  Credit default swaps. Federal Assistance to AIG

Because of concerns about the effect of an AIG failure, in 2008 and 2009,  the Federal Reserve System and Treasury agreed to make $182.3 billion  available to assist AIG. The Possibility of AIG’s Failure Drove Federal Reserve Aid after Private Financing Failed

A year before the first federal assistance to AIG, warning signs of the  company’s financial difficulties began to appear. Over the following  months, the Federal Reserve System received information about AIG’s  deteriorating condition from a variety of sources and contacts, and it  stepped in to provide emergency assistance as possible bankruptcy  became imminent in mid-September 2008. Attempts to secure private  financing, which would have precluded or limited the need for government  intervention, failed as the extent of AIG’s liquidity needs became clearer. Both the Federal Reserve System and AIG considered bankruptcy issues,  with AIG deciding independently to accept federal assistance in lieu of  bankruptcy. Because of urgency in financial markets by the time the  Federal Reserve System intervened, officials said there was little  opportunity to consider alternatives before extending the initial assistance  in the form of the Revolving Credit Facility. When AIG’s financial troubles  persisted after the Revolving Credit Facility was established, the company  and the Federal Reserve System considered a range of options for further  assistance. Throughout the course of AIG assistance, the company’s  credit ratings were a critical consideration, according to Federal Reserve  System officials, as downgrades would have triggered large new liquidity  demands on the company and could have jeopardized government  repayment. 1. 4. 2). But FRBNY’s policy objective was to prevent a disorderly failure of  AIG, and FRBNY officials said they did not believe that would have been  possible if AIG was downgraded to the levels rating agencies were  considering. FRBNY’s Maiden Lane III Design Likely Required Greater Borrowing, and Accounts of Attempts to Gain Concessions From AIG Counterparties are Inconsistent

After the first extension of federal assistance to AIG—the Revolving  Credit Facility—ML III was a key part of the Federal Reserve System’s  continuing efforts to stabilize the company. We found that in designing ML  III, FRBNY decided against plans that could have reduced the size of its  lending or increased the loan’s security, as it opted against seeking  financial contributions from AIG’s financial counterparties. We also found  that the Federal Reserve Board approved ML III with an expectation that  concessions would be negotiated with the counterparties, but that FRBNY  made varying attempts to obtain these discounts, which could have been  another way to provide greater loan security or to lower the size of the  government’s lending commitment. This willingness was  conditioned on all other counterparties agreeing to the same concession,  the counterparty told us.   FRBNY had little or no bargaining power given the circumstances. The official  declined to discuss conversations with Federal Reserve System officials,  citing French secrecy law. CDOs that ML III did not purchase were excluded due to decisions by  both FRBNY and counterparties. As the value of the  underlying assets changed, the value of AIG’s CDS protection became  different, the officials said. The Federal Reserve’s Actions Were Generally Consistent With Existing Laws and Policies, but They Raised a Number of Questions

The actions of the Federal Reserve System in providing several rounds of  assistance to AIG involved a range of laws, regulations, and procedures. In addition, we  identified a series of complex relationships involving FRBNY, its advisors,  AIG counterparties, and service providers to CDOs in which ML III  invested that grew out of the government’s intervention. The Federal Reserve Exercised Its Broad Emergency Lending Authority to Aid AIG but Did Not Fully Document Its Decisions

When the Federal Reserve Board approved emergency assistance for  AIG beginning in September 2008, it acted pursuant to its authority under  section 13(3) of the Federal Reserve Act. The Federal Reserve Influenced AIG’s Securities Filings About Federal Aid but Did Not Direct the Company on What Information to File

During the financial crisis, questions arose about FRBNY’s involvement in  AIG’s exclusion of some ML III-related information from its federal  securities filings—counterparty transaction details and the description of a  key ML III design feature. Its emergency lending also made it a significant  creditor to AIG. The lack of a  comprehensive policy for managing vendor conflicts, including relationships  that cause competing interests, could expose FRBNY to greater risk that it  would not fully identify and appropriately manage vendor conflicts of  interest in the event of future crises. We obtained these documents primarily from the Board of  Governors of the Federal Reserve System (Federal Reserve Board) and  the Federal Reserve Bank of New York (FRBNY), including records they  have provided to Congress. We conducted interviews with many of those involved in federal  assistance to AIG, to obtain information on their participation in the events  leading up to federal assistance for AIG, as well as their perspectives on  the condition of AIG and the financial markets at the time. From the private sector,  we interviewed current and former AIG executives, representatives from  FRBNY advisors, an AIG advisor, AIG business counterparties, credit  rating agencies, potential private-sector financiers, and academic and  finance experts. To examine the extent to which key actions taken were consistent with  relevant law or policy, we reviewed AIG-related documents indicated  earlier to identify key actions taken.
Why GAO Did This Study

In September 2008, the Board of Governors of the Federal Reserve System (Federal Reserve Board) approved emergency lending to American International Group, Inc. (AIG)--the first in a series of actions that, together with the Department of the Treasury, authorized $182.3 billion in federal aid to assist the company. Federal Reserve System officials said that their goal was to avert a disorderly failure of AIG, which they believed would have posed systemic risk to the financial system. But these actions were controversial, raising questions about government intervention in the private marketplace. This report discusses (1) key decisions to provide aid to AIG; (2) decisions involving the Maiden Lane III (ML III) special purpose vehicle (SPV), which was a central part of providing assistance to the company; (3) the extent to which actions were consistent with relevant law or policy; and (4) lessons learned from the AIG assistance. To address these issues, GAO focused on the initial assistance to AIG and subsequent creation of ML III. GAO examined a large volume of AIG-related documents, primarily from the Federal Reserve System--the Federal Reserve Board and the Federal Reserve Bank of New York (FRBNY)--and conducted a wide range of interviews, including with Federal Reserve System staff, FRBNY advisors, former and current AIG executives, AIG business counterparties, credit rating agencies, potential private financiers, academics, finance experts, state insurance officials, and Securities and Exchange Commission (SEC) officials. Although GAO makes no new recommendations in this report, it reiterates previous recommendations aimed at improving the Federal Reserve System's documentation standards and conflict-of-interest policies.

What GAO Found

While warning signs of the company's difficulties had begun to appear a year before the Federal Reserve System provided assistance, Federal Reserve System officials said they became acutely aware of AIG's deteriorating condition in September 2008. The Federal Reserve System received information through its financial markets monitoring and ultimately intervened as the possibility of bankruptcy became imminent. Efforts by AIG and the Federal Reserve System to secure private financing failed after the extent of AIG's liquidity needs became clearer. Both the Federal Reserve System and AIG considered bankruptcy issues, although no bankruptcy filing was made. Due to AIG's deteriorating condition in September 2008, the Federal Reserve System said it had little opportunity to consider alternatives before its initial assistance. As AIG's troubles persisted, the company and the Federal Reserve System considered a range of options, including guarantees, accelerated asset sales, and nationalization. According to Federal Reserve System officials, AIG's credit ratings were a critical consideration in the assistance, as downgrades would have further strained AIG's liquidity position. After the initial federal assistance, ML III became a key part of the Federal Reserve System's continuing efforts to stabilize AIG. With ML III, FRBNY loaned funds to an SPV established to buy collateralized debt obligations (CDO) from AIG counterparties that had purchased credit default swaps from AIG to protect the value of those assets. In exchange, the counterparties agreed to terminate the credit default swaps, which were a significant source of AIG's liquidity problems. As the value of the CDO assets, or the condition of AIG itself, declined, AIG was required to provide additional collateral to its counterparties. In designing ML III, FRBNY said that it chose the only option available given constraints at the time, deciding against plans that could have reduced the size of its lending or increased the loan's security. Although the Federal Reserve Board approved ML III with an expectation that concessions would be negotiated with AIG's counterparties, FRBNY made varying attempts to obtain these discounts. FRBNY officials said that they had little bargaining power in seeking concessions and would have faced difficulty in getting all counterparties to agree to a discount. While FRBNY took actions to treat the counterparties alike, the perceived value of ML III participation likely varied by the size of a counterparty's exposure to AIG or its method of managing risk. While the Federal Reserve Board exercised broad emergency lending authority to assist AIG, it was not required to, nor did it, fully document its interpretation of its authority or the basis of its decisions. For federal securities filings AIG was required to make, FRBNY influenced the company's filings about federal aid but did not direct AIG on what information to disclose. In providing aid to AIG, FRBNY implemented conflict-of-interest procedures, and granted a number of waivers, many of which were conditioned on the separation of employees and information. A series of complex relationships grew out of the government's intervention, involving FRBNY advisors, AIG counterparties, and others, which could expose FRBNY to greater risk that it would not fully identify and appropriately manage conflict issues and relationships.