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FACTORS AFFECTING EFFORTS TO LIMIT
PAYMENTS TO AIG COUNTERPARTIES

SIGTARP-10-003
NOVEMBER 17, 2009

SIGTARP
Office of the Special Inspector General
for the Troubled Asset Relief Program

November 17, 2009
FACTORS AFFECTING EFFORTS
COUNTERPARTIES

LIMIT PAYMENTS

AIG

What SIGTARP Found
Summary of Report: SIGTARP-10-003

Why SIGTARP Did This Study
In September 2008, American International
Group (“AIG”), was on the brink of collapse,
unable to access credit in the private markets
and bleeding cash. On September 16, 2008, the
Federal Reserve Bank of New York
(“FRBNY”), pursuant to the authorization of
the Board of Governors of the Federal Reserve
System (“Federal Reserve Board”, and,
collectively with FRBNY, “Federal Reserve”)
provided AIG with an $85 billion loan. On
November 10, 2008, Federal Reserve and
Department of the Treasury (“Treasury”)
announced the restructuring of the
Government’s financial support to AIG. As part
of this restructuring, Federal Reserve Board
authorized FRBNY to lend up to $30 billion to
Maiden Lane III, a newly formed limited
liability company. Pursuant to this
authorization, FRBNY lent $24.3 billion to
Maiden Lane III, which, in combination with a
$5 billion equity investment from AIG, was
used to fund the purchase of assets from
counterparties of American International Group
Financial Products (“AIGFP”) having a fair
market value of about $27.1 billion. In
exchange for payment and being permitted to
retain $35 billion in collateral payments
(effectively being paid par or face value), the
counterparties agreed to terminate their credit
default swap contracts—insurance-like
contracts intended to protect the underlying
assets—with AIGFP.
In light of the extent of the U.S. government’s
assistance to AIG, numerous members of
Congress asked SIGTARP to review the
counterparty transactions. This report addresses
(1) the decision-making processes leading up to
the creation of Maiden Lane III, (2) why AIG’s
counterparties were paid at par value, and (3)
AIG’s current exposure to credit default swaps
outside Maiden Lane III.
SIGTARP interviewed officials and reviewed
documentation from Federal Reserve regarding
efforts to negotiate concessions from the
counterparties, as well as the rationale to pay
counterparties at par. SIGTARP also met with
officials of two of AIG’s counterparties
regarding termination of the credit default
swaps. SIGTARP also interviewed officials and
obtained information from AIG. Our work was
performed in accordance with generally
accepted government auditing standards.

In the fall of 2008, the Federal Reserve and Treasury faced several key decisions
about the future of AIG. After attempts to find private-sector financing failed,
they chose to provide assistance to AIG rather than allow the company to file for
bankruptcy. FRBNY officials believed that an AIG failure would pose
considerable risk to the entire financial system and would have significantly
intensified an already severe financial crisis. FRBNY was concerned about the
effect of an AIG bankruptcy on key sectors of the market, such as retirement
accounts and the credit markets. FRBNY adopted in substantial part the
economic terms of a draft term sheet under consideration by a consortium of
private banks, the terms of which included a very high interest rate. When it
became apparent that AIG’s liquidity crisis would continue despite FRBNY
financing and that a further downgrade was coming, to avoid such a downgrade
the Federal Reserve and Treasury decided to create a special purpose vehicle,
called Maiden Lane III, that bought the underlying collateral of a portion of
AIG’s credit default swaps from a number of AIG’s counterparties. Terminating
these credit default swaps in this way prevented further collateral calls and eased
AIG’s liquidity pressures.
After limited efforts to negotiate concessions from the counterparties failed,
FRBNY decided to pay AIG’s counterparties at what was effectively face or
“par value” — the fair market value of the counterparty assets plus the collateral
payments they had already received — for the collateralized debt obligations
underlying AIGFP’s credit default swap portfolio. FRBNY was confronted with
a number of factors that it believed limited its ability to negotiate reductions in
payments effectively, including a perceived lack of leverage over the
counterparties because the threat of an AIG bankruptcy had already been
removed by FRBNY’s previous assistance to AIG. On March 15, 2009, after
significant public and Congressional pressure, AIG, after consultation with the
Federal Reserve, publicly disclosed the identities of the counterparties. FRBNY
officials state that they believe they will recoup the loan they made to Maiden
Lane III over time. As of September 30, 2009, the current fair market value of
the Maiden Lane III portfolio is $23.5 billion versus a loan balance of $19.3
billion.

Conclusions and Lessons Learned
SIGTARP concludes that: (1) the original terms of federal assistance to AIG,
including the high interest rate it adopted from the private bank’s initial term
sheet, inadequately addressed AIG’s long term liquidity concerns, thus requiring
further Government support; (2) FRBNY’s negotiating strategy to pursue
concessions from counterparties offered little opportunity for success, even in
light of the willingness of one counterparty to agree to concessions; (3) the
structure and effect of FRBNY’s assistance to AIG, both initially through loans
to AIG, and through asset purchases in connection with Maiden Lane III
effectively transferred tens of billions of dollars of cash from the Government to
AIG’s counterparties, even though senior policy makers contend that assistance
to AIG’s counterparties was not a relevant consideration in fashioning the
assistance to AIG; and (4) while FRBNY may eventually be made whole on its
loan to Maiden Lane III, it is difficult to assess the true costs of the Federal
Reserve’s actions until there is more clarity as to AIG’s ability to repay all of its
assistance from the Government. SIGTARP also draws lessons that should be
learned regarding the importance of transparency and the enormous impact that
ratings agencies had on the AIG bailout.

Special Inspector General for the Troubled Asset Relief Program

Table of Contents
Introduction

Key Decisions That Led to Creation of Maiden Lane III

FRBNY Decided to Compensate Counterparties Effectively at Par Value 16
Remaining AIG Credit Default Swap Exposure

Conclusions and Lessons Learned

Management Comments

Appendices
A. Scope and Methodology

B. Acronyms

C. Audit Team Members

D. Management Comments from Federal Reserve

E. Management Comments from Treasury

Special Inspector General for the Troubled Asset Relief Program

Factors Affecting Efforts To Limit Payments to
AIG Counterparties
SIGTARP REPORT 10-003

November 17, 2009

Introduction
In September 2008, multiple U.S. financial institutions had failed or were on the brink of failure
as a result of an escalating crisis in the financial markets. This ultimately led to enactment of the
Emergency Economic Stabilization Act of 2008 (“EESA”), which provided the Department of
the Treasury (“Treasury”) with $700 billion to aid financial institutions under the Troubled Asset
Relief Program (“TARP”). One of the companies that received the greatest assistance under
TARP, and even greater assistance from the Federal Reserve Bank of New York (“FRBNY”),
pursuant to the authorization of the Board of Governors of the Federal Reserve System (“Federal
Reserve Board”, and, collectively with FRBNY, “Federal Reserve”), was the insurance
conglomerate American International Group (“AIG”). Beginning in 2007, AIG began
experiencing a significant drain on its finances when, among other things, the company began
paying increasing amounts of collateral 1 to counterparty institutions that had purchased
insurance-like contracts called credit default swaps from AIG’s subsidiary, AIG Financial
Products (“AIGFP”). 2
By September 2008, bankruptcy loomed for AIG, in part because AIG was unlikely to be able to
raise the capital needed to meet additional calls for large collateral payments in the case of an
anticipated downgrade in its credit rating by credit rating agencies. 3 On the afternoon of
September 15, 2008, the three largest credit rating agencies—Standard and Poor’s Financial
Services, Moody’s Investors Service, Inc., and Fitch Ratings Ltd.—downgraded AIG. On
September 16, 2008, because of concerns that an AIG bankruptcy could cause systemic risk to
the entire financial system and the American retirement system, the Federal Reserve Board, with
the support of Treasury, authorized FRBNY to lend up to $85 billion to the firm under Section

Collateral generally means the property or assets that a borrower offers a lender in order to secure a loan or other
obligation to pay.
2
A credit default swap is an insurance-like contract in which the seller receives a series of payments from the buyer
in return for agreeing to make a payment to the buyer if a particular credit event outlined in the contract occurs—for
example, if a particular bond or loan goes into default or its credit rating is downgraded.
3
Credit rating agencies are companies that provide investors with analyses and assessments of credit risk for a
particular company or security. Credit ratings provide individual and institutional investors with information that
assists them in determining whether issuers of debt obligations and fixed income securities will be able to meet their
obligations with respect to those securities. Credit default swap contracts will often reference credit ratings in
determining whether a credit default swap party needs to post collateral and how much. In addition, credit default
swap contracts will also frequently provide that, as the market value of a particular bond declines, the seller may
have to post collateral to the buyer in the amount of the decrease in value.

13(3) of the Federal Reserve Act.4 This would be the first of several infusions of capital and
loans to AIG, first by the Federal Reserve and then by Treasury.
Despite this initial Government assistance, AIG’s financial difficulties continued, and there were
concerns that a further downgrade was forthcoming. Additional downgrades, among other
things, could trigger requirements for AIG to make additional collateral payments (referred to as
“posting collateral”) to AIG’s counterparties. The downgrades could thus exacerbate the liquidity
drain and the payments to swap counterparties. To help prevent further downgrades of AIG’s
credit rating that could lead to a disorderly bankruptcy with potentially destabilizing effects for
the U.S. economy, in November 2008, the Federal Reserve and Treasury announced a
restructuring of their official assistance. Among other measures, the Federal Reserve Board
authorized FRBNY to create a special purpose vehicle (“SPV”) 5 called Maiden Lane III and to
lend it up to $30 billion to buy collateralized debt obligations (“CDOs”) underlying the credit
default swaps from AIG’s counterparties.6 In connection with this purchase, AIG’s
counterparties agreed to terminate the associated swaps with AIG in return for retaining
collateral they had already received. This eliminated any future need for AIG to post additional
collateral or make future payments on the credit default swaps related to the CDOs purchased by
Maiden Lane III. The combination of the two components of the transaction equaled effectively
the par (or face) value of the credit default swaps. Once these payments became publicly known,
questions were raised about the propriety of paying the counterparties the equivalent of par value
because the market value of the underlying CDOs had dropped precipitously and because some
counterparties were already recipients of Treasury funding under TARP and the beneficiaries of
other federal bailout programs. Likewise, there were questions whether these counterparty
payments may also effectively have been paid using Government funding as a “backdoor
bailout” of these counterparties.

Background
AIG is a global organization doing business in more than 130 countries and jurisdictions. In
2007, it was ranked the largest life insurer and the second largest property/casualty insurer by
4

Section 13(3) of the Federal Reserve Act authorizes the Federal Reserve Board to make secured loans to
individuals, partnerships, or corporations in "unusual and exigent circumstances" and when the borrower is "unable
to secure adequate credit accommodations from other banking institutions." This authority, added to the Federal
Reserve Act in 1932, was intended to give the Federal Reserve the flexibility to respond to emergency conditions. It
was amended in 1991 to allow the Federal Reserve to lend directly to securities firms during financial crises.
5
A special purpose vehicle is an off-balance sheet legal entity that holds transferred assets that are theoretically
beyond the reach of the entities providing the assets.
6
The Federal Reserve had earlier created two other SPVs, Maiden Lane I and Maiden Lane II, named after the
downtown Manhattan street on which FRBNY’s offices are located. In March 2008, FRBNY and JPMorgan Chase
& Co. entered into an arrangement related to the financing provided by the FRBNY to facilitate the merger of
JPMorgan Chase and the Bear Stearns Companies Inc. by moving approximately $30 billion of Bear Stearns assets
into Maiden Lane, LLC (“Maiden Lane I"). On November 10, 2008, the Federal Reserve Board and Treasury
announced the restructuring of the Government’s financial support to AIG in order to facilitate its ability to
complete its restructuring process. As part of this restructuring, the Federal Reserve Board authorized FRBNY to
lend up to $22.5 billion to a newly formed Delaware limited liability company, Maiden Lane II LLC (“Maiden Lane
II”), to fund the purchase of residential mortgage-backed securities from the securities lending portfolio of several
regulated U.S. insurance subsidiaries of AIG. This was done to resolve liquidity pressures on AIG arising from
losses on its securities lending program.

premiums written in the United States. 7 AIG offers a broad spectrum of insurance and asset
management services. AIG’s 116,000 employees work in four principal business units:
•
•
•

•

Financial Services
Asset Management
Life Insurance & Retirement Services
General Insurance

AIGFP, AIG’s Financial Products subsidiary, offered a portfolio of products that included credit
default swaps. Credit default swaps are insurance-like instruments that AIGFP issued to
counterparty buyers such as financial institutions and investors. Under a credit default swap,
AIG would receive a series of payments from the counterparties in return for AIG agreeing to
make a payment to the counterparties if a particular defined credit event occurred with respect to
an underlying security (for example, if the credit rating on a security is downgraded or the
security goes into default). Credit default swaps are often used to hedge against a loss in value
of asset-backed securities. 8 AIGFP sold credit default swaps that offered loss protection on
assets such as multi-sector CDOs. CDOs are financial instruments that entitle the buyer to some
portion of cash flows from a portfolio of assets, which may include bundles of bonds, loans,
mortgage-backed securities, or even other CDOs. 9 A multi-sector CDO is a CDO backed by a
combination of corporate bonds, loans, mortgages, or asset-backed securities.
Under the terms of AIGFP’s credit default swap contracts, the counterparties purchasing the
credit default swaps paid AIG regular insurance-like premiums and were entitled to require
AIGFP to post collateral when certain events occurred relating to the underlying CDOs,
including a decline in the market value of the CDO. 10 In addition, if the credit rating on the
underlying CDOs were downgraded, AIGFP could also be required to post collateral. 11 The
credit default swap contracts also included collateral posting provisions that provided that certain
events related to AIG would also trigger an obligation for AIGFP to pay the counterparties cash
collateral as evidence of AIGFP’s ability to pay the counterparty in the event of a default. For
example, a common provision provided that, in the event AIG’s credit rating was downgraded,
7

AIG is supervised in the United States by a host of state insurance regulators. AIG’s holding company is
supervised by the Office of Thrift Supervision.
8
Asset-backed securities are tradable securities backed by a pool of loans, leases or other cash-flow producing
assets. Mortgage-backed securities are a type of asset-backed security representing claims to the cash flows from
pools of mortgage loans. Mortgage loans are purchased from banks, mortgage companies, and other originators and
then assembled into pools by a governmental, quasi-governmental, or private entity. The entity then issues securities
that represent claims on the principal and interest payments made by borrowers on the loans in the pool, a process
known as securitization.
9
The CDO can be split into different slices or “tranches” of securities that receive the cash flows from the
underlying debt securities in varying priority. The senior tranche is typically highly rated; it is ranked first in the
priority of payments of the tranches. The mezzanine tranche generally refers to the tranches rated lower than the
senior tranche. The equity tranche is the residual cash flow produced by the CDO collateral that remains after
expenses and senior and mezzanine tranches interest are paid.
10
It is important to note that the credit default swap contract is not actually tied to a security, but instead references
it. For this reason, the security involved in the transaction is called the "reference entity." A contract can reference a
single credit event or multiple credit events.
11
For more information about AIG’s credit default swaps, including the terms of the contracts, see AIG’s 2008
Annual Report, Form 10-K, Item 7.

AIGFP would have to post cash collateral to ensure payment. The amount of cash collateral
AIGFP was required to post differed for each event and was calculated based on AIGFP’s credit
rating, the rating of the underlying security, the market value of the underlying security, and
other terms set forth in the swap contract.
Although credit default swaps are sometimes referred to as insurance-like contracts, they are not
technically considered insurance, and, unlike insurance contracts, credit default swaps are not
regulated. As a result, AIGFP was not required to hold reserves to cover losses or other claims
as it would if it was selling insurance policies. AIGFP was thus able to sell swaps on $72 billion
worth of CDOs to counterparties without holding reserves that a regulated insurance company
would be required to maintain if it had written an equivalent amount of insurance coverage. 12
Counterparties assumed that AIG, which was a highly rated company at the time it wrote the
swaps, would be able to pay any claims on the swaps that might occur as required by the
contracts.
Beginning in the third quarter of 2007 and continuing through 2008, AIG’s financial condition
deteriorated, causing a decline in market confidence that, in turn, triggered downgrades of AIG's
credit rating. At the same time, the market value of the CDOs protected by AIGFP’s credit
default swaps declined. As a result, AIGFP was required to post collateral under the terms of its
credit default swap contracts, typically the difference between the market value of the underlying
CDO and its par value. By late summer 2008, however, AIG did not have nearly enough
liquidity to post the required collateral and was on the verge of defaulting on its obligations to its
counterparties, which would likely have forced AIG into bankruptcy. In response to the possible
systemic implications and the potential for significant adverse effects on the economy if AIG
failed, on September 16, 2008, the Federal Reserve Board, with the support of Treasury,
authorized FRBNY to lend up to $85 billion to assist AIG in meeting its obligations and to
facilitate the orderly sale of some of its businesses.
As AIG continued to experience problems in the fall of 2008, AIG received further government
assistance. In November 2008, Treasury purchased $40 billion of newly issued AIG preferred
shares under TARP’s Systemically Significant Failing Institutions program. These funds went
directly to FRBNY to pay back a portion of the funds previously provided to AIG by FRBNY
and permitted FRBNY to reduce the total amount available under the credit facility from $85
billion to $60 billion.
At the same time, the Federal Reserve Board announced a number of other measures intended to
put AIG on sounder financial footing. These included authorizing FRBNY to restructure the
terms of its credit facility to AIG and to create, and lend to, an SPV called Maiden Lane II that
was designed to resolve liquidity pressures stemming from AIG’s securities lending programs.
12

Although credit default swaps are subject to anti-fraud and similar provisions of the federal securities laws, these
instruments are not considered securities or regulated as such. In 2000, the Commodity Futures Modernization Act
(“CFMA”) excluded credit default swaps from the definition of "security" under the Securities Act of 1933 and the
Securities Exchange Act of 1934 and barred the regulation of credit default swaps and other derivatives. State
regulation of credit default swaps is also limited; the CFMA barred most state regulation of credit default swaps.
There is currently proposed Congressional legislation that would specify that credit default swaps fall within the
definition of a security and should be regulated as such.

The Federal Reserve Board further authorized FRBNY to create, and lend up to $30 billion to,
Maiden Lane III to buy the underlying CDOs from AIG’s counterparties. These purchases were
part of a transaction in which the counterparties, in exchange for agreeing to terminate their
credit default swap contracts, would be allowed to retain collateral previously posted by AIG.
Pursuant to this Federal Reserve Board authorization, Maiden Lane III was funded with $24.3
billion from FRBNY in the form of a senior loan and a $5 billion equity investment from AIG.
Maiden Lane III paid the fair market value of the multi-sector CDOs, or $29.6 billion, in
exchange for receiving CDOs with an approximate face value of $62.1 billion. Of the fair
market value amount paid by Maiden Lane III, $27.1 was paid to counterparties and $2.5 billion
was paid to AIGFP as an adjustment payment to reflect overcollateralization. In simultaneous
transactions, the counterparties were allowed to keep the $35 billion in collateral that had been
posted by AIG prior to the transaction in exchange for tearing up the associated credit default
swap contracts. That collateral was funded in part by the original $85 billion line of credit
advanced by FRBNY. As a result of combining the fair market value purchase of the CDOs and
the retention of collateral postings already received from AIG, AIG’s counterparties received
$62.1 billion overall, effectively the par value of the credit default swaps. No TARP funds were
directly used in the Maiden Lane III transaction. 13

Objectives
Twenty-seven members of Congress asked SIGTARP to review the basis for these counterparty
payments, whether they were in the best interests of the taxpayers, and whether they needed to be
made at 100% of par value. SIGTARP also sought to determine to what extent AIG continues to
have potential risk to other counterparty payments associated with their financial products. In
addressing these issues, this report is organized around these questions:
•

What were the key decisions that led to the creation of Maiden Lane III?

•

Why were counterparties paid at effectively par value?

•

What AIG exposures to credit default swaps exist outside of Maiden Lane III?

For a discussion of the audit scope and methodology, see Appendix A. For definition of the
acronyms, see Appendix B. For the audit team members, see Appendix C. For a copy of
comments from the Federal Reserve, see Appendix D. For a copy of the comments from
Treasury, see Appendix E.

AIG would eventually receive additional Government assistance when in March 2009, Treasury established an
equity capital facility permitting AIG to access up to $29.8 billion in return for preferred shares in AIG. As of
October 2, 2009, AIG had drawn down $3.2 billion from the facility.

Key Decisions That Led to the Creation of
Maiden Lane III
This section addresses the circumstances and decisions that led to the creation of Maiden Lane
III. AIG began suffering significant liquidity problems in September 2008 when it was required
to post collateral to its counterparties to make up for, among other things, the rapidly declining
value of the securities underlying its credit default swaps. On September 15, 2008, AIG’s longterm credit rating was downgraded, and, without some kind of assistance, the company faced
bankruptcy. FRBNY believed that a consortium of private banks would be able to offer
assistance to AIG. The consortium, however, believed AIG’s liquidity needs exceeded the value
of the company’s assets, and the private sector solution failed in the wake of the bankruptcy of
Lehman Brothers. After the prospect of receiving private sector financing disappeared, AIG
turned to the Federal Reserve. The Federal Reserve and Treasury considered the benefits of
supporting AIG, including the impact that an AIG failure could have on the financial system as a
whole and the risks of supporting AIG, which included increasing moral hazard. Because Federal
Reserve and Treasury officials believed that an AIG bankruptcy could ultimately have a greater
systemic impact than Lehman’s bankruptcy one day before, they decided that additional Federal
support was needed to maintain the overall stability of the financial markets. On September 16,
2008, the Federal Reserve Board authorized FRBNY to extend an $85 billion revolving credit
facility to AIG. In a rush to take action quickly, FRBNY did not craft its own terms and instead
simply adopted in substantial part the economic terms of a draft term sheet under consideration
by a consortium of private banks, which included a very high interest rate. The terms of this
agreement, including the substantial increase in the amount of AIG debt and the substantial
interest rate, would later put AIG’s credit rating in jeopardy once again, requiring additional
Government action. FRBNY further determined that addressing AIG’s credit default swap
portfolios and assuming liabilities associated with AIG’s most problematic credit default swap
obligations, which continued to be a drain on AIG’s liquidity, would be critical to any
restructuring of the original agreement. Therefore, on November 10, 2008, the Federal Reserve
Board authorized FRBNY to create Maiden Lane III to purchase the CDOs underlying certain
credit default swap contracts from the counterparties. Figure 1 shows the timeline of events
discussed in this section.

Figure 1: Timeline of Key Events Leading to the Creation of Maiden Lane III
September, 2008: The decline in value of the CDOs
underlying AIGFP’s credit default swaps forces AIG to post
increasing amounts of collateral, together with other factors
leading to a liquidity crisis for AIG.
Private banks evaluate a solution
to AIG’s liquidity crisis. AIG’s
credit rating is downgraded, and
the company must post more
collateral. AIG faces bankruptcy.

September 15, 2008

FRBNY considers options
for restructuring the credit
facility and addressing
AIG’s liquidity pressures.

Late September-October

September 16, 2008
The private sector solution
disappears. The Federal Reserve
Board, with the support of
Treasury, authorizes an $85
billion credit facility for AIG.

FRBNY negotiates with
AIG’s counterparties on
concessions for the
value of the CDOs
November 6-7, 2008

October-November 2008

FRBNY opts to create Maiden
Lane III by purchasing CDOs
from counterparties in exchange
for terminating the credit default
swaps.

Maiden Lane III purchases
CDOs from AIG counterparties.
November 25, December 18 and 22

November 10, 2008
Treasury announces $40 billion
in TARP funding for AIG. The
Federal Reserve announces the
restructuring of the $85 billion
credit facility and the creation
of Maiden Lane II and Maiden
Lane III.

AIG Suffers a Crisis in Liquidity in September 2008
AIGFP’s liquidity issues resulted largely from its obligation to post collateral in connection with
its credit default swaps. As the value of the underlying CDOs fell, AIG was contractually
obligated to post collateral to its counterparties to make up for the difference in the drop in price
of the securities. Some of the credit default swaps contracts also included a provision that if
AIG’s credit rating was downgraded, AIG would have to post additional collateral to provide
assurances that AIG could pay if the underlying CDOs suffered a credit event such as a default.
The amount of collateral posted varied from contract to contract. AIGFP’s contracts were
structured so that if the future value of the CDOs increases, AIGFP would be entitled to the
return of this collateral.
AIG’s significant collateral call problems began in the third quarter of 2007 and continued to
escalate throughout 2008. Prior to September 2007, AIGFP had not posted any collateral related
to its swap portfolio. Credit downgrades of AIG corporate debt and the precipitous decline in the
value of the underlying CDOs resulted in rapidly increasing collateral calls by counterparties in
the first three quarters of 2008, as seen in Table 1.14
14

Several other factors drove AIG’s liquidity crisis. AIG also faced severe liquidity pressures arising out of its
losses on residential mortgage-backed securities it had invested in as part of its securities lending program. The
Federal Reserve Board twice authorized the FRBNY to take steps to alleviate these pressures: on October 8, 2009,
the Federal Reserve Board authorized the FRBNY to establish a securities borrowing program, and on November
10, 2009, authorized the establishment of Maiden Lane II. Additionally, among other things, the deterioration in its
financial condition and credit rating meant that AIG needed to fund collateral obligations under guaranteed

Table 1: AIG Collateral Postings from December 31, 2007, through September 30,
2008 (dollars in millions)
Collateral posting during quarter ending
Collateral Posting by Portfolio
Foreign Regulatory Capital a
Arbitrage – Multi-sector CDO
Arbitrage – Corporate

June 30, September 30,
2008
2008

December 31,
2007

March 31,
2008

212

319

443

2,718

7,590

13,241

31,469

161

368

259

902

Total Collateral Postings
2,879
8,170
13,819
32,814
Source: SIGTARP analysis of AIG data
a
Foreign regulatory capital swaps portfolio refers to swaps written on diversified pools of residential mortgages and
corporate loans (made to both large corporations and small to medium-sized enterprises). In exchange for a periodic
fee, foreign financial institutions receive credit protection with respect to diversified loan portfolios they own, thus
reducing their minimum capital requirements.
b
Arbitrage portfolio refers to transactions written on multi-sector CDOs or designated pools of investment grade
senior unsecured corporate debt or collateralized loan obligations.

On Friday, September 12, 2008, Standard & Poor’s (“S&P”) placed AIG on negative credit
watch signaling a potential upcoming downgrade in the firm’s credit rating as early as the
following week. As described above, such a downgrade would have triggered additional
collateral postings under AIGFP’s credit default swap contracts. To prevent such a downgrade,
during the weekend, AIG attempted to raise capital from private equity firms and other potential
investors to address its liquidity crisis. AIG met with FRBNY officials to keep them abreast of
the status of these talks. Although aware of the impending crisis, Federal Reserve officials
believed that a private solution would be forthcoming and, as a result, did not foresee that
Federal Reserve assistance would be necessary.
On Monday, September 15, 2008, after Lehman filed bankruptcy early in the morning, the
private sector solution for AIG collapsed. That same day, then-FRBNY President Geithner
spearheaded an effort to encourage a private solution to AIG’s liquidity crisis. Mr. Geithner
mobilized a consortium of banks led by representatives from JPMorgan Chase & Co. and
Goldman Sachs to arrange private financing for a $75 billion loan to address AIG’s liquidity
crisis. The Federal Reserve believed that the bank consortium would provide the liquidity AIG
needed. A JPMorgan Chase vice chairman noted that participants felt a sense of urgency to find
an immediate solution to avert a potential downgrade by the credit rating agencies. The group
developed a loan term sheet, but an analysis of AIG’s financial condition revealed that liquidity
needs exceeded the valuation of the company’s assets, thus making the private participants
unwilling to fund the transaction. FRBNY officials told SIGTARP that, in their view, the private
participants declined to provide funding not because AIG’s assets were insufficient to meet its
needs, but because AIG’s liquidity needs quickly mounted in the wake of the Lehman
bankruptcy and the other major banks decided they needed to conserve capital to deal with
adverse market conditions.
investment contracts and to make capital contributions to a number of its subsidiaries in accordance with the
requirements of applicable regulators.

On the afternoon of September 15, 2008, the three largest rating agencies, Moody’s, S&P, and
Fitch Ratings Services, downgraded the long-term credit rating of AIG. The rating downgrades,
combined with a steep drop in AIG’s common stock price, prevented AIG from accessing money
in the short-term lending markets, and, without outside intervention, the company faced
bankruptcy, as it simply did not have the cash that was required to provide to AIGFP’s
counterparties as collateral. On the morning of September 16, 2008, Mr. Geithner was informed
that a private sector loan could not be arranged. That same day, the Federal Reserve Board, with
the encouragement of Treasury, authorized FRBNY to make an $85 billion revolving credit
facility available to AIG, so that it could make the collateral payments, meet the liquidity needs
arising from AIG’s securities lending programs, and meet other obligations necessary to avoid
bankruptcy.

Federal Reserve and Treasury Consider the Benefits and
Risks of Supporting AIG
In considering whether to rescue AIG, senior Federal Reserve and Treasury officials considered
the pros and cons of lending to AIG and identified concerns about an AIG bankruptcy that they
believed would be inevitable if AIG failed to make the collateral payments to counterparties.
Senior FRBNY officials discussed disadvantages of lending to AIG including the perception that
lending to AIG would be inconsistent with the treatment of Lehman, could diminish AIG’s
incentive to pursue private sector solutions, and could increase moral hazard. FRBNY also
identified several major concerns about the widespread impact of not lending to AIG and a
potential AIG bankruptcy: the impact on the American retirement system; the impact of AIG’s
commercial paper obligations,15 the broader effect on the already frozen credit markets and
money market mutual funds; and the considerable systemic risk to the global financial system.
First, Federal Reserve and Treasury officials believed that AIG’s failure posed considerable risk
to the entire financial system and would have significantly intensified an already severe financial
crisis and contributed to a further worsening of global economic conditions. Federal Reserve
Chairman Bernanke testified on March 24, 2009, before the House Financial Services
Committee, that Federal Reserve and Treasury had agreed that AIG’s failure “would have posed
unacceptable risks for the global financial system and for our economy.” Chairman Bernanke
cited losses that would be incurred by state and local governments that had lent $10 billion to
AIG; global banks and investment banks that had $50 billion in exposure to losses on loans, lines
of credit and derivatives; losses of $20 billion in AIG commercial paper; and losses by workers
whose 401(k) plans had purchased $40 billion of insurance against the risk that their values
would decline in value. As Chairman Bernanke testified, “[c]onceivably, its failure could have
resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications
for production, income, and jobs.” Mr. Geithner, who had since become Secretary of the
15

Commercial paper is an unsecured, short-term debt instrument used by companies to cover short-term obligations
such as operating and payroll expenses, accounts receivable, and inventories. The debt is usually issued at a
discount, reflecting prevailing market interest rates. Commercial paper is not usually backed by any form of
collateral, so only firms with high-quality debt ratings will easily find buyers without having to offer a substantial
discount (higher cost) for the debt issue.

Treasury, testified before that same Committee that the “collapse of AIG could cause large and
unpredictable global losses with systemic consequences—destabilizing already weakened
financial markets, further undermining confidence in the economy, and constricting the flow of
credit.” Secretary Geithner further testified that, “[a] disorderly failure of AIG risked deepening
and prolonging the current recession.” According to Congressional testimony of Donald Kohn,
the Vice Chairman of the Federal Reserve, such a failure would also have further undermined
business and household confidence and contributed to higher borrowing costs, reduced wealth,
and a further weakening of the economy.
Second, the Federal Reserve and Treasury considered the effect an AIG bankruptcy could have
on the American retirement system and determined that AIG’s failure would have a global retail
impact, notably on stable value funds and variable rate annuities. A stable value fund is an
investment vehicle found in company retirement plans and IRA accounts. 16 Stable value funds
are paired (or wrapped) with insurance contracts to guarantee a specific minimum return.
AIGFP had written approximately $38 billion of stable value fund wrap contracts to more than
200 wrap contract counterparties, including trustees and investment managers of company
retirement plans and 401k plans such as Fidelity, Vanguard, and the company retirement plans
for AT&T, DuPont, Wal-Mart, Bank of America, and other large U.S. corporations. If AIG
failed and the retirement plans could not secure new wrap contracts, the investment managers
would be forced to sell assets in their plans at distressed prices, which could generate immediate
losses in the stable value funds. Treasury and Federal Reserve officials were concerned that
large, unrealized losses could lead to real economic losses within the retirement funds and cause
a broader crisis of confidence in the American public about the security of retirement benefits.
Finally, Federal Reserve and Treasury officials were also concerned about the impact of an AIG
default on its commercial paper obligations and on the already frozen credit markets and
distressed money market mutual funds, particularly after observing the negative economic effects
of Lehman’s bankruptcy. Federal Reserve and Treasury senior officials believed that AIG’s
derivatives were more risky and unbalanced than Lehman’s; that investors could lose
confidence in AIG subsidiaries, which could lead to a liquidity shortfall; and finally, that AIG
would fail to perform on annuities and stable value wraps. Further, Federal Reserve and
Treasury officials discussed whether a default on AIG’s commercial paper could lead to further
“breaking-of-the buck” for money market funds. Money market funds are considered among the
safest investments and maintain a net asset value of $1 per share. When the fund falls below $1
per share, it is known as “breaking the buck,” an event that had not occurred in many years.
After Lehman filed for bankruptcy, the Reserve Primary Fund, the oldest money market fund in
the United States, was forced to write off debt issued by Lehman (about $785 million). As a
consequence, on September 16, 2008, the Reserve Primary Fund dipped below $1.00 per share,
thereby “breaking the buck,” which further aggravated the credit crisis. The resulting market
16

These funds seek to maintain a $1 share price calculated by dividing the total value of all of the securities in its
portfolio (less any liabilities) by the number of shares outstanding. Stable value funds comprise mostly “synthetic
guaranteed investment contracts” (known also as wrapped bonds) because of their inherent stability. Guaranteed
investment contracts are insurance contracts that guarantee the owner a repayment of principal and a fixed or
floating interest rate for a predetermined period of time. For example, if a company pension plan owns a bond with
a face value of $1,000 and the price in the market is $950, AIGFP would pay the $50 difference between the face
value and the market value. These bonds can be short or intermediate term with longer maturities than other choices
such as money market funds.

anxiety contributed to a run on the Reserve Primary Fund in which investors attempted to
withdraw their money quickly. In addition, large-scale redemptions caused money market
mutual fund companies to hoard cash rather than invest in funding markets, such as commercial
paper and certificates of deposit. AIG had approximately $20 billion in commercial paper
outstanding that was owned by institutional investors and money market funds that would likely
have taken losses had AIG failed. By contrast, in May 2008, Lehman had $8 billion in
commercial paper outstanding, an amount that decreased in the months leading to Lehman’s
bankruptcy. Federal Reserve and Treasury officials were concerned that an AIG commercial
paper default could force other money market funds to break the buck, which could cause
investor panic and a run on each of the funds holding AIG debt.
In the final analysis, the Federal Reserve and Treasury believed that the risks of not rescuing
AIG outweighed the risks associated with rescuing the troubled insurance company, and on
September 16, 2008, the Federal Reserve Board authorized an $85 billion credit facility for AIG.

FRBNY and Treasury Officials Realized that the Structure
of the Assistance Must Be Changed
Although FRBNY officials had been meeting with AIG management and advisors during the
weekend of September 12, 2008, and over the following days, Secretary Geithner informed
SIGTARP that he believed that the bank consortium led by JPMorgan Chase would provide the
liquidity AIG needed. When the consortium declined to assist AIG and the three largest credit
rating agencies downgraded AIG on September 15, 2008, the Federal Reserve and Treasury
made the decision, within a matter of hours, that FRBNY would provide $85 billion in financing
to AIG. FRBNY did not develop a contingency plan in the event that the private financing did
not go through and did not conduct an independent analysis regarding the appropriate terms for
Government assistance to AIG; instead it used in substantial part the economic terms of the
private sector deal, albeit for $85 billion instead of the $75 billion prepared by JPMorgan Chase
for the unsuccessful private sector solution. The deal gave FRBNY 79.9 percent equity in the
shares of AIG and a floating interest rate calculated to be more than 11 percent. 17 An FRBNY
official told SIGTARP that, by September 17, 2008—the day after FRBNY provided initial
assistance to AIG and two days after AIG’s downgrades—it was clear that the rating agencies
were planning another downgrade of AIG because of the deteriorating financial condition of the
company and the impact the $85 billion FRBNY loan could have on AIG’s capital structure,
including the high interest rate payments AIG would have to make to FRBNY. 18 FRBNY’s
General Counsel emphasized in an interview with SIGTARP that FRBNY “inherited the bank

The rate was a floating rate calculated using the 3-month London Interbank Overnight Rate (“LIBOR”) plus 8.5
percent which calculated to approximately 11.3 percent on September 17, 2008. The LIBOR is the rate of interest at
which banks borrow funds from other banks, in marketable size, in the London interbank market.
18
Capital structure is a mix of a company's long-term debt, specific short-term debt, common equity, and preferred
equity. The capital structure is how a firm finances its overall operations and growth by using different sources of
funds.

consortium deal,” that the interest rate was too high, and that FRBNY recognized the need to
restructure the deal by making it less onerous to AIG soon after the agreement was signed. 19

Federal Reserve and FRBNY Officials Decide to Purchase
Securities from Counterparties through Maiden Lane III
From the time FRBNY initially provided AIG with financing, FRBNY officials began meeting
with AIG management to understand AIG’s liquidity drain and to determine AIG’s liquidity
needs. S&P’s September 15, 2008 downgrade triggered further collateral postings in AIGFP’s
credit default swap portfolio, and these continued even after FRBNY provided financing. Indeed,
AIG needed billions of dollars a week to meet collateral calls and make payments to AIGFP’s
swap counterparties. As of November 5, 2008, AIG had drawn down approximately $61 billion
of the initial $85 billion FRBNY line of credit.
FRBNY sought help in evaluating the CDOs underlying AIGFP’s credit default swap contracts.
Senior FRBNY officials learned that AIG had previously retained BlackRock Solutions (“BRS”)
to evaluate AIG’s swap portfolios and underlying CDOs. A senior vice president of FRBNY
confirmed with SIGTARP that BRS’s knowledge of the portfolio and their analytical work were
important to FRBNY’s efforts to rescue AIG. As a result, FRBNY decided to hire BRS to assist
FRBNY in its evaluation of AIG’s liquidity needs. 20 A BRS managing director noted that AIG’s
swap exposure was complicated for two reasons. First, each swap contract had a different credit
event that would trigger a collateral posting under the contract. Second, the counterparties had
different mark-to-market valuations for the underlying CDOs than AIGFP, therefore making the
swap exposures difficult to track. 21 For example, AIGFP could have marked a CDO at 85 cents
on the dollar while the counterparty could have marked the CDO at 70 cents on the dollar on its
own books, which, among other things, created potential disputes with the counterparties as to
the amount of collateral owed. In late September, FRBNY asked BRS to help them analyze a
portfolio of multi-sector CDOs that would eventually become Maiden Lane III.
On October 3, 2008, S&P revised its outlook for AIG to “negative” from “developing,” and
Moody’s downgraded AIG’s senior unsecured credit rating, citing AIG’s plans to sell some of its
businesses to pay debt, thus leaving AIG with fewer businesses to generate income. It was clear
that the initial $85 billion line of credit had not sufficiently solved AIG’s liquidity crisis, and, in
some respects, actually exacerbated it as the high interest rate on amounts AIG drew down on the
line of credit would have required significant annual interest payments by AIG. For example,
the floating rate of interest was 11.3 percent as of September 17, 2008, and AIG’s annual interest
payment alone would have been $9 billion per year if AIG drew down the full line of credit.
According to the Federal Reserve, the size and terms of the $85 billion loan increased AIG’s
leverage (the amount of debt AIG used to finance its assets) and lowered its interest coverage
19

These changes, including a reduced interest rate, were reflected subsequently in the November 10, 2008, revised
term sheet.
20
BRS kept separate the work it continued to do for AIG. AIG’s CEO, Edward Liddy, consented to the FRBNY’s
retention of BRS.
21
Mark to market is the act of recording the price or value of a security, portfolio, or account to reflect its current
market value, rather than its book value.

ratio (a measure of how easily AIG can pay interest on a debt), 22 two metrics that credit rating
agencies use in assessing an issuer’s financial strength. In addition, according to Donald Kohn,
Vice Chairman of the Federal Reserve, the $19 billion decline in the market value of the CDOs
underlying the credit default swaps and the decline of AIG’s residential mortgage-backed
securities portfolio in the third quarter of 2008 resulted in an erosion in AIG’s capital that further
placed AIG’s credit ratings in jeopardy. 23 Further, the continued drain on AIG’s liquidity from
having to continue to make collateral payments to AIGFP counterparties also contributed to the
danger of a downgrade. According to an FRBNY senior vice president, any further downgrades
to AIG’s long-term credit rating would have been catastrophic and would most likely have led to
an AIG bankruptcy.
At this time, AIG was attempting to resolve its liquidity crisis caused by the collateral posting
requirements by negotiating a cash payment to the counterparties in return for terminating the
credit default swaps. AIG held bilateral discussions with counterparties about such terminations
and kept FRBNY informed on the status of its efforts.
Because these negotiations were not bearing fruit, FRBNY asked BRS to begin looking at a
number of options for dealing with AIG’s multi-sector CDO counterparties. From late October
to early November 2008, BRS presented three options for FRBNY to consider, but FRBNY,
however, believed that the first two options had significant limitations:
•

The first proposed option would have involved counterparties cancelling their credit
default swaps and selling the underlying CDOs to an FRBNY-financed SPV, for total
consideration of par, comprised of previously posted collateral, cash, and a mezzanine
note in the SPV. The SPV would purchase the CDOs at market value, funded by a senior
loan from FRBNY, the mezzanine notes held by the counterparties, and a subordinated
loan from AIG. The mezzanine notes would be repaid from the cash flows of the CDOs
after the FRBNY's senior loan was fully repaid, effectively leaving counterparties with a
long-term risk position in the CDOs. FRBNY was uncertain whether the counterparties
would be motivated to cancel the swaps if they were left with any un-hedged CDO risk
associated with retaining the mezzanine tranche. In any event, FRBNY officials stated
that this option would be time consuming and impracticable, given that the process would
have required negotiations with each counterparty over the size of the mezzanine note in
relation to the value of their swaps and the CDOs, complicated by market illiquidity that
led to credit default swap valuation differences between counterparties and AIG.
FRBNY believed it needed to gain the agreement of most major counterparties quickly to
achieve the liquidity relief necessary to de-risk AIG and that there would be insufficient
time to successfully negotiate this option.

•

The second proposed option would have allowed the counterparties to keep their multisector CDOs and the protection provided by the credit default swaps, with the obligation
to perform under the credit default swaps transferred from AIG to an SPV guaranteed by

According to a November 10, 2008, Report by the Federal Reserve, Report Pursuant to Section 129 of the
Emergency Economic Stabilization Act of 2008: Restructuring of the Government’s Financial Support to the
American International Group, Inc. on November 10, 2008, pg. 4.
23
Statement of Donald L. Kohn, Vice Chairman, Board of Governors of the Federal Reserve System, before the
Committee on Banking, Housing, and Urban Affairs, U.S. Senate, March 5, 2009.

the FRBNY, in exchange for counterparties agreeing to forego further collateral postings.
Under this proposal, FRBNY would not own the underlying CDOs, but the FRBNYfunded SPV would only have to make payments as provided in the credit default swap
contracts in the event of default on the underlying CDOs. FRBNY told SIGTARP that a
perceived downside of this structure from FRBNY’s perspective was that it could involve
FRBNY in long-term credit relationships with supervised institutions. Given further that
there was a lack of statutory authority of the Federal Reserve to provide such a guarantee,
FRBNY determined that this option was also not viable.
•

The third option, which FRBNY eventually selected, was to create an SPV to purchase
the underlying CDOs from AIGFP’s counterparties, in connection with a termination of
the related credit default swaps. Within this option, BRS noted that counterparties could
receive effectively par value or FRBNY could seek a reduction in the amount that
counterparties would receive—otherwise known as concessions or a “haircut”—for the
total of the CDOs and related swaps held by each of AIGFP’s counterparties. FRBNY’s
AIG monitoring team explained that this structure had the benefit of minimizing
valuation disputes with counterparties, because combining the payment by Maiden Lane
III for the CDOs and the offset of collateral for the tear-up of the credit default swap
contracts eliminated the need to agree with counterparties separately on the market price
of the CDOs and the value of the credit default swap contracts. BRS assessed this option
as having a “high certainty of execution” and the “simplest structure.” FRBNY officials
told SIGTARP that this structure was also attractive because it fit within the legal
authorities of the Federal Reserve to lend against collateral.

While FRBNY was conducting analysis on alternative solutions, AIG’s attempts to negotiate the
termination of its multi-sector credit default swap book with its counterparties were failing. AIG
requested FRBNY’s assistance in securing these terminations.
Ultimately, on November 3, 2008, FRBNY decided to create Maiden Lane III, the SPV through
which the CDOs underlying AIGFP’s credit default swaps were purchased and subsequently
managed. FRBNY officials concluded that, by purchasing the CDOs underlying AIGFP’s credit
default swaps from the counterparties and therefore compensating them at the equivalent of par,
the counterparties would agree to cancel the credit default swap contracts, and thus AIGFP
would no longer have to make collateral payments to the counterparties, which would ease the
liquidity crisis at AIG and help avoid another credit rating downgrade. After consulting with
staff at Federal Reserve Board and Treasury, FRBNY shared its proposal for resolving the multisector credit default swap book with AIG. On November 6, 2008, AIG formally requested that
FRBNY engage in discussions with counterparties on its behalf. On November 10, 2008, the
Federal Reserve Board authorized the FRBNY’s establishment of, and loan to, Maiden Lane III.
On November 25, 2008, Maiden Lane III was created and began purchasing the underlying
CDOs from the counterparties. As discussed more fully in the next section, there were concerns,
however, over the price paid for the credit default swaps.

FRBNY Decided to Compensate Counterparties
Effectively at Par Value
This section addresses the reasons why AIG counterparties were effectively paid at par, or 100
percent of face value. After FRBNY decided to create Maiden Lane III, FRBNY officials
attempted to obtain “haircuts,” or voluntary concessions, from eight of AIG’s largest
counterparties; those efforts were not successful. In November and December 2008, Maiden
Lane III paid AIG’s counterparties $27.1 billion, the fair market value of their CDOs, and the
counterparties were allowed to keep the $35 billion in collateral they had received prior to the
transaction for a total of $62.1 billion or par value. Then-FRBNY President Geithner and the
FRBNY General Counsel told SIGTARP that the financial condition of the counterparties was
not a relevant factor in the decision to create Maiden Lane III and pay counterparties effectively
at par. On March 15, 2009, after significant public and Congressional pressure, AIG, after
consultation with the Federal Reserve, publicly disclosed the identities of the counterparties.
FRBNY officials said that they believe they will recoup the loan they made to Maiden Lane III
over time. As of September 30, 2009, the current fair market value of the Maiden Lane III
portfolio is $23.5 billion, versus a loan balance of $19.3 billion.

FRBNY Efforts to Limit Counterparty Payments Were
Unsuccessful
After FRBNY decided to create Maiden Lane III to buy the underlying CDOs, it attempted to
obtain concessions from AIGFP’s counterparties. FRBNY developed talking points for its staff
for these negotiations. The talking points stressed that participation in concession negotiations
with FRBNY was voluntary and asked the counterparties to consider the cost of the considerable
direct and indirect benefits that the counterparties had derived from the Federal Reserve’s
support of AIG. FRBNY developed packets with detailed information about the CDO portfolio
for each counterparty. The packets included valuations of the multi-sector CDO portfolios and
identified possible opportunities for concessions.
On November 6 and 7, 2008, FRBNY assistant vice presidents, vice presidents, senior vice
presidents, and executive vice presidents contacted eight of AIGFP’s largest counterparties
(Société Générale, Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, Calyon, Barclays and
Bank of America) by telephone. They described a proposal under which each counterparty was
asked to accept a haircut from par. Seven of the eight counterparties told FRBNY officials that
they would not voluntarily agree to a haircut. The eighth counterparty, UBS, said that it would
accept a haircut of 2 percent as long as the other counterparties also granted a similar concession
to FRBNY. FRBNY officials told SIGTARP that their concerns about credit rating downgrades
limited the time available for negotiation about reductions in payments. According to an
FRBNY senior vice president, the counterparties that FRBNY approached that resisted being

paid anything less than the equivalent of par in exchange for terminating their credit default swap
contracts cited several reasons for this, including:
•

They had collateral already posted by AIG to protect against the risk of AIG default. The
combination of collateral in their possession plus the fair market value of the underlying
CDOs also in their possession equaled the par value of the credit default swaps. Thus,
from the counterparty’s perspective, offering a concession would mean giving away
value and voluntarily taking a loss, in contravention of their fiduciary duty to their
shareholders.

•

In addition to the collateral, they had a reasonable expectation that AIG would not default
on any further obligations under the credit default swaps because the U.S. government
had already demonstrated that it would not allow AIG to go bankrupt.

•

They had already incurred costs to mitigate the risk of an AIG default on its obligations
that would be exacerbated if they were paid less than par value.

•

They were contractually entitled to the par value of the credit default swap contracts.

SIGTARP spoke with officials from Goldman Sachs and Merrill Lynch (two of AIGFP’s largest
domestic counterparties) to obtain their perspectives:
•

Goldman Sachs: Goldman Sachs had approximately $22.1 billion of notional amount of
outstanding credit default swap contracts with AIG, approximately $20 billion of which
were against an underlying portfolio of CDOs. According to Goldman Sachs, it had one
telephone conversation with FRBNY staff in which the possibility of concessions was
mentioned. Goldman Sachs has since explained that it did not agree to concessions
because it would have realized a loss if it had. Goldman Sachs did not hold the
underlying CDOs but rather had sold equivalent credit protection to its clients who held
those positions; Goldman Sachs then purchased the corresponding value in protection
from AIG to hedge against its own exposure in the event of a default of the reference
CDOs. Accordingly, Goldman Sachs was obligated to pay its clients in full on the other
side of the derivative transactions, and, if it granted a haircut to FRBNY, it would have to
realize that amount as a loss.
In addition, Goldman Sachs informed SIGTARP that it had purchased additional credit
risk protection against an AIG default. Of the $22.1 billion of credit default swaps
outstanding in November 2008, approximately $13.9 billion was resolved through
Maiden Lane III. For that portfolio, Goldman had already received $8.4 billion of
collateral payments from AIG, representing AIG’s calculation of the decline in the fair
market value of the underlying CDOs. However, Goldman Sachs believed that the drop
in value was actually $9.6 billion, and it purchased credit default swaps and other
protection from third parties that would have paid Goldman Sachs slightly more than the
difference ($1.2 billion) had AIG defaulted on its obligations. That additional protection,
which related to all of Goldman Sachs’ AIG hedges, cost Goldman Sachs more than $100
million.

Thus, according to Goldman Sachs, even if AIG defaulted, Goldman Sachs would be
made whole on the Maiden Lane III credit default swaps in light of the collateral it
already held ($8.4 billion), the additional protection it had purchased (totaling more than
$1.2 billion), and what it calculated to be the value of the underlying CDOs ($4.3 billion).
As a result, it did not consider itself materially at risk if AIG in fact defaulted.
Of course, notwithstanding the additional credit protection it received in the market,
Goldman Sachs (as well as the market as a whole) received a benefit from Maiden Lane
III and the continued viability of AIG. First, in light of the illiquid state of the market in
November 2008 (an illiquidity that likely would have been exacerbated by AIG’s failure),
it is far from certain that the underlying CDOs could have easily been liquidated, even at
the discounted price of $4.3 billion. Second, had AIG collapsed, the systemic
implications on other market participants might have made it difficult for Goldman Sachs
to collect on the credit protection it had purchased against an AIG default, although
Goldman Sachs stated that it had received collateral from its counterparties in those
transactions. Finally, if AIG had defaulted, Goldman Sachs would have been forced to
bear the risk of further declines in the market value of the approximately $4.3 billion in
CDOs that it transferred to the Maiden Lane III portfolio as well as approximately $5.5
billion 24 for its credit default swaps that were not part of the Maiden Lane III portfolio;
Maiden Lane III removed any risk for the $4.3 billion within that portfolio, and continued
Government backing of AIG provided Goldman Sachs with ongoing protection against
an AIG default on the remaining $5.5 billion.
•

Merrill Lynch: A managing director told SIGTARP that, on November 7, an FRBNY
Vice President and Assistant Vice President called senior Merrill Lynch officials and
asked if Merrill Lynch would consider accepting a discounted price to tear up the
contracts. Senior Merrill Lynch officials told FRBNY that FRBNY would need to
contact directly John Thain, Merrill Lynch’s then-CEO, to discuss any potential
discount. FRBNY stated that an executive vice president called Mr. Thain at the outset
of the negotiations to request his cooperation. Later that night, FRBNY spoke by phone
to a Merrill Lynch managing director and proposed a transaction in which Merrill Lynch
would receive par for the contracts. The managing director told SIGTARP that Merrill
Lynch was not receptive to FRBNY’s request for concessions for reasons similar to those
described above by Goldmans Sachs and because Merrill Lynch had already paid
approximately $40 million in fees and to obtain credit protection and anticipated that it
would have to pay an additional approximately $36 million in fees and costs to resolve
the Maiden Lane III CDOs.

During these negotiations, an FRBNY executive vice president and senior vice president
contacted the Commission Bancaire 25 to inform them that the FRBNY was conducting

Goldman Sachs calculated that the $8.2 billion in non-Maiden Lane III AIG credit default swaps had a market
value of approximately $5.5 billion. It had received collateral or bought credit protection slightly in excess of the
$2.7 billion difference.
25
The Commission Bancaire is the French bank regulator. Its mission is to protect depositors and act as watchdog
over the French banking and financial system to ensure its profitability and financial stability. The Commission has

negotiations with Société Générale and Calyon, two of the counterparties with the largest credit
default swap contracts with AIG, and was requesting their support. The Commission Bancaire
then contacted the firms. The Commission Bancaire spoke again with FRBNY and forcefully
asserted that, under French law, absent an AIG bankruptcy, the banks could not voluntarily agree
to less than par value for the underlying securities in exchange for terminating the swap
contracts. Thus, the French banks claimed they were precluded by law from making concessions
and could face potential criminal liability for failing to comply with their duties to shareholders.
At the end of the day on November 7, after FRBNY officials had received negative reactions
from seven of the eight counterparties, including the French banks’ formal refusal, senior
FRBNY officials met with then-President Geithner. After discussing the counterparties’
reactions, including UBS’s conditional acceptance to give a 2 percent haircut, 26 the officials
recommended to President Geithner that the Maiden Lane III transactions go forward without
haircuts because it would be impractical to obtain haircuts from all the counterparties. Mr.
Geithner concurred, and it was decided that FRBNY would cease efforts to negotiate haircuts
and pay the counterparties the market value of the CDOs. When combined with the collateral
already posted, this effectively meant that counterparties would be paid for the credit default
swaps at par value. FRBNY officials then communicated this recommendation to officials of the
Federal Reserve Board, who assented.
Then-President Geithner believed it was prudent for FRBNY to try to obtain haircuts but had
little hope that the efforts would be successful because he felt that FRBNY had little available
leverage. FRBNY officials have cited several reasons for this:
• The greatest leverage that FRBNY might have had – the threat of default and an
associated AIG bankruptcy – was effectively removed by FRBNY’s intervention in
September, an intervention that the counterparties understood to mean that the U.S.
government would not permit an AIG failure. The officials stated that ethical constraints
prevented FRBNY from even suggesting that it would allow bankruptcy when it in fact
would not do so.
• In addition, FRBNY was concerned that its use of a threat of an AIG default might
introduce doubt into the marketplace about the resolve of the U.S. government in
following through on its commitments in support of financial stability. FRBNY
officials felt the introduction of such uncertainty might have been dangerous and
potentially expensive for the U.S. economy in light of the precarious market conditions
in November 2008 and the extraordinary official efforts that had been taken to support
market functioning.
• FRBNY was further concerned – as it was throughout the AIG rescue – about the
reaction of the rating agencies. While threatening not to support AIG might have been
useful for purposes of forcing concessions by the counterparties, it could also have been
the power to impose administrative penalties and financial sanctions to offenders (Article L613-1, Monetary and
financial code).
26
Secretary Geithner informed SIGTARP that while he has no reason to question the account of FRBNY officials
regarding this meeting, he did not recall being informed that UBS had agreed to a conditional haircut. FRBNY
officials who attended the meeting with Mr. Geithner, however, specifically recall briefing Mr. Geithner on the UBS
offer.

viewed by the credit rating agencies as an indication that the FRBNY and the U.S.
government was not standing fully behind AIG, which could have had a negative impact
on AIG’s credit rating.
• As a policy matter, FRBNY was unwilling to use its leverage as the regulator for several
of the counterparties to compel concessions, in part because in the negotiations it was
acting as a creditor of AIG and not as the counterparties’ primary regulator.
• Also as a policy matter, FRBNY was uncomfortable with violating the principle of
sanctity of contract.
• The refusal of the French banks to negotiate concessions played a significant role in
complicating FRBNY’s efforts. FRBNY views treating all parties equally as one of its
“core values,” and it did not want to be perceived as making a more favorable deal with
the French institutions than with the domestic institutions. Indeed, FRBNY recently
suggested that requiring concessions from some banks while not requiring concessions
of others was not consistent with principles found in Section 4 of the Federal Reserve
Act (requiring the Federal Reserve to treat member banks and banks equally) and the
principles of national treatment and equality of competitive opportunity in the
International Banking Act (requiring that domestic banks and branches of foreign banks
be treated equally).
• Secretary Geithner further explained to Congress that “we explored at that time every
possible means to reduce the drain on their resources including what you referred to.
But again, because we have no legal mechanism in place for dealing with this, like we
deal with banks, we did not have the ability to selectively impose losses on their
counterparties.” 27
Thus, despite the willingness of at least one counterparty to engage in discussions about a
potential haircut, all counterparties were paid effectively par value for the credit default swaps.
Table 2 presents a complete list of payments from Maiden Lane III to AIGFP counterparties for
the fair market value of the CDOs, which, in combination with the counterparties’ retention of
collateral previously posted by AIGFP, equaled effectively par value of the credit default swap
contracts.

Hearing before the Committee on Financial Services, Oversight of the Federal Government’s Intervention at
American International Group, U.S. House of Representatives, March 24th, 2009.

Table 2—Total Payments to AIG Credit Default Swap Counterparties
(in billions)

Maiden Lane III
Payment

Collateral Payments
Posted
(as of 11/7)

Total

Société Générale

6.9

9.6

16.5

Goldman Sachs

5.6

8.4

14.0

Merrill Lynch

3.1

6.2

Deutsche Bank

2.8

5.7

8.5

UBS

2.5

1.3

3.8

Calyon

1.2

3.1

4.3

Deutsche ZentralGenossenschaftsbank

1.0

0.8

1.8

Bank of Montreal

0.9

0.5

1.4

Wachovia

0.8

0.2

1.0

Barclays

0.6

0.9

1.5

Bank of America

0.5

0.3

0.8

The Royal Bank of Scotland

0.5

0.6

1.1

Dresdner Bank AG

0.4

0.0

0.4

Rabobank

0.3

0.6

Landesbank Baden-Wuerttemberg

0.1

0.0

0.1

0.0*

0.2

27.1**

35.0

62.1

AIG Counterparty

HSBC Bank, USA
Total

Source: SIGTARP analysis of AIG and FRBNY data
* Amount rounded down to $0.
** In addition to the $27.1 billion in payments to the counterparties, AIGFP received a payment of $2.5 billion as an
adjustment payment to reflect overcollateralization.

In addition to the payments reflected in Table 2, there was a $2.5 billion payment to AIGFP that
resulted from an agreement between AIG and FRBNY called the Shortfall Agreement. This
document implemented the agreement of the FRBNY and AIG that Maiden Lane III would
acquire the CDOs at their October 31, 2008, market value. Under this agreement, Maiden Lane
III compensated AIGFP for the difference between the actual amount of collateral that AIGFP
had previously paid to the counterparties and the fair market value of the CDOs as of October 31,
2008.

Federal Reserve and FRBNY Did Not Initially Disclose
Information on the Counterparties or Their Decision to Pay
Effectively at Par Value
Despite having made the decision to pay the counterparties effectively par value, the Federal
Reserve and FRBNY made an initial decision not to reveal the identities of AIG’s counterparties
or the amount of individual payments. On March 5, 2009, Federal Reserve Vice Chairman Kohn
testified before Congress about the decision to pay effectively par value to the counterparties, but
refused to reveal the identities of the counterparties or payments made. At the hearing, Senator
Christopher Dodd pressed for disclosure of AIG’s credit default swap counterparties during a
Senate Banking, Housing and Urban Affairs Committee hearing. Senator Dodd stated, “[t]his
Committee would like to know, and the taxpayers certainly have a right to know who they are
effectively funding and how much money has already been given. Again, AIG’s trading partners
are not innocent victims here. They were sophisticated investors who took enormous
irresponsible risks with the blessing of AIG's AAA rating.” Vice Chairman Kohn, however,
expressed his judgment that “giving the names would undermine the stability of the company
and could have serious knock-on effects to the rest of the financial markets and the government’s
efforts to stabilize them.”
Ten days following the Senate hearing, and approximately four months after the first of Maiden
Lane III’s payments to counterparties, AIG, in consultation with the Federal Reserve, released
the identity of the counterparties, as indicated in Table 2. On April 28, 2009, FRBNY provided
further information about Maiden Lane III on its website. The information on the website
includes a transaction overview, a portfolio breakdown by investment type, and ratings and
vintage information on the CDO securities included in the portfolio. It does not appear that the
disclosures had any of the negative consequences that Vice Chairman Kohn anticipated on AIG
or on the markets generally.

Value of the Maiden Lane III Portfolio of CDOs
It remains to be seen what the ultimate financial costs and benefits of the Maiden Lane III
transaction will be for the American taxpayers. AIG did not file for bankruptcy and has been
able to significantly address its liquidity issues after Maiden Lane III.
The FRBNY has an outstanding recourse loan on its balance sheet to Maiden Lane III for the
purchase of the CDOs. 28 As of November 4, 2009, the value of the CDO portfolio held by
Maiden Lane III had a current market value of $23.2 billion, while the balance of principal and
interest owed to the FRBNY on its loans to Maiden Lane III, after accounting for payments
already made on the loan, was approximately $19.3 billion. This loan balance, which is lower
than the original extension of credit to AIG, reflects $5.3 billion in repayments that FRBNY has
received over the first year of its loan to Maiden Lane III. FRBNY told SIGTARP that these
repayments are consistent with FRBNY’s expectations at the time that it entered into the
28

The loan is a recourse loan to the assets held by Maiden Lane III.

transaction. The Federal Reserve’s assessment is that the Maiden Lane III portfolio will generate
enough cash flow to repay the FRBNY’s senior loan in full.
When FRBNY authorized the creation of Maiden Lane III in November 2008, it lent
approximately $24.6 billion to the newly formed limited liability company, and AIG provided
Maiden Lane III approximately $5 billion in equity. These funds were used to purchase CDOs
from AIG counterparties worth an estimated fair value of $29.6 billion at the time of the
purchases, which were done in three stages on November 25, 2008, December 18, 2008, and
December 22, 2008. AIGFP’s counterparties were paid $27.1 billion, and AIGFP was paid $2.5
billion per an agreement between AIGFP and FRBNY. The $2.5 billion represented the amount
of collateral that AIGFP had previously paid to the counterparties that was in excess of the actual
decline in the fair value as of October 31, 2008.
FRBNY’s loan to Maiden Lane III is secured by the CDOs as the underlying assets. 29 After the
loan has been repaid in full plus interest, and, to the extent that there are sufficient remaining
cash proceeds, AIG will be entitled to repayment of the $5 billion that the company contributed
in equity, plus accrued interest. 30 After repayment in full of the loan and the equity contribution
(each including accrued interest), any remaining proceeds will be split 67 percent to FRBNY and
33 percent to AIG.
Approximately 70 percent of the multi-sector CDOs purchased by Maiden Lane III were based
on pools of subprime mortgages, 31 Alt-A mortgages, and other residential mortgage-backed
securities (“RMBS”), as shown in Figure 2 below. The portfolio contained 89 CDOs at the time
of closing. The overwhelming majority of the investments are made up of Super Senior tranches.
The Super Senior tranches are the highest-rated tranches in the CDO. 32

The loan was issued with a stated term of six years and may be extended at FRBNY’s discretion. The interest rate
on the loan is one-month LIBOR plus 1 percent.
30
Interest accrues at a rate of one-month LIBOR plus 3 percent.
31
A subprime mortgage is a type of mortgage for borrowers with lower credit scores. Conventional mortgages are
not offered to borrowers with low credit scores because the lender views the borrower as having a larger-thanaverage risk of defaulting on the loan. Alt-A loans are a classification of mortgages in which the risk profile falls
between prime and subprime. The borrowers behind these mortgages will typically have clean credit histories, but
the mortgage itself will generally have some issues that increase its risk profile, including higher loan-to-value and
debt-to-income ratios or inadequate documentation of the borrower's income.
32
A Super Senior tranche is defined as a layer of credit risk senior to one or more risk layers that have been rated
AAA by the credit rating agencies, or if the transaction is not rated, structured to the equivalent thereto.

Figure 2: Maiden Lane III Multi-sector CDO Portfolio

Source: SIGTARP analysis of FRBNY data
Notes:
a
Inner-CDOs, or CDO-squared, is a CDO backed by other CDO tranches.
b
Commercial Mortgage-backed Securities are financial instruments that are backed by a mortgage or a group of
mortgages that are packaged together. These securities are often backed by commercial real estate loans.
c
Mortgage-related assets refers to different types of residential mortgages.

FRBNY officials noted that because of the structure of the Maiden Lane III transaction, there are
two sources of repayment for the funds that were used to compensate AIG’s counterparties from
the time of the Federal Reserve’s intervention. One is repayment to FRBNY of the loan it made
to Maiden Lane III through cash flows on the assets in the Maiden Lane III portfolio. The other
is AIG’s repayment to FRBNY of the funds it borrowed under its credit facility to meet its
collateral posting obligations under the credit default swaps that were torn up as part of the
Maiden Lane III transaction.
The fair market value has changed since the time of purchase as shown below:
•
•
•
•

As of December 31, 2008, the fair value of the portfolio was $27.1 billion.
As of March 31, 2009, the fair value of the portfolio was $20.7 billion.
As of June 30, 2009, the fair market value of the portfolio was $22.4 billion.
As of September 30, 2009, the fair market value of the portfolio was $23.5 billion.

The value of the portfolio over time has been affected, in part, by the amortization of assets in
the portfolio as those assets have generated cash flows to pay down the loan extended by the
FRBNY. As of September 30, 2009, the balance of principal and interest owed to the FRBNY in
respect of its senior loan was $19.9 billion.
23

FRBNY has material asset and investment management control rights over the portfolio and is
the managing member of Maiden Lane III LLC. FRBNY as lender to Maiden Lane III has a first
priority security interest in all of the Maiden Lane III assets. FRBNY is also the controlling
party for Maiden Lane III, with the right to make all decisions with respect to the assets whether
or not there has been a default under the loan. FRBNY has created an Investment Committee of
senior staff that is responsible for the investment management of Maiden Lane III. The
investment committee is made up of senior FRBNY staff, and their primary strategy is to
maximize the cash flows without disrupting the financial market.
According to an Investment Committee member, performance of the Maiden Lane III portfolio is
dependent on the performance of the underlying assets and the resulting cash flows. FRBNY
provided SIGTARP with two scenarios for modeling the cash flow performance of the Maiden
Lane III portfolio: a base case modeled on the current performance and a stress case based on
more adverse conditions. FRBNY stressed that these scenarios depend on many factors and have
changed and will change over time, with the effect of changing the projected payoff dates.
•
•

In the base case for the FRBNY loan to Maiden Lane III, the principal is expected to be
paid by January 2014, and the accrued interest is expected to be paid in 2014.
In the stress case, the principal and the accrued interest will not be fully paid until 2015.

Committee members said that they believe the cash flows received from the CDOs will be
sufficient to pay down the loan over time.

Remaining AIG Credit Default Swap Exposure
This section discusses AIG’s continuing credit default swap exposure. Maiden Lane III reduced,
but did not eliminate, AIGFP’s exposure to credit default swaps. AIGFP still had about $302
billion in swaps on its books even after Maiden Lane III was created. An FRBNY senior vice
president stated to SIGTARP that FRBNY never considered using Maiden Lane III to resolve
positions other than the multi-sector CDO book because the other swaps did not present an
urgent problem for AIG. According to AIG’s third quarter 2009 Securities and Exchange
Commission (“SEC”) Form 10-Q, AIGFP has been able to reduce its credit default swap
exposure by $96 billion or 32 percent during the first nine months of 2009. According to AIG’s
Chief Risk Officer and AIGFP’s CEO, AIGFP expects that the majority of its remaining credit
default swap contracts will be unwound over the next several years. However, in recent SEC
filings, AIG warned that, if credit markets continue to worsen, AIG could be exposed to these
risks for a significantly longer period of time and experience additional losses. Currently, an
onsite management team of FRBNY and Treasury officials is monitoring the financial health and
stability of AIG, including the ongoing swap exposure.

AIGFP Has Reduced Credit Default Swap Exposure
Since the end of 2008, AIG’s total credit default swap exposure has fallen about 32 percent—
from about $302 billion to $206 billion, as is shown in Table 4 below.
Table 4—Changes to Value of AIGFP’s Credit Default Swap Portfolios between
December 31, 2008, and September 30, 2009 (dollars in millions)a
Type of Credit Default Swap
Portfolio
Foreign Regulatory Capital
Arbitrage
Mezzanine tranches
Total

December 31,
2008

March 31,2009

June 30,2009

September 30,
2009

234,449

192,554

177,473

171,704

63,051

61,585

50,092

30,751

4,701

4,217

3,501

3,504

$302,201

$258,356

$231,066

$205,959

(15%)

(24%)

(32%)

% decrease since 2008
Source: SIGTARP analysis of AIG data
a
Dates referenced are as of the last day of each calendar quarter.

As of September 30, 2009, AIG had $172 billion in exposure to swaps in its foreign regulatory
capital portfolio. The portfolio contains swaps purchased by financial institutions, principally in
Europe, to provide regulatory capital relief under Basel I. 33 AIGFP’s COO informed SIGTARP
in July 2009 that they expect that most of these swaps will be terminated by the end of the first
quarter 2010 as most financial institutions complete their transition to Basel II. Currently,
financial institutions are required to hold a certain level of capital against their assets, and one
way for a financial institution to reduce the amount of capital is to purchase swap protection on
its assets. However, new requirements decrease the level of capital required for such assets and,
in most cases, there will be limited capital benefit to holding on to the existing swaps.
Nonetheless, AIG warned in a June 29, 2009, SEC filing that if credit markets deteriorate, the
company may recognize unrealized losses in AIGFP’s regulatory capital credit default swap
portfolio. 34 AIG could continue to be at risk if the swaps in its regulatory capital portfolio are
not terminated by the end of first quarter 2010 as expected.
As of September 30, 2009, AIGFP had approximately $22.6 billion in its synthetic investment
grade corporate arbitrage credit default swaps portfolio and $8.2 billion in its synthetic multisector CDO credit default swap portfolio. In addition, as of September 30, 2009, a total of $3.5
billion exposure on mezzanine tranches remains across different types of collateral classes.
According to an AIG SEC filing, an ongoing concern for AIGFP is whether it will have to post
more collateral if credit markets continue to deteriorate. The amount of future collateral postings
is partly a function of AIG’s credit ratings, which may be affected by any further decline in
AIG’s financial condition. Given the current economic climate, AIGFP is unable to estimate
accurately when it will be able to retire fully its credit default swap portfolio.

FRBNY, Treasury and AIG Are Monitoring AIGFP’s
Remaining Exposure
FRBNY has established an oversight team to monitor AIGFP progress in unwinding the
remaining swap transactions, in consultation with the staff of the Federal Reserve Board. The
team is comprised of senior vice presidents, attorneys from the Office of General Counsel, and
other staff. FRBNY officials told SIGTARP that they receive daily risk reports from AIG and
attend weekly meetings in which they discuss the details of the AIGFP credit default swap
portfolio. Treasury officials also receive these reports.

The first Basel Accord, known as Basel I, was issued in 1988; it focused on the capital adequacy of financial
institutions. The capital adequacy risk—the risk that a financial institution will be hurt by an unexpected loss—
categorizes the assets of financial institution into five risk categories (0 percent, 10 percent, 20 percent, 50 percent,
and 100 percent). Banks that operate internationally are required to have a risk weight of 8 percent or less. The
second Basel Accord, known as Basel II, is to be fully implemented by 2015. It focuses on three main areas known
as the three pillars: minimum capital requirements, supervisory review, and market discipline. The focus of this
accord is to strengthen international banking requirements and to supervise and enforce these requirements.
34
AIG SEC Form 8-Ka, filed June 29, 2009. Subsequent to the June filing, European regulators adjusted the
implementation timing of Basel II, potentially affecting the holders of AIGFP’s regulatory capital swaps to hold
beyond previously anticipated termination dates.

AIGFP has also established various committees to ensure that the remaining swaps are
terminated on terms most favorable to and in the interest of the U.S. government, as described
below. These meetings are observed by a senior member of the FRBNY oversight team.
•

The Termination Risk Review Committee, made up of AIGFP traders and risk
management staff, meets weekly to review AIGFP’s positions.

•

The Risk Oversight Transaction Committee, made up of senior traders and risk
management staff, meets as needed to review and approve swap trades.

•

The Steering Committee, made up of senior AIG and AIGFP staff (including the CEO
and COO of AIGFP), meets weekly or on an ad hoc basis to review the credit default
swap portfolio. These meetings are observed by the FRBNY oversight team.

Conclusions and Lessons Learned
Conclusions
When first confronted with the liquidity crisis at AIG, the Federal Reserve Board and FRBNY,
who were then contending with the demise of Lehman Brothers, turned to the private sector to
arrange and provide funding to stave off AIG’s collapse. Confident that a private sector solution
would be forthcoming, FRBNY did not develop a contingency plan; when private financing fell
through, FRBNY was left with little time to decide whether to rescue AIG and, if so, on what
terms. Having witnessed the dramatic economic consequences of Lehman Brothers’ bankruptcy
just hours before, senior officials at the Federal Reserve and Treasury determined that an AIG
bankruptcy would have far greater systemic impact on the global financial system than Lehman’s
bankruptcy and decided to step in to prevent that result. Not preparing an alternative to private
financing, however, left FRBNY with little opportunity to fashion appropriate terms for the
support, and believing it had no time to do otherwise, it essentially adopted the term sheet that
had been the subject of the aborted private financing discussions (an effective interest rate in
excess of 11 percent and an approximate 80 percent ownership interest in AIG), albeit in return
for $85 billion in FRBNY financing rather than the $75 billion that had been contemplated for
the private deal. In other words, the decision to acquire a controlling interest in one of the
world’s most complex and most troubled corporations was done with almost no independent
consideration of the terms of the transaction or the impact that those terms might have on the
future of AIG.
The impact of those terms, however, soon became apparent to FRBNY. In a matter of days,
FRBNY officials recognized that, although the $85 billion credit line permitted AIG to meet
billions of dollars of collateral calls and thus avoid an immediate bankruptcy, its terms were
unworkable. Among other things, the interest rate imposed upon AIG was so onerous that, if
unaddressed, the burden of servicing the FRBNY financing greatly increased the likelihood that
there would be further credit rating downgrades for AIG, a result that FRBNY officials believed
would have “devastating” implications for AIG. For this and other reasons, modification of the
original terms thus became inevitable. One example of such modification was Treasury’s $40
billion investment in AIG in November 2008 through the Troubled Asset Relief Program —
which was used to pay down the FRBNY loan in part. Another was termination of a portion of
AIG’s credit default swap obligations made possible through the creation of Maiden Lane III.
A significant cause of AIG’s liquidity problems stemmed from its obligations to post collateral
(cash payments that equaled the drop in value of the securities) in connection with AIGFP’s
credit default swap contracts. To avoid the necessity for AIG to continue to post collateral and to
reduce the danger of further rating agency downgrades, by early November 2008, FRBNY
decided to create Maiden Lane III, a special purpose vehicle, to retire a portion of AIG’s credit
default swap portfolio by purchasing the underlying CDOs from the swap counterparties, which
eased pressure on FRBNY’s credit line and transferred the issues with these contracts off of
AIG’s balance sheet and on the Federal Reserve’s. When negotiating the amount of payment for
the underlying CDOs, FRBNY contacted by telephone eight of AIG’s largest counterparties over
a two-day period and attempted to obtain concessions, or so-called “haircuts,” from the
28

counterparties. Although one counterparty, UBS, was willing to make a modest 2 percent
concession if the other counterparties did so, FRBNY’s attempts to obtain concessions from the
others were completely unsuccessful, and FRBNY decided to pay the counterparties the full
market value of the CDOs, which, when combined with the already posted collateral, meant that
the counterparties were effectively paid full face (or par) value of the credit default swaps, an
amount far above their market value at the time.
In pursuing these negotiations, FRBNY made several policy decisions that severely limited its
ability to obtain concessions from the counterparties: it determined that it would not treat the
counterparties differently, and, in particular, would not treat domestic banks differently from
foreign banks — a decision with particular import in light of the reaction of the French bank
regulator which refused to allow two French bank counterparties to make concessions; it refused
to use its considerable leverage as the regulator of several of these institutions to compel haircuts
because FRBNY was acting on behalf of AIG (as opposed to in its role as a regulator); it was
uncomfortable interfering with the sanctity of the counterparties’ contractual rights with AIG,
which entitled them to full par value; it felt ethically restrained from threatening an AIG
bankruptcy because it had no actual plans to carry out such a threat; and it was concerned about
the reaction of the credit rating agencies should imposed haircuts be viewed as FRBNY backing
away from fully supporting AIG. Although these were certainly valid concerns, these policy
decisions came with a cost — they led directly to a negotiating strategy with the counterparties
that even then-FRBNY President Geithner acknowledged had little likelihood of success.
FRBNY’s decision to treat all counterparties equally (which FRBNY officials described as a
“core value” of their organization), for example, gave each of the major counterparties (including
the French banks) effective veto power over the possibility of a concession from any other party.
This approach left FRBNY with few options, even after one of the counterparties indicated a
willingness to negotiate concessions. It also arguably did not account for significant differences
among the counterparties, including that some of them had received very substantial benefits
from FRBNY and other Government agencies through various other bailout programs (including
billions of dollars of taxpayer funds through TARP), a benefit not available to some of the other
counterparties (including the French banks). It further did not account for the benefits the
counterparties received from FRBNY’s initial bailout of AIG, without which they would have
likely suffered far reduced payments as well as the indirect consequences of a potential systemic
collapse.
Similarly, the refusal of FRBNY and the Federal Reserve to use their considerable leverage as
the primary regulators for several of the counterparties, including the emphasis that their
participation in the negotiations was purely “voluntary,” made the possibility of obtaining
concessions from those counterparties extremely remote. While there can be no doubt that a
regulators’ inherent leverage over a regulated entity must be used appropriately, and could in
certain circumstances be abused, in other instances in this financial crisis regulators (including
the Federal Reserve) have used overtly coercive language to convince financial institutions to
take or forego certain actions. As SIGTARP reported in its audit of the initial Capital Purchase
Program investments, for example, Treasury and the Federal Reserve were fully prepared to use
their leverage as regulators to compel the nine largest financial institutions (including some of
AIG’s counterparties) to accept $125 billion of TARP funding and to pressure Bank of America
to conclude its merger with Merrill Lynch. Similarly, it has been widely reported that the
29

Government, while arguably acting on behalf of General Motors and Chrysler, took an active
role in negotiating substantial concessions from the creditors of those companies.
Questions have been raised as to whether the Federal Reserve intentionally structured the AIG
counterparty payments to benefit AIG’s counterparties — in other words that the AIG assistance
was in effect a “backdoor bailout” of AIG’s counterparties. Then-FRBNY President Geithner
and FRBNY’s general counsel deny that this was a relevant consideration for the AIG
transactions. Irrespective of their stated intent, however, there is no question that the effect of
FRBNY’s decisions — indeed, the very design of the federal assistance to AIG — was that tens
of billions of dollars of Government money was funneled inexorably and directly to AIG’s
counterparties. Although the primary intent of the initial $85 billion loan to AIG may well have
been to prevent the adverse systemic consequences of an AIG failure on the financial system and
the economy as a whole, in carrying out that intent, it was fully contemplated that such funding
would be used by AIG to make tens of billions of dollars of collateral payments to the AIG
counterparties. The intent in creating Maiden Lane III may similarly have been the improvement
of AIG’s liquidity position to avoid further rating agency downgrades, but the direct effect was
further payments of nearly $30 billion to AIG counterparties, albeit in return for assets of the
same market value. Stated another way, by providing AIG with the capital to make these
payments, Federal Reserve officials provided AIG’s counterparties with tens of billions of
dollars they likely would have not otherwise received had AIG gone into bankruptcy.
Any assessment of the costs of these decisions to the Government and the taxpayer necessarily
must look beyond FRBNY’s loan to Maiden Lane III to also take into account both the funds that
FRBNY previously loaned to AIG and the subsequent TARP investments. All of these infusions
to AIG are linked inextricably: more than half the total amounts paid to counterparties in
connection with the credit default swap portfolio retired through Maiden Lane III did not come
about through the Maiden Lane III CDO purchases, but rather from AIG’s earlier collateral
postings that were made possible in part by the original FRBNY loan, which was, in turn, paid
down with TARP funds. Because of this linkage, the ultimate costs to the Government and the
taxpayer cannot be measured in isolation. Stated another way, irrespective of whether FRBNY is
made whole on its loan to Maiden Lane III, we will only be able to be determine the ultimate
value or cost to the taxpayer after the likelihood of AIG repaying all of its assistance can be more
readily determined.

Lessons Learned
The remarkable narrative surrounding the AIG loans and the creation of Maiden Lane III set
forth in this audit gives rise to two additional lessons learned. First, AIG stands as a stark
example of the tremendous influence of credit rating agencies upon financial institutions and
upon Government decision making in response to financial crises. In the lead-up to the crisis,
the systemic over-rating of mortgage-backed securities by rating agencies was reflected in the
similarly over-rated CDOs that underlied AIGFP’s credit default swaps. Once the financial crisis
had come to a head, the credit rating agencies downgrades of AIG itself and of the underlying
securities played a significant role in AIG’s liquidity crisis as those downgrades and the related
market declines in the securities required AIG to post billions of dollars in collateral. The threat
of further rating agency downgrades due to the onerous terms of the initial FRBNY financing,
30

among other things, led to further Government intervention, including the TARP investment in
AIG and the necessity to do something with the swap portfolio, i.e., Maiden Lane III. And the
concern about the reaction of the credit rating agencies played a role in FRBNY’s decision not to
pursue a more aggressive negotiating policy to seek concessions from counterparties. All of
these profound effects were based upon the judgments of a small number of private entities that
operate, as described in SIGTARP’s October 2009 Quarterly Report, on an inherently conflicted
business model and that are subject to minimal regulation. Without drawing any conclusions
about the particular actions taken by the rating agencies in the case of AIG, this report further
demonstrates the dramatic influence of these entities on our financial system.
Second, the now familiar argument from Government officials about the dire consequences of
basic transparency, as advocated by the Federal Reserve in connection with Maiden Lane III,
once again simply does not withstand scrutiny. Federal Reserve officials initially refused to
disclose the identities of the counterparties or the details of the payments, warning that disclosure
of the names would undermine AIG’s stability, the privacy and business interests of the
counterparties, and the stability of the markets. After public and Congressional pressure, AIG
disclosed the identities. Notwithstanding the Federal Reserve’s warnings, the sky did not fall;
there is no indication that AIG’s disclosure undermined the stability of AIG or the market or
damaged legitimate interests of the counterparties. The lesson that should be learned — one that
has been made apparent time after time in the Government’s response to the financial crisis — is
that the default position, whenever Government funds are deployed in a crisis to support markets
or institutions, should be that the public is entitled to know what is being done with Government
funds. While SIGTARP acknowledges that there might be circumstances in which the public’s
right to know what its Government is doing should be circumscribed, those instances should be
very few and very far between.

Management Comments
SIGTARP received official written responses to this report from the Board of Governors of the
Federal Reserve and the Federal Reserve Bank of New York (collectively, “Federal Reserve”),
and the Department of Treasury (“Treasury”). The Federal Reserve generally agreed with the
information presented in the report but provided some comments about the conclusions and
lessons learned. Treasury concurred with the report’s two lessons learned and also pointed to a
third lesson relating to its current legislative efforts to obtain regulatory reform.
Copies of the responses are attached as Appendices D and E.

Appendix A—Scope and Methodology
We performed the audit under authority of Public Law 110-343, as amended, which also
incorporates the duties and responsibilities of inspectors general under the Inspector General Act
of 1978, as amended. The audit reports on payments to AIGFP counterparties. Our specific
objectives were to determine:
•
•
•

the key events that led to the creation of Maiden Lane III
why counterparty claims were paid at 100 percent of face value
AIGFP’s remaining exposure to credit default swaps

We performed work at the Federal Reserve Board, Federal Reserve Bank of New York, U.S.
Treasury Office of Financial Stability, and AIG corporate headquarters in New York.
To determine the key events that led to the creation of Maiden Lane III, we interviewed officials
from the FRBNY Office of General Counsel who were involved in the decision-making process,
other FRBNY officials and then-FRBNY President Timothy Geithner. We also interviewed
officials from BlackRock Solutions who advised FRBNY on solutions to remove AIG’s toxic
assets. We reviewed congressional testimony by key FRBNY and AIG officials, as well as
correspondence and other documents from FRBNY.
To determine why counterparty claims were paid at 100 percent of face value, we interviewed
FRBNY officials from the Office of General Counsel who were involved in making the decision
to pay at face value. We also reviewed correspondence and documents provided by FRBNY.
Furthermore, we interviewed the Chief Financial Officer of Goldman Sachs and a managing
director of Merrill Lynch to obtain their views on FRBNY efforts to negotiate concessions and
the rationale for paying counterparty claims at 100 percent of face value.
To determine the AIGFP’s remaining credit default swap exposure, we reviewed AIG SEC
filings that report AIG’s exposure on a quarterly basis. We also reviewed these SEC filings to
gain an understanding of the details of AIG’s credit default swap exposure. Furthermore, we
interviewed the CEO of AIGFP, AIG’s Chief Credit Officer, and several officials from the
Office of Compliance to determine their plans for unwinding the remaining credit default swaps.
This performance audit was performed in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions
based on our audit objectives. We believe that the evidence obtained provides a reasonable basis
for our findings and conclusions based on our audit objectives.

Limitations on Data
We reviewed email correspondence among FRBNY officials during the key months of
September through November of 2009. However, because much of the communication among
33

decision-making officials was via telephone during these dates, we relied on testimonial
evidence from these officials to develop an understanding of the key events and decision-making
processes during the AIG crisis.

Internal Controls
As part of our review of the decision making process for providing assistance to AIG and paying
the counterparties at par, we examined the government’s criteria and rationale behind these
decisions as a measure of controls over the decisions of Federal Reserve and Treasury.

Use of Computer-Processed Data
We relied on AIG’s quarterly and annual filings with the U.S. Securities and Exchange
Commission. That information is generally regarded as best representing the institutions’
financial standings because they are required by law to submit these financial documents.

Appendix B—Acronyms
Acronym

Definition

AIG

American International Group

AIGFP

American International Group Financial Products, Inc.

CDO

collateralized debt obligation

CEO
CFO

Chief Executive Officer
Chief Financial Officer

CMBS

Commercial Mortgage-backed Security

EESA

Emergency Economic Stabilization Act of 2008

FRB

Federal Reserve Board

FRBNY

Federal Reserve Board of New York

LIBOR

London Interbank Offered Rate

MBS

Mortgage-backed Securities

S&P

Standard & Poor’s

SIGTARP

Special Inspector General for the Troubled Asset Relief Program

SPV

special purpose vehicle

TARP

Troubled Asset Relief Program

Treasury

U.S. Department of the Treasury

Appendix C—Audit Team Members
This report was prepared and the review was conducted under the direction of Barry Holman,
Audit Director, Office of the Special Inspector General for the Troubled Asset Relief Program.
The staff members who conducted the audit and developed the report include:
Leah DeWolf
Michael Kennedy
Christopher G. Poor
Amy Poster

Appendix D—Management Comments from
Federal Reserve

Appendix E—Management Comments from
Treasury

SIGTARP Hotline
If you are aware of fraud, waste, abuse, mismanagement, or misrepresentations associated with the
Troubled Asset Relief Program, please contact the SIGTARP Hotline.
By Online Form: www.SIGTARP.gov

By Phone: Call toll free: (877) SIG-2009

By Fax: (202) 622-4559
By Mail:

Hotline: Office of the Special Inspector General
for the Troubled Asset Relief Program
1801 L Street., NW, 6th Floor
Washington, D.C. 20220

Press Inquiries
If you have any inquiries, please contact our Press Office:
Kristine Belisle
Director of Communications
Kris.Belisle@do.treas.gov
202-927-8940

Legislative Affairs
For Congressional inquiries, please contact our Legislative Affairs Office:
Lori Hayman
Legislative Affairs
Lori.Hayman@do.treas.gov
202-927-8941

Obtaining Copies of Testimony and Reports
To obtain copies of testimony and reports, please visit our website at www.sigtarp.gov.

Full text of Factors Affecting Efforts to Limit Payments to AIG Counterparties, SIGTARP-10-003

FRASER