Leading Analysts Slam Fed’s Posture Towards Credit Default Swaps

Four leading analysts – a former long-time Fed veteran, an economics professor and former high-level S&L regulator, former managing director at Soros Funds Management and chief economist of the Senate Banking Committee, and a professor of political science – are slamming the Fed’s treatment of credit default swaps in general, and AIG’s CDS obligations in particular:

“Remember that this is a firm that is 79.9 percent owned by the United States government . . . . The trustees need to split off the derivatives unit from the rest of the firm and separately incorporate it. This step leaves AIG’s other businesses free to operate as usual. If the recipients of the bonuses refuse to waive them, then the derivatives unit should at once be thrown into bankruptcy, terminating all obligations to pay them. ….

This leaves open the question of how to deal with all other obligations of the derivatives unit, including the notorious credit default swaps. We, like most independent analysts, are mystified by the determination of the Federal Reserve and Treasury to keep paying these off at 100 percent of their face value. But that’s an issue for tomorrow. Today the task is to stop a grotesque abuse before it is too late. The path we outline here would do it, without throwing markets into turmoil. Nothing less than public confidence in the United States government as a whole is now at stake.”

Similarly, veteran financial writer Darrell Delamaide says in front-page article on MarketWatch:

And what about those counterparties? Heaven forbid that Goldman Sachs Group should lose a penny on its reckless credit default swaps — that would mean the end of civilization as Paulson knows it. But that, thankfully, has been averted, as we also learned over the weekend, because that impoverished institution has received $13 billion of taxpayer money via AIG. I’m betting some of that money will find its way into Goldman bonuses as well.

And former New York governor Spitzer (who, notwithstanding some personal pecadilos, is a shrewd financial observer) writes today:

It all appears, once again, to be the same insiders protecting themselves against sharing the pain and risk of their own bad adventure. The payments to AIG’s counterparties are justified with an appeal to the sanctity of contract. If AIG’s contracts turned out to be shaky, the theory goes, then the whole edifice of the financial system would collapse

But wait a moment, aren’t we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes—income taxes to sales taxes—to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden. Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won’t be laid off. Why can’t Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn’t we already give Goldman a $25 billion capital infusion, and aren’t they sitting on more than $100 billion in cash? Haven’t we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn’t they have accepted a discount, and couldn’t they have agreed to certain conditions before the AIG dollars—that is, our dollars—flowed?

The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation.

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