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All Bailouts Are Counterparty Bailouts

By Anonymous

The recent uproar over the government's refusal to reveal AIG's counterparties on its CDS trades is silly, and reflects a basic misunderstanding of how financial markets work.

With regard to AIG specifically: yes, AIG used some of the bailout money to post collateral it owed to counterparties on CDS trades. But it also used a significant amount of bailout money to repay counterparties in its securities lending program (basically a repo desk?AIG lends out securities it owns on a short-term basis in exchange for cash.) To settle transactions with counterparties returning the borrowed securities, AIG has to return the cash (less interest). If the government hadn't rescued AIG, it wouldn't have had enough cash to pay these counterparties back, and it would have essentially defaulted. In fact, a full $19 billion of taxpayer money has gone to AIG's securities lending program so far.

So the AIG bailout was also a bailout of AIG's counterparties in its securities lending program. Should the government be forced to reveal the identity of all these counterparties as well? Surely not?and no sane person would disagree. Why should CDS counterparties be any different?

More generally, you can see how this reasoning applies to bailouts in general. Yes, AIG's bailout was a bailout of its counterparties, but all bailouts in the financial sector are bailouts of counterparties. The purpose of all bailouts is to avoid insolvency. Avoiding insolvency requires paying counterparties the money they're owed. There's nothing special about the AIG bailout in that regard.

Finally, regarding the ubiquitous claim that "taxpayers have the right to know" who AIG's counterparties are: no, we don't. All of AIG's CDS contracts are subject to confidentiality agreements. Becoming the majority owner of a publicly-traded company does not entitle you to breach contracts that are binding on the company.

Full post as published by Economics of Contempt on March 14, 2009 (boomark / email).