TPM: Maiden Lane I, II, and III

Hoo boy. After Bernanke's appearance today in front of the Senate Banking, Housing, and Urban Affairs Committee to deal with the AIG mess, a rather astute observer wrote Josh Marshall with a succinct explanation of what the Fed's been up to. Brace yourself:

Josh, your reporting on the AIG credit default swap/counterparties issue has been spot-on. But to understand what happened there, you have to understand the Fed's "Maiden Lane" vehicles and how it's used them to avoid what Congress intended with TARP, which was the real story that came out of Dodd's hearing on the AIG mess today. And the roots of it go back to the Bear Stearns rescue last year.

By law, the Fed isn't allowed to buy assets -- it can only lend, as lender of last resort. That was a problem for the Bear Stearns bailout, because JP Morgan said it would only buy Bear if someone else assumed responsibility for the crap. Fed came up with this idea to start a shadow company, called a special purpose vehicle (SPVs were how Enron operated, creating "Chewco" and the like named after Chewbacca - the New York Fed called their SPV "Maiden Lane LLC" for name of the street the NY Fed is located on in southern Manhattan). The deal then was JP Morgan put $1 billion into Maiden Lane, the Fed put $29 billion in cash into it. Maiden Lane paid Bear Stearns $30 billion, which went straight back to JP Morgan as this deal happened simultaneously to JP's purchase of Bear. So Morgan got $30 billion in cash ($29 billion net) and the Fed got stuck owning the crap, but was legally only making a loan to Maiden Lane, who was the legal owner (Maiden Lane was incorporated not in NYC, but in Delaware to avoid paying taxes). By the Fed's own accounting - which is very different from a real company's accounting - Maiden Lane has lost $5 billion between its creation and today.

The same problem happened in AIG, but this time there was no buyer. In Sept, the Fed bought AIG (80%) in exchange for an $85 bill loan. By Oct, it was clear AIG was still dying, so the Fed lent it another $40 billion. This $40 billion was restructured in November when the Treasury put in $40 billion of TARP funds, which was needed to bail out the Fed's loan which had by this time gone bad. But essentially AIG had 2 problems: it had lent out safe securities with real values and used that money to buy shit mortgage backed securities -- this was called 'Secured Lending Facility' which was done right under the nose of the state insurance commissioners. It was in the hole $20 billion. The other problem was the crappy insurance that AIG's financial products company had written on other people's shit mortgage backed securities - the credit default swaps (CDS). When the bad mortgages that AIG insured went bad, the insurance had to pay-up -- but because it wasn't called insurance, but rather derivatives, AIG hadn't reserved any money against it. This had lost about $25 billion.

Using the loophole it had learned during Bear Stearns, the Fed set up two new companies: Maiden Lane II and Maiden Lane III. Two dealt with the secured lending and Three the shitty credit default swaps. The Fed lent each Maiden Lane $20 billion and $25 billion and then Maiden Lane paid off the investors that had either lent AIG the money to buy the shitty mortgage backed securities (ML II) and those who had the shitty mortgages and the corresponding insurance (ML III). To avoid booking a loss on the Fed's balance sheet, because the Fed had some legal problems if either of these Maiden Lanes lost money, and because of a reporting requirement that Dodd had put into TARP which actually required the Fed to report to the Congress and the public about the cost to taxpayers from ML I, the Fed did some creative accounting. They still paid all of the investors off at full value (par), so that they didn't lose anything. But they booked the loss on AIG's balance sheet and kept Maiden Lane clean. This is the hidden story behind how AIG went from losing $38 billion during the first 9 months of 2008 to losing $61 billion in the 4th quarter.

This was all exposed at today's hearing. And despite repeated requests from Senators on both sides - Dodd, Shelby, Corker, Warner - the Fed is still refusing to say who it bailed out through Maiden Lane II and III.

I didn't get to hear this today but I'm going to watch as much as I can at C-Span.org. I've embedded the hearing below so you can, too.

I'll be back with more on this once I've seen the video.

Update: It's Donald Kohn, the vice chairman of the Fed, giving testimony, not Bernanke. More up above.