There’s a lot to choose from but I’m going to say that the very best thing about AIG’s pretending it might sue the government last week, and then not doing it, is that then it actually sued the government:

American International Group Inc. filed a lawsuit against a Federal Reserve vehicle created during AIG’s bailout that held some of its troubled mortgage bonds, in a dispute over rights to sue over the bonds. … At issue is whether AIG, in selling billions of dollars in troubled mortgage bonds to the New York Fed in late 2008, transferred its rights to sue for losses it incurred on the securities.

So it’s not quite as big as the Hank Greenberg give-me-back-my-$25-billion lawsuit that AIG opted out of, but it’s pretty big; AIG thinks it has over $7 billion in damages against Bank of America/Countrywide alone. If it’s right, either AIG or the Fed should be entitled to about $7bn of BofA’s cash. So call this 1/4 as big as joining the Greenberg suit, though considerably less than 1/4 as offensive.

One way to resolve this dispute amicably might be to conclude that both AIG and the Fed should be entitled to $7bn of BofA’s cash. After all, who decided that only one investor gets to sue BofA per mortgage? We’ve talked before about the fact that BofA’s liability for Countrywide mortgages does not seem to be limited by the amount of mortgages that Countrywide wrote; several lawsuits now cover overlapping pools of mortgages. How much BofA ends up paying for those mortgages will depend on political and PR factors, on the existence of embarrassing emails, on technicalities of contract drafting and legal doctrines, and on how much money BofA, y’know, has, but it seems unlikely that it will depend on some sort of one-mortgage-one-lawsuit principle. You write enough bad mortgages and you give up your expectations of tidiness.

And in fact on my reading of AIG’s complaint it looks like everyone might be entitled to a piece of BofA. On the one hand, the Fed owns the mortgage bonds, and the mortgage bonds include by their terms certain rights. One of those rights is the right to put back mortgages underlying the bonds to the originator – mostly Countrywide, meaning now BofA – if the reps and warranties attached to those mortgages turn out not to be true. It seems to be generally accepted that a lot of those reps and warranties – of the form “these mortgages are not garbage” – turned out not to be true. Accepted by BofA, even, which entered into an $8.5 billion settlement with the trustee of those bonds – still pending in the courts – to settle rep & warranty claims on those bonds. Maiden Lane, and thus the New York Fed, is a beneficiary of that settlement.

This makes perfect sense. Maiden Lane owns those mortgage bonds,1 which means it’s entitled to contractual cash flows under those bonds, which means that if (1) a homeowner pays his mortgage and/or (2) an originator buys back that mortgage under the terms of the contract, the money goes to the holder of the bonds. Both AIG and the Fed agree that these claims belong to Maiden Lane.

On the other hand, AIG bought the bonds from Countrywide in happier times at – let’s say – par, relying on disclosure documents provided to them by Countrywide/BofA, and then ended up selling the bonds in sadder times to Maiden Lane at their then market value, which was less than par:

The purchase price [of mortgages sold by AIG to Maiden Lane II] was $20.8 billion, the parties’ best estimate of the RMBS’ market value at the time based on their projected cash flows, and a massive discount off their face value of $39.3 billion. AIG incurred a loss of approximately $18 billion on the RMBS it sold ….

If instead of mortgage bonds AIG had bought, say, stock,2 and then sold it at a much lower price because of fraud, the analysis would be clear:

  • AIG buys stock in Company X at $100.
  • It comes out that Company X was cooking the books.
  • Stock falls to $20.
  • AIG sells stock to Maiden Lane for $20.
  • Maiden Lane now has stock that’s worth $20, which is what it expected, because it had full information with no fraud, so it has no damages.
  • AIG can go sue Company X for the fraud that caused it to lose $80.

This happens all the time, and people like me complain about it, since the net result of those lawsuits is just to move money from one set of innocent shareholders (Maiden Lane) to another (AIG), with lawyers taking a cut in the middle. But it’s, like, the law. The law of securities fraud.

AIG’s complaint is basically that, in the absence of really clear language in the Asset Purchase Agreement assigning the fraud claims to Maiden Lane, the fraud claims remain with AIG. This makes total sense since AIG are the ones who suffered losses from the fraud. Maiden Lane bought the mortgage bonds at full-information, no-fraud, super-depressed prices, and in fact ended up selling them at a $2.8 billion profit. Letting Maiden Lane sue for fraud would be silly.3

So everyone wins! Except BofA. The putback claims and the fraud claims are … obviously related. The reps and warranties in the mortgages – “these mortgages are properly underwritten and documented and non-crap” – overlap significantly with the claims in the marketing documents that apparently deceived AIG. One piece of bad behavior by Countrywide could give rise to both contractual-putback and securities-fraud suits. There’s an inefficiency here and if you’re very tidy-minded you’d like it resolved.4

But the world doesn’t necessarily work that way. The New York Fed has a good argument that it’s entitled to money from BofA. AIG has a good argument that it’s entitled to roughly the same money from BofA. BofA has a good argument that it shouldn’t pay twice. Who will end up holding the bag? I dunno. The answer mostly depends on legal issues beyond my expertise, as well as on negotiating and litigating leverage. It might also depend a little on who – AIG? BofA/Countrywide? the Fed? – manages to make everyone hate them the most. And there, BofA is a formidable competitor, but AIG is putting up quite a fight.

AIG Sues Federal Reserve Vehicle in Dispute Over Lawsuit Rights [Deal Journal]
AIG v. Maiden Lane II complaint and docket [SCROLL]

1. Oversimplified: Maiden Lane II has actually sold all its bonds by now. So current owner should have those putback rights.

2. The difference, to be clear, being that stock doesn’t really come with contractual rights. If your company is doing accounting fraud, you sue them for securities fraud because you bought too high / sold too low. You don’t, like, demand a higher dividend.

3. Or so AIG claim, and I sympathize. The Fed seems to disagree for reasons that are not currently all that clear, though the reason that anyone would maintain a position that entitles them to a few billion extra dollars is always sort of clear.

4. As a legal matter but also as a sort of efficient-markets matter: the sale price from AIG to Maiden Lane “should have” incorporated the prospect of future putback damages in the price, meaning that any losses to AIG “shouldn’t have” been caused by any fraud by Countrywide that could be remedied by putback claims. The securities that AIG sold to Maiden Lane II had a face value of $39.3 billion; ML II paid $20.8 billion for them and ultimately sold them for $24ish billion. The tidy partition of that $39.3 billion goes like:

  • There was some base value of the mortgages $A that was just like full-information expected cash flow from borrowers on the underlying mortgages.
  • There was some value of putbacks $B that ended up being crystallized in the $8.5 billion putback settlement.
  • There was some additional fraud value $C caused by Countrywide’s misleading marketing of the loans that can’t be recovered via putbacks.
  • There was some additional loss of market value $D caused by no-fault deteriorating macroeconomic conditions.
  • A + B + C + D = 39.3 billion.
  • A + 2008-expected-B = 20.8 billion, more or less, though the expected amount ascribed to B in late 2008 might have been small.
  • Maiden Lane already got $A (from its sales) and is entitled to $B.
  • AIG already got $A + expected-$B (from Maiden Lane) and is entitled to $C.
  • $C should be quite small: most bad underwriting, deceptive practice, etc., can be dealt with through putbacks.
  • No one is entitled to $D.

Even this is insufficiently tidy; to do it right you’d need to account for market values at time of (1) purchase by AIG, (2) sale to Maiden Lane II, and (3) sale by Maiden Lane II, but you get the idea.

9 comments (hidden to protect delicate sensibilities)
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Comments (9)

  1. Posted by Guest | January 14, 2013 at 10:39 AM

    The Federal Reserve is a governmental agency?

  2. Posted by Chartoholic | January 14, 2013 at 11:08 AM

    You had all weekend to work on it and no charts? WTF Matt?

    -Guy who misses kegs and eggs and would have appreciated some coffee and charts.

  3. Posted by Guest | January 14, 2013 at 11:20 AM

    We settled this out of court for a vertical of Boone's Farm and a slightly used tanning bed.

    –UBS general counsel

  4. Posted by UBS Hangover Quant | January 14, 2013 at 11:25 AM

    You'd be surprised what kinds of diverse establishments are part of the Federal government. I was in Hartford a while ago (great town!) and there was a bar called the Federal, not really sure why the govt. owns a bar, but I had a nice time there; much better than when I went to Minetta's in attire recommended by commenters on this site.

  5. Posted by Turnip Truck | January 14, 2013 at 12:57 PM

    Kudos on your proper use of the possessive with the gerund in the headline there, Matt.

  6. Posted by شات بنات مصر | January 28, 2013 at 12:59 PM

    My partner and I absolutely love your blog and find the majority of your post’s to be precisely what I’m looking for. Would you offer guest writers to write content for you personally? I wouldn’t mind composing a post or elaborating on many of the subjects you write related to here. Again, awesome site!

  7. Posted by sohbet | May 12, 2013 at 6:18 PM

    telling these little stories, here's a good idea: Have a point. It makes it so much more interesting for the listener.

  8. Posted by sohbet | July 8, 2013 at 9:17 PM

    officers to investigate Blackstone's fishy financial transactions, but they wound up giving them

  9. Posted by Car Title Loans | October 1, 2013 at 3:27 PM

    how often does a corporation like this win a case incase the government where the judge works for the very same entity he was to judge? is there not a hue conflict of interest when it comes to these types of cases? What is thew precedent here?