether the obligations, and
funds were it is unlikely
provided to AIG that they would
through the have been able to
Federal Reserve collect any
credit facilities shortfall because
or the ML2 of the
transaction. termination of
downstream
payments from the
AIG parent
company and
likely
intervention by
the state
insurance
regulators.
If AIG subsidiaries were unable
to provide cash collateral (for
collateral calls or
termination), SL CPs could sell
the lent securities to recover
some of the unpaid obligations
and assert a claim for any
shortfall.
The SL CPs' ability to collect
on their deficiency claims
would depend on the actions of
the state insurance regulators.
If the regulators seized the
insurance subsidiaries, the SL
CPs would likely have received
nothing for their deficiency
(or would have received a
minimal amount after all of the
policyholders were paid in
full, a potentially substantial
delay). If the regulators did
not seize the insurance
subsidiaries, the subsidiaries'
ability to pay would depend on
their financial condition or
solvency at the time of the
claim.
------------------------------------------------------------------------

FIGURE 51: CDS COUNTERPARTIES
------------------------------------------------------------------------
Bankruptcy Rescue Difference
------------------------------------------------------------------------
Collateral Status: Fully collateralized; owner of reference securities
(CDOs)
------------------------------------------------------------------------
CDS CPs would have been able to
terminate their CDS contracts,
seize previously posted
collateral, and offset or net
out other obligations. CDS CPs
would have received the
estimated value of the CDS
contract on the date of the
bankruptcy filing because they
were fully collateralized (the
market value of the CDOs plus
posted collateral equaled the
value of the CDS contract).The insurance on the CDOs would
have disappeared, and the CDS
CPs would have had continued
exposure to declines in the
market value of the CDOs.
CDS CPs terminated The value of the
CDS CPs would be exposed to the CDS CDS contracts
movements in the market value contracts, kept fluctuated with
of the CDOs but not to an AIG previously posted movements in the
bankruptcy per se. collateral, and market value of
sold their CDOs the reference
for their market CDOs, but the
value on the date bankruptcy filing
of transfer. date and the ML3
Market value transaction date
payments plus would have fixed
posted collateral the estimated par
approximated the value of the CDS
par value of the contracts.
CDS contracts. Whether CDS CPs
received more in
the rescue would
have depended on
the change in the
CDOs' market
value from the
bankruptcy date
to the rescue
date and whether
CDS CPs continued
to hold the CDOs
or sold them at a
depressed price
(e.g., if market
values plunged
after the
bankruptcy
filing).
If AIG filed for
bankruptcy and
CDS CPs continued
to hold the CDOs
and sold them at
a value below the
value estimated
for the ML3
transaction, they
would have
received more as
a result of the
rescue. If CDS
CPs continued to
hold the CDOs and
sold them at a
value above that
estimated for the
ML3 transaction,
they would have
received less as
a result of the
rescue.
CDS CPs also
benefited from
the rescue to the
extent that they
did not incur
legal fees to
protect their
claims or actions
from bankruptcy
challenges.
------------------------------------------------------------------------
Collateral Status: Undercollateralized; owner of reference securities
------------------------------------------------------------------------
CDS CPs would have been able to
terminate their CDS contracts,
seize previously posted
collateral, and offset or net
out other obligations. CDS CPs
would be protected to the
extent that they were
collateralized and would have
an unsecured claim for their
deficiency (subject to the
bankruptcy discount).The insurance on the CDOs would
have disappeared, and the CDS
CPs would have had continued
exposure to declines in the
market value of the CDOs.
CDS CPs terminated The value of the
CDS CPs would be exposed both to the CDS CDS contracts
movements in the market value contracts, kept fluctuated with
of the CDOs as well as to an previously posted movements in the
AIG bankruptcy to the extent collateral, and market value of
that they were sold their CDOs the reference
undercollateralized. for their market CDOs, but the
value on the date bankruptcy filing
of transfer. date and the ML3
Market value transaction date
payments plus would have fixed
posted collateral the estimated par
approximated the value of the CDS
par value of the contracts.
CDS contracts. Whether CDS CPs
received more in
the rescue would
have depended on
the extent to
which they were
undercollateraliz
ed, the change in
the CDOs' market
value from the
bankruptcy date
to the rescue
date, and whether
CDS CPs continued
to hold the CDOs
or sold them at a
depressed price
(e.g., if market
values plunged
after the
filing).
It is more likely
that CDS CPs
received more as
a result of the
rescue because of
their exposure to
an AIG bankruptcy
to the extent
that they were
undercollateraliz
ed.
If AIG filed for
bankruptcy and
CDS CPs continued
to hold the CDOs
and sold them at
a value below the
value estimated
for the ML3
transaction, they
would have
received more as
a result of the
rescue. If CDS
CPs continued to
hold the CDOs and
sold them at a
value above that
estimated for the
ML3 transaction,
they would have
received less as
a result of the
rescue.
CDS CPs also
benefited from
the rescue
because they were
not subject to
the bankruptcy
discount for
deficiency claims
and did not incur
legal fees to
protect their
claims or actions
from bankruptcy
challenges.
------------------------------------------------------------------------
Collateral Status: Fully collateralized; not owner of reference
securities
------------------------------------------------------------------------
CDS CPs would have been able to
terminate their CDS contracts,
seize previously posted
collateral, and offset or net
out other obligations. CDS CPs
would have received the
estimated value of the CDS
contract on the date of the
bankruptcy filing because they
were fully collateralized (the
market value of the CDOs plus
posted collateral equaled the
value of the CDS contract).
CDS CPs that did The value of the
Because CDS CPs did not own the not own the CDS contracts
CDOs, they would not have had reference CDOs fluctuated with
continued exposure to declines had to obtain movements in the
in the market value of the CDOs. them (either by market value of
con-tract or in the reference
the market) in CDOs, but the
order to benefit bankruptcy filing
from ML3 date and the ML3
(transactions transaction date
were physically would have fixed
settled). When the estimated par
the CDS CPs value of the CDS
obtained the contracts.
reference CDOs, Whether CDS CPs
they terminated received more in
their CDS the rescue would
contracts, kept have depended on
pre-viously the change in the
posted CDOs' market
collateral, and value from the
sold their CDOs bankruptcy date
for their market to the rescue
value on the date date and whether
of transfer. CDS CPs continued
Market value pay- to hold the CDOs
ments plus posted or sold them at a
collateral depressed price
approximated the (e.g., if market
par value of the values plunged
CDS contracts. after the
If CDS CPs could bankruptcy
not obtain or filing).
deliver the If AIG filed for
reference bankruptcy and
securities, they CDS CPs continued
would not have to hold the CDOs
been able to and sold them at
benefit from ML3. a value below the
value estimated
for the ML3
transaction, they
would have
received more as
a result of the
rescue. If CDS
CPs continued to
hold the CDOs and
sold them at a
value above that
estimated for the
ML3 transaction,
they would have
received less as
a result of the
rescue.
CDS CPs benefited
from the rescue
to the extent
that the rescue
prevented further
deterioration in
CDO market
values. The
rescue also
prevented the
value of the CDS
contracts from
being fixed on
the bankruptcy
date (in the
likely event that
they would have
terminated the
CDS contracts
upon AIG's
filing).
CDS CPs also
benefited from
the rescue to the
extent that they
did not incur
legal fees to
protect their
claims or actions
from bankruptcy
challenges.
------------------------------------------------------------------------
Collateral Status: Undercollateralized; not owner of reference
securities
------------------------------------------------------------------------
CDS CPs would have been able to
terminate their CDS contracts,
seize previously posted
collateral, and offset or net
out other obligations. CDS CPs
would be protected to the
extent that they were
collateralized and would have
an unsecured claim for their
deficiency (subject to the
bankruptcy discount).
CDS CPs that did The value of the
Because CDS CPs did not own the not own the CDS contracts
CDOs, they would not have had reference CDOs fluctuated with
continued exposure to declines had to obtain movements in the
in the market value of the CDOs. them (either by market value of
contract or in the reference
the market) in CDOs, but the
order to benefit bankruptcy filing
from ML3 date and the ML3
(transactions transaction date
were physi-cally would have fixed
settled). When the estimated par
the CDS CPs value of the CDS
obtained the contracts.
reference CDOs, Whether CDS CPs
they terminated received more in
their CDS the rescue would
contracts, kept have depended on
previously posted the extent to
collateral, and which they were
sold their CDOs undercollateraliz
for their market ed, the change in
value on the date the CDOs market
of transfer. value from the
Market value bankruptcy date
payments plus to the rescue
posted collateral date, and whether
approximated the CDS CPs continued
par value of the to hold the CDOs
CDS contracts. or sold them at a
If CDS CPs could depressed price
not obtain or (e.g., if market
deliver the values plunged
reference after the
securities, they filing).
would not have It is more likely
been able to that CDS CPs
benefit from ML3. received more as
a result of the
rescue because of
their exposure to
an AIG bankruptcy
to the extent
that they were
undercollateraliz
ed.
If AIG filed for
bankruptcy and
CDS CPs continued
to hold the CDOs
and sold them at
a value below the
value estimated
for the ML3
transaction, they
would have
received more as
a result of the
rescue. If CDS
CPs continued to
hold the CDOs and
sold them at a
value above that
estimated for the
ML3 transaction,
they would have
received less as
a result of the
rescue.
CDS CPs also
benefited from
the rescue
because they were
not subject to
the bankruptcy
discount for
deficiency claims
and did not incur
legal fees to
protect their
claims or actions
from bankruptcy
challenges.
CDS CPs that could
not deliver the
reference
securities
benefited from
the rescue to the
extent that the
rescue prevented
further
deterioration in
CDO market
values. The
rescue also
prevented the
value of the CDS
contracts from
being fixed on
the bankruptcy
date (in the
likely event that
they would have
terminated the
CDS contracts
upon AIG's
filing).
------------------------------------------------------------------------

SECTION TWO: ADDITIONAL VIEWS

A. J. Mark McWatters

I concur with the issuance of the June report and offer the
additional observations noted below. I appreciate the spirit
with which the Panel and the staff approached this complex
issue and incorporated suggestions offered during the drafting
process.

1. Cost of AIG Bailout to Taxpayers

Other than the bailouts of Fannie Mae and Freddie Mac, the
rescue of AIG has required the allocation of more taxpayer
funded resources than any other similar action undertaken by
the government since the inception of the current economic
crisis. In its January 2010 ``Budget and Economic Outlook,''
the Congressional Budget Office (CBO) estimated that the TARP
investment in AIG will cost the taxpayers $9 billion out of $70
billion committed or disbursed.\940\ In its March 2010 ``Report
on the Troubled Asset Relief Program,'' the CBO quadrupled its
estimated cost to $36 billion.\941\ In the President's Budget
for fiscal year 2011 released in February 2010, the OMB
estimated that the TARP investment in AIG will cost the
taxpayers $49.9 billion.\942\ Although the CBO and OMB--experts
in making these determinations--appear pessimistic that the
taxpayers will recover their investment, AIG nevertheless
remains optimistic that the taxpayers will receive repayment in
full.\943\ It is not entirely clear why such a material
disparity exists between CBO scores or on what reasonable basis
AIG anticipates that the taxpayers will receive repayment. It
is also troublesome that the CBO has quadrupled its estimated
cost of the AIG bailout even though market conditions have
significantly improved since the last quarter of 2008.
---------------------------------------------------------------------------
\940\ Congressional Budget Office, Budget and Economic Outlook, at
14 (Jan. 2010) (online at www.cbo.gov/ftpdocs/108xx/doc10871/01-26-
Outlook.pdf).
\941\ Congressional Budget Office, Report on the Troubled Asset
Relief Program--March 2010, at 4 (Mar. 2010) (online at www.cbo.gov/
ftpdocs/112xx/doc11227/03-17-TARP.pdf).
\942\ Office of Management and Budget, Analytical Perspectives,
Budget of the United States Government, Fiscal Year 2011, at 40 (Feb.
2010) (online at www.whitehouse.gov/omb/budget/ 2011/assets/
econ_analyses.pdf.)
\943\ The challenge presented with repaying the taxpayers in full
is evidenced by the recent collapse of the sale of AIA Group Ltd.,
AIG's main Asian business, to Prudential PLC, a UK insurer. See Peter
Stein, U.S. Taxpayers are Big Losers of AIA Deal's Death, The Wall
Street Journal (June 3, 2010) (online at online.wsj.com/article/
SB100014240527487033409045752842800
12636818.html?mod=WSJ_newsreel_business), which provides:
In this scenario, AIG is treating U.S. taxpayers like private-
equity investors funding its growth in hopes of a nice payoff down the
line. That's wrong. The only way to mitigate the moral hazard of saving
AIG is to repay U.S. taxpayers sooner, not later. This is why a sale
yielding $23 billion in cash up front clearly beat the alternatives.
An autopsy of this deal might reveal various causes of death.
Prudential's overambitious management, fixated on the appeal of a
transformative deal, lost sight of the perspective of its more
skeptical shareholders. Volatile markets undercut risk appetite right
when Prudential and AIG needed investors with strong stomachs.
But it was AIG's board, and its U.S. government owners, that pulled
the plug. U.S. taxpayers should mourn the fact that with this deal,
their best interests expired as well.'' [Emphasis added.]
See also Serena Ng, AIG Heads Back to the Drawing Board, The Wall
Street Journal (June 3, 2010) (online at online.wsj.com/article/
SB100014240527487045157045752829938796288
12.html?mod=WSJ_business_whatsNews); see also The Associated Press,
Fitch drops positive ratings watch for AIG unit, Bloomberg Businessweek
(June 3, 2010) (online at www.businessweek.com/ap/financialnews/
D9G38KH00.htm); see also Paul Thomasach, AIG shares overpriced after
deal collapse-Barron's,'' Reuters (June 6, 2010) (online at
www.reuters.com/article/idUSN0613653820100606).
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As I have done in prior reports,\944\ I think that it is
instructive to add some perspective to the magnitude of the
loss the taxpayers may suffer as a result of the AIG bailout.
By comparison, for fiscal year 2011 the National Institute of
Health (NIH) has requested $765 million for breast cancer
research, and the latest Nimitz-class aircraft carrier
commissioned by the Navy cost approximately $4.5 billion.\945\
It is entirely appropriate for the taxpayers who funded the
TARP program to ask if the bailout of AIG with a CBO estimated
cost of $36 billion merited 47 years of breast cancer research
or eight (8) Nimitz-class aircraft carriers. The ``guns v.
butter v. AIG'' comparisons clearly demonstrate that our
national resources are indeed limited and that the bailout of
AIG will require the government to reduce expenditures,
increase tax revenue or both.
---------------------------------------------------------------------------
\944\See Congressional Oversight Panel, March Oversight Report: The
Unique Treatment of GMAC Under the TARP: Additional Views of J. Mark
McWatters and Paul S. Atkins, at 122 (Oct. 9, 2009) (cop.senate.gov/
documents/cop-031110-report-atkinsmcwatters.pdf).
\945\See U.S. Department of Health and Human Services, National
Institutes of Health, Estimates of Funding for Various Research,
Condition and Disease Categories (RCDC) (Feb. 1, 2010) (online at
report.nih.gov/rcdc/categories/); see also U.S. Navy, Information about
the Ship (online at up-www01.ffc.navy.mil/cvn77/static/aboutus/
aboutship.html) (accessed Mar.10, 2010).
---------------------------------------------------------------------------

2. Collapse of World Financial System if AIG not Rescued

The American taxpayers were told in the last quarter of
2008 that they had no choice but to bail out AIG because absent
such action the global financial system would have collapsed
due to the systemic risk presented by and the financial
interconnectedness of AIG.
Secretary Geithner has stated that ``neither AIG's
management nor any of AIG's principal supervisors--including
the state insurance commissioners and the OTS--understood the
magnitude of risks AIG had taken or the threat that AIG posed
to the entire financial system.'' \946\
---------------------------------------------------------------------------
\946\ FRBNY and Treasury briefing with Panel and Panel staff, Apr.
12, 2010; House Committee on Oversight and Government Reform, Written
Testimony of Timothy F. Geithner, Secretary, U.S. Department of the
Treasury, The Federal Bailout of AIG, at 3, 111th Cong. (Jan. 27, 2010)
(online at oversight.house.gov/images/stories/Hearings/
Committee_on_Oversight/TESTIMONY-Geithner.pdf).
---------------------------------------------------------------------------
Secretary Paulson has stated that the failure of
AIG ``would have taken down the whole financial system and our
economy. It would have been a disaster.'' \947\
---------------------------------------------------------------------------
\947\ House Committee on Oversight and Government Reform, Written
Testimony of Henry M. Paulson, Jr., former secretary, U.S. Department
of the Treasury, The Federal Bailout of AIG, 111th Cong. (Jan. 27,
2010) (online at oversight.house.gov/
index.php?option=com_content&task=view&id=4756&Itemid=2).
---------------------------------------------------------------------------
Chairman Bernanke has stated that the FRBNY ``lent
AIG money to avert the risk of a global financial meltdown.''
\948\
---------------------------------------------------------------------------
\948\ House Committee on Financial Services, Written Testimony of
Chairman of the Board of Governors of the Federal Reserve System Ben S.
Bernanke, Oversight of the Federal Government's Intervention at
American International Group (Mar. 24, 2009) (online at www.house.gov/
apps /list/hearing/financialsvcs_dem/statement_-_bernanke032409.pdf).
---------------------------------------------------------------------------
Although such assessments no doubt motivated the FRBNY and
Treasury to rescue AIG, it is critical to note that the global
financial system does not consist of a single monolithic
institution but, instead, is comprised of an array of too-big-
to-fail financial institutions many of which were,
interestingly, also counterparties on AIG credit default swaps
(CDS) and securities lending transactions (SL). In other words,
the concept of a ``global financial system'' is really just
another term for the biggest-of-the-big financial institutions
and, as such, there remains little doubt that the principal
purpose in bailing out AIG was by definition to save these
institutions as well as AIG's insurance business from
bankruptcy or liquidation. It is troublesome that the plan
implemented by the FRBNY and Treasury to save AIG along with
the global financial system was without cost to those too-big-
to-fail members of the global financial system who were
rescued.
Assuming the bailout of AIG was in the best interest of the
taxpayers, a number of fundamental questions nevertheless
remain for consideration. A private sector solution was
negotiated and successfully implemented with respect to the
failure of LTCM in 1998. Why not AIG? Was a wholly taxpayer
funded bailout of AIG the only viable option available to the
FRBNY and Treasury in the last quarter of 2008? What action
could the FRBNY and Treasury have taken to orchestrate a pre-
packaged bankruptcy of AIG with, for example, post-petition
financing provided by the FRBNY and a syndicate of domestic and
cross-border private sector financial institutions, insurance
companies, hedge funds and private equity firms? Would it have
been possible for the FRBNY to have extended AIG a short-term
loan of 120 days or so while all parties worked to structure a
pre-packaged bankruptcy plan? Would it have been possible to
coordinate a pre-packaged bankruptcy with the AIG insurance and
other regulators? Would it have been possible for the FRBNY to
have guaranteed certain obligations of AIG instead of advancing
funds under a credit facility? Did the FRBNY and Treasury
attempt to negotiate a public-private arrangement where all of
the risk of the AIG bailout was not shouldered by the
taxpayers? If so, why did those efforts fail? Did the FRBNY and
Treasury seek the participation of hedge funds and private
equity firms as well as traditional domestic and cross-border
financial institutions and insurance companies in a rescue
attempt? If not, why not? The FRBNY and Treasury had their
greatest leverage to negotiate a discount to par with the AIG
counterparties in September 2008. Why did they fail to use that
position of strength for the benefit of the taxpayers? Although
the Panel has addressed many of these issues, I remain
unconvinced that the only reasonable approach available to the
FRBNY and Treasury during the fourth quarter of 2008 was for
the taxpayers to have assumed the full burden of bailing out
AIG.

3. Counterparties Unwilling to Share Pain of AIG Bailout with Taxpayers

It is ironic that although the bailout of AIG may have also
rescued many of its counterparties,\949\ none of these
institutions were willing to share the pain of the bailout with
the taxpayers and accept a discount to par upon the termination
of their contractual arrangements with AIG. Instead, they left
the American taxpayers with the full burden of the bailout. It
is likewise intriguing that these too-big-to-fail financial
institutions (leading members of the ``global financial
system'') were paid at par--that is, 100 cents on the dollar--
at the same time the average American's 401(k) and IRA accounts
were in free fall, unemployment rates were skyrocketing and
home values were plummeting.\950\
---------------------------------------------------------------------------
\949\ The CDSs of certain AIG counterparties were terminated
through the Maiden Lane III transaction, yet the CDSs of other AIG
counterparties remained outstanding. It is difficult to appreciate why
the former group of AIG counterparties received payment at par as their
CDSs were closed out. Like the Financial Crisis Inquiry Commission, it
has been challenging for the Panel to fully appreciate the economic and
legal relationships among the AIG counterparties and AIG. See John
Mckinnon, Finance Panel Accuses Goldman of Stalling, Wall Street
Journal (June 7, 2010) (online at online.wsj.com/article/
SB10001424052748703303904575292530057313818.html?mod=WSJ_hps_MIDDLETopSt
ories).
\950\ See Congressional Oversight Panel, January Oversight Report:
Exiting TARP and Unwinding Its Impact on the Financial Markets:
Additional Views of J. Mark McWatters and Paul S. Atkins, at 145 (Jan.
14, 2010) (cop.senate.gov/documents/cop-011410-report-
atkinsmcwatters.pdf).
---------------------------------------------------------------------------
It is also critical to recall that during the last quarter
of 2008 many of the AIG counterparties were most likely
experiencing their own severe liquidity and insolvency
challenges and were under attack from short-sellers and
purchasers of CDSs on their debt instruments.\951\ By receiving
payment at par, some of the counterparties were able to convert
illiquid and perhaps mismarked CDOs \952\ and other securities
into cash during the worst liquidity crisis in
generations.\953\ By avoiding the risk inherent in an AIG
bankruptcy and the issues regarding DIP financing,\954\ some of
the counterparties were also able to accelerate the conversion
of their AIG contracts into cash, and in late 2008, cash was
king. Although some of the counterparties may argue that they
held contractual rights to receive payment at par and were the
beneficiaries of favorable provisions of the U.S. bankruptcy
code, such rights and benefits would have been of diminished
assistance since in late 2008 AIG was out of cash. It also
appears problematic if AIG would have been able to obtain
sufficient post-petition financing following the implosion of
the global financial system that--according to the wisdom of
the day--would have followed from the bankruptcy of AIG. Thus,
without the taxpayer funded bailout, AIG would have most likely
held insufficient cash to honor in full its contractual
obligations notwithstanding the special rights and benefits
afforded the counterparties.\955\
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\951\ In order to hedge their AIG-related risk, some of the AIG
counterparties may have shorted the stock of AIG or purchased CDSs over
AIG. It also appears that some of the AIG counterparties entered into
back-to-back CDSs, as the protection seller, with their clients (AIG CP
clients), as the protection buyers. In order to hedge their AIG
counterparty-related risk, some of the AIG CP clients may have shorted
the stock of their AIG counterparty or purchased CDSs over their AIG
counterparty. These actions may have caused the stock of a wide variety
of financial institutions to drop precipitously in late 2008. As the
shares of financial institutions fell in value it is likely that other
investors joined the trend of shorting and selling the stock of
anything that looked like a financial institution. Although the SEC
responded with its temporary ban on selling short the stock of
financial institutions, one of the goals in rescuing AIG may have been
to address this issue. If so, such action serves as yet another
indication that the bailout of AIG was also intended as a bailout of
the AIG counterparties.
\952\ If an AIG counterparty had held $100 of face value CDOs with
a true fair market value of $60 and $40 of cash collateral posted by
AIG, the counterparty would not have suffered a loss upon the
bankruptcy of AIG because the counterparty could have sold the CDOs for
$60 and retained the $40 of posted cash collateral. This analysis
assumes--perhaps incorrectly--that the bankruptcy of AIG would not have
resulted in the collapse of the CDO market or the AIG counterparty. If,
however, the true fair market value of the CDOs was $20 (that is, the
CDOs were mismarked at $60), the AIG counterparty would have most
likely suffered a loss of $40 upon the bankruptcy of AIG. Since the CDO
market was all but frozen in the last quarter of 2008, it is quite
possible that the CDOs held by some of the AIG counterparties were
mismarked and that AIG had posted insufficient cash collateral.
\953\ If you're inclined to challenge this analysis, ask yourself
one question: In the last quarter of 2008 what would you have preferred
to own--(i) a CDS with a bankrupt AIG that is searching for post-
petition financing following the collapse of the global financial
system or (ii) U.S. dollars equal to the full face amount of the
referenced securities underlying your CDS?
\954\ It is also clear that many of the AIG counterparties (or
their counterparties or both) would have suffered in an AIG bankruptcy
for three reasons. First, following the collapse of the global
financial system the counterparties (as members of the global financial
system) certainly would have suffered and perhaps failed. Second,
unless they were fully hedged with posted cash collateral, the
counterparties most likely would not have received payment at par in an
AIG bankruptcy. Third, upon the collapse of the global financial
system, where would AIG have secured post-petition financing to pay
anyone--including the counterparties--anything (AIG was out of cash on
September 16, 2008)?
\955\ This is particularly true if, as previously noted, the
referenced CDO securities were mismarked and AIG had posted
insufficient cash collateral, or if the fair market value of the
referenced CDO securities continued to decline and AIG was unable to
post additional cash collateral.
---------------------------------------------------------------------------
While the facts and circumstances no doubt differed with
respect to the contractual and economic relationships of the
various counterparties with AIG, the bailout of AIG--at a
minimum--reduced systemic risk throughout the global financial
system to the benefit of the counterparties and most certainly
allowed some of the counterparties to receive a greater
distribution than they would have received following the
bankruptcy of AIG. Although some of the AIG counterparties were
apparently fully hedged--with posted cash collateral--against
the bankruptcy of AIG, the retention of the posted cash
collateral by the counterparties following the bankruptcy of
AIG and the ensuing collapse of the global financial system
would have served as little more than a Pyrrhic victory for the
counterparties. If President Geithner, Secretary Paulson and
Chairman Bernanke were correct in their assessments of the
threat posed by the bankruptcy of AIG to the global financial
system, the rescue of the company also saved the AIG
counterparties from substantial economic peril if not outright
failure. In light of this reality, the taxpayers should have
received a discount to par \956\ upon the termination of AIG's
contracts with its counterparties.\957\ In addition, since the
counterparties under the CDSs that the AIG counterparties
employed to hedge their AIG-related risk were in effect bailed
out upon the bailout of AIG, it would also not appear
unreasonable for the taxpayers to have received a discount to
par from such counterparties.\958\
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\956\ The successful and timely negotiation of discounts to par
from the counterparties would have most likely required the
intervention of the Secretary of the Treasury and the President of the
FRBNY with the senior executive officers of the counterparties.
Although time was of the essence, a meeting at the offices of the FRBNY
or a series of conference calls with the principals could have saved
the taxpayers several billion dollars. In those meetings and conference
calls, the Secretary or President of the FRBNY would have had to
address the potential collapse of the global financial system and the
consequences to the AIG counterparties as well as the ``shared
sacrifice'' expected of the counterparties (as noted by Martin J.
Bienenstock in the text below).
\957\ Counterparties who were fully hedged against AIG-related risk
with posted cash collateral may have argued with conviction that they
owed no duty to accept a settlement of their AIG contracts at a
discount to par. By making this assertion they would have failed to
acknowledge that the bailout of AIG may have also rescued their
institution from bankruptcy or liquidation. Such approach also runs
contrary to the ``shared sacrifice'' expected of the counterparties (as
noted by Martin J. Bienenstock in the text below).
\958\ If an AIG counterparty was fully hedged with cash collateral
posted by the protection seller to the AIG counterparty, as the
protection buyer, under a CDS over AIG, the AIG counterparty may have
recovered the full benefit of its bargain upon the bankruptcy of AIG.
Upon the bailout of AIG, the AIG counterparty would have possibly
returned the posted cash collateral to its protection seller and
cancelled its CDS over AIG. In such event, the protection seller would
have directly benefitted from the bailout of AIG because, absent the
bailout, the protection seller would have forfeited the cash collateral
posted to the AIG counterparty upon the bankruptcy of AIG. Conversely,
if the AIG counterparty was not fully hedged against the bankruptcy of
AIG, the AIG counterparty should have been willing to offer AIG a
discount to tear up its CDS with AIG because, absent the bailout of AIG
by the taxpayers, the AIG counterparty would have most likely suffered
a loss upon the bankruptcy of AIG.
---------------------------------------------------------------------------
The FRBNY and Treasury contend that their bailout plan for
AIG was the only viable approach under the circumstances and
they have raised a number of objections to more creative and
taxpayer-friendly structures that would have yielded
concessions from the AIG counterparties and other claimants. I
appreciate the arguments offered, but, for the reasons noted
below, I do not find them entirely compelling.
The FRBNY and Treasury have argued that it would have been
``unfair'' to ask the AIG counterparties to accept a discount
to par upon the termination of their CDS and SL contracts when
other AIG creditors were scheduled to receive payment at par.
In workouts of private sector enterprises, creditors often
agree to terms that are less favorable than those expressly
provided in their contractual agreements--even without the
threat of being crammed-down in a bankruptcy proceeding. As
such, it would not seem unusual for a group of multi-billion
dollar domestic and foreign \959\ AIG counterparties to accept
a discount to par where other creditors do not. This is
particularly true since the failure of AIG may have resulted in
the bankruptcy or liquidation of some of these counterparties.
Such a reality, along with the fact that many of the
counterparties would have received less than par upon the
bankruptcy of AIG--the only realistic alternative to a taxpayer
funded bailout in the last quarter of 2008, should have ensured
the cooperation of the counterparties. In a perfect world, the
concept of shared sacrifice would have included most if not all
of the AIG creditors, but it was arguably not possible to
administer this remedy to an enterprise with thousands of
claimants where time was of the essence. When you aggregate the
taxpayer funds employed to finance ML2 and ML3 together with
the share of the $85 billion FRBNY loan used to post cash
collateral with the CDS counterparties and settle redemptions
with the SL counterparties, it appears that the counterparties
received a substantial bulk of the taxpayer sourced funds,
further indicating that the bailout of AIG was also a bailout
of the AIG counterparties.
---------------------------------------------------------------------------
\959\ A substantial portion of the taxpayer sourced bailout funds
were paid to non-U.S. financial institutions.
---------------------------------------------------------------------------
The FRBNY and Treasury have also argued that the rating
agencies would have downgraded AIG upon the successful
negotiation of any discounts to par (a ``distressed exchange'')
and that any such downgrade would have caused the insurance
regulators to seize or take other adverse action with respect
to AIG's insurance subsidiaries. The negotiation of
counterparty concessions as consideration for the termination
of AIG's CDS and SL contracts would not have been undertaken
merely to enhance the liquidity or solvency of AIG, but,
instead, AIG, the FRBNY and Treasury should have firmly
requested the receipt of such concessions out of a sense of
equity and fairness to the taxpayers. In my view, the liquidity
and solvency of AIG were most likely assured once the FRBNY
advanced $85 billion to AIG and it seems unlikely--although not
without possibility--that the government would have walked away
from such a substantial investment of taxpayer funds and
allowed AIG to fail. Indeed, the government kept pouring money
into AIG after the initial infusion, giving the rating agencies
little reason to question the long-term liquidity or solvency
of AIG. It appears quite clear that AIG's financial stability
would not have turned on whether or not the counterparties
granted concessions to par upon the termination of their CDS
and SL contracts with AIG.
Further, it is significant to note that the taxpayers are
not members of a private equity or venture capital firm in
search of high-risk entrepreneurial activity and they should
not have been treated as such.\960\ The taxpayers owed no duty
to rescue AIG--a private sector firm--but they nevertheless
elected to allocate their limited resources to the firm out of
concern that its failure would have spawned dramatically
adverse consequences for the American economy. For these
reasons, the rating agencies--after thoughtful discussions with
AIG, the FRBNY and Treasury, including the Secretary of the
Treasury and the President of the FRBNY--should not have viewed
any concessions granted by the AIG counterparties as
``distressed exchanges'' but, instead, as appropriate and good
faith consideration payable to a reluctant investor--the
taxpayers--for performing a significant public service. I have
little doubt that the rating agencies would have grasped this
fundamental distinction. In addition, it is not at all clear
that the AIG insurance regulators would have acted in the
rather dramatic manner suggested by the FRBNY and Treasury. I,
again, have little doubt that the insurance regulators would
have acted in a prudent manner on behalf of present and future
policy holders so as to secure the safety and soundness of the
AIG insurance subsidiaries they regulate.
---------------------------------------------------------------------------
\960\ Since a private equity firm most likely would have received
concessions from creditors in return for providing workout capital to
AIG, it is possible that the FRBNY and Treasury committed the taxpayers
to a particularly unattractive bailout structure.
---------------------------------------------------------------------------
In addition, the FRBNY and Treasury have argued that the
failure or downgrade (resulting from a ``distressed exchange'')
of the AIG holding company would have resulted in a ``run'' on
the AIG insurance companies. A number of questions--largely
unanswered--are raised by this assertion. Where would the AIG
policy holders have run upon the seizure of the AIG insurance
subsidiaries? Was there enough excess capacity in the global
insurance system to absorb the failure of the AIG insurance
subsidiaries? Since property and casualty and even health and
life insurance may take a considerable amount of time to
underwrite, how would the AIG policy holders have effectively
run to another insurance company and received coverage on a
timely basis? What action might the insurance regulators have
taken to effectively stop any such run?
In essence, the FRBNY and Treasury have attempted to
justify the bailout of AIG--without the receipt of any
concessions to par from the AIG counterparties for the benefit
of the taxpayers--by shifting the responsibility for such
approach to the AIG counterparties (because they demanded
payment at par), the rating agencies (because they might have
downgraded the AIG parent upon the occurrence of a ``distressed
exchange''), and the insurance regulators (because they might
have seized the insurance subsidiaries upon the downgrade of
the AIG parent). It may have been preferable for the FRBNY and
Treasury to respond as follows: ``(i) we held no regulatory
authority over AIG and its subsidiaries, (ii) to the best of
our knowledge the OTS--the primary regulator--was properly
discharging its responsibilities, (iii) although we became
aware that AIG was experiencing financial stress in the summer
of 2008, we reasonably believed that the private sector would
supply whatever new capital that AIG might require, (iv) when
we became aware in September 2008 that AIG was experiencing
severe financial strain and that the private sector would not
provide a timely and robust solution, we responded as best we
could under the circumstances, (v) yes, upon reflection, we
should have paid closer attention to AIG given the
extraordinary problems affecting other similar institutions and
we should have more closely monitored the ability of private
sector participants to provide AIG with capital (perhaps with
our assistance), (vi) yes, upon reflection, we should have
pressed the AIG counterparties to accept concessions to par
upon the termination of their CDS and SL contracts out of a
sense of fairness to the taxpayers who reluctantly funded the
bailout, and (vii) yes, upon reflection, we believe that it
would have been possible to implement a more taxpayer-friendly
approach, such as proposed by Mr. Bienenstock of Dewey &
LeBoeuf at the Panel's hearing on the AIG bailout.''

4. An Elegant Approach to Protect the Interests of the Taxpayers

As noted, the FRBNY and Treasury have advised the Panel
that it was all but impossible for the taxpayers to have
received discounts to par from the AIG counterparties upon the
termination of their CDS and SL contracts with AIG. Not all
agree with this assessment. In his testimony before the Panel,
Mr. Bienenstock, a leading bankruptcy and restructuring
expert,\961\ concludes that the FRBNY and Treasury could have
structured the bailout of AIG within the time constraints
presented during the fourth quarter of 2008 so as to receive
concessions to par from the AIG counterparties for the benefit
of the taxpayers. In addition, Mr. Bienenstock argues that the
choices presented to the FRBNY and Treasury were not merely
``binary,'' that is, additional approaches existed outside of a
bailout at par or a bankruptcy filing, and that the advisers to
the FRBNY and Treasury were arguably conflicted. It is also
interesting to note that his suggested plan could have been
implemented under existing law. Mr. Bienenstock's written
testimony contains the following summary of his approach and
its impact on AIG creditors:
---------------------------------------------------------------------------
\961\ Martin J. Bienenstock is a member of the law firm, Dewey &
LeBoeuf LLP, where he is chair of its Business Solutions & Governance
Department and a member of its Executive Committee. Mr. Bienenstock
also teaches Corporate Reorganization as a lecturer at Harvard Law
School and University of Michigan Law School.

. . . AIG was in a position to advise certain
creditor groups such as the CDS counterparties, as
follows:
1. State law recovery actions against AIG would be
unlikely to yield any benefits due to the prior lien
held by FRBNY;
2. AIG would not voluntarily file bankruptcy;
3. Creditors would be unable to file involuntary
petitions in good faith because AIG was generally
paying its debts as they became due, even if AIG were
not to post additional collateral or pay certain other
debts of the entities that caused its losses; \962\
---------------------------------------------------------------------------
\962\ See 11 U.S.C. Sec. 303(h).
---------------------------------------------------------------------------
4. If creditors nevertheless filed involuntary
bankruptcy petitions against AIG, they would render
themselves liable for compensatory and punitive damages
if the court found AIG was generally paying its debts
as they became due and the creditors had been warned in
advance of that fact; \963\ and
---------------------------------------------------------------------------
\963\ See 11 U.S.C. Sec. 303(i)(2).
---------------------------------------------------------------------------
5. FRBNY was saving AIG with taxpayer funds due to
the losses sustained by the business divisions
transacting business with these creditor groups, and a
fundamental principle of workouts is shared sacrifice,
especially when creditors are being made better off
than they would be if AIG were left to file bankruptcy.
The impact of the foregoing on the creditors would include:
1. The knowledge that enforcement action would be
unlikely to yield recoveries;
2. The knowledge that an involuntary bankruptcy
petition would be a ``bet-the-ranch'' venture by the
creditors because the risk of suffering compensatory
and punitive damages for knowingly bankrupting AIG when
it was generally paying its debts as they became due;
3. The knowledge that any creditor enforcement action
would be highly publicized and would isolate the
creditor in the public as working against the efforts
of the United States and its taxpayers to save AIG and
the financial system; and
4. The knowledge by some of the creditors that
working against the United States would be singularly
unwise after the United States either provided them
rescue funds or helped them buy a company such as
Lehman Brothers for $250 million plus the appraised
value of the Manhattan office tower it owned.

The foregoing strategy concentrates pressure on creditors
to grant debt concessions, while yielding them very few
alternatives to granting concessions, and no alternatives
lacking delay, expense, and uncertainty. Unlike the negotiating
strategy that SIGTARP described as having had little
opportunity for success, this strategy is not based on bluffing
bankruptcy. It is based on straight talk and acknowledging
there would be no bankruptcy. Additionally, FRBNY retained an
outstanding law firm and attorney for its work. But, the law
firm is identified as having Wall Street institutions such as
JP Morgan as clients, and it would be awkward for it to devise
strategies to obtain concessions from those institutions.
Significantly, the foregoing strategy eliminates or at
least answers many of the reasons that ultimately caused FRBNY
not to obtain concessions.\964\ For instance, all lenders are
justified in requiring shared sacrifice. Therefore, FRBNY would
not have been using its regulatory status to demand
concessions. It could do so in its lender status. Most
importantly, FRBNY was not required to bluff about bankruptcy.
The correct strategy was the opposite--to show there would be
no bankruptcy and no real opportunity for the creditor to do
better. The foregoing process is carried out in conference
rooms, not in the public.\965\ [Emphasis added.]
---------------------------------------------------------------------------
\964\ Office of the Special Inspector General for the Troubled
Asset Relief Program, Factors Affecting Efforts to Limit Payments to
AIG Counterparties, at 18-19 (Nov. 17, 2009) (online at sigtarp.gov/
reports/audit/2009/
Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties.pdf).
\965\ See Congressional Oversight Panel, Written Testimony of
Martin J. Bienenstock, partner and chair of business solutions and
government department, Dewey & LeBoeuf, COP Hearing on TARP and Other
Assistance to AIG, at 3-4 (May 26, 2010) (online at cop.senate.gov/
documents/testimony-052610-bienenstock.pdf). Mr. Bienenstock also notes
in his testimony:
While the FRBNY might still be concerned about the sanctity of
[the] contract, fairness in debtor-creditor relations exists when
creditors share the pain, not when taxpayers bail out contracts they
did not make. I acknowledge this is often counterintuitive. We all grow
up learning to carry out all our promises. In debtor-creditor
relations, however, once a debtor cannot carry out one promise to one
creditor, it is more fair to break more promises so similarly situated
creditors share the pain, rather than having one take all the pain, or
worse yet, having innocent taxpayers take all the pain.
I understand there was also a concern about ratings downgrades
following any concessions. Intuitively, it should be illogical that AIG
would be viewed as a lesser credit risk once it procured concessions
from creditors which would reduce the amount AIG needed to borrow from
FRBNY and would reduce future debt service expense. To be sure, the
ratings protocols may not always appear logical to the layperson, but
given the singular unique aspects of the AIG rescue, it is hard to
figure out why the ratings agencies would believe AIG would be less
credit worthy without creditor concessions.
The argument exists that creditor concessions could signal that
FRBNY may not continue to provide AIG funds to satisfy all debt. The
answer to that is that FRBNY has not provided that assurance. Indeed, I
received many phone calls in September 2008, asking whether it was safe
to buy or hold AIG bonds after FRBNY provided the $85 billion facility.
The market clearly understood that FRBNY did not provide any guaranties
to creditors for the future. Therefore, it would be illogical for a
downgrade to turn on whether AIG already obtained concessions. The risk
of a future default is the same or less if prior concessions were
granted.
Recent experiences with workouts of the monoline insurance
companies help corroborate the likelihood of concessions. I have had
limited involvement in those negotiations, but my firm has been very
involved on behalf of the insurance companies. In those restructurings,
institutional lenders, including French institutions, were similarly
owed additional collateral to secure credit default swaps and other
derivatives. Consensual discounts were and are being granted in very
material amounts. Additionally, there is litigation pending today over
whether certain credit default swaps qualify for any priorities in
payment afforded insured contracts under state law. Accordingly, there
are many uncertainties causing counterparties to grant consensual
discounts.
---------------------------------------------------------------------------
It is critical to note that the amount of any discount to
par the taxpayers may have received from the counterparties
under Mr. Bienenstock's approach is not necessarily the key
issue. Instead, the fundamental issue concerns the ``principle
of a discount'' for the benefit of the taxpayers or, as Mr.
Bienenstock states, the principle of ``shared sacrifice'' among
the AIG creditors. The American taxpayers have repeatedly
proven themselves profoundly generous to the commercial and
investment banking communities and other institutions such as
AIG over the past two years. The reluctant acceptance by the
taxpayers of the numerous bailouts, however, is founded upon
the implicit understanding that Wall Street share the financial
burden with the taxpayers. The bailout of the AIG
counterparties at par without a gesture of support to the
taxpayers breached that agreement and further alienated Main
Street from Wall Street.

5. Exacerbation of Main Street v. Wall Street Debate

I appreciate that the senior management and counsel of some
of the AIG counterparties may cite standards of fiduciary duty
as a defense to their unwillingness to accept any concessions
to par. It is quite possible, however, that these officers owed
a higher fiduciary duty which was to save their respective
institutions from the very real threat of bankruptcy or
liquidation that existed in the final quarter of 2008. After
all, who can forget the photograph of the two-dollar bill taped
to the door of Bear Stearns's New York offices? \966\ That
image--like Charles Dickens' ghost of Christmas future--told
the story of what would come to pass for other financial
institutions, such as AIG and its counterparties, absent the
intercession of the American taxpayers. In the dark days of
late 2008 when AIG faltered, the American taxpayers--not the
FRBNY or Treasury--stood as the last safe-haven for many of
these financial institutions, and much of today's Main Street
v. Wall Street debate would have never arisen if Wall Street
had properly acknowledged the American taxpayers as its sole
benefactor. To many on Main Street, the bailout of AIG serves
as the prototypical example of the moral hazard risks presented
by government-sponsored bailout funds and implicit guarantees
where favored claimants are paid in full out of seemingly
limitless taxpayer funds, even though many of the recipients
would have surely received less in a bankruptcy proceeding. As
such, after the bailouts, it has become exceedingly difficult
for many Americans to accept that what's good for Wall Street
is necessarily good for Main Street.
---------------------------------------------------------------------------
\966\ See Kristina Cooke, Bear Stearns and the $2 Bill, Reuters
(Mar. 17, 2008) (online at blogs.reuters.com/reuters-dealzone/2008/03/
17/bear-stearns-and-the-2-bill/).
---------------------------------------------------------------------------

6. Other Issues

Other significant issues have arisen with respect to the
bailout of AIG, including, without limitation, the following:
(1) Even though, according to OMB, the taxpayers stand to
lose up to $49.9 billion \967\ on the allocation of TARP funds
to AIG, the pre-bailout common shareholders of AIG were
permitted to retain their interests in the company. These
shareholders should have been wiped out, yet, since AIG avoided
a bankruptcy filing and its common stock is publicly traded,
they are free to sell their shares and retain the proceeds. The
FRBNY and Treasury have placed the taxpayers in an awkward
position of suffering substantial losses even though the pre-
bailout shareholders were permitted to retain their equity
positions in AIG.
---------------------------------------------------------------------------
\967\ Office of Management and Budget, Budget of the U.S.
Government, Fiscal Year 2011, Analytical Perspective, Table 4-7 at 40
(online at www.whitehouse.gov/omb/budget/fy2011/assets/
econ_analyses.pdf) (accessed June 9, 2010).
---------------------------------------------------------------------------
(2) The FRBNY and Treasury have made much of the fact that
the assets acquired by ML2 (RMBS) and ML3 (collateralized debt
obligations) have appreciated in value to the benefit of the
taxpayers. At the time the ML2 and ML3 deals were struck,
however, most of these assets were arguably below junk status
with no reasonable expectation that the RMBS and CDO markets
would turn in the near future. Far from being an insightful
investment opportunity for the taxpayers, the FRBNY simply took
what collateral was available in the last quarter of 2008 and
benefitted from a fortuitous and unanticipated rebound in the
markets.\968\
---------------------------------------------------------------------------
\968\ If a rebound had been anticipated, the RMBS and CDO markets
would not have been moribund at the time the Maiden Lane II and Maiden
Lane III transactions were closed.
---------------------------------------------------------------------------
More significantly, since the FRBNY and Treasury were under
no obligation to bail out the AIG CDS and SL counterparties at
par, any economic gain generated by ML2 and ML3 should only be
viewed as an offset to the economic losses suffered by AIG and
the taxpayers upon the termination of the AIG CDS and SL
contracts at par. Since the government owns approximately 80
percent of the equity in AIG, the interests of the government
and AIG should be treated as a single economic unit in making
these determinations. For example, when AIG terminated certain
of its CDS contracts in November 2008 (i) it forfeited
approximately $35 billion of previously posted cash collateral
to the CDS counterparties and (ii) ML3 purchased the referenced
CDO securities from the CDS counterparties for approximately
$27 billion. Any subsequent appreciation in the fair market
value of the CDO securities above $27 billion should be viewed
as a partial recovery of the $35 billion of forfeited cash
collateral, not as ``profit'' generated from the ML3
transaction.
If, instead, AIG had not terminated the CDS contracts in
November 2008, the $35 billion of posted cash collateral would
have remained in place and upon any subsequent appreciation in
the fair market value of the CDO securities above $27 billion,
the CDS counterparties would have been obligated to return to
AIG cash collateral in an amount equal to the appreciation.
Since the taxpayers own approximately 80 percent of AIG, they
would have benefitted from the return of the previously posted
cash collateral to AIG by the CDS counterparties. In other
words, the taxpayers will benefit from any post-November 2008
appreciation in the fair market value of the referenced CDO
securities through their ownership interest in ML3, and the
taxpayers also would have benefitted from any such appreciation
through their ownership interest in AIG if AIG had left the CDS
contracts outstanding and not undertaken the ML3 transaction.
Since the economic consequences to the taxpayers appear
substantially similar under both approaches, the FRBNY could
have arguably left the AIG CDS contracts in place with,
perhaps, an agreement to post additional cash collateral as
required under the CDS contracts (which undertaking would not
have been required since the referenced CDO securities in the
aggregate have appreciated in value since November 2008). It is
problematic for the FRBNY and Treasury to assert that the use
of the ML3 vehicle achieved a materially superior result for
the taxpayers.
(3) I encourage SIGTARP to continue its investigation into
whether the FRBNY or Treasury encouraged or instructed AIG not
to release material information to the public, including,
without limitation, the names of and referenced securities held
by certain AIG counterparties and the decision to terminate the
contracts of such counterparties at 100 cents on the dollar.
(4) In order to mitigate the moral hazard risks presented
by the bailout of AIG, the government should exit its
investment in AIG as soon as is reasonably possible and return
AIG to the private sector. Although I do not recommend that the
government ``fire-sale'' its investments in AIG, I cannot
endorse a long-term ``buy and hold'' strategy. I am also
troubled that the retention of AIG securities in a trust format
may prolong the disposition process and appear to make
government sponsored bailouts somehow more palatable to the
taxpayers.
(5) Since the overwhelming majority of highly trained
investment professionals working on Wall Street and elsewhere
throughout the global financial services community failed to
recognize on a timely basis the underlying causes of the recent
financial crisis, I have little confidence that a group of
systemic regulators would have performed in a more insightful
or beneficial manner. AIG and its subsidiaries were overseen by
more than 400 regulators throughout the world who were charged
with enforcing countless volumes of regulations. Although AIG's
primary regulator--the OTS--as well as certain of its other
regulators no doubt failed to discharge their oversight
responsibilities, particularly with respect to AIGFP, it does
not follow that AIG and its subsidiaries were necessarily
under-regulated, or that the prudent enforcement of existing
regulations would not have averted AIG's financial crisis. It
is quite likely that many of AIG's regulators fully understood
that AIG was writing trillions of dollars of CDS contracts and
purchasing RMBS with proceeds from its SL transactions, but
very few, if any--including, apparently, the Ph.D's employed by
AIGFP--truly appreciated the interconnected risk embedded in
these investment strategies. The distinction between
incompetency in execution and insufficiency in scope is
critical.\969\ This is not to say, however, that out-of-date
regulations should not be appropriately revised, that new,
thoughtfully targeted regulations should not be introduced and
enforced, or that enhanced, yet rational regulatory models
should not be explored and implemented.
---------------------------------------------------------------------------
\969\ See Greg Gordon, To justify AIG's bailout, regulators
overlooked its colossal problems, McClatchy Newspapers (June 8, 2010)
(online at www.kansascity.com/2010/06/08/v-print/2002541/to-justify-
aigs-bailout-regulators.html).
---------------------------------------------------------------------------
(6) Additional questions for which the taxpayers have not
received satisfactory answers remain, such as the following: Is
AIG--as presently structured--too big or too interconnected
with the financial system and the overall economy to fail? What
action has AIG taken to mitigate the too-big-to-fail problem?
What risk management and internal control policies and
procedures has AIG implemented so as not to require a future
bailout from the taxpayers? What action has AIG taken to
prepare for the failure of the holding company and its
insurance subsidiaries? What effect does AIG's too big-to-fail
status and its implicit guarantee have on its competitors? What
is the exit strategy of the FRBNY and Treasury and when will
the taxpayers receive repayment of the funds advanced to AIG?
In what businesses will AIG be engaged one year and five years
from now? Why did the OTS and the other AIG regulators fail to
regulate AIG fully and effectively?
SECTION THREE: CORRESPONDENCE WITH TREASURY UPDATE

Assistant Secretary of the Treasury for Financial Stability
Herbert M. Allison, Jr. sent a letter to Chair Elizabeth Warren
on May 18, 2010,\970\ in response to a series of questions
presented by the Panel regarding General Motors' April 20th
repayment of $4.7 billion of TARP debt, and the company's
public announcement related to that repayment.\971\ The
Assistant Secretary enclosed with that letter a copy of two
letters Treasury sent in response to similar inquiries from
Members of Congress: one dated April 27, 2010 addressed to
Senator Charles Grassley,\972\ and another dated April 30, 2010
addressed to Representatives Paul Ryan, Jeb Hensarling, and
Scott Garrett.\973\
---------------------------------------------------------------------------
\970\ See Appendix I of this report, infra.
\971\ See Appendix II of the Panel's May Oversight Report.
Congressional Oversight Panel, May Oversight Report: The Small Business
Credit Crunch and the Impact of the TARP, at 135 (May 13, 2010) (online
at cop.senate.gov/documents/cop-051310-report.pdf).
\972\ See Appendix II of this report, infra.
\973\ See Appendix III of this report, infra.
SECTION FOUR: TARP UPDATES SINCE LAST REPORT

A. TARP Repayments

On May 19, 2010, Texas National Bancorporation repaid
Treasury's $4 million investment for the company's preferred
shares. As of May 26, 2010, 17 institutions have repurchased
their preferred shares in 2010. Treasury received $15.4 billion
in repayments from these transactions.

B. CPP Warrant Dispositions

As part of its investment in senior preferred stock of
certain banks under the CPP, Treasury received warrants to
purchase shares of common stock or other securities in those
institutions. During May, Comerica Inc. repurchased its
warrants from Treasury for $183.9 million and Texas National
Bancorporation repurchased additional preferred shares from
Treasury for $199 thousand. Treasury also sold 110,261,688
warrants for Wells Fargo & Company common stock and 2,532,542
warrants for Valley National Bancorp common stock through
secondary public offerings. The aggregate net proceeds to
Treasury from these offerings were $840.4 million. On June 3,
2010, Treasury closed a secondary public offering for 465,117
warrants to purchase First Financial Bancorp common stock. At
$6.20 per warrant, Treasury expects to receive $3 million in
aggregate net proceeds. Deutsche Bank acted as the sole
underwriter for this offering.

C. Treasury Names Appointee to Ally Financial Board of Directors

On May 26, 2010, Marjorie Magner was named to the Ally
Financial Inc. (formerly GMAC Financial Services, Inc.) board
of directors. Ms. Magner, who is the current director of
Accenture Ltd and Gannett Company, Inc., is the first of two
Treasury appointees. When Treasury's ownership interest in Ally
increased to 56.3 percent in December 2009, it received the
right to designate two additional representatives to the board.
Ally Financial is currently a recipient of federal funds
through the Automotive Industry Financing Program.

D. Chrysler Holding Settles $1.9 Billion of Original Chrysler Loan

Chrysler Holding (CGI Holding) repaid $1.9 billion to
settle a $4 billion Treasury loan extended to Chrysler LLC (the
``old Chrysler'') in January 2009. As a result of the
repayment, CGI Holding and Chrysler Financial currently do not
have outstanding obligations to the Treasury under TARP. In
June 2009, after old Chrysler filed for bankruptcy the previous
month, Chrysler Group LLC (the ``new Chrysler'') acquired old
Chrysler's assets and $500 million of its debt.
In total, Treasury has provided $14.3 billion in loans to
old Chrysler, new Chrysler, and Chrysler Financial throughout
the duration of TARP. Such loans include $1.5 billion to
Chrysler Financial to provide funds for consumer vehicle
financing, a $1.9 billion DIP loan for old Chrysler, and a $7.1
billion investment in new Chrysler. As of May 17, 2010,
Treasury has received $3.9 billion in loan repayment from all
Chrysler entities.

E. HAMP Update: New Servicer Performance Measures Announced

Data from the Administration's April report on the Home
Affordable Modification Program (HAMP) estimates 300,000
homeowners permanently modified their loans through HAMP. The
amount of modifications grew 13 percent since March 2010. The
Administration also announced plans to include a more thorough
evaluation of mortgage servicer performance in its reporting of
the program. In July 2010, the monthly HAMP report will include
measurable figures on the eight largest servicers and their
current management of HAMP. Areas of evaluation include:
transparency regarding non-HAMP alternatives for homeowners who
do not qualify for the program, compliance with HAMP
guidelines, and overall interaction between homeowner and
servicer. With this report, the Administration aims to outline
areas where various mortgage servicers could improve their
execution of HAMP protocols.

F. Metrics

Each month, the Panel's report highlights a number of
metrics that the Panel and others, including Treasury, the
Government Accountability Office (GAO), (SIGTARP), and the
Financial Stability Oversight Board, consider useful in
assessing the effectiveness of the Administration's efforts to
restore financial stability and accomplish the goals of EESA.
This section discusses changes that have occurred in several
indicators since the release of the Panel's May report.
Interest Rate Spreads. Since the Panel's May
report, interest rate spreads widened, suggesting a slowdown in
economic growth. The conventional mortgage spread, which
measures the 30-year mortgage rate over 10-year Treasury bond
yields, increased by 17.7 percent in May. Despite the growing
spread during this period, 30-year mortgage interest rates have
been decreasing.\974\ The TED Spread, which serves as an
indicator for perceived risk in the financial markets,
continued its upward trend, growing 39 percent in May.
Increases in the LIBOR rates and TED Spread suggest hesitation
among banks to lend to other counterparties.\975\ The interest
rate spread for AA asset-backed commercial paper, which is
considered mid-investment grade, has increased by 53.3 percent
since the Panel's May report. The interest rate spread on A2/P2
commercial paper, a lower grade investment than AA asset-backed
commercial paper, increased by 12.7 percent during May.
---------------------------------------------------------------------------
\974\ Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release H.15: Selected Interest Rates: Historical
Data (Instrument: Conventional Mortgages, Frequency: Weekly) (online at
www.federalreserve.gov/releases/h15/data/Weekly_Thursday_/
H15_MORTG_NA.txt) (hereinafter ``Federal Reserve Statistical Release
H.15'') (accessed June 8, 2010).
\975\ The Federal Reserve Bank of Minneapolis, Measuring Perceived
Risk--The TED Spread (Dec. 2008) (online at www.minneapolisfed.org/
publications_papers/pub_display.cfm?id=4120).
---------------------------------------------------------------------------
The widening commercial paper spreads in May could be
attributed to recent problems in the Euro zone. Money market
mutual funds are divesting from Greece, Spain, and Portugal.
Risk-averse money managers are favoring shorter term commercial
paper or long-dated issues from top-rated financial companies.
In addition, investors are now calling for higher interest
rates on European commercial paper than on U.S. commercial
paper, with interest rate spreads increasing to more than 0.50
percentage point.\976\
---------------------------------------------------------------------------
\976\ Richard Leong and Emelia Sithole-Matarise, European,
Regulatory Worries Lift Bank Costs, Reuters (May 25, 2010) (online at
www.reuters.com/article/idUSN2516218620100525).

FIGURE 52: INTEREST RATE SPREADS
------------------------------------------------------------------------
Percent Change
Indicator Current Spread Since Last Report
(as of 6/2/10) (5/13/10)
------------------------------------------------------------------------
Conventional mortgage rate spread 1.53 17.7
\977\............................
TED Spread (basis points)......... 39.02 39.0
Overnight AA asset-backed 0.11 53.3
commercial paper interest rate
spread \978\.....................
Overnight A2/P2 nonfinancial 0.20 12.7
commercial paper interest rate
spread \979\.....................
------------------------------------------------------------------------
\977\ Federal Reserve Statistical Release H.15, supra note 974 (accessed
June 2, 2010); Board of Governors of the Federal Reserve System,
Federal Reserve Statistical Release H.15: Selected Interest Rates:
Historical Data (Instrument: U.S. Government Securities/Treasury
Constant Maturities/Nominal 10-Year, Frequency: Weekly) (online at
www.federalreserve.gov/releases/h15/data/Weekly_Friday_/
H15_TCMNOM_Y10.txt) (accessed June 2, 2010).
\978\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release: Commercial Paper Rates and Outstandings: Data
Download Program (Instrument: AA Asset-Backed Discount Rate,
Frequency: Daily) (online at www.federalreserve.gov/DataDownload/
Choose.aspx?rel=CP) (hereinafter ``Federal Reserve Statistical
Release: Commercial Paper'') (accessed June 2, 2010). In order to
provide a more complete comparison, this metric utilizes the average
of the interest rate spread for the last five days of the month.
\979\ Id. In order to provide a more complete comparison, this metric
utilizes the average of the interest rate spread for the last five
days of the month.

LIBOR Rates. As of June 2, 2010, the 3-month and
1-month LIBOR, the prices at which banks lend and borrow from
each other, are 0.538 and 0.351, respectively. Beginning on
March 1, 2010, the 3-month LIBOR experienced a 113.6 percent
increase, and grew 23.3 percent since the Panel's May report.
The 1-month LIBOR has also increased significantly in the past
three months. Since March 1, the 1-month LIBOR rate rose 53.8
percent. These heightened levels indicate growing concern among
banks about lending to and borrowing from one another.\980\
---------------------------------------------------------------------------
\980\ Data accessed through Bloomberg data service on June 2, 2010.

FIGURE 53: 3-MONTH AND 1-MONTH LIBOR RATES (AS OF JUNE 2, 2010)
----------------------------------------------------------------------------------------------------------------
Percent Change from Data
Indicator Current Rates (as of 6/ Available at Time of Last
2/2010) Report (5/13/2010)
----------------------------------------------------------------------------------------------------------------
3-Month LIBOR \981\...................................... .538 23.3
1-Month LIBOR \982\...................................... .351 4.2
----------------------------------------------------------------------------------------------------------------
\981\ Data accessed through Bloomberg data service on June 2, 2010.
\982\ Data accessed through Bloomberg data service on June 2, 2010.

FIGURE 54: 3-MONTH AND 1-MONTH LIBOR RATES

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Housing Indicators. Foreclosure actions, which
consist of default notices, scheduled auctions, and bank
repossessions, dropped 9.1 percent in May to 333,837. This
metric is 19.4 percent above the foreclosure action level at
the time of the EESA enactment. Both the Case-Shiller Composite
20-City Composite as well as the FHFA Housing Price Index
decreased slightly in February 2010. The Case-Shiller and FHFA
indices remain at 6.7 percent and 4.9 percent, respectively,
below their levels at the time EESA was enacted.

FIGURE 55: HOUSING INDICATORS
----------------------------------------------------------------------------------------------------------------
Percent Change from Percent
Indicator Most Recent Data Available at Time Change Since
Monthly Data of Last Report October 2008
----------------------------------------------------------------------------------------------------------------
Monthly foreclosure actions \983\...................... 333,837 (9.1) 19.4
S&P/Case-Shiller Composite 20 Index \984\.............. 145.9 (.1) (6.7)
FHFA Housing Price Index \985\......................... 192.9 (.5) (4.9)
----------------------------------------------------------------------------------------------------------------
\983\ RealtyTrac, Foreclosure Activity Press Releases (online at www.realtytrac.com/ContentManagement/
PressRelease.aspx) (accessed June 2, 2010). Most recent data available for April 2010.
\984\ Standard & Poor's, S&P/Case-Shiller Home Price Indices (Instrument: Seasonally Adjusted Composite 20
Index) (online at www.standardandpoors.com/spf/docs/case-shiller/SA_CSHomePrice_History.xls) (accessed June 2,
2010). Most recent data available for March 2010. Data accessed through Bloomberg data service.
\985\ Federal Housing Finance Agency, U.S. and Census Division Monthly Purchase Only Index (Instrument: USA,
Seasonally Adjusted) (online at www.fhfa.gov/webfiles/15669/MonthlyIndex_Jan1991_to_Latest.xls) (accessed June
2, 2010). Most recent data available for March 2010. Data accessed through Bloomberg data service.

National Delinquency Rates. The Mortgage Bankers
Association's (MBA) National Delinquency Survey, which tracks
all loans types that are past due, indicates a non-seasonally
adjusted delinquency rate of 9.38 percent for all loans
outstanding during the first quarter of 2010. Including loans
in foreclosure, the total delinquency rate was 14.01 percent at
the end of the first quarter of 2010. Florida, Nevada,
Mississippi, Arizona and Georgia continue to have the highest
delinquency rates in the country, each with a rate above 10
percent. Compared to the fourth quarter of 2009, seasonally
adjusted delinquency rates increased for all loan types except
Federal Housing Administration (FHA) loans. Furthermore,
foreclosure starts during the first quarter of 2010 are up from
the last quarter, with the exception of subprime loans.\986\
---------------------------------------------------------------------------
\986\ Mortgage Bankers Association, National Delinquency Survey
Q1210 (Mar. 31, 2010) (online at www.mbaa.org/ResearchandForecasts/
ProductsandSurveys/NationalDelinquencySurvey.htm).
---------------------------------------------------------------------------

FIGURE 56: TOTAL PERCENTAGE OF LOANS WITH INSTALLMENTS PAST DUE, BY
CENSUS REGION, FIRST QUARTER 2010 \987\

---------------------------------------------------------------------------
\987\ Id.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Consumer Credit. The Federal Reserve Consumer
Credit Index tracks short-term and long-term credit given to
individuals for all purposes excluding real estate loans. In
March 2010, consumer credit grew at a 0.5 percent annual rate.
Revolving credit decreased at a 5.3 percent annual rate, while
nonrevolving credit decreased at a 1.2 percent annual rate.
Data from the Federal Reserve's G.19 report indicate that there
was $2.44 trillion in consumer credit outstanding for the first
quarter of 2010. This figure is down from $2.54 trillion in the
first quarter of 2009.\988\
---------------------------------------------------------------------------
\988\ Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release G.19: Consumer Credit: Historical Data
(online at www.federalreserve.gov/releases/g19/current/g19.htm)
(accessed June 2, 2010).
---------------------------------------------------------------------------

FIGURE 57: FEDERAL RESERVE CONSUMER CREDIT TOTAL NET CHANGE (SEASONALLY
ADJUSTED) \989\

---------------------------------------------------------------------------
\989\ Id.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

G. Financial Update

Each month, the Panel summarizes the resources that the
federal government has committed to economic stabilization. The
following financial update provides: (1) an updated accounting
of the TARP, including a tally of dividend income, repayments,
and warrant dispositions that the program has received as of
April 29, 2010; and (2) an updated accounting of the full
federal resource commitment as of May 26, 2010.

1. The TARP

a. Costs: Expenditures and Commitments
Treasury has committed or is currently committed to spend
$520.3 billion of TARP funds through an array of programs used
to purchase preferred shares in financial institutions, provide
loans to small businesses and automotive companies, and
leverage Federal Reserve loans for facilities designed to
restart secondary securitization markets.\990\ Of this total,
$214.2 billion is currently outstanding under the $698.7
billion limit for TARP expenditures set by EESA, leaving $481.1
billion available for fulfillment of anticipated funding levels
of existing programs and for funding new programs and
initiatives. The $214.2 billion includes purchases of preferred
and common shares, warrants and/or debt obligations under the
CPP, AIGIP/SSFI Program, PPIP, and AIFP; and a loan to TALF
LLC, the SPV used to guarantee Federal Reserve TALF loans.\991\
Additionally, Treasury has spent $187.8 million under the Home
Affordable Modification Program, out of a projected total
program level of $50 billion.
---------------------------------------------------------------------------
\990\ EESA, as amended by the Helping Families Save Their Homes Act
of 2009, limits Treasury to $698.7 billion in purchasing authority
outstanding at any one time as calculated by the sum of the purchase
prices of all troubled assets held by Treasury. Pub. L. No. 110-343
Sec. 115(a)-(b); Helping Families Save Their Homes Act of 2009, Pub. L.
No. 111-22 Sec. 402(f) (reducing by $1.23 billion the authority for the
TARP originally set under EESA at $700 billion).
\991\ Treasury Transactions Report, supra note 2.
---------------------------------------------------------------------------
b. Income: Dividends, Interest Payments, CPP Repayments,
and Warrant Sales
As of May 26, 2010, a total of 74 institutions have
completely repurchased their CPP preferred shares. Of these
institutions, 46 have repurchased their warrants for common
shares that Treasury received in conjunction with its preferred
stock investments; Treasury sold the warrants for common shares
for 10 other institutions at auction.\992\ In May 2010,
Comerica Inc. repurchased its warrants for $183.8 million.
Warrants for common shares of Wells Fargo & Company and Valley
National Bancorp were sold at auction for $854.6 million in
total proceeds. On May 19, 2010, Treasury received a $4 million
repayment from Texas National Bancorporation, along with a
warrant to purchase $199,000 in preferred shares. In addition,
Treasury receives dividend payments on the preferred shares
that it holds, usually five percent per annum for the first
five years and nine percent per annum thereafter.\993\ To date,
Treasury has received approximately $20.8 billion in net income
from warrant repurchases, dividends, interest payments, and
other considerations derived from TARP investments,\994\ and
another $1.2 billion in participation fees from its Guarantee
Program for Money Market Funds.\995\
---------------------------------------------------------------------------
\992\ Treasury Transactions Report, supra note 2.
\993\ U.S. Department of the Treasury, Securities Purchase
Agreement [CPP]: Standard Terms, at 7 (online at
www.financialstability.gov/docs/CPP/spa.pdf) (accessed June 8, 2010).
\994\ U.S. Department of the Treasury, Cumulative Dividends and
Interest Report as of April 30, 2010 (May 14, 2010) (online at
www.financialstability.gov/docs/dividends-interest-reports/
April%202010%20Dividends%20and%20Interest%20Report.pdf) (hereinafter
``Treasury Cumulative Dividends and Interest Report'').
\995\ U.S. Department of the Treasury, Treasury Announces
Expiration of Guarantee Program for Money Market Funds (Sept. 18, 2009)
(online at www.treasury.gov/press/releases/tg293.htm).
---------------------------------------------------------------------------
c. TARP Accounting

FIGURE 58: TARP ACCOUNTING (AS OF APRIL 29, 2010) 996
[Dollars in billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total
Anticipated Actual Repayments/ Funding Funding
TARP Initiative Funding Funding Reduced Outstanding Losses Available
Exposure
--------------------------------------------------------------------------------------------------------------------------------------------------------
Capital Purchase Program (CPP) \997\............................. $204.9 $204.9 $137.3 \998\ $67.6 \999\ $2.3 $0
Targeted Investment Program (TIP) \1000\......................... 40.0 40.0 40 0 -- 0
AIG Investment Program (AIGIP)/Systemically Significant Failing 69.8 \1001\ 49.1 0 49.1 -- 20.7
Institutions Program (SSFI).....................................
Automobile Industry Financing Program (AIFP)..................... 81.3 81.3 \1002\ 10.8 67.1 \1003\ 3.5 0
Asset Guarantee Program (AGP) \1004\............................. 5.0 5.0 \1005\ 5.0 0 -- 0
Capital Assistance Program (CAP) \1006\.......................... -- -- -- -- -- --
Term Asset-Backed Securities Lending Facility (TALF)............. 20.0 \1007\ 0.10 0 0.10 -- 19.9
Public-Private Investment Program (PPIP) \1008\.................. 30.0 30.0 0 30.0 -- 0
Supplier Support Program (SSP) \1009\............................ \1010\ 3.5 3.5 3.5 0 -- 0
Unlocking SBA Lending............................................ 15.0 \1011\ 0.11 0 0.11 -- 14.89
Home Affordable Modification Program (HAMP)...................... \1012\ 50 \1013\ 0.19 0 0.19 -- 49.8
Community Development Capital Initiative (CDCI).................. \1014\ 0.78 0 0 0 -- 0.78
Total Committed.................................................. 520.3 414.20 -- 214.20 -- 106.08
Total Uncommitted................................................ 178.4 -- 196.6 -- -- \1015\ 375.
02
Total........................................................ $698.7 $414.20 $196.6 $214.20 $5.8 $481.10
--------------------------------------------------------------------------------------------------------------------------------------------------------
\996\ Treasury Transactions Report, supra note 2.
\997\ As of December 31, 2009, the CPP was closed. U.S. Department of the Treasury, FAQ on Capital Purchase Program Deadline (online at
www.financialstability.gov/docs/FAQ%20on%20Capital%20Purchase%20Program%20Deadline.pdf).
\998\ Treasury has classified the investments it made in two institutions, CIT Group ($2.3 billion) and Pacific Coast National Bancorp ($4.1 million),
as losses on the Transactions Report. Therefore Treasury's net current CPP investment is $65.4 billion due to the $2.3 billion in losses thus far.
Treasury Transactions Report, supra note 2.
\999\ This figure represents the TARP losses associated with CIT Group ($2.3 billion) and Pacific Coast National Bancorp ($4.1 million). This number
does not include UCBH Holdings or Midwest Banc Holdings, Inc. UCBH Holdings, Inc. received $299 million in TARP funds and is currently in bankruptcy
proceedings. As of May 26, 2010, the banking subsidiary of the TARP recipient Midwest Banc Holdings, Inc. ($89.4 million) was in receivership.
Treasury Transactions Report, supra note 2.
\1000\ Both Bank of America and Citigroup repaid the $20 billion in assistance each institution received under the TIP on December 9 and December 23,
2009, respectively. Therefore the Panel accounts for these funds as repaid and uncommitted. Treasury Transactions Report, supra note 2.
\1001\ AIG has completely utilized the $40 billion made available on November 25, 2008 and drawn-down $7.54 billion of the $29.8 billion made available
on April 17, 2009. This figure also reflects $1.6 billion in accumulated but unpaid dividends owed by AIG to Treasury due to the restructuring of
Treasury's investment from cumulative preferred shares to non-cumulative shares. AIG Form 10-K for FY09, supra note 50, at 45; Treasury Transactions
Report, supra note 2; information provided by Treasury staff in response to Panel request.
\1002\ On May 14, 2010, Treasury accepted a $1.9 billion settlement payment from Chrysler Holding to satisfy Chrysler Holdco's existing debt. In
addition, Chrysler LLC, ``Old Chrysler,'' repaid $30.5 million of its debt obligations to Treasury on May 10, 2010 from proceeds earned from
collateral sales. Treasury Transactions Report, supra note 2.
\1003\ The $1.9 billion settlement payment represents a $1.6 billion loss on Treasury's Chrysler Holding Investment. This amount is in addition to
losses connected to the $1.9 billion loss from the $4.1 billion debtor-in-possession credit facility, or Chrysler DIP Loan. U.S. Department of the
Treasury, Chrysler Financial Parent Company Repays $1.9 Billion in Settlement of Original Chrysler Loan, Press Release (May 17, 2010) (online at
www.financialstability.gov/latest/pr_05172010c.html); Treasury Transactions Report, supra note 2.
\1004\ Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation terminated the asset guarantee with Citigroup on December 23, 2009.
The agreement was terminated with no losses to Treasury's $5 billion second-loss portion of the guarantee. Citigroup did not repay any funds directly,
but instead terminated Treasury's outstanding exposure on its $5 billion second-loss position. As a result, the $5 billion is now counted as
uncommitted. U.S. Department of the Treasury, Treasury Receives $45 Billion in Repayments from Wells Fargo and Citigroup (Dec. 22, 2009) (online at
www.treas.gov/press/releases/20091229716198713.htm).
\1005\ Although this $5 billion is no longer exposed as part of the AGP and is accounted for as available, Treasury did not receive a repayment in the
same sense as with other investments. Treasury did receive other income as consideration for the guarantee, which is not a repayment and is accounted
for in Figure 59.
\1006\ On November 9, 2009, Treasury announced the closing of this program and that only one institution, GMAC, was in need of further capital from
Treasury. GMAC subsequently received an additional $3.8 billion in capital through the AIFP on December 30, 2009. U.S. Department of the Treasury,
Treasury Announcement Regarding the Capital Assistance Program (Nov. 9, 2009) (online at www.financialstability.gov/latest/tg_11092009.html); U.S.
Department of the Treasury, Treasury Announces Restructuring of Commitment to GMAC (Nov. 9, 2009) (online at www.financialstability.gov/latest/
tg_11092009.html) (updated Jan. 5, 2010); Treasury Transactions Report, supra note 2.
\1007\ Treasury has committed $20 billion in TARP funds to a loan funded through TALF LLC, a special purpose vehicle created by the Federal Reserve Bank
of New York. The loan is incrementally funded and as of May 26, 2010, Treasury provided $104 million to TALF LLC. This total includes accrued payable
interest. Treasury Transactions Report, supra note 2; Federal Reserve H.4.1 Statistical Release, supra note 342.
\1008\ On April 20, 2010, Treasury released its second quarterly report on the Legacy Securities Public-Private Investment Partnership. As of March 31,
2010, the total value of assets held by the PPIP managers was $10 billion. Of this total, 88 percent was non-agency Residential Mortgage-Backed
Securities and the remaining 12 percent was Commercial Mortgage-Backed Securities. U.S. Department of the Treasury, Legacy Securities Public-Private
Investment Program, Program Update--Quarter Ended March 31, 2010 (Apr. 20, 2010) (online at www.financialstability.gov/docs/External%20Report%20-%2003-
10%20Final.pdf).
\1009\ On April 5, 2010 and April 7, 2010, Treasury's commitment to lend to the GM SPV and the Chrysler SPV respectively under the ASSP ended. In total,
Treasury received $413 million in repayments from loans provided by this program ($290 million from the GM SPV and $123 million from the Chrysler
SPV). Further, Treasury received $101 million in proceeds from additional notes associated with this program. Treasury Transactions Report, supra note
2.
\1010\ On July 8, 2009, Treasury lowered the total commitment amount for the program from $5 billion to $3.5 billion. This action reduced GM's portion
from $3.5 billion to $2.5 billion and Chrysler's portion from $1.5 billion to $1 billion. GM Supplier Receivables LLC, the special purpose vehicle
(SPV) created to administer this program for GM suppliers has made $290 million in partial repayments and Chrysler Receivables SPV LLC, the SPV
created to administer the program for Chrysler suppliers, has made $123 million in partial repayments. These were partial repayments of drawn-down
funds and did not lessen Treasury's $3.5 billion in total exposure under the ASSP. Treasury Transactions Report, supra note 2.
\1011\ Treasury settled on the purchase of three floating rate Small Business Administration 7(a) securities on March 24, 2010, and another on April 30,
2010. Treasury anticipates a settlement on one floating rate SBA 7(a) security on May 28, 2010. As of May 3, 2010, the total amount of TARP funds
invested in these securities was $58.64 million. Treasury Transactions Report, supra note 2.
\1012\ On February 19, 2010, President Obama announced the Housing Finance Agency Innovation Fund for the Hardest Hit Housing Markets (HFA Hardest Hit
Fund). The proposal commits $1.5 billion of the $50 billion in TARP funds allocated to HAMP to assist the five states with the highest home price
declines stemming from the foreclosure crisis: Nevada, California, Florida, Arizona, and Michigan. The White House, President Obama Announces Help for
Hardest Hit Housing Markets (Feb. 19, 2010) (online at www.whitehouse.gov/the-press-office/president-obama-announces-help-hardest-hit-housing-
markets). On March 29, 2010, Treasury announced $600 million in funding for a second HFA Hardest Hit Fund which includes North Carolina, Ohio, Oregon
Rhode Island, and South Carolina. U.S. Department of the Treasury, Administration Announces Second Round of Assistance for Hardest-Hit Housing Markets
(Mar. 29, 2010) (online at www.financialstability.gov/latest/pr_03292010.html). Until further information on these programs is released, the Panel
will continue to account for the $50 billion commitment to HAMP as intact and as the newly announced programs as subsets of the larger initiative. For
further discussion of the newly announced HAMP programs, and the effect these initiatives may have on the $50 billion in committed TARP funds, see
section D.1 of the Panel's April report. Congressional Oversight Panel, April Oversight Report: Evaluating Progress on TARP Foreclosure Mitigation
Programs, at 227 (Apr. 14, 2010) (online atcop.senate.gov/documents/cop-041410-report.pdf).
\1013\ In response to a Panel inquiry, Treasury disclosed that, as of May 31, 2010, $187.8 million in funds had been disbursed under HAMP. As of May 26,
2010, the total of all the caps set on payments to each mortgage servicer was $39.8 billion. Treasury Transactions Report, supra note 2.
\1014\ On February 3, 2010, the Administration announced an initiative under TARP to provide low-cost financing for Community Development Financial
Institutions (CDFIs). Under this program, CDFIs are eligible for capital investments at a two percent dividend rate as compared to the five percent
dividend rate under the CPP. In response to Panel request, Treasury stated that it projects the CDCI program to utilize $780.2 million.
\1015\ This figure is the sum of the uncommitted funds remaining under the $698.7 billion cap ($178.4 billion) and the repayments ($196.5 billion).

FIGURE 59: TARP PROFIT AND LOSS
[Dollars in millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Warrant Other Proceeds Losses \1019\
TARP Initiative Dividends \1016\ Interest \1017\ Repurchases \1018\ (as of 4/30/ (as of 5/26/ Total
(as of 4/30/10) (as of 4/30/10) (as of 5/26/10) 10) 10)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total................................................ $14,996 $726 $7,031 $3,833 ($5,822) $20,764
CPP.................................................. 8,969 28 5,760 \1020\ 1,308 (2,334) 13,731
TIP.................................................. 3,004 - 1,256 - - 4,260
AIFP................................................. \1021\ 2,701 674 15 - (3,488) (97)
ASSP................................................. N/A 15 - - - 15
AGP.................................................. 321 - 0 \1022\ 2,234 - 2,555
PPIP................................................. - 9 - \1023\ 15 - 24
Bank of America Guarantee............................ - - - \1024\ 276 - 276
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1016\ Treasury Cumulative Dividends and Interest Report, supra note 994.
\1017\ Treasury Cumulative Dividends and Interest Report, supra note 994.
\1018\ Treasury Transactions Report, supra note 2.
\1019\ See note 999, supra.
\1020\ As a fee for taking a second-loss position up to $5 billion on a $301 billion pool of ring-fenced Citigroup assets, as part of the AGP, Treasury
received $4.03 billion in Citigroup preferred stock and warrants; Treasury exchanged these preferred stocks for TruPS in June 2009. Following the
early termination of the guarantee, Treasury cancelled $1.8 billion of the TruPS, leaving Treasury with a $2.23 billion investment in Citigroup TruPS
in exchange for the guarantee. At the end of Citigroup's participation in the FDIC's TLGP, the FDIC may transfer $800 million of $3.02 billion in
Citigroup TruPS it received in consideration for its role in the AGP to the Treasury. U.S. Department of the Treasury, Troubled Asset Relief Program
Transactions Report for Period Ending May 26, 2010 (May 28, 2010) (online at www.financialstability.gov/docs/transaction-reports/5-
2810%20Transactions%20Report%20as%20of%205-26-10.pdf).
\1021\ This figure includes $815 million in dividends from GMAC preferred stock, trust preferred securities and mandatory convertible preferred shares.
The dividend total also includes a $748.6 million senior unsecured note from Treasury's investment in General Motors. Information provided by Treasury
in response to Panel inquiry.
\1022\ As a fee for taking a second-loss position up to $5 billion on a $301 billion pool of ring-fenced Citigroup assets, as part of the AGP, Treasury
received $4.03 billion in Citigroup preferred stock and warrants; Treasury exchanged these preferred stocks for trust preferred securities in June
2009. Following the early termination of the guarantee, Treasury cancelled $1.8 billion of the trust preferred securities, leaving Treasury with a
$2.23 billion investment in Citigroup trust preferred securities in exchange for the guarantee. At the end of Citigroup's participation in the FDIC's
TLGP, the FDIC may transfer $800 million of $3.02 billion in Citigroup Trust Preferred Securities it received in consideration for its role in the AGP
to the Treasury. Treasury Transactions Report, supra note 2.
\1023\ As of April 29, 2010, Treasury has earned $15.4 million in membership interest distributions from the PPIP. Treasury Cumulative Dividends and
Interest Report, supra note 994.
\1024\ Although Treasury, the Federal Reserve, and the FDIC negotiated with Bank of America regarding a similar guarantee, the parties never reached an
agreement. In September 2009, Bank of America agreed to pay each of the prospective guarantors a fee as though the guarantee had been in place during
the negotiations. This agreement resulted in payments of $276 million to Treasury, $57 million to the Federal Reserve, and $92 million to the FDIC.
U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Bank of America
Corporation, Termination Agreement, at 1-2 (Sept. 21, 2009) (online at www.financialstability.gov/docs/AGP/BofA%20-%20Termination%20Agreement%20-
%20executed.pdf).

d. Rate of Return
As of June 8, 2010, the average internal rate of return for
all financial institutions that participated in the CPP and
fully repaid the U.S. government (including preferred shares,
dividends, and warrants) was 9.9 percent. The internal rate of
return is the annualized effective compounded return rate that
can be earned on invested capital.
e. Warrant Disposition

FIGURE 60: WARRANT REPURCHASES/AUCTIONS FOR FINANCIAL INSTITUTIONS THAT HAVE FULLY REPAID CPP FUNDS AS OF JUNE 8, 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Panel's Best
Investment Warrant Warrant Valuation Price/ IRR
Institution Date Repurchase Repurchase/ Sale Estimate at Estimate (Percent)
Date Amount Repurchase Date Ratio
--------------------------------------------------------------------------------------------------------------------------------------------------------
Old National Bancorp.......................................... 12/12/2008 5/8/2009 $1,200,000 $2,150,000 0.558 9.3
Iberiabank Corporation........................................ 12/5/2008 5/20/2009 1,200,000 2,010,000 0.597 9.4
Firstmerit Corporation........................................ 1/9/2009 5/27/2009 5,025,000 4,260,000 1.180 20.3
Sun Bancorp, Inc.............................................. 1/9/2009 5/27/2009 2,100,000 5,580,000 0.376 15.3
Independent Bank Corp......................................... 1/9/2009 5/27/2009 2,200,000 3,870,000 0.568 15.6
Alliance Financial Corporation................................ 12/19/2008 6/17/2009 900,000 1,580,000 0.570 13.8
First Niagara Financial Group................................. 11/21/2008 6/24/2009 2,700,000 3,050,000 0.885 8.0
Berkshire Hills Bancorp, Inc.................................. 12/19/2008 6/24/2009 1,040,000 1,620,000 0.642 11.3
Somerset Hills Bancorp........................................ 1/16/2009 6/24/2009 275,000 580,000 0.474 16.6
SCBT Financial Corporation.................................... 1/16/2009 6/24/2009 1,400,000 2,290,000 0.611 11.7
HF Financial Corp............................................. 11/21/2008 6/30/2009 650,000 1,240,000 0.524 10.1
State Street.................................................. 10/28/2008 7/8/2009 60,000,000 54,200,000 1.107 9.9
U.S. Bancorp.................................................. 11/14/2008 7/15/2009 139,000,000 135,100,000 1.029 8.7
The Goldman Sachs Group, Inc.................................. 10/28/2008 7/22/2009 1,100,000,000 1,128,400,000 0.975 22.8
BB&T Corp..................................................... 11/14/2008 7/22/2009 67,010,402 68,200,000 0.983 8.7
American Express Company...................................... 1/9/2009 7/29/2009 340,000,000 391,200,000 0.869 29.5
Bank of New York Mellon Corp.................................. 10/28/2008 8/5/2009 136,000,000 155,700,000 0.873 12.3
Morgan Stanley................................................ 10/28/2008 8/12/2009 950,000,000 1,039,800,000 0.914 20.2
Northern Trust Corporation.................................... 11/14/2008 8/26/2009 87,000,000 89,800,000 0.969 14.5
Old Line Bancshares Inc....................................... 12/5/2008 9/2/2009 225,000 500,000 0.450 10.4
Bancorp Rhode Island, Inc..................................... 12/19/2008 9/30/2009 1,400,000 1,400,000 1.000 12.6
Centerstate Banks of Florida Inc.............................. 11/21/2008 10/28/2009 212,000 220,000 0.964 5.9
Manhattan Bancorp............................................. 12/5/2008 10/14/2009 63,364 140,000 0.453 9.8
Bank of Ozarks................................................ 12/12/2008 11/24/2009 2,650,000 3,500,000 0.757 9.0
Capital One Financial......................................... 11/14/2008 12/3/2009 148,731,030 232,000,000 0.641 12.0
JPMorgan Chase & Co........................................... 10/28/2008 12/10/2009 950,318,243 1,006,587,697 0.944 10.9
TCF Financial Corp............................................ 1/16/2009 12/16/2009 9,599,964 11,825,830 0.812 11.0
LSB Corporation............................................... 12/12/2008 12/16/2009 560,000 535,202 1.046 9.0
Wainwright Bank & Trust Company............................... 12/19/2008 12/16/2009 568,700 1,071,494 0.531 7.8
Wesbanco Bank, Inc............................................ 12/5/2008 12/23/2009 950,000 2,387,617 0.398 6.7
Union Bankshares Corporation.................................. 12/19/2008 12/23/2009 450,000 1,130,418 0.398 5.8
Trustmark Corporation......................................... 11/21/2008 12/30/2009 10,000,000 11,573,699 0.864 9.4
Flushing Financial Corporation................................ 12/19/2008 12/30/2009 900,000 2,861,919 0.314 6.5
OceanFirst Financial Corporation.............................. 1/16/2009 2/3/2010 430,797 279,359 1.542 6.2
Monarch Financial Holdings, Inc............................... 12/19/2008 2/10/2010 260,000 623,434 0.417 6.7
Bank of America............................................... \1025\ 10/ 3/3/2010 1,566,210,714 1,006,416,684 1.533 6.5
28/08
\1026\ 1/9/
2009
\1027\ 1/14/
2009
Washington Federal Inc./ Washington Federal Savings & Loan 11/14/2008 3/9/2010 15,623,222 10,166,404 1.537 18.6
Association..................................................
Signature Bank................................................ 12/12/2008 3/10/2010 11,320,751 11,458,577 0.988 32.4
Texas Capital Bancshares, Inc................................. 1/16/2009 3/11/2010 6,709,061 8,316,604 0.807 30.1
Umpqua Holdings Corp.......................................... 11/14/2008 3/31/2010 4,500,000 5,162,400 0.872 6.6
City National Corporation..................................... 11/21/2008 4/7/2010 18,500,000 24,376,448 0.759 8.5
First Litchfield Financial Corporation........................ 12/12/2008 4/7/2010 1,488,046 1,863,158 0.799 15.9
PNC Financial Services Group Inc.............................. 12/31/2008 4/29/2010 324,195,686 346,800,388 0.935 8.7
Comerica Inc.................................................. 11/14/2008 5/4/2010 183,673,472 276,426,071 0.664 10.8
Valley National Bancorp....................................... 11/14/2008 5/18/2010 5,571,592 5,955,884 0.935 8.3
Wells Fargo Bank.............................................. 10/28/2008 5/20/2010 849,014,998 1,064,247,725 0.798 7.8
First Financial Bancorp....................................... 12/23/2008 6/2/2010 3,116,284 3,051,431 1.021 8.2
Total..................................................... ........... ........... $7,014,943,327 $7,131,508,443 0.984 9.90
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1025\ Investment date for Bank of America in CPP.
\1026\ Investment date for Merrill Lynch in CPP.
\1027\ Investment date for Bank of America in TIP.

FIGURE 61: VALUATION OF CURRENT HOLDINGS OF WARRANTS AS OF JUNE 8, 2010
[Dollars in millions]
------------------------------------------------------------------------
Warrant Valuation
Stress Test Financial --------------------------------------
Institutions with Warrants Low High Best
Outstanding Estimate Estimate Estimate
------------------------------------------------------------------------
Citigroup, Inc................... $10.95 $1,001.97 $318.78
SunTrust Banks, Inc.............. 13.70 333.82 200.48
Regions Financial Corporation.... 16.21 235.88 137.59
Fifth Third Bancorp.............. 90.72 381.08 239.21
Hartford Financial Services 380.32 725.70 545.72
Group, Inc......................
KeyCorp.......................... 16.81 158.87 104.25
AIG.............................. 173.36 1,594.41 1,020.39
All Other Banks.................. 893.43 2,096.14 1,661.88
Total............................ $1,595.49 $6,527.87 $4,228.32
Citigroup, Inc................... $10.95 $1,001.97 $318.78
------------------------------------------------------------------------

2. Other Financial Stability Efforts

Federal Reserve, FDIC, and Other Programs
In addition to the direct expenditures Treasury has
undertaken through the TARP, the federal government has engaged
in a much broader program directed at stabilizing the U.S.
financial system. Many of these initiatives explicitly augment
funds allocated by Treasury under specific TARP initiatives,
such as FDIC and Federal Reserve asset guarantees for
Citigroup, or operate in tandem with Treasury programs, such as
the interaction between PPIP and TALF. Other programs, like the
Federal Reserve's extension of credit through its Section 13(3)
facilities and SPVs and the FDIC's Temporary Liquidity
Guarantee Program, operate independently of the TARP.
Figure 62 below reflects the changing mix of Federal
Reserve investments. As the liquidity facilities established to
address the crisis have been wound down, the Federal Reserve
has expanded its facilities for purchasing mortgage-related
securities. The Federal Reserve announced that it intended to
purchase $175 billion of federal agency debt securities and
$1.25 trillion of agency mortgage-backed securities.\1028\ As
of May 26, 2010, $167.4 billion of federal agency (government-
sponsored enterprise) debt securities and $1.1 trillion of
agency mortgage-backed securities were purchased.\1029\ These
purchases were completed on March 31, 2010.\1030\ In addition,
$174.7 billion in GSE MBS remain outstanding as of May 2010
under Treasury's GSE Mortgage Backed Securities Purchase
Program.\1031\
---------------------------------------------------------------------------
\1028\ Board of Governors of the Federal Reserve System, Minutes of
the Federal Open Market Committee, at 10 (Dec. 15-16, 2009) (online at
www.federalreserve.gov/newsevents/press/monetary/
fomcminutes20091216.pdf) (``[T]he Federal Reserve is in the process of
purchasing $1.25 trillion of agency mortgage-backed securities and
about $175 billion of agency debt'').
\1029\ Federal Reserve Data Download Program, supra note 317.
\1030\ Federal Reserve Bank of New York, Agency Mortgage-Backed
Securities Purchase Program (online at www.newyorkfed.org/markets/mbs/
); Federal Reserve H.4.1 Statistical Release, supra note 809.
\1031\ U.S. Department of the Treasury, MBS Purchase Program:
Portfolio by Month (online at www.financialstability.gov/docs/
May%202010%20Portfolio%20by%20month.pdf) (accessed June 2, 2010).
Treasury received $42.2 billion in principal repayments $10.3 billion
in interest payments from these securities. U.S. Department of the
Treasury, MBS Purchase Program Principal and Interest (online at
www.financialstability.gov/docs/
May%202010%20MBS%20Principal%20and%20Interest%20Monthly%20Breakout.pdf)
(accessed June 2, 2010).
---------------------------------------------------------------------------

FIGURE 62: FEDERAL RESERVE AND FDIC FINANCIAL STABILITY EFFORTS (AS OF
APRIL 28, 2010) \1032\

---------------------------------------------------------------------------
\1032\ Federal Reserve Liquidity Facilities include: Primary
credit, Secondary credit, Central Bank Liquidity Swaps, Primary dealer
and other broker-dealer credit, Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility, Net portfolio holdings of
Commercial Paper Funding Facility LLC, Seasonal credit, Term auction
credit, and Term Asset-Backed Securities Loan Facility. Federal Reserve
Mortgage Related Facilities Include: Federal agency debt securities and
Mortgage-backed securities held by the Federal Reserve. Institution
Specific Facilities include: credit extended to American International
Group, Inc., the preferred interests in AIA Aurora LLC and ALICO
Holdings LLC, and the net portfolio holdings of Maiden Lanes I, II, and
III. Federal Reserve Data Download Program, supra note 317. For related
presentations of Federal Reserve data, see Board of Governors of the
Federal Reserve System, Credit and Liquidity Programs and the Balance
Sheet, at 2 (Nov. 2009) (online at www.federalreserve.gov/
monetarypolicy/files/monthlyclbsreport200911.pdf). The TLGP figure
reflects the monthly amount of debt outstanding under the program.
Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance
Under the Temporary Liquidity Guarantee Program (Dec. 2008-Mar. 2010)
(online at www.fdic.gov/regulations/resources/TLGP/reports.html). The
total for the Term Asset-Backed Securities Loan Facility has been
reduced by $20 billion throughout this exhibit in order to reflect
Treasury's $20 billion first-loss position under the terms of this
program.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

3. Total Financial Stability Resources (as of April 30, 2010)

Beginning in its April 2009 report, the Panel broadly
classified the resources that the federal government has
devoted to stabilizing the economy through myriad new programs
and initiatives such as outlays, loans, or guarantees. Although
the Panel calculates the total value of these resources at
nearly $3 trillion, this would translate into the ultimate
``cost'' of the stabilization effort only if: (1) assets do not
appreciate; (2) no dividends are received, no warrants are
exercised, and no TARP funds are repaid; (3) all loans default
and are written off; and (4) all guarantees are exercised and
subsequently written off.
With respect to the FDIC and Federal Reserve programs, the
risk of loss varies significantly across the programs
considered here, as do the mechanisms providing protection for
the taxpayer against such risk. As discussed in the Panel's
November report, the FDIC assesses a premium of up to 100 basis
points on TLGP debt guarantees.\1033\ In contrast, the Federal
Reserve's liquidity programs are generally available only to
borrowers with good credit, and the loans are over-
collateralized and with recourse to other assets of the
borrower. If the assets securing a Federal Reserve loan realize
a decline in value greater than the ``haircut,'' the Federal
Reserve is able to demand more collateral from the borrower.
Similarly, should a borrower default on a recourse loan, the
Federal Reserve can turn to the borrower's other assets to make
the Federal Reserve whole. In this way, the risk to the
taxpayer on recourse loans only materializes if the borrower
enters bankruptcy. The only loan currently ``underwater''--
where the outstanding principal loan amount exceeds the current
market value of the collateral--is the loan to Maiden Lane
LLC,\1034\ which was formed to purchase certain Bear Stearns
assets.
---------------------------------------------------------------------------
\1033\ November Oversight Report, supra note 411, at 36.
\1034\ Maiden Lane LLC is often referred to as Maiden Lane I, due
to the later establishment of ML2 and ML3.

FIGURE 63: FEDERAL GOVERNMENT FINANCIAL STABILITY EFFORT (AS OF MAY 26, 2010) i
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Treasury Federal
Program (TARP) Reserve FDIC Total
----------------------------------------------------------------------------------------------------------------
Total........................................... $698.7 $1,642.6 $670.4 $2,995.2
Outlays ii.................................. 271.4 1,316.3 69.4 1,630.6
Loans....................................... 37.8 326.3 0 380.1
Guarantees iii.............................. 20 0 601 621
Uncommitted TARP Funds...................... 369.5 0 0 363.4
AIG iv.......................................... 69.8 90.1 0 159.9
Outlays..................................... v 69.8 vi 25.4 0 95.2
Loans....................................... 0 vii 64.7 0 64.7
Guarantees.................................. 0 0 0 0
Citigroup....................................... 25 0 0 25
Outlays..................................... viii 25 0 0 25
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 0 0
Capital Purchase Program (Other)................ 42.7 0 0 42.7
Outlays..................................... ix 42.7 0 0 42.7
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 0 0
Capital Assistance Program...................... N/A 0 0 x N/A
TALF............................................ 20 180 0 200
Outlays..................................... 0 0 0 0
Loans....................................... 0 xii 180 0 180
Guarantees.................................. xi 20 0 0 20
PPIP (Loans) xiii............................... 0 0 0 0
Outlays..................................... 0 0 0 0
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 0 0
PPIP (Securities)............................... xiv 30 0 0 30
Outlays..................................... 10 0 0 10
Loans....................................... 20 0 0 20
Guarantees.................................. 0 0 0 0
Home Affordable Modification Program............ 50 0 0 50
Outlays..................................... xv 50 0 0 50
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 0 0
Automotive Industry Financing Program........... xvi 67.1 0 0 67.1
Outlays..................................... 59.0 0 0 59.0
Loans....................................... 8.1 0 0 8.1
Guarantees.................................. 0 0 0 0
Auto Supplier Support Program................... 3.5 0 0 3.5
Outlays..................................... 0 0 0 0
Loans....................................... xvii 3.5 0 0 3.5
Guarantees.................................. 0 0 0 0
Unlocking SBA Lending........................... xviii 15 0 0 15
Outlays..................................... 15 0 0 15
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 0 0
Community Development Capital Initiative........ xix 0.78 0 0 0.78
Outlays..................................... 0 0 0 0
Loans....................................... 0.78 0 0 0.78
Guarantees.................................. 0 0 0 0
Temporary Liquidity Guarantee Program........... 0 0 569 569
Outlays..................................... 0 0 0 0
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 xx 569 569
Deposit Insurance Fund.......................... 0 0 69.4 69.4
Outlays..................................... 0 0 xxi 69.4 69.4
Loans....................................... 0 0 0 0
Guarantees.................................. 0 0 0 0
Other Federal Reserve Credit Expansion.......... 0 1410.7 0 1410.7
Outlays..................................... 0 xxii 1305.7 0 1305.7
Loans....................................... 0 xxiii 105 0 105
Guarantees.................................. 0 0 0 0
Uncommitted TARP Funds.......................... 374.8 0 0 374.8
----------------------------------------------------------------------------------------------------------------
i All data in this exhibit is as of May 26, 2010, except for information regarding the FDIC's Temporary
Liquidity Guarantee Program (TLGP). This data is as of April 30, 2010.
ii The term ``outlays'' is used here to describe the use of Treasury funds under the TARP, which are broadly
classifiable as purchases of debt or equity securities (e.g., debentures, preferred stock, exercised warrants,
etc.). The outlays figures are based on: (1) Treasury's actual reported expenditures; and (2) Treasury's
anticipated funding levels as estimated by a variety of sources, including Treasury pronouncements and GAO
estimates. Anticipated funding levels are set at Treasury's discretion, have changed from initial
announcements, and are subject to further change. Outlays used here represent investment and asset purchases
and commitments to make investments and asset purchases and are not the same as budget outlays, which under
section 123 of EESA are recorded on a ``credit reform'' basis.
iii Although many of the guarantees may never be exercised or exercised only partially, the guarantee figures
included here represent the federal government's greatest possible financial exposure.
iv AIG received an $85 billion credit facility (reduced to $60 billion in November 2008 and then to $35 billion
in December 2009 and then to $34 billion in May 2010) from FRBNY. A Treasury trust received Series C preferred
convertible stock in exchange for the facility and $0.5 million. The Series C shares amount to 79.9 percent
ownership of common stock, minus the percentage common shares acquired through warrants. In November 2008,
Treasury received a warrant to purchase shares amounting to 2 percent ownership of AIG common stock in
connection with its Series D stock purchase (exchanged for Series E noncumulative preferred shares on April
17, 2009). Treasury also received a warrant to purchase 3,000 Series F common shares in May 2009. Warrants for
Series D and Series F shares represent 2 percent equity ownership, and would convert Series C shares into 77.9
percent of common stock. However, in May 2009, AIG carried out a 20:1 reverse stock split, which allows
warrants held by Treasury to become convertible into 0.1 percent common equity. Therefore, the total benefit
to Treasury would be a 79.8 percent voting majority in AIG in connection with its ownership of Series C
convertible shares. Government Accountability Office, Troubled Asset Relief Program: Update of Government
Assistance Provided to AIG (Apr. 2010) (GAO-10-475) (online at www.gao.gov/new.items/d10475.pdf). Additional
information was also provided by Treasury in response to the Panel's inquiry.
v This number includes investments under the AIGIP/SSFI Program: $40 billion investment made on November 25,
2008 and $30 billion investment committed on April 17, 2009 (less a reduction of $165 million, representing
bonuses paid to AIGFP employees). As of March 31, 2010, AIG had utilized $47.5 billion of the available $69.8
billion under the AIGIP/SSFI and owed $1.6 billion in unpaid dividends. This information was provided by
Treasury in response to the Panel's inquiry.
vi As part of the restructuring of the U.S. government's investment in AIG announced on March 2, 2009, the
amount available to AIG through the Revolving Credit Facility was reduced by $25 billion in exchange for
preferred equity interests in two special purpose vehicles, AIA Aurora LLC and ALICO Holdings LLC. These SPVs
were established to hold the common stock of two AIG subsidiaries: American International Assurance Company
Ltd. (AIA) and American Life Insurance Company (ALICO). As of May 26, 2010, the book value of FRBNY's holdings
in AIA Aurora LLC and ALICO Holdings LLC was $16 billion and $9 billion in preferred equity, respectively.
Hence, the book value of these securities is $25 billion, which is reflected in the corresponding table.
Federal Reserve Bank of New York, Factors Affecting Reserve Balances (H.4.1) (May 27, 2010) (online at
www.federalreserve.gov/releases/h41/20100527/).
vii This number represents the full $34 billion that is available to AIG through the Revolving Credit Facility
with FRBNY ($26.1 billion had been drawn down as of May 26, 2010), and the outstanding principal of the loans
extended to the ML2 and ML3 SPVs to purchase AIG assets (as of May 26, 2010, $15 billion and $16 billion,
respectively). The amounts outstanding under the ML2 and ML3 facilities do not reflect the accrued interest
payable to FRBNY. Income from the purchased assets is used to pay down the loans made under ML2 and ML3,
reducing the taxpayers' exposure to losses over time. Board of Governors of the Federal Reserve System,
Federal Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet, at 17 (Oct.
2009) (online at www.federalreserve.gov/monetarypolicy/files/monthlyclbsreport200910.pdf). On December 1,
2009, AIG entered into an agreement with FRBNY to reduce the debt AIG owes the FRBNY by $25 billion. In
exchange, FRBNY received preferred equity interests in two AIG subsidiaries. This also reduced the debt
ceiling on the loan facility from $60 billion to $35 billion. American International Group, AIG Closes Two
Transactions That Reduce Debt AIG Owes Federal Reserve Bank of New York by $25 billion (Dec. 1, 2009) (online
at phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjE4ODl8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1). The maximum
available amount from the credit facility was reduced from $34.1 billion to $34 billion on May 6, 2010, as a
result of the sale of HighStar Port Partners, L.P. Board of Governors of the Federal Reserve System, Federal
Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet, at 17 (May 2010) (online
at www.federalreserve.gov/monetarypolicy/files/monthlyclbsreport201005.pdf).
viii On May 26, 2010, Treasury completed sales of 1.5 billion shares of Citigroup common stock for $6.1 billion
in gross proceeds and $1.3 billion in net proceeds. U.S. Department of the Treasury, Troubled Asset Relief
Program Transactions Report for Period Ending May 26, 2010, at 15 (May 28, 2010) (online at
financialstability.gov/docs/transaction-reports/5-28-10%20Transactions%20Report%20as%20of%205-26-10.pdf).
ix This figure represents the $204.9 billion Treasury disbursed under the CPP, minus the $25 billion investment
in Citigroup identified above, and the $137.3 billion in repayments that are reflected as available TARP
funds. This figure does not account for future repayments of CPP investments, dividend payments from CPP
investments, or losses under the program. U.S. Department of the Treasury, Troubled Asset Relief Program
Transactions Report for Period Ending May 26, 2010 (May 28, 2010) (online at www.financialstability.gov/docs/
transaction-reports/5-28-10%20Transactions%20Report%20as%20of%205-26-10.pdf).
x On November 9, 2009, Treasury announced the closing of the CAP and only one institution, GMAC, was in need of
further capital from Treasury. GMAC, however, received further funding through the AIFP. Therefore, the Panel
considers CAP unused and closed. U.S. Department of the Treasury, Treasury Announcement Regarding the Capital
Assistance Program (Nov. 9, 2009) (online at www.financialstability.gov/latest/tg_11092009.html).
xi This figure represents a $20 billion allocation to the TALF SPV on March 3, 2009. However, as of May 26,
2010, TALF LLC had drawn only $104 million of the available $20 billion. Board of Governors of the Federal
Reserve System, Factors Affecting Reserve Balances (H.4.1) (May 27, 2010) (online at www.federalreserve.gov/
releases/h41/20100527/); U.S. Department of the Treasury, Troubled Asset Relief Program Transactions Report
for Period Ending May 26, 2010 (May 28, 2010) (online at www.financialstability.gov/docs/transaction-reports/5-
28-10%20Transactions%20Report%20as%20of%205-26-10.pdf). As of June 2, 2010, investors had requested a total of
$73.3 billion in TALF loans ($13.2 billion in CMBS and $60.1 billion in non-CMBS), and $71 billion in TALF
loans had been settled ($12 billion in CMBS and $59 billion in non-CMBS). Federal Reserve Bank of New York,
Term Asset-Backed Securities Loan Facility: CMBS (online at www.newyorkfed.org/markets/cmbs_operations.html)
(accessed June 2, 2010); Federal Reserve Bank of New York, Term Asset-Backed Securities Loan Facility: non-
CMBS (online at www.newyorkfed.org/markets/talf_operations.html) (accessed June 2, 2010).
xii This number is derived from the unofficial 1:10 ratio of the value of Treasury loan guarantees to the value
of Federal Reserve loans under the TALF. U.S. Department of the Treasury, Fact Sheet: Financial Stability Plan
(Feb. 10, 2009) (online at www.financialstability.gov/docs/fact-sheet.pdf) (describing the initial $20 billion
Treasury contribution tied to $200 billion in Federal Reserve loans and announcing potential expansion to a
$100 billion Treasury contribution tied to $1 trillion in Federal Reserve loans). Because Treasury is
responsible for reimbursing the Federal Reserve for $20 billion of losses on its $200 billion in loans, the
Federal Reserve's maximum potential exposure under the TALF is $180 billion.
xiii It is unlikely that resources will be expended under the PPIP Legacy Loans Program in its original design
as a joint Treasury-FDIC program to purchase troubled assets from solvent banks. See also Federal Deposit
Insurance Corporation, FDIC Statement on the Status of the Legacy Loans Program (June 3, 2009) (online at
www.fdic.gov/news/news/press/2009/pr09084.html); Federal Deposit Insurance Corporation, Legacy Loans Program--
Test of Funding Mechanism (July 31, 2009) (online at www.fdic.gov/news/news/press/2009/pr09131.html). The
sales described in these statements do not involve any Treasury participation, and FDIC activity is accounted
for here as a component of the FDIC's Deposit Insurance Fund outlays.
xiv As of February 25, 2010, Treasury reported commitments of $19.9 billion in loans and $9.9 billion in
membership interest associated with the program. On January 4, 2010, Treasury and one of the nine fund
managers, TCW Senior Management Securities Fund, L.P., entered into a ``Winding-Up and Liquidation
Agreement.'' U.S. Department of the Treasury, Troubled Asset Relief Program Transactions Report for Period
Ending May 26, 2010 (May 28, 2010) (online at www.financialstability.gov/docs/transaction-reports/5-28-
10%20Transactions%20Report%20as%20of%205-26-10.pdf).
xv Of the $50 billion in announced TARP funding for this program, $39.8 billion has been allocated as of May 26,
2010. However, as of February 2010, only $187.8 million in non-GSE payments have been disbursed under HAMP.
Disbursement information provided by Treasury in response to the Panel's inquiry. U.S. Department of the
Treasury, Troubled Asset Relief Program Transactions Report for Period Ending May 26, 2010 (May 28, 2010)
(online at www.financialstability.gov/docs/transaction-reports/5-28-10%20Transactions%20Report%20as%20of%205-
26-10.pdf).
xvi A substantial portion of the total $81.3 billion in loans extended under the AIFP have since been converted
to common equity and preferred shares in restructured companies. $8.1 billion has been retained as first lien
debt (with $1 billion committed to old GM, and $7.1 billion to Chrysler). This figure ($67.1 billion)
represents Treasury's current obligation under the AIFP after repayments.
xvii U.S. Department of the Treasury, Troubled Asset Relief Program Transactions Report for Period Ending May
26, 2010 (May 28, 2010) (online at www.financialstability.gov/docs/transaction-reports/5-28-
10%20Transactions%20Report%20as%20of%205-26-10.pdf).
xviii U.S. Department of Treasury, Fact Sheet: Unlocking Credit for Small Businesses (Apr. 26, 2010) (online at
www.financialstability.gov/roadtostability/unlockingCreditforSmallBusinesses.html) (``Jumpstart Credit Markets
For Small Businesses By Purchasing Up to $15 Billion in Securities'').
xix This information was provided by Treasury in response to the Panel's inquiry.
xx This figure represents the current maximum aggregate debt guarantees that could be made under the program,
which is a function of the number and size of individual financial institutions. $305.4 billion of debt
subject to the guarantee is currently outstanding, which represents approximately 53.7 percent of the current
cap. Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance Under the Temporary Liquidity
Guarantee Program: Debt Issuance Under Guarantee Program (Apr. 30, 2010) (online at www.fdic.gov/regulations/
resources/TLGP/total_issuance04-10.html). The FDIC has collected $10.4 billion in fees and surcharges from
this program since its inception in the fourth quarter of 2008. Federal Deposit Insurance Corporation, Monthly
Reports Related to the Temporary Liquidity Guarantee Program (Apr. 30, 2010) (online at www.fdic.gov/
regulations/resources/tlgp/fees.html).
xxi This figure represents the FDIC's provision for losses to its deposit insurance fund attributable to bank
failures in the third and fourth quarters of 2008, and the first, second, and third quarters of 2009. Federal
Deposit Insurance Corporation, Chief Financial Officer's (CFO) Report to the Board: DIF Income Statement
(Fourth Quarter 2008) (online at www.fdic.gov/about/strategic/corporate/cfo_report_4qtr_08/income.html);
Federal Deposit Insurance Corporation, Chief Financial Officer's (CFO) Report to the Board: DIF Income
Statement (Third Quarter 2008) (online at www.fdic.gov/about/strategic/corporate/cfo_report_3rdqtr_08/
income.html); Federal Deposit Insurance Corporation, Chief Financial Officer's (CFO) Report to the Board: DIF
Income Statement (First Quarter 2009) (online at www.fdic.gov/about/strategic/corporate/cfo_report_1stqtr_09/
income.html); Federal Deposit Insurance Corporation, Chief Financial Officer's (CFO) Report to the Board: DIF
Income Statement (Second Quarter 2009) (online at www.fdic.gov/about/strategic/corporate/cfo_report_2ndqtr_09/
income.html); Federal Deposit Insurance Corporation, Chief Financial Officer's (CFO) Report to the Board: DIF
Income Statement (Third Quarter 2009) (online at www.fdic.gov/about/strategic/corporate/cfo_report_3rdqtr_09/
income.html). This figure includes the FDIC's estimates of its future losses under loss-sharing agreements
that it has entered into with banks acquiring assets of insolvent banks during these five quarters. Under a
loss-sharing agreement, as a condition of an acquiring bank's agreement to purchase the assets of an insolvent
bank, the FDIC typically agrees to cover 80 percent of an acquiring bank's future losses on an initial portion
of these assets and 95 percent of losses of another portion of assets. See, e.g., Federal Deposit Insurance
Corporation, Purchase and Assumption Agreement Among FDIC, Receiver of Guaranty Bank, Austin, Texas, FDIC and
Compass Bank, at 65-66 (Aug. 21, 2009) (online at www.fdic.gov/bank/individual/failed/guaranty-
tx_p_and_a_w_addendum.pdf). In information provided to Panel staff, the FDIC disclosed that there were
approximately $132 billion in assets covered under loss-sharing agreements as of December 18, 2009.
Furthermore, the FDIC estimates the total cost of a payout under these agreements to be $59.3 billion. Since
there is a published loss estimate for these agreements, the Panel continues to reflect them as outlays rather
than as guarantees.
xxii Outlays are comprised of the Federal Reserve Mortgage Related Facilities and the preferred equity holdings
in AIA Aurora LLC and ALICO Holdings LLC. The Federal Reserve's balance sheet accounts for these facilities
under Federal agency debt securities, mortgage-backed securities held by the Federal Reserve, and the
preferred interests in AIA Aurora LLC and ALICO Holdings LLC. Board of Governors of the Federal Reserve
System, Factors Affecting Reserve Balances (H.4.1) (online at www.federalreserve.gov/datadownload/
Choose.aspx?rel=H41) (accessed June 2, 2010). Although the Federal Reserve does not employ the outlays, loans,
and guarantees classification, its accounting clearly separates its mortgage-related purchasing programs from
its liquidity programs. See Board of Governors of the Federal Reserve, Federal Reserve System Monthly Report
on Credit and Liquidity Programs and the Balance Sheet, at 2 (Nov. 2009) (online at www.federalreserve.gov/
monetarypolicy/files/monthlyclbsreport200911.pdf).
On September 7, 2008, Treasury announced the GSE Mortgage Backed Securities Purchase Program (Treasury MBS
Purchase Program). The Housing and Economic Recovery Act of 2008 provided Treasury with the authority to
purchase Government Sponsored Enterprise (GSE) MBS. Under this program, Treasury purchased approximately
$214.4 billion in GSE MBS before the program ended on December 31, 2009. As of May 2010, there was $174.5
billion outstanding under this program. U.S. Department of the Treasury, MBS Purchase Program: Portfolio by
Month (online at www.financialstability.gov/docs/May%202010%20Portfolio%20by%20month.pdf) (accessed June 2,
2010). Treasury has received $45.9 billion in principal repayments and $11.1 billion in interest payments from
these securities. U.S. Department of the Treasury, MBS Purchase Program Principal and Interest (online at
www.financialstability.gov/docs/May%202010%20MBS%20Principal%20and%20Interest%20Monthly%20Breakout.pdf)
(accessed June 2, 2010).
xxiii Federal Reserve Liquidity Facilities classified in this table as loans include: Primary credit, Secondary
credit, Central bank liquidity swaps, Primary dealer and other broker-dealer credit, Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility, Net portfolio holdings of Commercial Paper Funding Facility
LLC, Seasonal credit, Term auction credit, Term Asset-Backed Securities Loan Facility, and loans outstanding
to Bear Stearns (Maiden Lane I LLC). Board of Governors of the Federal Reserve System, Factors Affecting
Reserve Balances (H.4.1) (online at www.federalreserve.gov/datadownload/Choose.aspx?rel=H41) (accessed June 2,
2010).

SECTION FIVE: OVERSIGHT ACTIVITIES

The Congressional Oversight Panel was established as part
of the Emergency Economic Stabilization Act of 2008 (EESA) and
formed on November 26, 2008. Since then, the Panel has produced
eighteen oversight reports, as well as a special report on
regulatory reform, issued on January 29, 2009, and a special
report on farm credit, issued on July 21, 2009. Since the
release of the Panel's May oversight report, which assessed the
credit crunch facing the nation's small businesses and
Treasury's ongoing efforts to spur lending to that sector of
the economy, the following developments pertaining to the
Panel's oversight of the TARP took place:
The Panel held a hearing in Washington, DC on May
26, 2010, to discuss the financial assistance provided to AIG
under the TARP and other financial stability programs. The
Panel heard testimony from both current and former AIG
executives, policymakers and regulators in charge at the time
of the government's initial rescue of the company, the official
from Treasury in charge of monitoring the company's current
government-held assets, as well as other analysts with insight
regarding the company's current financial health. A video
recording of the hearing, the written testimony from the
hearing witnesses, and Panel Members' opening statements all
can be found online at cop.senate.gov/hearings.

Upcoming Reports and Hearings

The Panel will release its next oversight report in July
2010. The report will focus on financial assistance provided to
small- and medium-sized banks under the CPP, discussing, among
other things, a full accounting of the investments made in
small banks under the program, the restrictions on and
expectations of banks that have received financial assistance,
and Treasury's plan for managing and ultimately divesting its
portfolio of investments in these banks.
The Panel is planning a hearing in Washington on June 22,
2010, with Treasury Secretary Timothy Geithner. The Panel will
seek to get a general update from the Secretary on the current
status and future direction of TARP. This will be Secretary
Geithner's fourth appearance before the Panel.
SECTION SIX: ABOUT THE CONGRESSIONAL OVERSIGHT PANEL

In response to the escalating financial crisis, on October
3, 2008, Congress provided Treasury with the authority to spend
$700 billion to stabilize the U.S. economy, preserve home
ownership, and promote economic growth. Congress created the
Office of Financial Stability (OFS) within Treasury to
implement the TARP. At the same time, Congress created the
Congressional Oversight Panel to ``review the current state of
financial markets and the regulatory system.'' The Panel is
empowered to hold hearings, review official data, and write
reports on actions taken by Treasury and financial institutions
and their effect on the economy. Through regular reports, the
Panel must oversee Treasury's actions, assess the impact of
spending to stabilize the economy, evaluate market
transparency, ensure effective foreclosure mitigation efforts,
and guarantee that Treasury's actions are in the best interests
of the American people. In addition, Congress instructed the
Panel to produce a special report on regulatory reform that
analyzes ``the current state of the regulatory system and its
effectiveness at overseeing the participants in the financial
system and protecting consumers.'' The Panel issued this report
in January 2009. Congress subsequently expanded the Panel's
mandate by directing it to produce a special report on the
availability of credit in the agricultural sector. The report
was issued on July 21, 2009.
On November 14, 2008, Senate Majority Leader Harry Reid and
the Speaker of the House Nancy Pelosi appointed Richard H.
Neiman, Superintendent of Banks for the State of New York,
Damon Silvers, Director of Policy and Special Counsel of the
American Federation of Labor and Congress of Industrial
Organizations (AFL-CIO), and Elizabeth Warren, Leo Gottlieb
Professor of Law at Harvard Law School, to the Panel. With the
appointment on November 19, 2008, of Congressman Jeb Hensarling
to the Panel by House Minority Leader John Boehner, the Panel
had a quorum and met for the first time on November 26, 2008,
electing Professor Warren as its chair. On December 16, 2008,
Senate Minority Leader Mitch McConnell named Senator John E.
Sununu to the Panel. Effective August 10, 2009, Senator Sununu
resigned from the Panel, and on August 20, 2009, Senator
McConnell announced the appointment of Paul Atkins, former
Commissioner of the U.S. Securities and Exchange Commission, to
fill the vacant seat. Effective December 9, 2009, Congressman
Jeb Hensarling resigned from the Panel and House Minority
Leader John Boehner announced the appointment of J. Mark
McWatters to fill the vacant seat. Senate Minority Leader Mitch
McConnell appointed Kenneth Troske, Sturgill Professor of
Economics at the University of Kentucky, to fill the vacancy
created by the resignation of Paul Atkins on May 21, 2010.

Acknowledgements

The Panel wishes to thank the numerous insurance
specialists, analysts, academics, auditors, investors, and
other experts for their insight and assistance. The Panel also
thanks Professor Susan Koniak for her assistance in reading the
report.
APPENDIX I: LETTER TO CHAIR ELIZABETH WARREN FROM ASSISTANT SECRETARY
HERB ALLISON, RE: GM LOAN REPAYMENT, DATED MAY 18, 2010

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

APPENDIX II: LETTER TO SENATOR CHARLES GRASSLEY FROM SECRETARY TIMOTHY
GEITHNER, RE: GM LOAN REPAYMENT, DATED APRIL 27, 2010

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APPENDIX III: LETTER TO REPRESENTATIVES PAUL RYAN, JEB HENSARLING, AND
SCOTT GARRETT FROM SECRETARY TIMOTHY GEITHNER, RE: GM LOAN REPAYMENT,
DATED APRIL 30, 2010

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