You are currently viewing our forum as a guest, which gives you limited access to view most discussions and access our other features. By joining our community, at no cost, you will have access to post topics, communicate privately with other members (PM), respond to polls, upload content and access many other special features. Registration is free, fast and simple, so please join our community today!
Since this subsection is starting to devolve into BS once again, let's get back on track.
Quote:
Originally Posted by Joe Nocera
Talking Business - Propping Up a House of Cards
By JOE NOCERA
Published: February 27, 2009
Next week, perhaps as early as Monday, the American International Group is going to report the largest quarterly loss in history. Rumors suggest it will be around $60 billion, which will affirm, yet again, A.I.G.’s sorry status as the most crippled of all the nation’s wounded financial institutions. The recent quarterly losses suffered by Merrill Lynch and Citigroup — “only” $15.4 billion and $8.3 billion, respectively — pale by comparison.
At the same time A.I.G. reveals its loss, the federal government is also likely to announce — yet again! — a new plan to save A.I.G., the third since September. So far the government has thrown $150 billion at the company, in loans, investments and equity injections, to keep it afloat. It has softened the terms it set for the original $85 billion loan it made back in September. To ease the pressure even more, the Federal Reserve actually runs a facility that buys toxic assets that A.I.G. had insured. A.I.G. effectively has been nationalized, with the government owning a hair under 80 percent of the stock. Not that it’s worth very much; A.I.G. shares closed Friday at 42 cents.
Donn Vickrey, who runs the independent research firm Gradient Analytics, predicts that A.I.G. is going to cost taxpayers at least $100 billion more before it finally stabilizes, by which time the company will almost surely have been broken into pieces, with the government owning large chunks of it. A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.’s dubious business practices during the housing bubble it pretty much has the world’s financial system by the throat.
If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks “will face their own capital and liquidity crisis, and we could have a domino effect.” A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.
I don’t doubt this bit of conventional wisdom; after the calamity that followed the fall of Lehman Brothers, which was far less enmeshed in the global financial system than A.I.G., who would dare allow the world’s biggest insurer to fail? Who would want to take that risk? But that doesn’t mean we should feel resigned about what is happening at A.I.G. In fact, we should be furious. More than even Citi or Merrill, A.I.G. is ground zero for the practices that led the financial system to ruin.
“They were the worst of them all,” said Frank Partnoy, a law professor at the University of San Diego and a derivatives expert. Mr. Vickrey of Gradient Analytics said, “It was extreme hubris, fueled by greed.” Other firms used many of the same shady techniques as A.I.G., but none did them on such a broad scale and with such utter recklessness. And yet — and this is the part that should make your blood boil — the company is being kept alive precisely because it behaved so badly.
When you start asking around about how A.I.G. made money during the housing bubble, you hear the same two phrases again and again: “regulatory arbitrage” and “ratings arbitrage.” The word “arbitrage” usually means taking advantage of a price differential between two securities — a bond and stock of the same company, for instance — that are related in some way. When the word is used to describe A.I.G.’s actions, however, it means something entirely different. It means taking advantage of a loophole in the rules. A less polite but perhaps more accurate term would be “scam.”
As a huge multinational insurance company, with a storied history and a reputation for being extremely well run, A.I.G. had one of the most precious prizes in all of business: an AAA rating, held by no more than a dozen or so companies in the United States. That meant ratings agencies believed its chance of defaulting was just about zero. It also meant it could borrow more cheaply than other companies with lower ratings.
To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities. Unlike many of the Wall Street investment banks, A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps.
These exotic instruments acted as a form of insurance for the securities. In effect, A.I.G. was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses. And because A.I.G. had that AAA rating, when it sprinkled its holy water over those mortgage-backed securities, suddenly they had AAA ratings too. That was the ratings arbitrage. “It was a way to exploit the triple A rating,” said Robert J. Arvanitis, a former A.I.G. executive who has since become a leading A.I.G. critic.
Why would Wall Street and the banks go for this? Because it shifted the risk of default from themselves to A.I.G., and the AAA rating made the securities much easier to market. What was in it for A.I.G.? Lucrative fees, naturally. But it also saw the fees as risk-free money; surely it would never have to actually pay up. Like everyone else on Wall Street, A.I.G. operated on the belief that the underlying assets — housing — could only go up in price.
That foolhardy belief, in turn, led A.I.G. to commit several other stupid mistakes. When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off. Not understanding the real risk, the company grievously mispriced it.
Second, in many of its derivative contracts, A.I.G. included a provision that has since come back to haunt it. It agreed to something called “collateral triggers,” meaning that if certain events took place, like a ratings downgrade for either A.I.G. or the securities it was insuring, it would have to put up collateral against those securities. Again, the reasons it agreed to the collateral triggers was pure greed: it could get higher fees by including them. And again, it assumed that the triggers would never actually kick in and the provisions were therefore meaningless. Those collateral triggers have since cost A.I.G. many, many billions of dollars. Or, rather, they’ve cost American taxpayers billions.
The regulatory arbitrage was even seamier. A huge part of the company’s credit-default swap business was devised, quite simply, to allow banks to make their balance sheets look safer than they really were. Under a misguided set of international rules that took hold toward the end of the 1990s, banks were allowed use their own internal risk measurements to set their capital requirements. The less risky the assets, obviously, the lower the regulatory capital requirement.
How did banks get their risk measures low? It certainly wasn’t by owning less risky assets. Instead, they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G., and the collateral triggers made the bank portfolios look absolutely risk-free. Which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets. This practice became especially rampant in Europe. That lack of capital is one of the reasons the European banks have been in such trouble since the crisis began.
At its peak, the A.I.G. credit-default business had a “notional value” of $450 billion, and as recently as September, it was still over $300 billion. (Notional value is the amount A.I.G. would owe if every one of its bets went to zero.) And unlike most Wall Street firms, it didn’t hedge its credit-default swaps; it bore the risk, which is what insurance companies do.
It’s not as if this was some Enron-esque secret, either. Everybody knew the capital requirements were being gamed, including the regulators. Indeed, A.I.G. openly labeled that part of the business as “regulatory capital.” That is how they, and their customers, thought of it.
There’s more, believe it or not. A.I.G. sold something called 2a-7 puts, which allowed money market funds to invest in risky bonds even though they are supposed to be holding only the safest commercial paper. How could they do this? A.I.G. agreed to buy back the bonds if they went bad. (Incredibly, the Securities and Exchange Commission went along with this.) A.I.G. had a securities lending program, in which it would lend securities to investors, like short-sellers, in return for cash collateral. What did it do with the money it received? Incredibly, it bought mortgage-backed securities. When the firms wanted their collateral back, it had sunk in value, thanks to A.I.G.’s foolish investment strategy. The practice has cost A.I.G. — oops, I mean American taxpayers — billions.
Here’s what is most infuriating: Here we are now, fully aware of how these scams worked. Yet for all practical purposes, the government has to keep them going. Indeed, that may be the single most important reason it can’t let A.I.G. fail. If the company defaulted, hundreds of billions of dollars’ worth of credit-default swaps would “blow up,” and all those European banks whose toxic assets are supposedly insured by A.I.G. would suddenly be sitting on immense losses. Their already shaky capital structures would be destroyed. A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful.
I asked Mr. Arvanitis, the former A.I.G. executive, if the company viewed what it had done during the bubble as a form of gaming the system. “Oh no,” he said, “they never thought of it as abuse. They thought of themselves as satisfying their customers.”
That’s either a remarkable example of the power of rationalization, or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean it up.
Who’s Really Being Propped Up in the A.I.G. Bailout?
By Joe Nocera
It is a simple enough question: who bought the credit-default swaps that American International Group sold during the housing bubble? And at this point — after Bailout No. 4, with the government handing A.I.G. another $30 billion to go with the previous $150 billion — you would think that the taxpayers would have the right to know that information. Is it Goldman? Royal Bank of Scotland? The Irish banks that are on the verge of collapse? What happened to all that transparency the new administration keeps talking about?
In the wake of my column on Saturday, I received a number of comments here at Executive Suite along the lines of this one:
Joe, I’m trying to find info re: what percentage of these credit-default swaps are “owned” by foreign investors, what percent owned by banks, what percent owned by pension funds. (And if banks are owning them, as your column suggests, which ones?) Seems to me … it’d be helpful to know as A.I.G. continues to be bailed out where exactly the $$$ is going. I’m assuming much of it (most? all?) is going to cover their CDSs. Why this is important? To keep the spin machines honest.
Thanks.
This strikes me as a completely legitimate question. After all, the reason A.I.G. is being propped up is that the government fears that if the company defaulted, the counterparties would suddenly be faced with tens of billions of dollars worth of unacknowledged losses — and they would go bust. It would make the Lehman fiasco look like a garden party. As Nouriel Roubini put it on CNBC recently (I’m paraphrasing): It’s not a bailout of A.I.G.; it’s a bailout of the counterparties.
What’s more, a fair amount of what A.I.G. was doing was pretty sleazy behavior, using credit-default swaps to help banks evade regulatory capital requirements. And yet when newspapers like this one have requested the information, they have been ignored or turned down.
The answer, as I understand it, is that A.I.G. views these as “confidential transactions,” and the government (as per usual?) is going along with that rationale. One government official told me that if the federal government divulged the names of the counterparties it would amount to a violation of the Trade Secrets Act — unless the counterparties agreed to it, which they never will.
Pretty unsatisfying, isn’t it? Gobs of tax money is going to bail out unnamed companies — and yet we aren’t allowed to know who they are, and are supposed to take it all on faith. You know those awful cases you read about every once in a while where a child dies in a troubled home — and then the state health department won’t divulge any information out of “privacy concerns”? This strikes me as the financial equivalent of those cases. As excuses go, it sure is convenient.
AIG I love you. Gov't I love you. You're going to make me wealthy
beyond my wildest dreams. My only concern is where the USD is
going to come to rest post financial apocalpyse. Sigh.
...the TAKE of the MIllenium continues...$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
in all seriousness they should just let AIG fail, but it will never happen. the vast majority of its credit default swaps are for European banks who were able to use a greater leverage than their American counterparts because of the insurance of the credit default swaps.
if AIG goes some of the largest banks in Europe will go.
__________________
Only when you have lost everything can you truly accomplish anything.
The market can stay irrational longer than you can stay solvent. -John Maynard Keynes
IMO you either go 0% or all the way. We've committed to this stupid plan so we might as well throw everything at it in some kind of hope that it will work. Whatever.
When does one say "when", though? And if AIG isn't doing good a year from now.. what then? How much money does a company need?
Bush and Obama have had a hand in these bailouts, it's not a dem or repub issue. It's stealing from us to prop up failing, mismanaged companies. This is a bipartisan issue every American should be up in arms about. No company is ever too large to fail.
AIG Told U.S. Failure May Cripple Banks, Money Funds (Update4)
By Hugh Son and Scott Lanman
March 9 (Bloomberg) -- American International Group Inc. appealed for its fourth U.S. rescue by telling regulators the company’s collapse could cripple money-market funds, force European banks to raise capital, cause competing life insurers to fail and wipe out the taxpayers’ stake in the firm.
AIG needed immediate help from the Federal Reserve and Treasury to prevent a “catastrophic” collapse that would be worse for markets than the demise last year of Lehman Brothers Holdings Inc., according to a 21-page draft AIG presentation dated Feb. 26, labeled as “strictly confidential” and circulated among federal and state regulators.
“What happens to AIG has the potential to trigger a cascading set of further failures which cannot be stopped except by extraordinary means,” said the presentation by New York-based AIG. “Insurance is the oxygen of the free enterprise system. Without the promise of protection against life’s adversities, the fundamentals of capitalism are undermined.”
Regulators revised AIG’s bailout last week to ease loan terms and extend $30 billion in fresh capital after the firm posted a $61.7 billion fourth-quarter loss, the worst in U.S. corporate history. Lawmakers are reluctant to give more support beyond the package already in place, worth about $160 billion, because they say regulators haven’t given enough detail about how the funds are being used or when the bailouts will end.
The Fed is “asking for an open-ended check” and is “not going to get” it, Senator Robert Menendez, a New Jersey Democrat, said last week in Congressional hearings.
Global Impact
AIG warned of turmoil around the globe if the government allowed the insurer to fail, adding “it is questionable whether the economy could tolerate another shock to the system that a failure of AIG would produce.” The value of the U.S. dollar might fall, Treasury borrowing costs could rise and the agency would face “doubts about the ability of the U.S. to support its banking system,” according to the presentation, parts of which were reported earlier by the New York Times. The municipal bond market would be stressed and Boeing Co. could lay off workers if AIG’s plane-leasing unit folded, the company said.
“It seems like they’re reaching on this litany of claims they’re making, some of which aren’t supported” by facts, said Haag Sherman, who helps oversee $8 billion as chief investment officer of Houston-based Salient Partners. “They are correct that without the government stepping in, you’d see big holes blown in the equity of American and European banks.”
Overseas Seizures
Under the scenarios sketched by AIG, European banks that bought credit-default swaps might need to raise $10 billion in capital and could face rating downgrades. Life insurance customers, their faith shaken in the industry, would redeem some of their $19 trillion in U.S. policies, overwhelming firms already weakened by the credit crisis, AIG said.
The $38 billion in support provided by the firm to money- market funds would be in jeopardy, AIG said, possibly forcing some to “break the buck.” The term refers to a money fund that suffers losses so large that it must pay investors less than the traditional $1-a-share value that gives the short-term funds their reputation for safety.
Outside the U.S., where AIG operates in more than 140 countries, a collapse could lead to the “immediate seizure” of its businesses by regulators and could impair “the entire insurance industry within certain regions,” the presentation said, which added that its conclusions were “speculative” and a matter of judgment.
Creating ‘Crisis’ Atmosphere?
“Who knows if what they’re saying is true?” said Phillip Phan, professor of management at the Johns Hopkins Carey Business School in Baltimore. “A lot of it sounds like conjecture, that if AIG collapses the rest of the industry will, too. It’s a way of creating a crisis atmosphere and the sense you have to respond quickly.”
Fed spokeswoman Michelle Smith said the central bank “came to its conclusions based on our own analysis.” Christina Pretto, an AIG spokeswoman and Isaac Baker of the Treasury declined to comment.
If AIG were forced to liquidate its investments, it would have “enormous downward pressure” on asset classes including municipal bonds, the firm said. The company’s commercial insurance division owns more than $50 billion in muni bonds.
AIG’s International Lease Finance Corp. is the world’s biggest aircraft lessor by plane value, and its failure would jeopardize $12.5 billion in orders, causing job losses at Chicago-based Boeing. ILFC would have to sell its 1,000 planes at distressed prices, “severely impacting” the aircraft industry. Banks and pension funds holding about $30 billion in ILFC debt would take losses, the company said.
European Banks
European banks named by AIG as potentially needing capital if the insurer fails include the Royal Bank of Scotland Group Plc, Societe Generale SA, BNP Paribas SA, Banco Santender SA, Danske Bank A/S, Rabobank Group NV, Credit Logement SA and Credit Agricole SA’s Calyon.
Danske Bank has insured a third of its mortgage bonds through AIG, which promises a payout of $200 million in case of “extreme high losses,” the Danish lender said in a statement. The agreement can be annulled in 2010 and AIG has not yet paid out any money, Danske bank said.
Credit Logement Chief Financial Officer Eric Veyront said in a telephone interview that the firm “wouldn’t be directly touched by an AIG failure.” The company estimates it has about 10 million euros at risk “at a maximum” on credit-default swaps where AIG is counterparty, he said.
Rabobank sold assets insured by AIG at yearend, effectively ending the contracts, said Raymond Salet, a spokesman for the Utrecht, Netherlands-based bank. The transaction didn’t impact Rabobank’s annual results, he said. Representatives from RBS, Societe Generale, BNP, Santander and Calyon didn’t immediately have comment.
Buffett Supports Bailout
AIG’s latest rescue package includes equity, new credit and lower interest rates on existing loans designed to keep it in business. Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner have said the government must prop up AIG to avoid damaging the financial system.
Billionaire Warren Buffett, appearing on CNBC today, said the bailout of “quasi-financial” firms like AIG was necessary, even if everyone dislikes what had to be done to salvage it.
New York Insurance Superintendent Eric Dinallo said at a March 5 hearing he had received the presentation.
The document doesn’t say which other companies have benefited from AIG’s repeated rescues. Goldman Sachs Group Inc. and Deutsche Bank AG were among at least two dozen financial institutions that were paid $50 billion from the bailout funds received by AIG, the Wall Street Journal reported, citing a confidential document and people familiar with the matter whom it didn’t identify.
Goldman and Deutsche got about $6 billion each between September and December, the Journal said. Merrill Lynch & Co., Societe Generale, Morgan Stanley, Royal Bank of Scotland and HSBC Holdings Plc were other counterparties that also received payments, the newspaper said, citing the document.
Taxpayer Wipeout
AIG’s presentation said that without more U.S. help, investment losses would mean “AIG will not be able to repay its obligations” and that cash previously provided by the U.S., which controls a 79.9 percent stake in the insurer, could be lost. Chief Executive Officer Edward Liddy, who took over the top job in September, has vowed that AIG will repay all of its debts to taxpayers.
At AIG itself, failure could have led to dismissals from its workforce of 116,000, the document said. At that level, the staff is unchanged from the end of 2007 before AIG’s bailout. The global credit crunch has led to at least 284,000 job cuts at the rest of the world’s financial companies, according to Bloomberg data.
The insurer’s first bailout package, crafted last September, later grew to $150 billion. After failing to sell enough subsidiaries to repay the government, AIG had to turn to U.S. taxpayers again. The company may need more support if financial markets don’t improve, the Treasury and Federal Reserve said last week in a joint statement.
You would think that people that leveraged with AIG would have been bailing already which would reduce this risk, but I imagine there is nowhere to go with those kind of numbers.
Bush and Obama have had a hand in these bailouts, it's not a dem or repub issue. It's stealing from us to prop up failing, mismanaged companies. This is a bipartisan issue every American should be up in arms about. No company is ever too large to fail.
I agree. No bailout for people buying homes they cant afford nor businesses. It seems like in America we have opted to fix a problem without thinking we have to accept the pain of fixing it.
__________________
Jeff Wisener
350Z Editor
Nissan Sport Magazine
in any case...i guess it depends on you describe it..., AIG is destined to dissapear anyways(fail), Fed will take risk on bad assets, and good assets will be sold back to private investors. even if a new company rises up from the pieces that were good of AIG ,i wont be called AIG....in the short term ..ugh... sucks ass....imo sorry aig shareholders but you were going down anyways...just nationalize it already(short term).
I agree. No bailout for people buying homes they cant afford nor businesses. It seems like in America we have opted to fix a problem without thinking we have to accept the pain of fixing it.
AIG should have never been allowed to take on that much risk/exposure, you have to understand that people that were buying credit default swaps from AIG were doing the right thing, but AIG was not. I would be all for AIG failing if it just affected AIG, but it doesn't only affect them. They were the insurer for all the mortgage securities which people bought in case the market went tits up, which it did. AIG just didn't expect everyone to come calling at once and basically it was a run on the bank..
Letting AIG fail would be rough... and would cause a lot more damage that would take a lot longer to fail. I don't think historically there has been a company like AIG in such a bad position with the collatereal damage that you could even compare this against.
no they were not doing the right thing. they all have risk analysis units. they all failed in their duties.
Exactly. That's what these risk management tools are being paid to do, assess risk and act accordingly. But apparently they never factored failure into their algorithms.
Let this company die already, these bailouts are just preventing the market from reaching a true bottom. Let's deal with the pain immediately if it means a stronger and more stable economy to build off of in the future, just get it over with already. AIG is just using scare tactics to con the government into preventing the eventual meltdown of their company. It borders on a direct threat, really. "Save us or your world will BURN!"
AIG Continual Bailout
