Tags: US | New | York | Fed | Transparency

Geithner's N.Y. Fed Paid Full Price for 'Toxic' Investments in Bailout

Thursday, 01 Apr 2010 12:23 PM

 

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After two years of secrecy, the Federal Reserve Bank of New York is disclosing key details about billions of dollars of risky investments it bought while rescuing insurance giant American International Group Inc. and supporting the sale of failed investment bank Bear Stearns.

The New York Fed on Wednesday said what investments are held by three companies it created to buy them from Bear Stearns, AIG and AIG's business partners. The New York Fed also revealed their current values.

Wednesday's disclosure marks a sharp reversal for the Fed, which has long refused to disclose many key details about the bailouts, including what assets it holds in these companies, and what assets it accepted as collateral when making low-cost loans to banks.

These "toxic" investments were at the heart of the 2008 financial crisis. Their values often are based on the values of thousands of underlying mortgage loans, which were pooled and sliced up into complex securities and other financial products.

Once homeowners started defaulting on the risky subprime mortgages that made up these pools, banks didn't know how much the investments were worth. That made it nearly impossible to sell or trade them.

When Bear Stearns teetered in March 2008, the New York Fed brokered the company's sale to JPMorgan Chase & Co. The New York Fed created Maiden Lane LLC to buy $30 billion of investments that JPMorgan was unwilling to take over.

It was the first major bailout of the financial crisis, occurring almost six months before the collapse of investment bank Lehman Bros. pushed the global financial system to the brink.

In buying those assets, the new disclosures show, the Fed took on billions of dollars worth of risky derivatives called credit-default swaps — insurance-like products that pay off when a company defaults on its debt or a bond fails to produce the expected returns.

The company also holds $1.49 billion in whole residential mortgage loans, mortgage securities backed by Fannie Mae and Freddie Mac and loans for hotels and other commercial real estate.

The New York Fed created Maiden Lane II LLC and Maiden Lane III LLC to support the $182 billion AIG rescue. The former bought mortgage-backed bonds from AIG's insurance subsidiaries. The latter bought investments AIG had insured that were held by other big banks.

The New York Fed, then run by Treasury Secretary Timothy Geithner, paid banks full price for investments that already had lost much of their value. It needed to buy them so banks like Goldman Sachs Group Inc. and Societe Generale would cancel AIG's insurance obligations.

Critics have argued these "backdoor bailouts" cost taxpayers billions more than necessary because Geithner and former Treasury Secretary Henry Paulson did not demand concessions from the banks.

The holdings of Maiden Lane III were disclosed in January, over the objections of the New York Fed. Maiden Lane II holds about $34.5 billion in mortgage-backed investments that are not guaranteed by Fannie Mae and Freddie Mac.

The Fed has said its secrecy was necessary to help rebuild confidence in the financial sector and stabilize the banking system.

Critics argue for more transparency given that the bailouts could have cost taxpayers tens of billions of dollars.

Identifying the assets "would compromise the New York Fed's ability to maximize value for the taxpayer in the long-run," New York Fed President William Dudley wrote this month.

Dudley was responding to a request for the information from California Rep. Darrell Issa, the top Republican on the House Committee on Oversight and Government Reform. Issa has been a leading critic of the bailouts, and has successfully pushed the New York Fed to disclose more information about the AIG rescue.

In January, Issa released details about the holdings of Maiden Lane III. He disputed the Fed's argument that revealing details would upset financial markets and drive down the values of the investments.

Issa sent letters to the New York Fed and JPMorgan on March 3 requesting more information about the Bear Stearns bailout. He was reacting to reports that the assets held by Maiden Lane LLC had lost nearly 10 percent of their value.

JPMorgan is cooperating with the congressional probe, a bank spokeswoman said.

Issa called Wednesday's disclosures "a step in the right direction" but said they didn't go far enough.

"The ultimate goal is full transparency and accountability," Issa said in a statement. "There are still a number of outstanding requests for information that the (New York Fed) has either refused or ignored."

Asked about the New York Fed's about-face, a bank spokeswoman referred to a statement that says in part: "The Federal Reserve recognizes the importance of transparency to its financial stability efforts and will continue to review disclosure practices with the goal of making additional information publicly available when possible."

The disclosures were only possible after the New York Fed struck deals with JPMorgan and AIG about how much information it would reveal.

The disclosures omit all whole residential mortgages held by the Maiden Lane companies because describing them would violate borrowers' privacy.

© Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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