French Hoodwink Geitner During AIG Bailout
As Dennis Berman reported in the Wall Street Journal, the French appear to have bested Tim Geithner when the Federal Reserve agreed to the full payment demands of France's bank regulator and two of AIG's largest creditors, Société Générale SA and Calyon Securities, a unit of Crédit Agricole SA., as part of its bailout of American International Group Inc.
The French banks and the regulator, known as the Commission Bancaire,won the day by arguing that the bank executives could be criminally liable for accepting a discount on their contracts. While true in the abstract, "their argument was very overstated," said Pierre-Henri Conac, a University of Luxembourg law professor and a director of France's oldest corporate-law review. "Banks give haircuts every day." Their refusal was crucial, as it helped set the tone for U.S. banks, including Goldman and Merrill, to resist negotiation.
In November 2008, the Fed, having already committed $85 billion to rescue AIG, was worried about a set of AIG holdings tied to mortgage securities that were draining cash from the company, according to the inspector general's report. At the top of the counterparty list: Société Générale, with $16.5 billion in contracts. Calyon Securities was sixth, with $4.3 billion. Goldman Sachs was second with $14 billion.
The Fed and AIG finally seized on a plan, according to the inspector general's report. Step one: Let the banks keep $35 billion of collateral already posted by AIG. Two: Purchase the banks' underlying securities, which were derivatives tied to low-grade mortgages. Three: Cancel the contracts.
Over one frenzied weekend in early November, Fed and AIG officials struggled with the final step: What should they pay for those securities? By contract, the banks were guaranteed full payment.
There were some factors to suggest a lower, negotiated price was in order. The securities' market value had fallen significantly. And absent the extraordinary U.S. bailout, AIG would have been in bankruptcy, potentially leaving counterparties with zero.
A call went out from the New York Fed to Société Générale and Calyon, as well as to France's Commission Bancaire, according to the report by Neil Barofsky, the TARP inspector general. They wanted to treat all the parties equally. By demanding payment in full, the French helped the other banks get the same treatment.
"[T]he French banks concluded they were precluded by law from making concessions and could face potential criminal liability for failing to comply with their duties to shareholders," Mr. Barofsky found in interviews with Fed officials. The French were "indignant that we would even contemplate asking for this," added one person close to the New York Fed. Other banks, including Goldman Sachs and Merrill Lynch, rebuffed the Fed on similar grounds at the same time. In the end, no one took a haircut.
Yet there appear plenty of grounds for challenging the French conclusion, said French lawyers and law professors. "To say that these people would have gone to jail if they cut a deal and signed the same agreement as Goldman Sachs is really pushing beyond what goes on in France," said Christopher Mesnooh, a partner at Paris's Fields Fisher Waterhouse who has written a book on French corporate law.
