By on May 5, 2009

May 5, 2009

The Honorable Neil M. Barofsky
Office of the Special Inspector General for the Troubled Assets Relief Program
1500 Pennsylvania Avenue, NW, Suite 1064
Washington, DC 20220

Dear Inspector General Barofsky:

Thank you for your work investigating the American International Group, Inc. (AIG) counterparty payments. I appreciate the update you provided me on this audit on April 28.

As we discussed, I am also concerned by the circumstances surrounding the current efforts to resuscitate the American automobile industry. The Department of the Treasury and the Federal Reserve have provided billions of dollars in working capital for General Motors (GM) and Chrysler LLC (Chrysler) while the two firms pursue financial restructuring solutions. While the assistance to Chrysler terminated at the end of April, GM has approximately three weeks left to complete its restructuring before the working capital ends.

The Chrysler situation was particularly troubling. The company had some $10 billion in outstanding debt that was due to the United Auto Workers Retiree Health Plan. Chrysler and the union were able to negotiate an agreement that modified worker contracts and gave the union an equity position in the restructured auto company.

However, in addition to the contributions owed to the union health plan, Chrysler also carried additional debt in the amount of $6.9 billion. Creditors included JPMorgan Chase & Co., The Goldman Sachs Group Inc., Citigroup Inc., Morgan Stanley, and several smaller banks and hedge funds. Perella Weinberg Partners, Oppenheimer and Stairway Capital Management have been identified thus far as hedge fund creditors.

As you are well aware, Chrysler recently filed for Chapter 11 bankruptcy protection, though a deal is ostensibly in place to merge Chrysler with the Italian automaker Fiat SpA, pending court approval. Until the filing occurred, eleventh hour hopes persisted that Chrysler could reach an agreement with the creditors that provided the $6.9 billion. While differing accounts exist as to how the actual negotiations played out, the fact remains that Chrysler was not able to reach an agreement with its creditors to the $6.9 billion.

As an issuer of credit default swaps, it is plausible that AIG had issued swaps on the debt of the American auto companies. We know that the collateral calls and threat of payouts triggered by an AIG bankruptcy forced the federal government to commit up to $182.5 billion to the insurance giant. We also know that many holders of AIG credit default swaps were apparently compensated at 100 percent of par value in order to retire the swaps they held and enable the purchase of the underlying securities (the counterparty payments). Finally, the recipients of the counterparty payments in some cases were the same firms that held auto industry debt. The Wall Street Journal ran a story on April 30, 2009 detailing the objections identified by some creditors:

Bank-debt holders, many of them hedge funds or distressed debt funds, voted against the latest deal for various reasons, ranging from financial interests to philosophical ones. Some said their funds had bigger positions in Ford Motor Co. or General Motors Corp. and could benefit by a Chrysler bankruptcy and the production capacity that may eliminate. Some funds may also have credit-default swaps on Chrysler bank debt that pay out in the event of a bankruptcy[1].

These circumstances could create tremendous potential for abuse of government assistance to AIG. Knowing that AIG swap counterparties have previously been paid with government funds without being compelled to take any discount or “haircut”, if auto creditors had purchased swaps on their debt, they may have had a perverse incentive to allow Chrysler to fail. By not negotiating down the claims or accepting a debt-for-equity arrangement, the auto creditors could collect any credit default swap payments triggered by a Chrysler bankruptcy. Essentially, these creditors could stand to potentially benefit more from a Chrysler bankruptcy than from a restructuring out of court.

While the issues were described in the context of the Chrysler bankruptcy, I believe that potential conflicts could have existed regarding the debt of each Chrysler and GM. Accordingly, I respectfully request that you address the following questions:

1. Did AIG issue credit default swaps on debt securities of automobile companies?
2. Did creditors to GM or Chrysler hold credit default swaps on the debt? If so, were these AIG-issued swaps?
3. How many creditors to the auto companies also received payments as AIG counterparties?
4. What obligations are owed by the swap issuers to the holders of auto debt in the event of a bankruptcy or other default event?
5. What was the extent of the potential for abuse of taxpayer funds based on the scenario laid out above?

Thank you for your continued advocacy on behalf of the American taxpayers and for your examination of these issues. Please contact Martin Levine in my office…with any questions.

Sincerely,

Elijah E. Cummings
Member of Congress

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21 Comments on “MD Congressman to TARP: Did AIG Credit Default Swaps Crater Chrysler?...”


  • avatar

    seems a very plausable concept

  • avatar
    seanx37

    I had a similar conversation yesterday with my friends wife. She is a Chrysler employee. I explained that for a lot of hedge funds, the death of Chrysler was good for them. That they bet against Chrysler. She didn’t understand why such a thing was legal. I just laughed and explained the fun part. That we taxpayers were paying for them to gamble. She walked away mumbling

  • avatar
    Sutures

    Wow, that is an impressive read.

  • avatar
    John Horner

    Hedge funds and other Wall Street types gaming the system to make money off the backs of anyone and everyone? I’m shocked …. not really.

  • avatar

    Cummings is carrying water for the UAW in this regard. The hedge funds objecting to the deal aren’t the ones likely to hold credit default swaps on Chrysler debt.

    Some of the biggest TARP recipients have also received money via credit default swaps that AIG had to make good on. JPMorgan, citibank, and a couple others got billions through the TARP and additional taxpayer billions via AIG. They’re double and triple dipping and colluding with the PTFOA to rush this deal through. They are not the smaller non-TARP holders of Chrysler debt that are trying to put the brakes on a rush to restructure Chrysler into Fiat/Federal/UAW ownership.

  • avatar
    shaker

    So… there are ‘good’ bondholders and ‘bad’ bondholders? Sheesh.

  • avatar
    PeteMoran

    So “they” creatively slice/dice/dilute the direct line to the ownership of “The Risk” such that no-one can trace it, or get their heads around it. Unravel “it”, if you will.

    There’s genius in this somewhere.

    Too bad it helped caused the near financial destruction of the USA.

  • avatar
    OldandSlow

    I wonder if Cerberus through one of their funds took out CDS protection against a Chrysler bankruptcy? Credit Default Swaps are the modern equivalent of the old-time bucket shops.

  • avatar
    indi500fan

    When I see this guy on the televised Congressional hearings, he reminds me of the guy in the Miller High Life sports stadium commercials.

  • avatar
    guyincognito

    Did the creditors get CDS’ on their Chyrsler secured debt? I’d be really suprised if they didn’t. Did that crater Chrysler? Uh, no.

  • avatar
    MidLifeCelica

    I stopped reading the Wikipedia link about credit default swaps after the first two pages because it made my head hurt. As near as I can tell, the world economy is now similar to a ‘C’ program designed with arrays of pointers to structures containing pointers to the same array of structures…it compiles, but no one can tell what will happen when the code is executed.

  • avatar
    Luther

    Earth to Elijah E. Cummings…Chrysler cratered Chrysler…Thanks to your idiotic taxes and laws.

  • avatar
    PeteMoran

    @ MidLifeCelica

    ….the world economy is now similar to a ‘C’ program designed with arrays of pointers to structures containing pointers to the same array of structures…

    So true. I’d modify that however and say “a Basic program designed with line after line of Gotos with inline asm JMPs just for fun”.

  • avatar
    superbadd75

    Whether or not AIG had a little something to do with Chrysler finally having to go C11 rather than limp along for years on taxpayers’ money isn’t really that big of a deal. Chrysler (and Daimler) committed suicide by not being competitive. The half-assed attempts that were on their dealers’ lots weren’t enough to draw customers in numbers to keep them viable. That’s the bottom line, and picking apart what delivered the final blow isn’t going to change it. Chrysler was done before Daimler walked away from them.

  • avatar
    GS650G

    I’m waiting for the headline that everything is worthless and we are all broke. It’s almost that bad.

    Next up will be devaluing the US dollar, outlawing the sale or possession of gold and other precious metals, and government controls on prices and wages.

    Change Indeed.

  • avatar
    windswords

    PeteMoran:

    @ MidLifeCelica

    “….the world economy is now similar to a ‘C’ program designed with arrays of pointers to structures containing pointers to the same array of structures…

    So true. I’d modify that however and say “a Basic program designed with line after line of Gotos with inline asm JMPs just for fun”. ”

    Or a COBOL program with a recursive call:
    300-CREATE-ECONOMIC-CHAOS.
    ____PERFORM 400-CHECK-FOR-CDS.

    400-CHECK-FOR-CDS.
    ____IF CREDIT-DEFAULT-SWAP = ‘YES’
    ________PERFORM 300-CREATE-ECONOMIC-CHAOS.

  • avatar
    NBK-Boston

    Let’s walk through the questions that the good Congressman asks:

    1. Did AIG issue credit default swaps on debt securities of automobile companies?

    This one is pretty straightforward, and the TARP overseers should be able to answer this after a few days (hours?) of research. After all, the Feds now own AIG, and I assume can look into their books whenever the TARP overseer feels like it.

    2. Did creditors to GM or Chrysler hold credit default swaps on the debt? If so, were these AIG-issued swaps?

    How on earth is the TARP overseer supposed to know this? The Feds can answer this question only as to the second part — to the extent of saying how many swaps were issued by troubled institutions, like AIG, which are now subject to strict oversight. They have no way of knowing how many private hedge-fund issuers sold swaps to how many private hedge-fund bondholders, or even non-bondholder speculators. Stupid question.

    3. How many creditors to the auto companies also received payments as AIG counterparties?

    Fair enough, but really just a remix of the answerable parts of 1 and 2.

    4. What obligations are owed by the swap issuers to the holders of auto debt in the event of a bankruptcy or other default event?

    This one actually contains the easter egg that the congressman may not have seen coming. Chrysler filing for Chapter 11 was probably a trigger event on the relevant swaps. But there are other typical trigger events in most swap contracts, and it is just possible that the set of other trigger events includes the consummation of some sort of debt-for-equity exchange, like the one GM is flogging. If it does, then swap-holders get to cash in whether or not they force the car company into actual Chapter 11, and the whole about how hedge funds are pushing car companies into bankruptcy for their own private purposes unravels — because they collect in any event.

    Moreover, when the swap is made with an actual holder of the bonds, the somebody gets to keep the defaulted bond and try to recover from the company (often, the swap seller will take the bond and try to offset some of the payout by collecting on the bond). This person has all the usual incentives to maximize the value of the bond, be that by way of playing hardball for a cash settlement, or seeking a favorable equity exchange.

    5. What was the extent of the potential for abuse of taxpayer funds based on the scenario laid out above?

    Come on, scary stories are for politicians to tell, not for a financial supervisor to come up with. And if anyone was courting abuse, it was the federal government, which, over the past several years allowed a company (AIG) to become to big, and too enmeshed in the system, to fail — and yet it got to operate without constraints or oversight. Banks and their depositors get special treatment, but then they pay for it by accepting FDIC oversight, and sometimes paying a cash premium into the deposit insurance system. Here it was just concentrate the gains and disperse the losses.

  • avatar
    golf4me

    It doesn’t matter what this guy asks or implies, it’s all perfectly legal and there is nothing the gov’t can do about it. The holdouts made a choice based on which was more beneficials to their investors, as they should. That AIG, with gov’t funding, has to pay out the losses is pretty hilarious. This joker is just mad because he & the rest of the gov’t just got played.

  • avatar
    AnalogKid

    This is an interesting question insofar as it offers a further rationale for the non-Tarp bondholders to resist the current terms, though I would be surprised if they were selling swaps to other hedges.

    The far more interesting question is whether, if swaps were held on Chrysler debt, the counterparties were paid at full value. This is the real scandal of AIG, that the government has given them far more money that all of the automakers combined, only to have to used to pay out counterparties at full value. Everyone should be taking a haircut here.

  • avatar
    Landcrusher

    NBK,

    I have a couple questions/comments about your explanations.

    2. Why is this a stupid question? Aren’t all these large transactions reportable within 30 days through one sort of legal obligation or another? Also, how is it that a highly regulated insurance company, or bank, or even bank holding company, or whatever, is allowed to sell what is essentially an insurance policy to someone who does not own the insured asset? I have been wanting to know for some time why non-bond holders are not guilty of fraud when buying a CDS.

    3. This seems to be a good stab at why did we bail out AIG rather than breaking it up? Which was a great question 6 months ago.

    4. Well put.

    5. I think you overstate the lack of oversight at AIG. It’s semantic, but very important to state that AIG was a REGULATORY failure, and not a poster child for deregulation. Everyone involved acted as if AIG was a highly regulated company, but in reality, the regulators were asleep at the wheel. I believe history will show that AIG could not have happened in a regulatory vacuum, but that the actors involved took risks primarily due to government influences rather than acting in a laissez faire environment that never really existed. Just like the Cali energy crisis was not a deregulation failure, but an example of how a bunch of legislative hubris will always get punished by the smarter and more numerous actors in the economy.

    The CDS issues could not have killed AIG alone, the wall we hit last year was multi faceted, and many of those facets get traced back to things DC actually did, rather than failed to do. Add to that some pretty ridiculous, almost enronesque, attitudes of superiority and entitlement, and you get the colossal failure we witnessed.

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