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hay rick

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Member since: Thu Jan 31, 2008, 11:08 PM
Number of posts: 6,981

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The AIG Bailout, Part 1.

I am currently reading Neal Barofsky's "Bailout" which recounts his tenure as the Inspector General overseeing TARP. The chapter on the AIG bailout is very enlightening, so I thought I would extract and share some of the highlights.

Barofsky breaks the AIG bailout into two parts. The first part was a $85 billion loan from the New York Fed in exchange for 80% of the stock of AIG. Barofsky continues the story:

A second part of the November deal covered the ongoing payouts required each time AIG was downgraded or the prices of the CDOs covered by AIG's credit default swap contracts plunged lower. Geithner and his team decided to terminate $62.1 billion of AIG's contracts with the banks. The deal had two parts. First, the counterparty banks were paid the approximate market value of the CDOs covered by the credit default swap contracts, about $27.1 billion in cash, which was provided almost entirely by the New York Fed in return for the CDOs themselves. For the second part of the deal, AIG and the New York Fed agreed that the banks could keep all of the previously posted collateral, approximately $35 billion, in return for the banks agreeing to rip up the credit default contracts. As a result, the bleeding of cash was staunched and the taxpayers became the proud owners of a mass of ill-conceived CDOs. For the banks, between the cash that they received from the Fed and the collateral they had previously received from AIG, they had essentially been paid 100 cents on the dollar for $62 billion in CDOs that were actually worth far less than that.

The deal was a gross distortion of the normal functions of the market. In a bailout-free world, instead of being saved by the government, AIG would have been unable to make its cash collateral payments to the banks and gone into bankruptcy. As a result, the banks would have been left with the CDOs and stuck with their continued declines in value. Those losses would have punished the banks for what had been bad and risky bets- i.e., assuming that AIG would be able to meet all its obligations. In market parlance, each of the banks would have borne the "counterparty risk" of doing business with AIG and suffered the consequences of betting on the wrong counterparty. Instead they were paid out in full.

In that respect, Geithner's opening of the spigot of taxpayer cash for AIG was more of a bailout of the banks than it was of AIG itself. The government thereby sent Wall Street a very dangerous message: counterparties who do business with financial institutions whose collapse could have devastating consequences for the entire financial system needn't do due diligence or worry about their counterparty risk. Instead they can rely on the government to bail them out.

That is the crux of the too-big-to-fail problem. The failure of giant financial institutions that are so big and have built up so many obligations to one another could cause a domino effect that could take down other major players and eventually the entire financial system. If the government had not stopped in to save AIG, major banks in the United States and Europe would have potentially suffered tens of billions of dollars in losses at a time when neither they nor the system could withstand such a further shock. The government felt it had no choice, and perhaps that was correct, but as long as there are financial institutions of such size and with so many interconnections, future massive crises- and bailouts- are all but inevitable.

Barofsky contrasts the favored treatment of the banks that dealt with AIG with a more typical scenario that played out earlier in 2008 with the bond insurer Ambac and in which counterparties recieved between 28 and 60 cents on the dollar. The problem with too-big-too-fail institutions is that the American people are taken financial hostage. We are involuntary counterparties to Wall Street's transactions, liable for losses without the offsetting benefit of participation in profits.

AIG Bailout, Part 2: http://www.democraticunderground.com/111632332
AIG Bailout, Part 3: http://www.democraticunderground.com/111632331

The AIG Bailout, Part 2. Bonuses.

More from "Bailout" by Neil Barofsky.

Back in the fall of 2008, the New York Fed tried to get a handle on AIG's various bonus agreements, but it wasn't terribly concerned with the details of who would be paid what. The bonus commitments were considered simply in terms of getting a full accounting of how much cash AIG needed. When you are on the hook for $85 billion and counting, as the New York Fed was, $168 million in bonus payments may well seem like just a drop in the bucket.

But as the later reaction to the payments showed, Treasury should have had different priorities. The TARP legislation required that Treasury include executive compensation limits in its contracts, and Treasury had done so with AIG. Executive compensation had already become a hot-button issue with the public, particularly in the beginning of 2009, when news came out that bailed-out Wall Street banks were issuing tens of billions of bonuses. But other than sending some Treasury officials over to AIG in November 2008 for a quick review of the compensation structure for its top executives (but not the Financial Products executives), Treasury took a hands-off approach toward AIG's compensation issues, doing little to oversee the taxpayer's $40 billion investment.

As a result, Treasury was caught flat-footed, finding out about the bonus payments only a couple of weeks before they were due. Had Treasury officials been more effectively monitoring the government's investment in AIG and more concerned with accountability and basic fairness, they might have helped prevent the blowup. For example, they could have forced AIG to renegotiate the terms of the contracts as a condition of the additional $30 billion in TARP funds that they announced several days after learning about the imminent bonus payments. They could have refused to allow AIG to make the payments and dealt with the legal consequences that might have followed. At the very least, they could have alerted Congress and the public before making the payments. Instead, with no notice, Treasury and Geithner stood behind the "sanctity" of the executives' contracts.

Meanwhile, the rationale Neel Kashkari had given me for making the payments- that the bonus recipients were essential personnel necessary to wind down AIG's complex transactions- didn't quite wash. When I asked the audit team for a breakdown of the bonuses by position, I saw that although the overwhelming majority of the payments had gone to a small group of executives, every single employee at the Financial Products group seemed to have received some payment, including $7,700 to a kitchen assistant, $700 to a file administrator, and $7,000 to a mail room assistant. Though I was skeptical that the executives were so essential, I was pretty sure that those lower-level employees receiving taxpayer-funded bonus payments had nothing whatsoever to do with the supposedly complex work of resolving AIG's positions.

Ironically, the very executives who were most responsible for AIG's problems were the ones that received the bonuses. Geithner's insistence on the "sanctity" of the executives' contracts could be construed as taking the high road- if he consistently advocated that position. The book makes it clear that was not the case as his concern for the sanctity of contracts seemed to evaporate as soon as it applied to someone other than his Wall Street friends. For example, Geithner and Treasury simply couldn't be bothered with the contract rights of auto dealerships during the GM bailout or homeowner's rights in the administration of HAMP.

As Barofsky notes, the bonuses, more than anything else, solidified the notion "that TARP was little more than a massive transfer of wealth from taxpayers to undeserving Wall Street executives.

AIG Bailout, Part 1: http://www.democraticunderground.com/111632333
AIG Bailout, Part 3: http://www.democraticunderground.com/111632331

The AIG Bailout, Part 3. Negotiations.

Barofsky paints a devastating portrait of Geithner's deference to Wall Street in his account of the "negotiations" on the price that the government would pay the banks for the toxic CDOs that AIG had insured.

Even worse than the bonus payments, at least in terms of financial cost, was the subject of our other AIG audit, which explored the reasons for Geithner's agreement to effectively pay full value to the banks for the CDOs the government purchased from them. These beneficiaries included Societe Generale ($16.5 billion in CDOs bought), Goldman Sachs ($14 billion), Deutsche Bank ($8.5 billion), Merrill Lynch ($6.2 billion), UBS ($4.3 billion), Wachovia ($1 billion), and Bank of America ($800 million). Our audit sought to find out why Geithner hadn't negotiated a lower price on behalf of the public.

On its face, it seemed unfair and unnecessary that the government would so grossly overpay for the bonds, particularly to those banks that had already received so much TARP money. The New York Fed, obviously aware of this problem, did initially seek some concessions from the banks, asking them to take less than full payment for the bonds. But we found that these negotiations were halfhearted at best and demonstrated a characteristic deference to the banks, taking an almost apologetic approach. It was as if the New York Fed found the whole process of negotiating unseemly.

If Paulson, Geithner, and Bernanke's discussions with the banks over CPP {the Capital Purchase Program} were a lesson in Negotiations 101, Geithner's approach to concessions in the CDO purchases was Neville Chamberlain-esque. Instead of gathering the CEOs of the banks together in one room and personally explaining that it was "for the good of the country" and necessary to ensure ongoing support for the bailouts to negotiate a deal that fairly protected the taxpayers' interests, Geithner handed the job over to midlevel New York Fed staffers. The staffers were then required to use a prepared script that emphasized, up front, that any concession made by the banks would be "entirely voluntary." He also put the staffers into negotiating straitjackets: they were prohibited from suggesting that they would pull the plug on AIG and leave the banks high and dry; and they were prohibited from using their leverage from being the regulator of several of the entities. That approach resulted in a departure from the normal workings of the marketplace, where concessions on debt owed by struggling companies are not uncommon. For example, in 2008, the bond insurer Ambac reportedly settled claims on $1.4 billion of mortgage-related CDOs that it had insured for Citigroup for about 60 cents on the dollar, and later settled with a number of other counterparties on $3.5 billion in mortgage-backed debt exposure for just $1 billion.

Geithner's team also undercut any chance for getting relief for the tax payer by deciding that no one concession would be accepted unless all of the banks agreed to the exact same percentage reduction. The New York Fed told us that for this reason, after the regulator overseeing AIG's French bank counterparties told them that it would be against French law to accept less than full value for the bonds, the negotiations effectively ended.

The story gets worse. Geithner avoids meeting with the auditors and Treasury fails to provide requested documents. One bank (UBS) offers a concession, but the offer is never used as leverage with the other banks and UBS receives full price for their CDOs even after offering the concession. The French law against accepting less than full value for the bonds turns out to be a less than insurmountable barrier...

AIG Bailout, Part 1: http://www.democraticunderground.com/111632333
AIG Bailout, Part 2: http://www.democraticunderground.com/111632332

Gutting the Postal Service.

James Royal recently published an article at Motley Fool evaluating the Postal Service as a business. Link: http://www.fool.com/investing/general/2013/03/04/how-the-postal-service-is-being-gutted.aspx

The title of the article is "How the Postal Service is Being Gutted" and draws the conclusion that "...the postal service is a fundamentally sound business, though not without its challenges. If you look closely, you'll see a concerted campaign to drive USPS out of business..."

Royal outlines three myths about the Postal Service. The first myth is that recent losses demonstrate that USPS is not a viable business. Royal notes that the majority of the red ink is the result of the healthcare pre-funding mandate imposed by the lame-duck Republican Congress in 2006. The pre-funding mandate requires the Postal Service to pay for 75 years of future employee health care benefits in a 10 year period. This onerous requirement means that the Postal Service is currently paying for future health benefits for employees who have not been hired yet and, in many cases, not born yet. Despite this burden, credit needs to be given where credit is due:

And the USPS has been a model for prudent squirreling. As of Feb. 2012, it had more than $326 billion in assets in its retirement fund, good for covering 91% of future pension and health-care liabilities. In fact, on its pensions, the USPS is more than 100% funded, compared to 42% at the government and 80% at the average Fortune 1000 company. In health-care pre-funding, the USPS stands at 49%, which sounds not so good until you understand that the government doesn't pre-fund at all and that just 38% of Fortune 1000 companies do, at just a median 37% rate. The USPS does better than almost everyone.

As if the pre-funding mandate were not a sufficient burden, the Postal Service is also restricted to investing those funds in low-yield Treasury bonds. This forces the Postal Service to save even more now than a private company would to obtain the same payout later.

The second myth that the article examines is "snail mail is dead." The article points out that, even though letter mail volume is declining due to replacement by e-mail, the larger problem is that, at 46 cents, first class mail is grossly underpriced compared to European services which are priced closer to $1 for a letter. Though the article doesn't mention the fact, European postal services tend to be more privatized than their American counterpart. FedEx and UPS provide no comparable service at anything close to the same price. Another area in which USPS provides underpriced service is pre-sorted bulk mail. Bulk mailers get discounts for pre-sorting mail that exceed the cost-savings to the Postal Service.

One barrier to proper pricing is that price increases are overseen by a separate agency, the Postal Regulatory Commission, and are restricted to increasing no more than the general rate of inflation. If costs exceed the inflation rate during a given period, they can not be recovered.

Proper pricing is important for a business mandated to deliver everywhere for a fixed price, a burden not faced by private services. Of necessity, many locations, such as rural ones, lose money -- part of the price of a national postal service. Private services can simply leave a location if it's not profitable. In fact, private services rely on USPS to deliver to unprofitable locations for them.

In addition to saddling the Postal Service with the suffocating health care pre-funding mandate and preventing it from properly pricing its products, Congress has also prevented the USPS from increasing revenue by expanding its services into related lines. While our representatives exhort the Postal Service to operate like a business on the one hand, on the other they also say that USPS can not "unfairly" compete with private companies. Recent restrictions include: implementation of an online payment system in 2000 (internet companies complained); putting public copy machines in Post Office lobbies; selling phone cards; and selling postage meter cartridges (Pitney Bowes objected). "And, of course, rivals such as UPS complained, ultimately leading Congress in 2006 to restrict USPS to mail delivery."

The third myth examined is that "privatized mail delivery would be cheaper and more effective." The article points out that in 2011, USPS delivered more than 30% of FedEx Ground's packages. FedEx uses the Postal Service because it is cheaper. Another way the Postal Service is forced to operate at a handicap is by preventing it from negotiating volume discounts with large parcel shippers. And then there's this:

It's bad enough that USPS is forbidden from entering new markets. When it does well on its home turf, rivals turn to Congress, silencing USPS when it delivers better rates. As economist Dean Baker explains, "About a decade ago, the Postal Service had an extremely effective ad campaign highlighting the fact that its express mail service was just a fraction of the price charged for overnight delivery by UPS and FedEx. {They} went to court to try to stop the ad campaign. When the court told them to get lost, they went to Congress. Their friends in Congress then leaned on the Postal Service and got it to end the ads."

The article concludes by suggesting that the only sensible reason for handicapping the Postal Service in this fashion is to set it up for "failure" and subsequent privatization. The Cato Institute, which was founded by Charles Koch, has been advocating for this outcome for decades. FedEx founder and CEO Frederick Smith has served on the Board at the Cato Institute and FedEx continues to help fund the think tank.

Royal points out "two plums" that can be plucked from a privatized Postal Service. One would be "busting the union, lowering wages, and shifting that profit into investors' hands..." And the other:

Second, and perhaps sweeter, that well-funded USPS retirement account might be opened for raiding. An acquirer could invest in higher-return securities and adjust their return assumptions (not even unfairly), freeing tens of billions that could then be returned to investors. For context, FedEx and UPS have a combined market cap of $110 billion against nearly $330 billion in USPS retirement assets.

I have been following the Postal Service's plight for many years and have explained the financial squeeze imposed by Congress to numerous people. In doing so I have witnessed a curious phenomenon. When I explain the health care pre-funding mandate people suddenly appear almost disoriented. Not a minute later they often refer to it as "pension pre-funding" and I have to correct them. "The pensions are fully funded. The pensions are actually overfunded. The pre-funding mandate covers future health care premiums..." People need to be told twice- and then their jaw drops...

I think people resist understanding the truth about the mandate because the truth is- it is blatantly abusive. Nobody wants to examine what else is hiding underneath that rock. If Congress will sabotage the Postal Service, what else might they be capable of doing? Is the handling of the Postal Service an anomaly or a template? They also have Social Security, Medicare, and Medicaid in their hands...

NALC (the carriers' union) is sponsoring a national day of action to mobilize public support on March 24. Details here: http://www.nalc.org/

Highly recommended site for information on USPS: http://www.savethepostoffice.com/

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