FT challenges notion of “backdoor bailout”

The front page of today’s Financial Times features an article (“Fed makes ‘a killing’ on AIG contracts”) discussing the Federal Reserve’s rescue of troubled insurer AIG, principally the Fed’s role in using AIG’s exposure to credit-insurance contracts as a means to funnel money to struggling banks during the height of the financial crisis, something that I and others have termed a “backdoor bailout” for much of the past year. As the FT has it:

“The Fed rescue has generated criticism because the banks received 100 cents on the dollar for credit insurance they bought from AIG on collateralised debt obligations – financial instruments that promise the buyer cash flows from pools of bonds or loans. This had led to claims that AIG’s rescue was a “backdoor bail-out” of big banks.”

In the very next paragraph, the FT claims that the Fed is “in a position to reap profits from this part of the rescue,” although the FT’s accounting of the real value of these instruments leaves a lot to be desired. My understanding is that the Fed purchased the instruments at full value – part of “making the banks whole” – even though they were worth less than half that at the time. Estimates now place the value of these instruments somewhere in between. If the FT’s “several people with direct knowledge of the portfolio” are to be believed, these instruments have risen in value by about $15 billion since the time of purchase. That’s great, but you’re still $17 billion in the hole…how is that “making a killing”?

And that assumes that you could sell the stuff and realize said gains, but the illiquidity of these instruments is part of why they’re so toxic. Nobody wants to buy them, certainly not in the quantity the Fed has them to sell. Besides, the selling of such a large quantity would surely move the price down. Naked Capitalism, the financial blog, has a pretty devastating critique of the FT’s math and their underlying editorial disingenuousness.

I’m less worried about the math. We all know that AIG is one of the costliest interventions of the financial crisis, and while we can argue in philosophical terms about it, the bailout did accomplish its immediate goal of stabilizing the system. I am more worried about the revisionist approach to the intervention, where the Fed wants us to believe (apparently) that it wasn’t really a bailout at all, which is ludicrous. Interestingly, there is a bit of text in the print edition of the FT that has been deleted from the web version of the article. The print edition reads:

“The gains in the Maiden III portfolio [the New York Fed’s AIG financing vehicle] – which came as credit markets rallied – provide ammunition for Fed officials who have argued that the central bank would be repaid.”

I’m not sure why this was deleted from the web version accessed this morning, which presumably post-dates the print version, but it would have been smarter to scupper the whole piece. It’s akin to shilling and not worthy of the Financial Times.