Who Broke AIG?

Last weekend AIG released information about the amounts and recipients of roughly $100 billion of its government loans from September to December 2008.  The utterly unreported surprise is that the staid, boring, heavily regulated insurance businesses managed to run up losses on securities lending requiring $44 billion of government support.  By way of contrast, the credit derivatives widely blamed for bringing down the world's financial system were consuming $27 billion of direct government support [and another $27 billion of indirect support, totaling $54 billion]; municipal investment agreements (essentially, deposits) made by municipalities with AIG Financial Products took another $12 billion, and maturing debt took $13 billion. 

Why the misdirected coverage?  My guess is that we are seeing an unholy alliance of insurance regulators who would rather point the finger at unregulated credit derivatives, people who always favor more regulation as the answer to everything, and public officials who don't want people to wonder whether other staid, boring insurance companies that don't do credit derivatives might still have huge problems in their core portfolios.  Since securities lending lacks the glamour of M&A or international "Master of the Universe" trading, the media is easily distracted.

Let's cut to some numbers:

Government support of AIG - Where Did The Money Go

Insurance Divisions
Securities lending:                      $44.0 billion

AIG Financial Products

Credit Derivatives - collateral           $22.4
Credit Derivatives - Maiden Lane equity   5.0
Credit Derivatives through Maiden Lane: 27.4

Municipal Investment Agreements           12.1
Maturing Debt                              12.5

Total:                                   $123.4

The recipients of payments for the securities lending is a Who's Who of global finance and reeks of systemic risk; here are the top names:

Barclays    $7.0 billion   
Deutsche Bank  6.4
BNP Paribas  4.9
Goldman Sachs  4.8
Bank of America 4.5
HSBC  3.3
Citigroup  2.3

Yet how is this presented in the media?  Its all about AIG FP.  Here is ABC News today reporting on the AIG bonuses and the upcoming Congressional hearing:

The CEO of the bailed-out insurance giant AIG will take the hot seat today in a congressional hearing, but may be hoping to cool things off with a report that he will send a letter to AIG executives asking them to return $165 million in bonuses.

The testimony of Edward M. Liddy, who took over as AIG's CEO in September as part of the government's rescue efforts for the embattled firm, will come days after a furor erupted over the revelation that AIG awarded fat retention bonuses to employees of the AIG Financial Products unit.

The Financial Products unit is blamed for plunging AIG into the financial turmoil that eventually led the government to lend and invest about $170 billion in taxpayer money in the company.

After a big skip we get this:

Part of the purpose of today's hearing is to examine how AIG arrived at its "terrible situation" and why it is receiving so much taxpayer money, according to a statement issued by the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises.

"Taxpayers do not understand how AIG ended up in such a terrible situation, nor do they understand why the federal government continues to give it money," Rep. Paul E. Kanjorski, D-Pa., the chairman of the subcommittee, said in the statement. "We must assess AIG's progress, as well as how we move forward to ensure that any taxpayer money AIG receives is spent efficiently and effectively."

In addition to Liddy, witnesses scheduled to testify at today's House AIG hearing include Joel Ario, the insurance commissioner for the Pennsylvania Insurance Department; Scott Polakoff, the acting director of the Office of Thrift Supervision; Orice M. Williams, the director of Financial Markets and Community Investment at the Government Accountability Office; and Rodney Clark, managing director of insurance ratings at Standard & Poor's.

Stable Insurance Companies, Shaky Hedge Fund?

Ario told ABCNews.com Tuesday that today's hearing represents "another opportunity for us to clarify the difference between the financial products which are regulated -- to the extent it was regulated at all, by the federal government -- and the insurance companies which are regulated by, we think, a very effective state-based regulatory system."

Ario said he agreed with Federal Reserve chairman Benjamin Bernanke, who has described AIG as a hedge fund attached to a large, stable insurance company.

That hedge fund, said Ario, was AIG's Financial Products unit and that is "what's caused systemic risk in this case."

"The larger, stable insurance company is the 71 separate domestic insurance companies of AIG," Ario said. "They've had some difficulty because of the problems at the holding company level but basically they were not the cause of the systemic risk and they remain large and stable insurance companies."

The problem of "systemic risk" is what AIG and bailout proponents cite in arguments in support of the government's multibillion-dollar AIG rescue.

Look, I understand why an insurance commissioner who failed to do his job would like to point the blame elsewhere; I even understand why people who champion more regulation as the answer to every problem are willing to play along and blame unregulated credit derivatives.  I even understand why public officials (like Bernanke) who want to promote public confidence in the insurance industry and its regulators will prefer to point at credit derivatives (since AIG was alone among insurance companies in this activity in a way it is probably not alone with securities lending). 

I am less sure why the media is willing to play along.  And to be fair, Sen. Shelby took a tough line with NY State Insurance Commissioner Eric Dinallo at a March 5 Senate hearing, as reported in the Times:

Mr. Shelby expressed doubts that A.I.G.’s state-regulated insurance companies were entirely innocent. He said they had engaged in a risky securities lending business and ended up needing $35 billion of the Fed’s bailout last fall.

“Are you trying to evade your responsibility?” he asked Mr. Dinallo. “You can claim here today that you have little responsibility for all of these problems?”

Mr. Dinallo said that it was true that the securities in the lending program were the property of A.I.G.’s insurance companies, but that the lending activity had been orchestrated by another part of A.I.G. — a special unit set up and controlled by A.I.G. the holding company. State regulators had no jurisdiction over the special unit, but it could layer big risks back onto the insurers, he said.

In any case, Mr. Dinallo said that the New York State Insurance Department spotted the problem in 2006 and began quietly working with A.I.G. to unwind the risky investments. But they ran out of time. Only about a quarter of the portfolio had been cleaned up by the time last September’s crisis struck.

Dinallo's full CYA finger-pointing is in his testimony.  The numbers not available on March 5 refute this claim:

Financial Products' trillions of dollars of transactions created systemic risk. Securities lending did not.

Let's snip this:

AIG securities lending was consolidated by the holding company at a special unit it set up and controlled. This special unit was not a licensed insurance company. As with some other holding company activities, it was pursued aggressively rather than prudently.

AIG maintained two securities lending pools, one for U.S. companies and one for non-U.S. companies. At its height, the U.S. pool had about $76 billion. The U.S. security lending program consisted of 12 life insurers, three of which were from New York. Those three New York companies contributed about 8% of the total assets in the securities lending pool.

The program was invested almost exclusively in the highest-rated securities. Even the few securities that were not top rated, not triple A, were either double A or single A. Today, with the perfect clarity of hindsight, we all know that those ratings were not aligned with the market value of many mortgage-backed securities, which made up 60 percent of the invested collateral pool.

As early as July 2006, we were engaged in discussions about the securities lending program with AIG. In 2007, we began working with the company to start winding down the program.

Unfortunately, the securities lending program could not be ended quickly because beginning in 2007 some of the residential mortgage securities could not be sold for their full value. At that time there were still few if any defaults, the securities were still paying off. But selling them would have involved taking a loss.

Still, we insisted that the program be wound down and that the holding company provide a guarantee to the life companies to make up for any losses that were incurred as that happened. In fact, the holding company provided a guarantee of first $500 million, then $1 billion and finally $5 billion.

And what is the guarantee of an insolvent holding company worth?  Or, how would the insurance subs have been helped by the return of formerly AAA housing bonds? 

Let's close with Dinallo's explantion that AIG Financial Products sneezed on his house of cards:

At that point, the crisis caused by Financial Products caused the equivalent of a run on AIG securities lending. Borrowers that had reliably rolled over their positions from period to period for months began returning the borrowed securities and demanding their cash collateral. From September 12 to September 30, borrowers demanded the return of about $24 billion in cash.

Cash which was not available, despite Dinallo's rigorous oversight.

Here is Sen. Shelby yesterday calling for wholesale revisions to the regulation of insurance companies:

AIG’s insurance subsidiaries suffered more than $20 billion in losses from their securities lending operations and had to be recapitalized with a loan from the Federal Reserve, Shelby said.

“The circumstances that permitted AIG’s securities lending operations to potentially threaten the solvency of several of its insurance companies and their counterparties suggest that our regulatory system has not been keeping up with developments in the market,” Shelby added.

We will see which way the wind blows today.

For background, Bloomberg reported on AIG's securities lending losses last year and gave some background.  Sorry, no highly paid traders or exotic locales to hold your interest.  But you get a trip to Texas!

``We were aware of this portfolio, but we didn't have transparency on what was in it because it was off-balance sheet'' in the company's statutory accounting reports, said Doug Slape, chief analyst at the Texas Department of Insurance in Austin, which oversees three AIG insurers that have suffered about 60 percent of the writedowns.

Whining is allowed in Texas?  I try to learn something new every day.

STILL MORE:  Some background on losses in securities lending at pension funds and asset managers.

Comments

[Appalled]

What might be interesting is seeing what events were triggering the payouts in the securities lending business. Is there any disclosure of that?

I am sure the media will be on top of status of the AIG corporate jet. But i wonder igf anyone has the intellectual curiosity to answer my reasonably simple question.

[Charlie (Colorado)]

I swear to God, I'm beginning to think the general journalistic reaction to this whole thing is "But I went to Journalism school because they said there was no maaaaath!"

[clarice]

The jig is up--or almost so --for the Obama deflection on AIG:
http://www.americanthinker.com/blog/2009/03/aig_bonus_outrage_exposed_as_a.html>Who do you rhink you're kidding?

[Charlie (Colorado)]

I'm also a little confused about this furor about the AIG money being paid out to other big banks -- some people calling it "laundering" even.

(1) The reason AIG was important was that it was counter-party to so many big deals and owed out so much money.
(2) Winding down the business would mean settling those deals.
(3) That means paying what AIG owes.
(4) Guess who the counter-parties are going to be?

[Charlie (Colorado)]

The jig is up

racist.

[Foo Bar]

As I pointed out on another thread, I think your totals are wrong, TM. Your $27 billion total in support of credit derivatives is too low because it leaves out $22 billion in collateral postings related to credit default swaps and $5 billion in equity for Maiden Lane III, an entity used for cancelling credit default swap contracts by buying back the underlying bonds.

[Pofarmer]

"But I went to Journalism school because they said there was no maaaaath!"

How many J school students have you known? My wife roomed with a couple. Oh, the stories.

[Charlie (Colorado)]

Not that many, but that was a quote from one of the ones I have known.

[Foo Bar]

Actually, let me clarify what I wrote earlier. I'm not sure if you're leaving out the payments related to collateral postings or the $27 billion in Maiden Lane III payments to credit default swap counterparties, but it looks like you're leaving out one or the other.

[DebinNC]

Hot Air wonders about Freddie Mac's retention bonuses: LUN

[Donald]

I'm starting to think that the guy with the stories about a crack smoking, blow job giving Barry are true. I mean, there is no grip on reality here. Fuck you Obamites. You are the stupidest of the stupids.

[Cecil Turner]

Your $27 billion total in support of credit derivatives is too low because it leaves out $22 billion in collateral postings related to credit default swaps and $5 billion in equity for Maiden Lane III . . .

AFAICT, the 27 billion he notes is precisely those two amounts. If there's something else in there, I'm not seeing it. (But I'll freely admit reading those types of reports ain't my cup of tea.)

[Tom Bowler]

I'm trying to imagine how AIG could lose $44 billion in a securities lending operation. Here's a thought: they could have been lending out of their portfolio of stocks or bonds, and making their spread on the cash collateral they received by investing in Lotto tickets -- or maybe mortgage backed securities.

Or... maybe they borrowed mortgage backed securities, handing over cash collateral to firms that then went belly up. Could they be acting as broker/dealer for their own hedge fund? Borrowing to sell short? And the counterparties left town rather than take back the CMOs! Oooh tough break! But then, can you even sell those things short?

On the other hand... that's an impressive list of counterparties receiving AIG collateral payments. Collateral for what? They borrowed something that went up in value and had to hand over more collateral? Or AIG originally gave them non-cash collateral -- mortgage backed securities -- that went way down in value. Hence the need to pony up.

I don't know. But whatever AIG did, Congress and Obama will most likely want to step in to regulate securities lending because it's connected with Wall Street, which as we all know is very evil. Hope and change!

[Foo Bar]

AFAICT, the 27 billion he notes is precisely those two amounts

As I said in my second comment, it's actually not clear which portion of the total cost of supporting AIG's credit derivatives activity TM is leaving out, but I'm pretty sure he's leaving out something on the order of $20 billion or so.

If you go back to the original AIG press release TM posted, you'll see that it explains that AIG CDS counterparties received $22 billion in collateral between 9/16/08 and 12/31/08. These counterparties are disclosed in Attachment A of the doc. Additionally, on 11/10/08, Maiden Lane III was formed for the sake of cancelling CDS contracts by purchasing the underlying securities from the counterparties. Attachment B explains that there was $27 billion in payments under this program as well. So that's a total of $49 billion.

[matt]

Hey, I didn't get a harrumph out of you!

This whole thing is descending into farce..posturing worthy of a Noh play.....

[Don]

Then read Attachment B, and tell me what that money was used for.

[Tom Bowler]

Apparently, Douglas Appell favors the Lotto option in my earlier comment:

Institutional investors thought the collateral was invested in safe, plain-vanilla securities. Somewhere after 2000, however, the range of permissible investments was expanded to include things such as asset-backed securities and home equity loans, which have been eviscerated by the credit crisis, said Cynthia Steer, chief research strategist with investment consultant RogersCasey, Darien, Conn.

[Fresh Air]

It seems to me that securities lending by its nature features a built-in colinear risk in that one of the major reasons to borrow a security is to cover a short. A security that is already short is believed by the borrower or its client(s) to be heading down. Egads. An institutional investor called it "picking up nickels in the street." Expensive goddamned nickels.

Charlie--

I went to J-School. Yes, most of the people there can't do math...or physics...or chemistry...or law...or economics...or logic...or reason...or...

[PD]

The jig is up

racist.

But Obama claimed to be part Irish yesterday.

[Charlie (Colorado)]

An institutional investor called it "picking up nickels in the street." Expensive goddamned nickels.

Or maybe just a whole lot of them.

[Mike K]

An institutional investor called it "picking up nickels in the street." Expensive goddamned nickels.

That is actually a quote from Long Term Capital Management story, which is the preview for this double feature. "When Genius Failed" is the book and it predicts this crisis almost perfectly. Until the book is written about this story in a few years, that is probably the best explanation in print.

These posts are also an excellent source.

[Charlie (Colorado)]

But Obama claimed to be part Irish yesterday.

Dancing a jig would be worse.

And God help you if you say "Irish jig" now.

[SteveM]

I'm also a little confused about this furor about the AIG money being paid out to other big banks -- some people calling it "laundering" even.

I guess you are, because the furor is not over AIG money being paid to big banks, it's over taxpayer dollars beng paid to big banks.

AIG functions as a shell company in this process, allowing the politicians to distance themselves from what's going on.

If Congress was giving money directly to banks, including European banks like Barclays and Deitsche Bank, you'd see a political firestorm. Doing it via AIG, a supposedly "independent" entity (wink) is a purely political ploy. It would be cheaper for Congress to cut out the middle man and pay the money directly to Goldman-Sachs etc.

But considering that Goldman-Sachs is also an arm of the Democratic Party, that might look bad enough that even the media woud finally start to ask questions.

[matt]

derivitive junk
AIG knowingly sold
Obama Dodd cashed in

[Jim Ryan]

I voted for him?
How many friends did I tell?
Just act natural...

[kim]

Wake up this morning
On big Mock Obama Hill.
On Broke Bank Mountain.
=========================

[Cecil Turner]

Attachment B explains that there was $27 billion in payments under this program as well. So that's a total of $49 billion.

Well, I admit not being able to make much sense of this thing, but it's fairly obvious that doesn't add up. Per the disclosure, we're talking about a total of $85 billion in the public money emergency loan, and $43.7bil of it was spent on securities lending operations. Any way you look at it, that's a majority. Unfortunately, any way you add up the numbers, they also come up to more than $85 bil.

The discrepancy appears to be how much of the public money was spent on each of the various programs, and the one attachment that doesn't purport to be direct use of public funds is the ML III one (though they mention in the text that some of the public money was put to that use). It's going to take a smarter guy than me to unravel all this, but in any event, counting 27 billion in payments without noting $2.5 bil is back to AIG, and counting $5bil in equity and then adding all the payments appears to be double counting.

[Joe Y]

Everyone here is almost all or completely wrong. There is no mystery to what happened. This is a failure of Fredie and Fannie, pure and simple. The whole financial system is--was--built on the credibility of these securities. Any insurance company, bank, or institutional investor would see a Fannie/Freddie security with the highest rating as the 2nd safest security possible, after Federal paper. If you don't believe me, pick up any Series 6 or 7 exam prep book, and it will confirm this. I found my old one and it said this quite clearly, adding that "although these securities are not officially guaranteed by the US government, it is assumed that the federal government will not allow a default." EVERYONE in the financial community knows this--or thought they knew it. Until the last few months, the only criticism an institutional investor would get for buying these securities was that they were being too conservative. And that's the truth, Ruth.

[Enlightened]

AIG bailout #1 = $85.0 Bil
AIG Bailout #2 = $37.8 Bil
Total: $122.8 Bil as of Nov 10 2008

Payouts:
AIGFP: $52.0 Bil
AIG: $43.7 Bil
Maiden III: $27.1
Total: $122.8 Bil

[Foo Bar]

Per the disclosure, we're talking about a total of $85 billion in the public money emergency loan

No, the initial loan was $85 billion, but total assistance to AIG in one form or another has since grown to $170 billion.

counting 27 billion in payments without noting $2.5 bil is back to AIG, and counting $5bil in equity and then adding all the payments appears to be double counting.

That's a fair point. Thanks for pointing that out. However, it doesn't change the fact that TM is overlooking tens of billions of dollars.

[Enlightened]

"AIG is using some of the cash from a recently announced sale of preferred shares to the U.S. Treasury Department to buy $5 billion in Maiden Lane III stock.

The New York Fed, the sole managing member of Maiden Lane III, has lent $15.1 billion to the entity and could lend up to a total of $30 billion, AIG says.

AIG can ask for additional drawdowns, up to the $30 billion limit, by giving the New York Fed 3 days’ notice, according to a senior loans funding provision in the Maiden Lane III master investment and credit agreement.

Maiden Lane III is supposed to pay back the New York Fed over 6 years using cash flowing from CDOs that are still performing. The interest rate will be equal to the 1-month London Interbank Offered Rate for dollars plus 1 percentage point.

Once the entity repays the New York Fed, the New York Fed will get 67% of any remaining amounts, and AIG will get 33%, AIG says.

LUN

[jag]

Having worked in Sec Lending at Mellon/Boston Safe in the 90's when our group extended maturities in the portfolio too far, I thought no one could ever be so stupid again.

That was a piddling loss compared to this fiasco. Sec Lending IS a riskless business if it is run CONSERVATIVELY. Don't stretch the maturities, don't dip down in quality and you should be able to whether any storm as well as make a "free" .5-1% on the portfolio (net).

Apparently an extra, riskless, 1% or so wasn't good enough for the managers or their clients. They both deserve to be fired. I was because I questioned the portfolio back in the day. It was fun reading about Mellon blowing up some 6 months later, being right but it was a total waste of money by arrogant tools.

[Fat Man]

The feigned outrage over “bonuses” to AIG employees is like a three card monte game. The real purpose is distract the spectators while the card players confederates pick their pockets. AIG was a conduit for over $170 billion to its counter-parties like Goldman Sachs. The “bonuses” were 1/10th of 1% of that amount, and what is worse, 1/100th of 1% of the $1.5 trillion that Congress has appropriated since Jan 20. The spectators are the taxpayers. The three card monte players are the politicians.

[bad]

How many J school students have you known?

I know a couple who are both J school grads. Their oldest child is a pathological liar and manipulator.

[Charlie (Colorado)]

Fat man, on the "conduit" thing, as Cathyf and I pointed out previously, in the real world that's called "paying your debts." The reason AIG needed the bailout was so that they wouldn't default to all their big counter-parties. What did you think they were going to do with the money?

[Fat Man]

In the real world companies that run out of money, don't get some hot off the press at the federal reserve to pay their debts, they file bankruptcy and everybody gets to go to court and work out something like a fair arrangement.

If the fed thought Goldman Sachs needed the money they could have given it to them directly, and received a good note for it rather than stuffing through AIG where they get bad paper.

The sin here is the Fed's that they used the AIG transaction as a bailout for banks that should have been floated separately and with due consideration.

[Mo MoDo]

Maureen Dowd calls these banks double dippers because they are getting direct subsidies and back door payments through AIG.

[mel]

jag-

What about the rash encounter with debt ratings that are hollow?

That's what got the lending arm at AIG. They trusted the ratings.

When the bids disappeared, they were screwed. Their collateral became black holes, and sucked more of where that came from, right behind it. Insurance companies in this situation would be forced to liquidate everything they owned to keep up with the collateral replacement. That's what started the meltdown in September.

Now I really have to go to bed.

Night all.

[cathyf]

Ok, I have to admit to being a little confused... The way I understand the problems in the securities-lending business is not the lending of the securities, but what they did with the collateral. So:

-- AIG owns a portfolio of stocks.

-- Some short sellers borrow the stocks so that they can sell them short.

-- The short sellers give AIG money for borrowing the stocks.

-- AIG takes the money and invests it.

-- The short sellers return the stocks when they are done with them, and AIG returns the money to the short sellers, but gets to keep the investment income that they earned while the short sellers had the stocks.

The problem, at least as I understand it, is that the investments that AIG made were buying MBOs. While that may indeed be a failure in the securities lending business, it's not a failure of the securities lending business. A failure of the securities lending business would be where the borrowers took the securities and didn't bring them back or something like that.

I don't think that you can really make this sort of distinction between the losses in the securities lending business from MBSs losing value and losses in the CDS business from MBSs losing value. It's like something my econ professor said about the Continental Bank bailout -- when a big part of your business is loaning to oil drillers, residential mortgages in Houston do not qualify as "diversification."

[kim]

I'm a little surprised the ratings agencies aren't under a lot more heat. Sure, they had garbage to rate, so why didn't they label it garbage? They were not under compunction to make risky loans, like the banks were.
=======================================

[Robert Arvanitis]

Tom:

You're right that execs, regulators and rating agencies all blundered badly, missing the fatal interaction of two uncoordinated silos -- FP and securities lending.

But the fundamental error was to treat credit risk like any other insurable risk.

Credit is not diversifiable and actuarial methods do not apply. Note that banks, hedge funds, and traders all try to match their books, while insurers are always net takers of risk. Letting FP be a one-sided seller of credit was fundamentally stupid.

(And yes, that flaw applies to the Ambacs and MBIAs of the world. When municipal bond writers act as a sort of "title insurer" that may be a good service business, but taking actual corporate risk is not.)

FP is clearly to blame, clearly the origin of the fire, with accelerant.

So how did execs, regulators and rating agencies ALL fail so spectacularly? The short answer is misalgned feedback systems. Glad to share a short paper on this idea: "Rube Goldberg Woulda Been Proud."

[kim]

Heh, so we got loudspeaker screech insteaad of high fidelity. I like it.
======================================

[SteveM]

as Cathyf and I pointed out previously, in the real world that's called "paying your debts."

It is not paying your debts when you do it with other peoples money. AIG is not paying any debts. AIG is bankrupt and has zero money. The US taxpayer is paying its debts. Why?

If we want to give money to Goldman-Sachs, and that is what we are really doing, why are we doing it via AIG?

[boris]

why are we doing it via AIG?

One way of looking at what's going on is how wasteful it would be to pour in billions of taxpayer dollars to prop up AIG and GS then sabotage the effort so they fail anyway.

The other way to look at it is "faster please". FUBAR the system so bad that the electorate pushes the Reset Button in 2010.

[cathyf]

If we want to give money to Goldman-Sachs, and that is what we are really doing, why are we doing it via AIG?

Well nobody is reading this thread, so this is basically futile, but anyway, I'll take that as a serious question...

Banks are somewhat different sorts of institutions -- all businesses deal with credit risk, but at a bank, taking credit risk in exchange for money is their core business. What this means is that creditworthiness, and explicit actions which occur in response to "credit events" are explicitly written into financial contracts, whereas in other businesses this stuff is implicit and relies on the bankruptcy code.

So company XYZ declares bankruptcy, but they still have substantial assets, and an ongoing business, and they reorganize, emerge from bankruptcy. You are company XYZ's landlord. They manage to keep paying rent to you throughout the whole process. You have no legal right to any recourse against them because they are still paying you.

Now suppose AIG were to declare bankruptcy because mark-to-market says that their assets are worthless so they are insolvent. But those MBSs keep paying off every month because only a small fraction of mortgage payers are in default, so even though the "market value" is zero, the cash keeps rolling in, and so AIG has the money to pay their obligations. Well, their landlord wouldn't have cause against them, but their counterparties would -- because the credit event of the "insolvency" has effects which AIG and the counterparties are contractually obligated to follow through on. That's true even if the insolvency is an accounting fiction and the company never runs out of money.

Think of it like this: my electric utility went bankrupt a few years back. It's a regulated utility, so my power never stopped coming down the wires, I never stopped paying bills, quite frankly, I never really noticed. Now imagine if my mortgage, and every mortgage in the state, had a clause in it that said that if the electric company went bankrupt then my mortgage was instantly called in and I had five business days to come up with my principal, paid in full. You better believe that I would care if the power company was technically insolvent!

[clarice]

I always read you, cathy and I always find what you say clear and useful.

[sbw]

Hey! If nobody is reading this thread, what am I? Chopped liver?

[Pofarmer]

Oh, come on now, nobody reading? What am I, sbw?

You're talking about the CDS clauses, correct? Just declare them unenforceable and move on unless they were publicly traded on an open market. At least then there is some transparency. And before folks start opining about the law and breaking contracts and etc, etc, that would be much less disruptive and expensive than what we've wound up doing.

[Robert Arvanitis]

cathyf:

Important to distinguish which credit events.

First, at the AIG level: the CDS contracts called for collateral in case AIG lost its triple-A. OK, so Spitzer nails them on fraud for so-called "finite insurance." Rating agencies lower the rating, and now AIG has to post collateral to ensure its performance, where it didn't have to originally.

Second at the CDS contract level: ISDA has standards to define events of default. IF a guaranteed security triggers one of these events, then AIG has to pay out under the CDS.

So we must distinguish. AIG itself is bankrupt, and should be treated as such. Therefore it is unable to post collateral to protect Goldman. Goldman has to get in line like all the other creditors.

Later if some of the mortgage securities DO default under ISDA, then Goldman can increase its claim in bankruptcy to include those losses as well as the collateral.

Glad to share ISDA docs etc. NOT glad to pay taxes for a back-door subsidy to Goldman.