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By Ronald Fink
The Federal Reserve should not have saved American International Group in order to bail out Goldman Sachs and other counterparties to the insurer in late 2008, a prominent finance expert wrote on Thursday.
Lucian Bebchuk, a professor at Harvard University who specializes in corporate governance, observed in a column posted on Project Syndicate's website that putting AIG into bankruptcy would not have caused a default on all of its obligations and caused investors to lose confidence in Goldman and other AIG counterparties.
The assertion contradicts Federal Reserve Chairman Ben Bernanke's testimony to Congress last March that failing to bail out AIG could have threatened the solvency of those counterparties. The Fed provided AIG with $182 billion in funds, with much of it ending up at banks, including $13 billion for Goldman.
In the column, Bebchuk pointed out that AIG's insurance subsidiaries were capitalized separately from its financial products subsidiary. So while Goldman and other buyers of its derivatives products would have suffered losses in a Chapter 11 proceeding, the losses would not have been so large as to cause investors to lose confidence in those counterparties.
"The US government felt that it had a weak hand, because it was not prepared to allow AIG to default on any of its obligations," Bebchuk observed. "This was a mistake."
He argued that the government should have been prepared to place AIG into reorganization under Chapter 11 and force the derivative parties to take the desired "haircut" on their claims that the Treasury initially asked for but ultimately chose not to pursue.
While that would have caused losses for Goldman and other counterparties, Bebchuk wrote that such an outcome would not have been at all "unacceptable."
Even if Goldman needed government help as a result of AIG's bankruptcy, the professor argued, the Fed could then have provided funds to the bank directly instead of through a bailout of AIG. And he said direct help would have been preferable, because taxpayers would have received something in exchange.
"To address a potential capital shortage," Bebchuk wrote, "taxpayers would have been better off providing $13 billon to Goldman in exchange for Goldman securities with adequate value, rather than footing the bill for the $13 billion that AIG gave to Goldman."
Going forward, he insisted, the government should make it clear the federal safety net for failing banks doesn't apply to derivatives.
"Communicating such a commitment clearly would induce parties to derivative transactions not to rely on a governmental safety net, but to monitor whether their partners have adequate reserves," Bebchuk explained.
That would not only reduce future costs to taxpayers from cases like AIG, he continued, but also "would reduce the likelihood that cases like AIG would ever arise."
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