NY Fed Gives AIG, Geithner the Finger; Maiden Lane II to be Auctioned Off Piece by Piece

For background on this matter and the interaction among the NY Fed, Treasury and AIG, see our prior post here. We wrote:

Why would AIG want this [Maiden Lane II] portfolio? Now that non-performing assets have been written down or off entirely, the remaining performing assets, consisting in part of vintage subprime securitizations, pay a spiffy yield in the neighborhood of 8% to 10%. A nice return considering comparable securities of more modern creation are paying several percentage points lower.

After a series of recent debt and equity restructurings by AIG, the US Treasury now owns 92% of the company, and is keen on unloading its interest via a public stock offering. As the FT writes today, the inclusion of the high yielding ML II portfolio on AIG's balance sheet materially improves the offering price, and hence the amount received directly by the Treasury.

Minutes ago, the NY Fed announced (emphasis and brackets ours):

The Federal Reserve today announced that it has declined American International Group’s (AIG) offer to purchase all of the assets in Maiden Lane II LLC (MLII).

After careful review, the Federal Reserve Bank of New York (New York Fed) and the Board of Governors of the Federal Reserve System (Board) judged that the public interest in maximizing returns from any sale and promoting financial stability would be better served by an alternative approach to realizing value that is also more consistent with normal market practice [that is, a package deal would have commanded a lower price, inviting public scrutiny upon a press-beleaguered NY Fed].

In light of improved conditions in the secondary market for non-agency residential mortgage backed securities (RMBS), and a high level of interest by investors, the Federal Reserve believes that conditions are right for ML II to begin more extensive asset sales while taking appropriate care at all times to avoid market disruption. In light of this decision, the New York Fed has changed the investment management objective for ML II consistent with such sales.

The New York Fed, through its investment manager, BlackRock Solutions will dispose of the securities in the ML II portfolio individually and in segments over time as market conditions warrant through a competitive sales process. There will be no fixed timeframe for the sales and at each stage the Federal Reserve will only transact if the best available bid represents good value for the public.

Offering the Maiden Lane securities for sale individually and in segments rather than as a single block will give a larger set of investors opportunity to bid for the assets. The Federal Reserve believes that this will maximize sale proceeds while also reducing the likelihood that any one institution ends up with concentrated exposure to these assets [Not that there's anything wrong with them].

BlackRock Solutions will offer the securities for sale using the standard bid list process in the secondary market for RMBS securities. The bid list process involves marketing a list of securities from the portfolio via multiple broker dealers to obtain the best available price for each security [Hopefully better than the process used by the NY Fed to purchase MBS].

Over time, the Federal Reserve will also entertain investor inquiries to acquire specific parcels of securities where these offer superior value, though no such bid will be accepted without being put into competition with other interested investors. In such cases, investors may submit offers for parcels of securities directly (without necessarily going through a dealer.) [Wow, no need to go through the hallowed primary dealers--what's happening? Perhaps just a nod to the PE guys to step up (no dealer commissions!)]

BlackRock Solutions is expected to circulate the first bid list sale early next week. Inquiries relating to the sales process can be made at ML2inquiries@blackrock.com. In keeping with the Federal Reserve’s commitment to enhanced transparency information will be released as soon as is practicable, while preserving the effectiveness of the asset disposition process.

The New York Fed already publishes on its website a list of all the securities in its portfolio. In order to allow the public to track progress on asset dispositions, the New York Fed will provide monthly updates on portfolio holdings and a list of the securities sold within the prior month. In addition, it will provide quarterly updates on total proceeds from sales, and the total amount purchased by each counterparty. Finally, the New York Fed will provide further details regarding these transactions, including an account showing the acquirer and the price paid for each individual security three months after the last asset is sold, ensuring timely accountability without jeopardizing the ability to generate maximum sale proceeds for the public.

This also takes the focus off the senior NY Fed officer, Brian Peters, who passed through the public/private revolving door to AIG a few short months ago. Looks like he'll be retaining his full 2011 bonus after all.

With tomorrow's court-ordered discount window document production looming, the NY Fed is showing it's feeling the heat. Indeed, EPJ gets results once again (at least that's one EPJ writer's opinion :->).

Fed Revolving Door Update: Will Brian Peters Forgo His 2011 AIG Bonus & Shares?

It is now becoming clear why a high level New York Federal Reserve official named Brian Peters recently departed the Fed to join AIG, a company about which he possesses valuable and specific knowledge. Here, we will republish the SIGTARP documents that reveal Peters' direct involvement with AIG assets that would first be sold to the NY Fed in 2008 as the company teetered on the edge of bankruptcy, only to be sought once again by AIG in a sweetheart deal.

As Robert Wenzel wrote on February 4, 2011, in a post titled "The Revolving Door (Federal Reserve Edition)":

American International Group Inc.has hired Federal Reserve Bank of New York veteran Brian Peters to help manage risk.

Peters is joining as a senior managing director in the enterprise risk management group, according to a Jan. 18 memo to staff from Sid Sankaran, chief risk officer, reports Bloomberg.

The Fed bailed out AIG to the tune of billions in 2008. Thanks to Bernanke money printing, they repaid the last $21 billion it owed the Fed on Jan. 14.

Peters was senior vice president in risk management at the New York Fed, where he helped oversee the 12 “largest and most systemically important financial institutions and industry utilities,” according to the memo.

At the time of Peters' passage through the revolving door, AIG had only the month prior (as Wenzel points out) paid down the remainder of its multi-billion dollar revolving credit line with the New York Federal Reserve, in part, through spin offs and asset sales. With about $20 billion in cash left over, it has been poised to bid for some of the vary assets that had led to its downfall in 2008--namely the Maiden Lane II portfolio, currently valued by BlackRock at $15.9 billion. AIG indeed sent the NY Fed an offer of $15.7 billion last December, which went unanswered.

Why would AIG want this portfolio? Now that non-performing assets have been written down or off entirely, the remaining performing assets, consisting in part of vintage subprime securitizations, pay a spiffy yield in the neighborhood of 8% to 10%. A nice return considering comparable securities of more modern creation are paying several percentage points lower.

After a series of recent debt and equity restructurings by AIG, the US Treasury now owns 92% of the company, and is keen on unloading its interest via a public stock offering. As the FT writes today, the inclusion of the high yielding ML II portfolio on AIG's balance sheet materially improves the offering price, and hence the amount received directly by the Treasury (brackets and italics ours):

At AIG, the plan to buy back the portfolio of mostly subprime mortgage securities has been part of its strategy as it emerges from government ownership.

The insurer has stockpiled about $20bn in cash to purchase the Maiden Lane II assets and similar securities.

“It’s a very different story with or without these securities,” Robert Benmosche, AIG’s chief executive, told the Financial Times. “We can improve yields by 3-4 per cent.”

The increase, Mr Benmosche said, would help AIG reap an additional $500m-$700m in annual income [which would surely increase the bonus pool for the AIG execs, including Peters].

Writes ZeroHedge:

It appears that the Treasury had been hoping to quietly get the deal done where AIG buys the toxic mortgages at a preferential price so that Geithner can than proceed to sell off bits and pieces to bankers at a lowball IPO valuation where the deficit would once again be borne out by US taxpayers.

As the FT reports, the NY Fed looks to be increasingly image-conscious (emphasis ours):

People familiar with matter said the Treasury had sought to help broker a deal between the insurer and the New York Fed, reasoning that management’s knowledge of the some 800 securities might help squeeze more profits out of them and maximise taxpayers’ returns on their AIG investment. Fed officials remain concerned how a quick deal with AIG might appear to the public, the people said.

Concerned, indeed, as Brian Peters, a senior risk manager at the NY Fed, would in the end leave the Fed's payroll to get on AIG's. The following two documents are internal emails from the NY Fed produced as part of the SIGTARP investigation. Both demonstrate Peters' involvment in the creation of Maiden Lane II from the then-toxic AIG assets. The first email chain (presented in reverse chronological order) reveals Peters was involved in an important, unmentioned policy decision that depended on whether or not the specific securities that were to be purchased by ML II would be made public on the SEC's EDGAR website. [As an aside, this request, by an SEC feeling tremendous public heat at the time, generated much internal consternation at the NY Fed, as revealed by other emails (not shown).]

Brian Peters Frbny Towns r3 009067

The second email is from Peters to then-current NY Fed president Timothy Geithner (approximately two months prior to him being nominated as Obama's Treasury Secretary), which conclusively demonstrates Peters was in the AIG asset pricing loop.

Brian Peters Frbny Towns r1 195659

Yves Smith at Naked Capital writes:

So we have a former NY Fed official, deeply involved in the exchanges among the Fed and AIG and almost certainly the Treasury as well, now joining AIG. It isn’t hard to imagine that the reason he was hired was due to his intimate knowledge of how to move things along at the NY Fed and Treasury, and in particular, what Blackrock had told the NY Fed about Maiden Lane II and what the NY Fed’s return and political considerations were. The Treasury is not trying to protect the NY Fed from any information advantage AIG might have regarding the Maiden Lane II assets; Blackrock is certainly up to that task. It’s entirely about appearances of cutting a deal that favors AIG without that looking too bloody obvious.

So in this warped world of priorities, where giving financial firms great deals to “preserve the system” and cook the books on the TARP are top priorities, having an former insider grease the wheels is probably seen as really helpful. It’s merely another proof of what Simon Johnson pointed out in May 2009: the government is firmly in the hands of financial oligarchs.

To be fair, AIG spokesman Mark Herr said to Bloomberg regarding the Peters hire, “As is standard, he has agreed not to engage in business dealings with the FRBNY, the Federal Reserve Board or the U.S. Department of Treasury for six months.” However, "engage in business dealings" is sufficiently vague to allow Peters to use the inside knowledge he gained at the NY Fed to help AIG re-acquire the ML II portfolio.

As Barclays and other investors are now bidding for the assets (as reported by the FT), AIG might not end up with the portfolio after all--at least not on terms as favorable as it believed it could get last December. As to Brian Peters, we believe the relevant question is: if AIG does acquire the ML II assets, will he forgo (i) the portion of his 2011 bonus related to the $500m-$700m in annual income that said assets generate, and (ii) any shares that would be allocated to him in an offering, the valuation of which was enhanced by said asset acquisition?

Everything You Wanted to Know About the Tri-Party Repo Market, But Didn't Know to Ask...

...will be the next post on the NY Fed's new blog: Liberty Street "Economics" (scare quotes ours). We can't wait, because by "Everything", we assume this will include details, such as, the average commission earned gifted to the primary dealers who act as counterparties in the transactions.

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Presenting the Fed's [LOL] Worst Case Stress Test Assumptions: Why Another TBTF Bailout is Guaranteed, If Not Imminent

As the threat of nuclear disaster in the world's third largest economy looms, the Federal Reserve saw fit today to permit some of the largest 19 US banks to erode their meager capital bases by increasing or restarting the payment of shareholder dividends, as well as ramping up stock repurchase programs.

According to Business Wire, already JPMorgan Chase has announced it will quintuple the next quarterly common stock dividend payable April 30, 2011 to $0.25 per share (from $0.05 per share), in addition to the announcement of a new $15 billion multi-year common stock repurchase plan, with $8 billion approved for 2011. Similarly Wells Fargo announced a special March 31, 2011 dividend of $0.07 per share, an increase of 29% from the $0.05 per share dividend declared on January 25, 2011.

And, as we write, Goldman Sachs has just announced it will redeem all 50,000 shares held by Warren Buffet's Berkshire Hathaway at $110,000 per share, plus accrued and upaid dividends, which includes a one-time preferred dividend of $1.64 billion. [Recall that Buffet likely had a ring side seat to the negotiations that were going on at the highest levels of the Treasury and Fed.] Nice profit on your $5 billion sure thing investment, Warren.

In support of this regulatory grant of capital erosion, the Federal Reserve Board of Governors today released its Comprehensive Capital Analysis and Review: Objectives and Overview. From the report:

I. Executive Summary The Comprehensive Capital Analysis and Review (CCAR) involved the Federal Reserve’s forward‐ looking evaluation of the internal capital planning processes of large, complex bank holding companies and their proposals to undertake capital actions in 2011, such as increasing dividend payments or repurchasing or redeeming stock. On November 17, 2010, the Federal Reserve issued guidelines to provide a common, conservative approach to ensure that these bank holding companies hold adequate capital to maintain ready access to funding, continue operations and meet their obligations to creditors and counterparties, and continue to serve as credit intermediaries, even under adverse conditions. 1 Nineteen large bank holding companies submitted comprehensive capital plans and additional supervisory information to the Federal Reserve in early January. 2 The Federal Reserve evaluated these plans across five areas of supervisory consideration. These are the bank holding company’s

1. Capital assessment and planning processes;

2. Capital distribution policy;

3. Plans to repay any government investment;

4. Ability to absorb losses under several scenarios; and

5. Plans for addressing the expected impact of Basel III and the Dodd‐Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd‐Frank Act).

The purpose of this paper is to provide an overview of the methodology that the Federal Reserve used in reviewing these five areas; a description of the CCAR’s supervisory context, including an explanation of how its results should be interpreted; an explanation of the CCAR’s connection with the Supervisory Capital Assessment Program (SCAP) and stress testing requirements mandated under the Dodd‐Frank Act; and the Federal Reserve’s expectations regarding disclosure of the CCAR’s results.

Not all of the 19 bank holding companies proposed an increase in capital distributions in connection with the CCAR. ...

Skipping ahead to the methodology of the stress testing (emphasis and brackets ours):

The supervisory stress scenario was intended to represent developments in a recession, with negative economic growth for at least a couple of quarters, a rise in unemployment, and a sharp drop in risky asset prices. The scenario covers the nine‐quarter planning horizon of the stress scenario analysis – 4Q 2010 to 4Q 2012 – and an additional four quarters through the end of 2013, to provide a basis for estimating loan losses and thus loan loss reserve needs at the end of the planning horizon. The scenario was developed in early November 2010, and is based upon the economic and financial market conditions prevailing at that time. [Note: this is prior to civil unrest in MENA and the Tokyo quake/tsunami] Table 1 reports the key variables defining the supervisory stress scenario; the full scenario is available in the appendix.

In addition to the macroeconomic scenario provided by the Federal Reserve to all 19 bank holding companies, the six largest firms were required to estimate potential losses stemming from trading activities and private equity investments using the same severe global market shock scenario that was applied in the SCAP. Specifically, the firms estimated potential mark‐to‐market and default‐ related losses on trading and private equity positions and from exposures to trading and financing transaction counterparties. The scenario provided assumed an instantaneous revaluation of these positions that was based on the change in market risk factors from the end of June 2008 to the end of December 2008. The scenario required the six firms to assume that the deterioration in global markets that occurred over this period would occur in one day. [Is this a prediction of another Flash Crash?] This represents a very ["]conservative["] scenario and by design allows for no offsetting benefits from any actions management at the firms might be able to take to mitigate losses from these exposures as the scenario unfolds.

More detail appears in the Appendix, as referenced above:

Click for large image.

With 10 Year Treasurys projected to reach a maximum of 3.81% into Q4 2013, the Fed seems to be operate under the delusion that US Treasurys will perennially benefit from flight to quality status. As Zero Hedge points out, if Japan's response to an admittedly unmitigated disaster is to print the equivalent of half a trillion Dollars in one week, how quickly will Bernanke, Trichet & Co. be to pound the printing button as contagion and fallout spreads to the rest of the world from any one of a variety of sources? Even more preposterous is the Fed's expectation that the BLS' CPI (itself a gamed statistic) will fluctuate in a narrow annualized band of 0.90% to 1.85%, thus ignoring the effects of both deflationary and inflationary shocks.

On the heals of serial eruption of violence and chaos, the very banks that are guaranteed to receive taxpayer support in the wake of future financial disaster will be in a weaker capital position because of the actions today of the Federal Reserve, whose economic worst case scenario predictions will look tamer than baby Bambi in the rear view mirror of the post-Dollar, post-QE apocalyptic financial landscape of 2014.

Full laugh cry-out-loud report may be found here.

How the NY Fed Gifted an Extra $15.7 Million to Wall Street Today

As part of the Federal Reserve's ongoing QE2 program, nearly each day, the NY Fed purchases US Treasury securities from a select group of primary dealers in what is called a permanent open market operation (POMO). Ordinarily, the auction begins at 10:16 am and ends at 11:00 am Eastern. While the exact mechanics of the operations are not public, the NY Times published an article about the team that manages them here, divulging a few details, which we subsequently analyzed here.

Only minutes before today's auction was scheduled to complete (while most, if not all, offers from the primarily dealers were presumably in), the European Union’s energy commissioner warned of ‘further catastrophic events’ at Japan’s stricken nuclear power plant. Shortly thereafter, the NY Fed cancelled the POMO--to our knowledge, an unprecedented act. According to Tyler Durden of Zero Hedge, Reuters reported the cancellation at 10:57 or 10:58 am.

In the minutes that followed, equities and other risk markets tumbled, while the very 5 and 7 Year Treasury Notes the Fed would end up buying surged in price over 50 bps (0.50%). At 11:24 am, after prices had settled a bit (though were still materially higher than before), the NY Fed restarted the POMO, which finally closed at 12:04 pm. It would end up purchasing a total of $6.580 billion in Treasury securities (reported at par), with a heavy concentration in the 5 Year tenor at $5.089 billion (of which $3.209 billion had been issued by the Treasury in the last two months).

Using 5 Year Note futures as a proxy, we have calculated the difference in average price between what the NY Fed would have paid had it not cancelled the first auction versus what it actually ended up paying: $15.7 million ($12.1 million for the 5's and $3.6 million for the 7's). This amount was simply pocketed by the primary dealers and is now a liability of the Federal Reserve, and putatively the US taxpayer.

The below chart illustrates the sequence of events with the 5 Year Note futures (click for large image).

It is now incumbent upon the NY Fed to issue an explanation detailing its decision making process today. Just why did it cancel the auction when prices were starting to move in its favor (against the dealers)? If Mr. Frost, who supervises the purchase operations at the NY Fed, was telling the truth when he told the NY Times, "We are looking to get the best price we can for the taxpayer", then why did the opposite occur today?

Indeed Zero Hedge has chronicled how the Fed serially purchases the richest spline in its operations, to the benefit of the primary dealers (see here, here, here, here, here, and here). We also reiterate and incorporate herein our previously expressed concerns regarding the NY Fed's black box computer program that virtually runs the Fed's daily auctions. Just who programmed it, and how does it assess "fair value"?

As is usually the case with the Federal Reserve, there are more questions than answers.

Update: Reuters has backtracked with the following:

EU Energy Commissioner did not say a catastrophe was going to happen, he just expressed his fear - spokesman

Excess Reserves Continue to Build, Signalling Bank Caution

As we first wrote here, and updated in our daily dispatch here, bank reserves held at the Fed (to earn 0.25% interest) continue to rise, despite the ongoing money printing. Specifically, non-borrowed reserves are up $82.028 billion over the last two weeks, of which $78.190 billion is due to excess (not required) reserves. Over the same two week period, $57.214 billion in Treasury coupons were purchased by the NY Fed. Overall, a net drain of $24.814 billion.

We do note that the (likely permanent) wind down of the Treasury's Supplemental Financing Program, an account it holds at the Fed, is ongoing and is adding $25 billion per week of liquidity. However, we continue to view the banks' actions as very defensive.