Pure gold from Josh Marshall on the bankruptcy bill.* Via Yves, Talking Points Memo:

[I]t turns out that one of the features of the 2005 Bankruptcy bill was to put derivative counter parties [like CDS holders] at the front of the line ahead of other creditors in bankruptcy proceedings. Actually, from what I can tell, they don't just go to the head of the line. They got to skip the line entirely. As the Financial Times noted last fall, "the 2005 changes made clear that certain derivatives and financial transactions were exempt from provisions in the bankruptcy code that freeze a failed company's assets until a court decides how to apportion them among creditors."

2005, eh? Interesting how far-sighted some people were.

And who might these counterparties be?

It looks like (again, to its credit, TPM is on this, because neither the Fed nor the administration is saying a word**), the counterparties are the ones who got the bailout money from the banks (that which didn't go for executive compensation or into the mattress). That is, hedge funds:

The heart of darkness was the AIG Financial Products (AIGFP) office in London, where a large proportion of the derivatives were written. AIG had placed this unit outside American borders, which meant that it would not have to abide by American insurance reserve requirements. In other words, the derivatives clerks in London could sell as many products as they could write—even if it would bankrupt the company.

The president of AIGFP, a tyrannical super-salesman named Joseph Cassano, certainly had the experience. In the 1980s, he was an executive at Drexel Burnham Lambert, the now-defunct brokerage that became the pivot of the junk-bond scandal that led to the jailing of Michael Milken, David Levine, and Ivan Boesky.

During the peak years of derivatives trading, the 400 or so employees of the London unit reportedly averaged earnings in excess of a million dollars a year. They sold "protection"—this Runyonesque term was favored—worth more than three times the value of parent company AIG. How could they have not known that they were putting at risk the largest insurer in the world and all the businesses and individuals that it covered?

This scheme that smacks of securities fraud facilitated the dreams of buyers called "counterparties" willing to ante up. Hedge fund offices sprouted in Kensington and Mayfair like mushrooms after a summer shower. Revenue from premiums for derivatives at AIGFP rose from $737 million in 1999 to $3.26 billion in 2005. Cassano reportedly hectored ever-willing counterparties to "play the power game"—in other words, gobble up all the credit derivatives backing CDOs that they could grab. As the bundled adjustable-rate mortgages ballooned, stretched home buyers defaulted, and the exciting power game became about as risky as blasting sitting ducks with a Glock.

People still seem surprised to read that hedge principals have raked in billions of dollars in a single year. They shouldn't be. These subprime-time players knew how to score. The scam bled AIG white. In mid-September, when it was on the ropes, AIG received an astonishing $85 billion emergency line of credit from the Fed. Soon, that was supplemented by another $67 billion. Much of that money, to use the government's euphemism, has already been "drawn down." Shamefully, neither Washington nor AIG will explain where the billions went. But the answer is increasingly clear: It went to counterparties who bought derivatives from Cassano's shop in London.

And Marshall rightly draws the political implication for how Versailles operates these days:

But separate from the immediate financial implications related to AIG, it does point us toward the larger political economy point: the self-reinforcing cycle in which financialization leads to vast sums of money concentrated in the hands of paper-jobbers, who then mobilize that money in Washington to rewrite the laws to privilege them for even greater profits.

Yep. And it looks to me like that's exactly what happened with TARP I, looking back on it -- which the FKD wrote and passed, and for which President Obama worked the phones. Really, do you think anybody serious in the Village wouldn't have known about the 2005 Bankruptcy Bill provision -- and, therefore, where the bailout money was going to go? Pas si bête. And plus ça "change"...

How about that Bobby Jindal?

NOTE * Glad to see TPM return to covering the news. More like this, please.

UPDATE ** Ritholtz, too. Ditto the Times:

the rescue of A.I.G. also involved a bailout of its many customers, none of whom the insurer or the government is willing to identify.

Nevertheless, Edward M. Liddy, the chief executive of A.I.G., explained to investors last week that “the vast majority” of taxpayer funds “have passed through A.I.G. to other financial institutions” as the company unwound deals with its customers.

On Wall Street, those customers are known as “counterparties,” and Mr. Liddy wouldn’t provide details on who the counterparties were or how much they received. But a person briefed on the deals said A.I.G.’s former customers include Goldman Sachs, Merrill Lynch and two large French banks, Société Générale and Calyon [which is not the same as hedge funds... Unless these banksters, in their turn, passed the money along... It really is exactly like a shell game, isn't it?].

All the banks declined to comment.

How much money has gone to counterparties since the company’s collapse? The person briefed on the deals put the figure at around $50 billion.

Unfortunately, that is likely to rise.

According to its most recent financial statements, A.I.G. had $302 billion in credit insurance commitments at the end of 2008. Of course, the company is not going to have to make good on all that insurance: the underlying securities are not all going to zero.

But as the economy deteriorates, A.I.G.’s insurance bets certainly become more perilous. And because most of A.I.G.’s swaps are known as the “pay as you go type,” collateral must be supplied when the underlying debt declines in value. Swap arrangements made by other insurers require payments only if a default occurs.

So the meter is constantly running at A.I.G. Just as quickly as taxpayer funds flow into the firm, chunks of it go right out the door to settle derivatives claims.

Yay!

Since both TPM and Big Picture are right next door to the saner version of the Conventional Wisdom, I'd say the lid won't be kept on this story much longer, and a scapegoat will have to be found, so that the looters can keep most of their money. (It's notable that although the FKD in Congress is terrific at getting the Fed to say "I won't tell you anything," they haven't, so far, sent the Fed, or Treasury, so much as one sternly worded letter. They know the drill.) Let the airbrushing begin!

NOTE Speaking of mobilizing money....