What Exactly Is a Counterparty Payment, Anyway?

Tim — Tue, 24 Mar 2009 20:53:59 +0000

Much of the media attention on Capitol Hill over the past two weeks has focused on the $165 million in bonuses paid to AIG employees, but many have begun to point the finger at what they say is the “real outrage,” so-called “counterparty payments” from AIG to other financial institutions. The counterparty question has gained substantial steam on the internet and in certain corners of the mainstream media. Geithner was asked directly about these payments during the hearing today in Congress.

So what exactly is a counterparty payment?

When one party (such as a bank or a corporation) enters a financial agreement with another party, there is always a certain amount of “counterparty risk,” that is to say that there is a chance the borrower won’t pay their debt or otherwise fulfill their side of the deal.

AIG was in the middle of a LOT of deals on Wall Street and around the world, involving all kinds of financial instruments. In particular they were insuring a lot of this counterparty risk. So when AIG suddenly ran out of money last year, they took the federal TARP bailout funds they received, and paid their counterparties. In AIG’s case, the counterparties included the world’s biggest banks. AIG ended up paying $12.9 billion to Goldman Sachs, and similar amounts to Bank of America, Merrill Lynch, Germany’s Deutsche Bank AG, and France’s Société Générale.

A (very) simplified example, using three parties, Alex, Bob, and Carl:

Alex wants to borrow $100 from Bob, but Bob is worried that Alex won’t pay him back. So Alex tells Bob to give him some collateral. Bob doesn’t have anything worth $100, but he does have a little money. His friend Carl offers to make him a deal: if Alex goes bankrupt, Carl will pay Bob the $100 he is owed. In exchange, Alex pays Carl a smaller amount, maybe $5.

A month later, Alex loses his job and can’t pay his debt. Alex tells Carl what happened, but Carl admits he doesn’t have the $100 he owes Bob. Carl asks the government for help, and with some new capital from the Treasury, Carl pays Alex (his counter party), Alex pays Bob (all of this with taxpayer dollars).

Now just multiply that scenario by a billion or two, and you’ve got some idea of what’s happening with AIG.

CNN’s Money Summit: Bailout would cost $9,718 per taxpayer!

Joseph — Mon, 09 Feb 2009 23:09:44 +0000

When it comes to the various stimulus packages and bank bailouts making their way through Congress, there’s no shortage of pundits, columnists, and bloggers offering their “expert opinion.” Amid all the hot air, however, it can be hard to find straightforward analysis of the issues at hand.

CNN’s Money Summit, however, is an attempt to provide straight answers to questions about the economy. They are asking economists to respond to viewer questions– from “Can the government go bankrupt?” to “If they want to stimulate the economy, why don’t they give every taxpayer $10,000?”

This is a great resource for anyone who wants to understand what’s happening in the economy.

Econ4U.org » bailout

What Exactly Is a Counterparty Payment, Anyway?

CNN’s Money Summit: Bailout would cost $9,718 per taxpayer!