Lehman Brothers Holdings Inc. is asking a bankruptcy judge to force American International Group Inc. to pay it millions of dollars under credit-default swaps it sold to the investment bank, in a dispute that pits two of the firms at the heart of the financial meltdown against each other.
Lehman says AIG is trying to "exploit" the investment bank's bankruptcy case by refusing to pay out, in a bid to delay payments until the market turns around in the insurer's favor. In effect, Lehman says, AIG intends to "enjoy the benefits of the swap agreement, but avoid having to 'pay to play.'"
AIG could have terminated the swaps when Lehman filed for Chapter 11 last September, but hasn't done so because it would be on the hook for $50 million, the investment bank says in a bankruptcy court filing.
At issue is a series of trades between the two firms involving credit-default swaps, which act like insurance on a company's debt. The derivatives contracts were at the center of AIG's near failure last year, just days after Lehman Brothers collapsed into bankruptcy.
Lehman bought credit protection from AIG on debt issued by General Motors Corp., Washington Mutual Inc., the predecessor of the company now known as AbitibiBowater Inc. and Station Casinos Inc., all of which later filed for bankruptcy protection. Lehman also sold credit protection to AIG on the debts of Fannie Mae, Freddie Mac and WaMu.
Firms buy credit-default swaps to hedge against the risk of defaults or downgrades on corporate debt. When a credit event occurs - for example, a default or bankruptcy filing - the protection seller must pay the buyer the face amount of the outstanding debt. In return, the buyer is required to hand over the company's bonds to the protection seller.
However, in the unregulated market for credit-default swaps, the buyer of credit protection doesn't have to actually own the bonds, thereby allowing firms to speculate on the health of companies.
Some U.S. lawmakers, along with the Obama administration, have pledged to impose tougher regulations on so-called naked credit-default swaps, which aren't used to hedge credit risk but are used to bet on the fortunes of companies. Many experts blame the swaps for helping to spread the financial panic in September of last year as AIG tottered and Lehman collapsed.
Indeed, Lehman itself purchased the bonds it was required to deliver to AIG to settle the trades this summer. It says it paid $5 million to buy the bonds to settle the contracts.
But Lehman also says AIG now owes it $9.1 million under the four deals where it bought credit protection from the insurer. The bank has moved to settle eight trades - half as the credit-protection buyer and half as the seller - with AIG, but Lehman says the insurer has refused to make any payments or accept delivery of bonds.
The failed investment bank is asking U.S. Bankruptcy Court Judge James Peck to compel AIG to pay out the cash it owes under the swaps, to accept delivery of the bonds and to pay it default interest. The bank says that if AIG doesn't pay out, it may sell the bonds on the open market and seek "money damages from AIG in respect to any losses and expenses" as a result of the sale.
A hearing on the dispute is scheduled for Oct. 14 in U.S. Bankruptcy Court in Manhattan.
AIG also hasn't respond to Lehman's notice that credit events took place where it bought protection. AIG's decision to "do nothing," Lehman says, means it loses the protection it bought.
AIG spokesperson Lauren Day declined to comment on the dispute.
The Federal Reserve Bank of New York and the U.S. Treasury Department have pumped billions into AIG since its near failure in the days following Lehman's Sept. 15, 2008, bankruptcy filing. The U.S. government, which owns nearly 80% of AIG in the form of preferred shares as a result of the bailout, has committed in total some $170 billion to keep the company running over the past 11 months.
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