October 27, 2009 - Last November, in his role as president of the New York Federal Reserve, Tim Geithner personally interceded in negotiations between AIG and banks like Goldman Sachs, Société Générale, and Deutsche Bank, and arranged for said banks to receive in-full payment on the credit default swaps they had purchased rather than the 40 cents on the dollar the struggling insurance company was proposing. Per Bloomberg:
The New York Fed’s decision to pay the banks in full cost AIG — and thus American taxpayers — at least $13 billion. Under the agreement, the government and its taxpayers became owners of the dubious CDOs, whose face value was $62 billion and for which AIG paid the market price of $29.6 billion. The CDOs were shunted into a Fed-run entity called Maiden Lane III. FULL STORY
RELATED:
Collateralized debt obligations (CDOs) are a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets. CDOs securities are split into different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk.
A few academics, analysts and investors such as Warren Buffett and the IMF's former chief economist Raghuram Rajan warned that CDOs, other ABSs and other derivatives spread risk and uncertainty about the value of the underlying assets more widely, rather than reduce risk through diversification. Following the onset of the 2007-2008 credit crunch, this view has gained substantial credibility. Credit rating agencies failed to adequately account for large risks (like a nationwide collapse of housing values) when rating CDOs and other ABSs.
Many CDOs are valued on a mark to market basis and thus have experienced substantial write-downs on the balance sheet as their market value has collapsed.
