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Never Before Seen Secret Memo On AIG Bailout From Fed’s Tarullo To Obama Revealed In Podesta Emails

The fall of 2008 was a hectic time, when in the aftermath of the Lehman failure, the entire financial system was on the verge of collapse and only the biggest Fed/taxpayer-backed bailout in history avoided an all out depression. Today, as a result of the latest, 12th Podesta leak, we find that then president-elect Barack Obama was also being intimately briefed with unfolding events.

In a previously never before seen confidential memo, sent on November 9, 2008 from current Fed governor Dan Tarullo addressed to Barack Obama, Tarullo send John Podesta an email in which Tarullo, who at the time was not employed by the Fed and was Professor of Law at Georgetown University Law Center, reveals what Hank Paulson and Ben Bernanke in which Tarullo was told on a “confidential basis that, before the markets open tomorrow morning, they will be announcing a significant restructuring of the AIG bailout package.  They are taking this step in order to avoid what they asserted would be a systemic crisis.

The step in question involved the TARP investment of $40 billion in preferred shares in AIG to avoid a collapse of the failed insurer as a result of an imminent ratings downgrade. “This sum will be used to allow AIG to begin repaying the money it has borrowed from the Fed facility.  They will thereby reduce the amount of debt on AIG’s balance sheet and thus avoid the ratings downgrade.   Until AIG can begin selling assets, however, it will continue to draw on the Fed liquidity facility, just not in the amounts originally provided.”

Tarullo tells Obama that “there will likely be some criticism from economic and market observers, because this restructuring has relaxed the terms of financing for AIG without additional taxpayer benefits (in the form of additional warrants, for example).” He adds that “Paulson and Bernanke emphasized that they were not happy about having to do this, and both said that the current approach is the one they would originally have taken in September had the TARP been in place.

While the subsequent details of the revised bailout are familiar, what is not known is the implicit “request” made by Tarullo: that when Obama officially becomes president on January 20, he does not undo the “modification” to the AIG bailout as otherwise the markets would be “unnerved”…

As to our reaction – we surely do not want to unnerve markets by saying anything that would suggest your Treasury Department would undo this modification after January 20.  However, the combination of the questionable terms of the original Fed lending and failure to increase the effective stake of taxpayers as part of this deal means that we should avoid saying anything that would identify us with this move.  Our position is perhaps best framed as regret that it was necessary to make these changes in the September arrangement.

… with the most concerning part of the exchange: “we should avoid saying anything that would identify us with this move.”

More optical collusion, all for the sake of preserving market stability? Potential improper, collusive behavior aside, what we would like to know is how Dan Tarullo, who was not a coworker of either Hank Paulson or Ben Bernanke was privy to this information which was shared to him on a “confidential basis” by the then-Treasury Secretary Paulson and then Fed Chair Ben Bernanke, and while we are asking, we wonder what other collusion has taken place between Tarullo and the executive branch off the record?

Finally, in what capacity is Tarullo sharing confidential Treasury and Fed information with the president elect, who in November 2008 was still a private citizen?

As a reminder, Tarullo took office at the Fed on January 28, 2009, one week after Barack Obama was inaugurated.

Here is the full confidential memo released by Tarullo:

CONFIDENTIAL
November 9, 2008

 

MEMORANDUM FOR THE PRESIDENT-ELECT
FROM:    Dan Tarullo
SUBJECT:    Restructuring of AIG Deal

 

I received a call earlier this evening from Secretary Paulson and Chairman Bernanke informing me on a confidential basis that, before the markets open tomorrow morning, they will be announcing a significant restructuring of the AIG bailout package.  They are taking this step in order to avoid what they asserted would be a systemic crisis.

 

They apparently were anticipating a downgrading of AIG’s debt to below investment grade status.  Had this occurred, they believe (reasonably, in my view) that a run on AIG would almost certainly have ensued.  The essentials of the restructuring are that the Treasury will be using the TARP to make a $40 billion investment of preferred stock into AIG.  This sum will be used to allow AIG to begin repaying the money it has borrowed from the Fed facility.  They will thereby reduce the amount of debt on AIG’s balance sheet and thus avoid the ratings downgrade.   Until AIG can begin selling assets, however, it will continue to draw on the Fed liquidity facility, just not in the amounts originally provided.

 

Paulson and Bernanke emphasized that they were not happy about having to do this, and both said that the current approach is the one they would originally have taken in September had the TARP been in place.  There is something to this point, although I observe that some believed (rightly, it turns out) that the terms of the original Fed facility were too onerous.. 

 

There will likely be some criticism from economic and market observers, because this restructuring has relaxed the terms of financing for AIG without additional taxpayer benefits (in the form of additional warrants, for example).  Moreover, although Secretary Paulson emphasized that the terms of the injection of preferred stock were less favorable than those of the initial rounds of investments last month in Citi, Goldman, etc., my understanding is that Treasury will be initially waiving payments of dividends.

 

As to our reaction – we surely do not want to unnerve markets by saying anything that would suggest your Treasury Department would undo this modification after January 20.  However, the combination of the questionable terms of the original Fed lending and failure to increase the effective stake of taxpayers as part of this deal means that we should avoid saying anything that would identify us with this move.  Our position is perhaps best framed as regret that it was necessary to make these changes in the September arrangement.

 

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