Along with the firestorm that has erupted over American International Group’s bonus payments to employees, former disgraced New York State Governor Eliot Spitzer spoke out against A.I.G. paying billions to its trading counterparties.

According to today’s New York Times, Spitzer criticized A.I.G.’s payments to trading counterparties on the WNYC Brian Lehrer radio program on Wednesday.

Yesterday’s New York Daily News chimed in, pointing out that Spitzer was actually criticizing New York Attorney General Andrew Cuomo (his successor) for focusing on the bonuses and missing the bigger picture.

"The bonuses are the flavor of the month," Spitzer said on the radio program, as reported in the Daily News. "You see the word bonus in a headline, someone gets a subpoena two minutes later.”

Spitzer reportedly told listeners, "This is typical political screaming and shouting and missing the larger issue," which, Spitzer said, is that A.I.G. is funneling bailout money to cash-rich firms like Goldman Sachs and Bank of America, wrote the Daily News.

Of the $170 million in bailout money committed to AIG, $49.5 billion of taxpayer funds went to financial institutions. (Goldman Sachs received $6.1 billion, while Merrill Lynch got $4.9 billion, for example.) There is also uproar that some of the largest payments went to foreign banks like Societe Generale, which received $11 billion.

It seems strange that Spitzer, who was forced out of office over a prostitution scandal, should criticize A.I.G. for its corporate ethics. However, when Spitzer was attorney general he led an investigation into A.I.G. for deceptive practices, which led to a $1.6 billion settlement, recalled the Times, so A.I.G. was a target during his crusading days against Wall Street transgressions.

Spitzer criticized the payments because the same financial institutions that already received TARP funds (Goldman, Merrill, Wachovia) are being made whole with taxpayer funds to get out of the derivatives contracts.

But the bigger picture here is that if A.I.G. doesn’t honor its derivatives contracts, or if the U.S. breaks them, that will further rattle the interconnected global financial system. Contracts matter. However, some critics argue that foreign banking institutions wouldn’t do the same if the situation were reversed.

It shouldn’t be a surprise that A.I.G. had to make payments to financial institutions that were its counterparties on the other side of credit derivatives or mortgage pools it sold to them. Derivatives are based on contracts, and written into those contracts were the condition that if AIG’s credit rating dropped it would need to post more collateral.

But what’s troubling is that when the government bought the underlying securities in these mortgage pools, to cancel the insurance (derivatives contracts) with A.I.G. counterparties, it chose to pay par or 100 percent of the face value, pointed out the Times in "Fast A.I.G. Payments To Foreign Institutions More Grist for Critics." That means the taxpayer has downside risk if the securities lose value but virtually no upside, wrote the Times on Wednesday.

I asked one seasoned industry source, who is not a trader, whether AIG should have paid the trading counterparties out of the bailout money. “Absolutely,” said the source. What irks Congress and other critics, the names of the trading counterparties were kept a secret for about six months. “Where do you think the money went? To fund the cafeteria,” said the industry source. Trading is a zero sum gain. “They won. We lost.”

Also, the government owns 80 percent of AIG, but it hasn’t seized the company. Why didn’t they seize the institution?” It could have been seized and changed but it doesn’t change the nature of contractual agreements,” said the source.

“If we abrogate a contract, we’ll have a trillion loss,” said the source.

Here’s the New York Times story

Here’s the Daily News Story