Last week, the Federal Reserve Bank of New York announced with great fanfare the sale of all of the remaining assets in Maiden Lane III. Maiden Lane III was one of the special purpose vehicles set up by FRBNY to hold mortgage-related assets in connection with the government's rescue of AIG. The sale of the securities in Maiden Lane III, which was just one small part of the AIG rescue, is not a cause for celebration to the taxpayers who subsidized it. The $6.6 billion gain from these sales looks less than impressive when the full cost to taxpayers considered.
FRBNY established and funded Maiden Lane III in late 2008 to purchase mortgage-related securities from the derivatives counterparties of AIG's Financial Products unit. These counterparties had entered into derivatives contracts with AIGFP to protect themselves from losses on the securities that Maiden Lane III later bought. Under the derivatives contracts, they had the right to demand collateral when the market value of the securities fell, as it did in 2007 and 2008. More than $20 billion of the government's initial $85 billion loan to AIG went to make collateral payments under these derivatives contracts.
The government reasoned that cancelling the derivatives by buying the securities at full value was the cheapest way out of AIGFP's troubles. Maiden Lane III paid the counterparties almost $30 billion, $5 billion of which was from AIG and the rest of which was funded directly by FRBNY. In addition, the counterparties got to keep almost $35 billion in collateral that AIG had paid out on related derivatives contracts (much of which came from taxpayer funds). In total, the counterparties got more than $60 billion, which was approximately the face value of the securities.
The $6.6 billion profit calculation was based on the discounted price that Maiden Lane III paid for the securities in late 2008. Maiden Lane III had to pay only half of the purchase price for the securities, because the rest was covered by the collateral payments that AIG - with the help of taxpayers - had already made. The Maiden Lane III transaction and any profits it generated cannot be looked at in isolation; it was part of the larger AIG rescue, which is still ongoing with more than $30 billion in TARP funds still unpaid.
In a way, FRBNY's characterization of Maiden Lane III as a success is reminiscent of the argument that Joe Cassano - the head of AIGFP -got so much grief for making after AIG's rescue. He argued that, if AIG had just held on, it would not have experienced losses in the long-run, because the securities would not have incurred losses large enough to trigger the derivatives contracts. He told the Financial Crisis Inquiry Commission in 2010, "I believe these portfolios are standing the test of time today when it comes to credit risk analysis, as they are paying back the Taxpayer in Maiden Lane III."
Making money in the long-term is irrelevant, though, if you can't survive the short-term. AIG survived the short-term only because the government came in at AIG's moment of desperation with truckloads of cash. That initial infusion of taxpayer money - at least the portion of it that went to pay off derivatives counterparties -- is relevant context for both Mr. Cassano's and FRBNY's profit analyses.
Mr. Cassano may feel vindicated now that FRBNY has proclaimed Maiden Lane III a success, but taxpayers should still be mad that they were forced to subsidize the AIG-FRBNY joint venture and are now being told they made a profit because some of the money they put in was returned.