18 Nov 2009, Alexander Campbell, Risk magazine
The Federal Reserve Bank of New York crippled its own attempts to negotiate haircuts with American International Group's (AIG) credit default swap (CDS) counterparties late last year, effectively turning the AIG rescue into a backdoor bailout of several major banks, according to a US government report published on November 17.
Neil Barofsky, the special inspector general for the US Troubled Asset Relief Program (Sigtarp), blamed New York Fed president, Timothy Geithner (now Treasury secretary) for failing to negotiate aggressively with AIG's counterparties in November 2008. The New York Fed decided to treat all major counterparties equally - effectively giving a veto over haircuts to any of the counterparties.
Foreign banks such as Société Générale and Calyon were legally prevented from agreeing to voluntary haircuts and less vulnerable to suasion from the Fed and other US regulators. However, the Fed should have been ready to offer different terms to US banks, Barofsky said, especially since many had already received billions of dollars of aid from the US government, and should have used its leverage as their primary regulator to encourage them to accept haircuts. As it was, the Fed ended up with "a negotiating strategy with the counterparties that even then-FRBNY president Geithner acknowledged had little likelihood of success", Barofsky wrote.
In its response to the report, the New York Fed said that "it would not have been appropriate to use our supervisory authority to obtain concessions", especially if this meant treating foreign banks more generously than US banks. The government's existing commitment to saving AIG left the Fed with very little negotiating leverage with the counterparties, it added.
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