Feb. 23 (Bloomberg) — When a congressional panel
convened a hearing on the government rescue of American International
Group Inc. in January, the public scolding of Treasury Secretary
Timothy F. Geithner got the most attention.

Lawmakers said the former head of the New York
Federal Reserve Bank had presided over a backdoor bailout of Wall
Street firms and a coverup. Geithner countered that he had acted
properly to avert the collapse of the financial system.

A potentially more important development slipped by
with less notice, Bloomberg Markets reports in its April issue.
Representative Darrell Issa, the ranking Republican on the House
Committee on Oversight and Government Reform, placed into the hearing
record a five-page document itemizing the mortgage securities on which
banks such as Goldman Sachs Group Inc. and Societe Generale SA had
bought $62.1 billion in credit-default swaps from AIG.

These were the deals that pushed the insurer to the
brink of insolvency — and were eventually paid in full at taxpayer
expense. The New York Fed, which secretly engineered the bailout,
prevented the full publication of the document for more than a year,
even when AIG wanted it released.

That lack of disclosure shows how the government has
obstructed a proper accounting of what went wrong in the financial
crisis, author and former investment banker William Cohan says. “This
secrecy is one more example of how the whole bailout has been done in
such a slithering manner,” says Cohan, who wrote “House of Cards”
(Doubleday, 2009), about the unraveling of Bear Stearns Cos. “There’s
been no accountability.”

CDOs Identified

The document Issa made public cuts to the heart of
the controversy over the September 2008 AIG rescue by identifying
specific securities, known as collateralized-debt obligations, that had
been insured with the company. The banks holding the credit-default
swaps, a type of derivative, collected collateral as the insurer was
downgraded and the CDOs tumbled in value.

The public can now see for the first time how poorly
the securities performed, with losses exceeding 75 percent of their
notional value in some cases. Compounding this, the document and
Bloomberg data demonstrate that the banks that bought the swaps from
AIG are mostly the same firms that underwrote the CDOs in the first

The banks should have to explain how they managed to
buy protection from AIG primarily on securities that fell so sharply in
value, says Daniel Calacci, a former swaps trader and marketer who’s
now a structured-finance consultant in Warren, New Jersey. In some
cases, banks also owned mortgage lenders, and they should be challenged
to explain whether they gained any insider knowledge about the quality
of the loans bundled into the CDOs, he says.

‘Too Uncanny’

“It’s almost too uncanny,” Calacci says. “If these
banks had insight into the underlying loans because they had
relationships with banks, originators or servicers, that’s at the least

The identification of securities in the document,
known as Schedule A, and data compiled by Bloomberg show that Goldman
Sachs underwrote $17.2 billion of the $62.1 billion in CDOs that AIG
insured — more than any other investment bank. Merrill Lynch &
Co., now part of Bank of America Corp., created $13.2 billion of the
CDOs, and Deutsche Bank AG underwrote $9.5 billion.

These tallies suggest a possible reason why the New
York Fed kept so much under wraps, Professor James Cox of Duke
University School of Law says: “They may have been trying to shield
Goldman — for Goldman’s sake or out of macro concerns that another
investment bank would be at risk.”

Poor Performers

Goldman Sachs spokesman Michael DuVally declined to comment.

Schedule A also makes possible a more complete
examination of why AIG collapsed. Joseph Cassano, the former president
of the AIG Financial Products unit that sold the swaps, said on a
December 2007 conference call that his firm pulled back from selling
swaps on U.S. subprime residential CDOs in late 2005. The list shows
that the $21.2 billion in CDOs minted after 2005, mostly based on prime
and commercial mortgages, performed as badly as or worse than the
earlier subprime vintages.

A lawyer for Cassano declined to comment.

As details of the coverup emerge, so does anger at
the perceived conflicts. Philip Angelides, chairman of the Financial
Crisis Inquiry Commission, at a hearing held by his panel on Jan. 13,
questioned how banks could underwrite poisonous securities and then bet
against them. “It sounds to me a little bit like selling a car with
faulty brakes and then buying an insurance policy on the buyer of those
cars,” he said.

‘Part of the Coverup’

Janet Tavakoli, founder of Tavakoli Structured
Finance Inc., a Chicago-based consulting firm, says the New York Fed’s
secrecy has helped hide who’s responsible for the worst of the
disaster. “The suppression of the details in the list of counterparties
was part of the coverup,” she says.

E-mails between Fed and AIG officials that Issa
released in January show that the efforts to keep Schedule A under
wraps came from the New York Fed. Revelation of the messages
contributed to the heated atmosphere at the House hearing.

“What date did you know there was a coverup?”
Republican Congressman Brian Bilbray of California demanded of
Geithner. Lawmakers used the word coverup more than a dozen times as
they peppered Geithner with questions.

Geithner said that he wasn’t involved in matters of
disclosure and that his former colleagues did the best they could. In a
Jan. 19 statement, the New York Fed said, “AIG at all times remained
responsible for complying with its disclosure requirements under the
securities laws.”

The government has committed more than $182 billion to AIG and owns almost 80 percent of the company.

Document Withheld

In late November 2008, the insurer was planning to
include Schedule A in a regulatory filing — until a lawyer for the Fed
said it wasn’t necessary, according to the e-mails. The document was an
attachment to the agreement between AIG and Maiden Lane III, the fund
that the Fed established in November 2008 to hold the CDOs after the
swap contracts were settled.

AIG paid its counter­parties — the banks — the
full value of the contracts, after accounting for any collateral that
had been posted, and took the devalued CDOs in exchange. As requested
by the New York Fed, AIG kept the bank names out of the Dec. 24 filing
and edited out a sentence that said they got full payment.

The New York Fed’s January 2010 statement said the
sentence was deleted because AIG technically paid slightly less than
100 cents on the dollar.

Paid in Full

Before the New York Fed ordered AIG to pay the banks
in full, the company was trying to negotiate to pay off the credit-
default swaps at a discount or “haircut.”

By March 2009, responding to a request from
Christopher Dodd, chairman of the Senate Committee on Banking, Housing
and Urban Affairs, AIG released the names of the counterparty banks. In
a filing later that month, AIG included Schedule A, showing bank names
while withholding all identification of the underlying CDOs and the
amounts of collateral each bank had collected. The document had more
than 800 redactions.

In May 2009, AIG again filed Schedule A, this time
with about 400 redactions. It revealed that Paris-based Societe
Generale got the biggest payout from AIG, or $16.5 billion, followed by
Goldman Sachs, which got $14 billion, and then Deutsche Bank and
Merrill Lynch. It still kept secret the CDOs’ identification and
information that would show performance.

‘Right to Know’

“This is something that belongs in the public domain
because it was done with public money,” Issa says. “The public has the
right to know what was done with their money and who benefited from
it.” Now, thanks to Issa, the list is out, and specific information
about AIG’s unraveling can be learned from it.

At the Jan. 27 hearing, the New York Fed was still
arguing that the contents of Schedule A shouldn’t be fully disclosed.
Thomas Baxter, the New York Fed’s general counsel, testified that
divulging the names of the CDOs could erode their value: “We will be
hurt because traders in the market will know what we’re holding.”

Tavakoli calls that wrong. With many CDOs, providing
more information to the market will give the manager a greater chance
of fetching a realistic price, she says.

Jack Gutt, a spokesman for the New York Fed, declined to comment, as did AIG’s Mark Herr.

Bad to Worse

Tavakoli also says that the poor performance of the
underlying securities (which are actually specific slices or tranches
of CDOs) shows they were toxic in the first place and were probably
replenished with bundles of mortgages that were particularly troubled.
Managers who oversee CDOs after they are created have discretion in
choosing the mortgage bonds used to replenish them.

“The original CDO deals were bad enough,” Tavakoli
says. “For some that allow reinvesting or substitution, any reasonable
professional would ask why these assets were being traded into the
portfolio. The Schedule A shows that we should be investigating these

Among the CDOs on Schedule A with notional values of
more than $1 billion, the worst performer was a tranche identified as
Davis Square Funding Ltd.’s DVSQ 2006-6A CP. It was held by Societe
Generale, underwritten by Goldman Sachs and managed by TCW Group Inc.,
a Los Angeles-based unit of SocGen, according to Bloomberg data. It
lost 77.7 percent of its value — though it isn’t in default and
continues to pay.

SocGen spokesman James Galvin and TCW spokeswoman Erin Freeman declined to comment.

Documentation Needed

Ed Grebeck, CEO of Tempus Advisors, a global debt
market strategy firm in Stamford, Connecticut, agrees that more digging
is necessary. “You need all the documentation and more than that, all
the e-mails,” he says. “That would allow us to understand what went
wrong and how to fix it going forward.”

Neil Barofsky, the special inspector general for the
Troubled Asset Relief Program, who delivered a report on the AIG
bailout in November, says he’s not finished. He has begun a probe of
why his office wasn’t provided all of the 250,000 pages of documents,
including e-mails and phone logs, that Issa’s committee received from
the New York Fed.

Schedule A provides some answers — and raises questions that need to be tackled to avoid the next expensive bailout.

–With assistance by Hugh Son and Laurie Meisler in New York. Ed

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