2010 0430 – FCIC – Interview – James M. Mahoney – FRB-NY – 6p

2010 0430 - FCIC - Interview - James M. Mahoney, FRB-NY - 6p

2010 0430 - FCIC - Interview - James M. Mahoney, FRB-NY - Team Leader: Dixie Noonan --- [BonkNote] --- 6p

AIG - Securities Lending, Maiden Lane II, AIGFP, GIC's, OTS, Insurance Regulators

Mr. Mahoney said that he first became involved with AIG was in September 2008 when he was asked to meet with AIG management about the company’s liquidity problems.
- ... lead on Maiden Lane 2, he has been on the AIG team since September 12, 2008. He said his responsibilities include looking at liquidity at AIG, going through cash flow needs of the company, its cash flow forecasts, and its upcoming needs.
(p2) - Dixie asked what would have immediately precipitated a ratings downgrade, and Mr. Mahoney said that in the second quarter of 2008, the company “had extraordinary losses in the order of $20 billion, which were announced I think August 6 and then in the subsequent days, each of the sell side analysts, from Merrill and Goldman to the banks and sell-side firms, issued reports to examine the losses - where they came from, was it a one-time event – and subsequently, the rating agencies put them on a watch for a downgrade.
- Because there were lots of rating agency triggers in the CDS contracts where counterparties could demand more collateral in the event of a downgrade,” AIG felt a need to explain its situation to the NY Fed, he said.
  - He said that the securities lending program, which was already experiencing problems because counterparties were terminating trades, would have suffered greatly in the event of a downgrade because counterparties would terminate their trades in huge numbers.
  - He also said that a downgrade would have triggered automatic cash demands, and would make it much harder for the company to roll commercial paper – “we heard this parade of horrible events,” he said, noting that “lots of the things they discussed did end up happening.”
- (p2) - He said that another threat to the company was that conservative money managers leading pension funds that invested in Guaranteed Investment Contracts (“GICs”) would sell their investments en masse in the event of a downgrade. He said that ultimately that did happen to a degree, but that “it could have been worse.”
- Dixie asked if Mr. Mahoney could help distinguish which consequences of a downgrade were caused by provisions in contracts between AIG and its counterparties, and which were behavioral.
  - Mr. Mahoney said that the CDS triggers were contractual, and the problems with the securities lending division were behavioral.
  - “Counterparties rely on collateral and ratings in securities lending, so if the rating falls in value, they will demand more collateral,” he said.
- Dixie asked if Mr. Mahoney could explain the relationship between the problems in the securities lending business and AIG FP, and whether or not the problems at the two companies were triggered by the same things.“
  - Mahoney ... So they were all risky assets, and they all suffered the same fate.”
- (p3) - Chris [Seefer]asked who at AIG was most knowledgeable about the company’s problems.
  - Mr. Mahoney said that the people he listed earlier provided the best information to his knowledge.
  - They included Bob Gender, David Hertzog, and two other people whose name he could not remember who knew the most about the variety of liquidity needs at the company.
- (p4) - Mahoney - So at that point we hadn’t made the loan, we were feeding information to policymakers… because before then, no one had given authority to work on anything because we were not a lender or anything.”
- (p5) - Dixie asked who described the problems with the securities lending program.
  - Mr. Mahoney said, “no particular representative sticks out in my mind as particularly knowledgeable about sec lending.
    - I don’t recall anyone from the sec lending area being particularly noteworthy, unlike the FP people who had clearly originated many details and knew well the various contracts, termination clauses etc.,” he said
- “I never met anyone from the OTS, and they weren’t there in person. There was a lot more interaction with state of New York insurance department - that’s where the sec lending program problems were… so there was lots of daily interaction with the Insurance Department, I’m not sure about interaction with the OTS, but as far as boots on the ground, I had no interaction with the OTS,” he said.
- Mr. Mahoney said that three areas of focus were (1) maturing debt, (2) the fact that if CDOs deteriorated further, the company would face more collateral calls, and (3), the company was unable to roll its mature securities lending contracts.”
  - He said that the NY Fed was “able to maintain three counterparties out of a dozen from sec lending – Credit Suisse, Barclays, and Citi. Everyone else was turning securities back in.”
  - He explained that starting on October 8, the NY Fed instituted a temporary securities borrowing facility.
    - “We said, ‘these securities that counterparties are giving back are high quality corporate bonds – the kind of things we lend against,’ so we could take in this high quality collateral, enhance our collateral position, and not have the parent facility used to make a direct loan to the insurance subsidiary.
    - So we instituted a temporary secured borrowing facility so the company could take those securities, pledge against our debt window which was set up specifically for sec lending, for the 11 insurance subs.”
- (p5) - Dixie asked Mr. Mahoney to describe the terms of the securities borrowing facility.
  - He said that there was a question of how to turn the NY Fed’s temporary solution (the securities borrowing facility) into a more permanent resolution, which is where Maiden Lane 2 came in.
    - “One big issue was that if the held securities still had lots of credit risk in holding corporate bonds, but the reinvestment pool was not something state regulators were looking at.
      - So it was not viewed as viable that company would maintain ownership of residential-backed securities because prices were so volatile.
      - They didn’t get the type of capital credit when you calculate insurance companies’ risk-based capital – they were not the type of assets they could keep holding.
      - So it was clear these RMBS would experience defaults.
      - So it was clear they would ultimately be downgraded.
      - And a well known criticism of rating agencies [was that they were] using the same [ratings] scheme for corporations as for securities.
      - You don’t see AA and AAA firms failing, but they said AA is AA whether it’s for a company or a structure.
      - Turned out not to be true.”
      - He said that there was a “huge migration of ratings over that time period.
      - It hadn’t happened yet, but everyone knew it was a matter of time before the ratings agencies would change.
      - Prices already reflected it.
      - People, traders in the market knew that risk was not reflected in the ratings themselves.”
(p6) - Dixie asked if he or his team conducted any analysis of how AIG got to the position where it found itself in the fall of 2008.
- “We did almost no looking back,” he said.
(p6) - Dixie asked if the sec lending program has been shut down, and he said that the domestic sec lending program was shut down the day Maiden Lane was created.