Myths of the AIG Collapse
Happy Anniversary, AIG !
It was exactly one year ago today that AIG went belly up, a collapse caused by the massive risk taking of their Financial Products (FP) division.
AIG FP remains somewhat unknown to most people. Numerous issues associated with the collapse seem to be still misunderstood by many professionals, analysts and pundits.
Consider these factoids:
• Hedge Fund: AIG FP was essentially a derivative writing quasi-hedge fund within AIG. They were essentially a writer of highly leveraged, naked options. Indeed, their $3 trillion is leveraged bets was simply unconscionable.
• Lehman Did Not Kill AIG: Even if Lehman Brothers was saved, AIG would still have had enormous exposure — over $3 trillion dollars! — and carried tremendous risk. They had huge, leveraged exposure to mortgages, especially credit default swaps written against sub-prime mortgages. The housing collapse was going to do in AIG, regardless of whether Lehman was rescued or not.
• Exempt: Thanks to the CFMA, these derivatives were exempt from ALL regulation and ALL supervision — There was no oversight from an exchange, no listing of derivative trades, no disclosures of risk, no transparency, no counter-party information. Most damaging of all, these derivatives required zero reserves in case of a claim. No other traded financial instruments receive this special treatment;
• No Reserves Required: If AIG was forced to maintain reserves, they would not have been able to write $3 trillion dollars in derivatives, while maintaining the assumption/delusion that they would never ever have to pay on any of them. The “Free lunch” fees on this was $3 billion. Even a 5% reserve requirement would have meant having to pony up $150 billion dollars;
• No Supervision: FP benefited from being part of a highly regulated, triple AAA rated Insurance business. However, the derivative exemption prevented any of the usual state insurance supervisors from requiring normal disclosures, reserves, etc.;
• Only a Few Employees Did In AIG: The firm had over 86,000 employees, but the FP division was a mere 400 people.
Chalk another win up for the Free Lunch crowd!
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September 16th, 2009 at 9:18 am
“The firm had over 86,000 employees, but the FP division was a mere 400 people.”
_____________
Even the Mafia has some legit business interests. Those 400 would have made a great entry point for a RICO Act investigation of the entire organization and its counter-parties. That is, if we had any law enforcement whatsoever.
September 16th, 2009 at 9:19 am
AIG up in pre-opening trading .. at OVER 40 as I type this. [BR: Note that is after a reverse 20 for 1 split]
What does this mean? If the stock market is a forecasting mechanism (another myth), then does this portend that the dollar is going to be worth a penny in the next 6 months?
What possible value can there be in the shares of AIG?
But then, I guess it’s not about value, only momentum, and AIG has got it’s momentum up. Perhaps that’s how they intend to save the company — jack the price up to a hundred bucks a share and sell stock!
September 16th, 2009 at 9:22 am
http://www.counterpunch.org/whitney09152009.html
Maybe your folks will like this one from Counterpunch by Mike Whitney:
“Lehman Died So TARP and AIG Might Live”
September 16th, 2009 at 9:22 am
I mean, AIG has quadrupled since July — what a bunch of chumps we all were for not loading up on it back in July, eh? Sure makes those fools who bought grandpa stocks like AAPL look silly.
September 16th, 2009 at 9:25 am
The performance of the “trash complex” has been mind-boggling. LEHMQ up? Really?
September 16th, 2009 at 9:39 am
If anyone still believes in the “efficient markets” theory, this ought to stop them dead in their tracks.
AIG, LEHMQ, MTLQQ, FRE, FNM Just pull up a chart of these over the past 3 months.
All bankrupt, all with an intrinsic value of pretty close to zero, all up by substantial percentage amounts in the past 3 months.
September 16th, 2009 at 9:40 am
cn says-
“the stock market is a forecasting mechanism (another myth)”
funny you say that constant- I just posted that same observation on another thread-
it was interesting how well it was forecasting – with the 2007 run-up to Dow 14,000 as the storm clouds were circling overhead-
as the another poster said regarding the current run-up- the market was “discounting a robust profits recovery”-
i call bullshit on that explanation of the recent run-up- it is a reflation play by the USG- and people are buying into the notion that the “market cannot go down”-
as was quoted yesterday by yet another poster-
“With the economy improving and the government guaranteeing it, why would anyone take the opposite side of that??”
so there we have it
September 16th, 2009 at 9:42 am
@cn
“AIG, LEHMQ, MTLQQ, FRE, FNM Just pull up a chart of these over the past 3 months.”
Maybe they’re trying to get AHEAD of the TARP II announcement…
September 16th, 2009 at 9:43 am
I can’t get enough Hank Greenburg interviews on CNBC. Always learn a lot, actionable. …never a moment of mawkish self-exculpation.
September 16th, 2009 at 9:45 am
Kinda reminds one of the heights of the dot-com bubble, when anyone with a ridiculous idea could IPO it and sell a gazillion bucks worth of stock.
I think the time is ripe for Uncle Sam to roll out the “new, improved AIG”.
They shoulda bought the entire company instead of only 80%, then they could do exactly that, selling shares in the new AIG for $10,000 per shr and putting an end to that nasty debt problem we have. Yeah, it would mean selling a lotta shares, but I’m sure that they could find an underwriter capable of handling the deal, and I’m confident the new company would have a quadruple-A debt rating.
September 16th, 2009 at 9:48 am
@cn
Also, with all that cash raised, AIG would then become a big horse in the CDS derby… Oh think about the profit potential!
September 16th, 2009 at 9:50 am
Then why did AIGFP have a pre-tax loss in 2008, after a financial crisis of only $40bn? Where is the $150bn that surely would have been close to zero after a calamity? Or maybe you’re wrong?
~~~
BR: Are you suggesting that AIG’s accounting was transparent, accurate and fully forthcoming as to their exposure or losses?
I need to reach for the thesaurus for words to describe how exquisitely idiotic that statement is: Stupid, unintelligent, dim thick, dense, brainless, obtuse, dim-witted, unwise, foolish, etc.
September 16th, 2009 at 9:53 am
I really have a hard time understanding why there isn’t criminal culpability here and these people cannot be prosecuted to some level. there are shades of grey looking back at stupid business decisions, but pulling in $3B for $3T of exposure isn’t one of them.
September 16th, 2009 at 9:56 am
@cvienne 9:48 am
“… with all that cash raised, AIG would then become a big horse in the CDS derby …”
D’ya think they might be betting against themselves? But who would take the other side of that bet?
Oh … Uncle Stupid.
I can just see it now, AIG writing several trillion bucks of leveraged CDS betting that AIG will fail, Uncle Stupid taking the other side of that bet, saying “no it won’t”.
It ends with Czar Geithner having AIG kneel before him, tapping each shoulder with his (paper) sword, and says,
“Your debts are forgiven — Go now, and sin no more.”
AIG promptly collapses under the weight of a fresh layer of busted CDS bets, and Uncle Stupid steps in to cover the bet.
Rinse and repeat.
September 16th, 2009 at 10:05 am
@dan10400 9:53 am
Sadly, there is no law against stupidity. If there were, we could all get rich investing in the prison construction industry.
That’s one reason why we used to have rules and regulations, to protect the system from idiotic behavior. But as Greenspan noted, “that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
http://www.nytimes.com/2008/10/23/business/worldbusiness/23iht-gspan.4.17206624.html
I only reference the article because it casts the lunacy of removing regulation into stark relief, because the free markets would never work to destroy themselves, after all, people are rational beings … right? RIGHT???
And suddenly, we’re back at AIG, a bankrupt company, trading at over $40/shr … this is not a penny stock, folks, this is some real money here.
September 16th, 2009 at 10:07 am
and what about the role of serial shareholder shakedown artist Elliot Spitzer — whose personal vendetta drove Hank Greenberg (no angel himself) out of AIG, leaving it to founder?
~~~
BR: Well, did Spitzer require AIG take $ three trillion in derivative exposure?
September 16th, 2009 at 10:11 am
In a practical equity marketplace, there would be rules to prevent such stocks from being traded, perhaps a partitioning of the markets into the “viable companies”, “pink sheets”, IPO stocks, and the “brown sheets”, with pensions, insurance companies and mutual funds only allowed to trade in the “viable companies” marketplaces.
But that would be regulation, and as we all know, that hampers the efficiency of our fine system.
September 16th, 2009 at 10:12 am
reminder folks: AIG did a 20 to 1 reverse stock split so they wouldn’t be delisted.
another myth, perpetuated by those who should know better, is that AIG will be able to repay the $180BB the government lent them. Ed Liddy told Congress they still had $1.5T in “hard-to-value” assets still on their books. CDO-squareds, anyone?
September 16th, 2009 at 10:19 am
@cn
“Uncle Stupid steps in to cover the bet”
Yeah, and promptly hands over the bill to the US taxpayer…
You see, I have a plan…and that is… to MAKE NO MONEY… I bought the farm, paid cash, live small, but MAKE NO MONEY (so I have to give as little as possible to Uncle Stupid)…
Oh… I’ll LOAN them the money, but I won’t give it to them…
Now… If someone wants to put an ADULT in charge of the operation (and it tanks the economy in the process)… I’ll take the bet on that, profit from it, pay some taxes, and thank everyone for playing…
Then, when it’s about time for some REAL HEALING to be done, I’ll be in for that ride… I will become an INWESTOR…
Like I said in another thread… If you’re in the S&P jerking around for the last 20% because your “street sense” tells you it’s there… Well, I understand you might have a fiduciary responsibility to do well for your clients (and enrich yourself in the process)…
Buy hey… you could say the same about Mozillo, Fuld, Prince, and all the others, right?
Fortunately, (from my own POV), I am not burdened by those obligations…
September 16th, 2009 at 10:28 am
crabsofsteel,
CDO-squareds, anyone? Shh, “We”‘re still suppressing those, so they don’t count..
also, in that vein: http://digg.com/politics/AIG_CIA_Drug_Running_Exposed_in_2001
September 16th, 2009 at 10:29 am
BR replied: Well, did Spitzer require AIG take $ three trillion in derivative exposure?
A case can be made that Spitzer’s vendetta against Greenberg removed a level of governance which might have limited AIG’s derivative exposure.
My point is that Spitzer , who is attempting a political comeback, succeeded mainly in garnering headlines, fleecing taxpayers (AIG and many others) while sending no-one to jail, and ultimately helped enable the “radical deregulation” in financial circles which you decry. A great defender of the little guy — not.
~~~
BR: Not sure I would call that a comeback attempt — he was unscatehd at that point.
I’d like to see the chart of their pre- and post- Hank exposure. That would prove your point.
Somehow, I don’t imagine Hank looking over every CDS traded . . .
September 16th, 2009 at 10:37 am
$3trillion is alot of money. How much of this represents offsetting trades? That is, if AIG bought a CDS from BankA and sold one with the same terms to BankB, is this included in the number? Bigger numbers make for better headlines, but may not tell the whole story.
September 16th, 2009 at 10:53 am
It is a pity that one cannot simply examine their balance sheets and see where they stand. But without credible accounting standards, that relate items on the balance sheet at a particular moment in time to what they are actually worth at that particular moment in time, it all dissolves into a flurry of nonsense and deception.
September 16th, 2009 at 11:02 am
Here’s a few more truths of the AIG collapse:
http://alephblog.com/wp-content/uploads/2009/04/To%20What%20Degree%20Were%20AIG%E2%80%99s%20Operating%20Subsidiaries%20Sound.pdf
Quick summary:
1) Life subsidiaries would have failed without the rescue, because they substituted Subprime mortgage collateral for the clean collateral in their securities lending operation.
2) Heavy interlacing of capital across subsidiaries through ownership of affiliated companies and securities made the system less stable.
3) Mortgage subsidiaries probably would have failed. Loss experience was overwhelming reserves.
September 16th, 2009 at 11:04 am
Oh, but the plus side — aside from a few cross-guarantees that I can’t unravel, the P&C subsidiaries would have survived.
September 16th, 2009 at 11:09 am
Some arrows must be slung at the U.K. regarding AIGFP. In theory, if AIGFP was located in the U.S. they’d be subject to statutory accounting principles (SAP), basically a 2nd set of books for state insurance regulators that require more conservative loss rserving than GAAP. There is no Statutory accounting nor regulatory equivalent to this in the U.K. and Europe. I say ‘in theory’ because I know AIGFP was in CT for awhile (somehow they sidestepped the Stat reporting requirement). I understand that the CDS weren’t regulated as insurance however, they still represent potential liabilities and as such under Stat accounting would need to be reserved against. If anyone can shed light on how AIG got around this for years I’d like to know.
September 16th, 2009 at 11:10 am
“$3 trillion is a lot of money. How much of this represents offsetting trades?”
How much larding-up with fees can be tolerated between institutions before it is obvious that the same deal is passing round and round and round with a new fee every time and that there is no ‘there’ there? The big banks cannot all make money off each other except by pretending. Then it will collapse… as it did.
September 16th, 2009 at 11:11 am
@Cunning Linguist 10:29 am
“… removed a level of governance which might have limited AIG’s derivative exposure”
uh, suggest you take a few and read up on the history of AIG and its foray into the derivatives business …
http://voices.washingtonpost.com/washingtonpostinvestigations/2008/12/cassano_aig_facing_investigati.html
Hank Greenberg was the one that brought in the guys who created and ran FP, and Hank was the one who chafed at paying people who understood that business huge amounts to run it, and who wanted to toss them out and keep all of the profits (and risk exposure) in-house. There is nothing to suggest that he would have done any better than his successor in managing things once the people who built the machine were tossed out. I’ll grant you that Hank had a much better notion of the value of AIG’s debt rating, and probably would have moved heaven and earth to keep it from being lowered (i.e., paid the ratings whores whatever it took to keep the AAA rating), but AIG’s CDS exposure to the mortgage markets was sufficiently large that it would have wound up in the same place it is today, even if they had kept their AAA rating right up to the point of (and probably after, who knows?) collapse.
September 16th, 2009 at 11:32 am
Hank tried to sidestep the AIG damage by disowning FP once he was out of the picture but he brought in Cassano and must have known they were in doo-doo up to their neck once the Housing Ponzi began to collapse.
We are officially in a pets.com market now. Congratulations to Barry for knowing the market and staying long this rally, I know he is nimble enough to bail before the thing collapses. Every options expiration brings us closer to a change in direction, all I am doing is watching the Euro rise and rise and the US$ fall and fall….
September 16th, 2009 at 11:39 am
Even with the reverse split the stock has quintupled since Jul 10 of this year. That’s what those like constantnormal are marveling at. It’s absurd. It’s just a shell of a company being wound down with huge losses. The fact that it still trades and is being valued at anything at all is the perfect example of how broken this market and economy is right now.
But hey, maybe we’re all wrong here and the market “knows” something we don’t about AIG; and Lehman, FNM, FRE; right. You go bet on that.
September 16th, 2009 at 11:40 am
I’ve got an idea, you might say the perfect business plan.
1) Write trillions (say a cool three trillion) in insurance contracts (aka derivatives), collect the fees.
2) Write these contracts covering all kinds of crazy things, make State governments, national governments and big banks the counter parties on these contracts.
3) Pay out, are you kidding me, there is no way to pay off these contracts/bets.
You have the perfect business plan. In most circles this is known as stealing, writing trillions in insurance products (uh derivatives)
that you have no way in hell of paying out.
Take away, if you are going to steal, steal big (Bernie was oh so small time, look what it got him) so if you go down the government can’t allow you to fail.
September 16th, 2009 at 11:59 am
sure is comforting to know there’s no more leveraged derivative contract exposure in the marketplace to worry about. must be why the stock market keeps going up.
in fact, if memory serves, the market started up 6 months ago. and if the market leads the economy by 6 months then that must be why the economy is ( per bernanke ) out of the recession and bank lending is rising.
let’s all celebrate and have a good time making the easy money again.
September 16th, 2009 at 12:25 pm
“the perfect business plan. In most circles this is known as stealing, writing trillions in insurance products (uh derivatives) that you have no way in hell of paying out. ‘
pretty much it- there was no way they could honor the claims- -thus the USG backstopping
September 16th, 2009 at 1:23 pm
@Onlooker 11:39 am
I have SEEN THE LIGHT!
I am even now taking out a fresh mortgage on our paid-for home, and am putting it all into AIG.
I should be able to take the profits, buy the rest of the block, and repeat the process early next year.
By Christmas 2012, I should own the county, and by 2015, the state.
Citizens concerned about declining home values, fear not — HOPE IS ON THE WAY.
September 16th, 2009 at 3:19 pm
factoid? or fractoid?
• Only a Few Employees Did In AIG: The firm had over 86,000 employees, but the FP division was a mere 400 people.
The famous 400 in FP were the tip of the pyramid enabled by legions of smoke and mirrors interdealer brokers swapping tales to I Banks and their Hedgies fees a’bulging all the live-long to this day. Financials are going up because GS has found a way to ratio hedge this rally and will walk away with their fancy skirts clean after the merde frappe le ventilateur.
September 16th, 2009 at 10:08 pm
Barry,
there certainly is a free lunch. Think of the huge bonuses these guys made. With 400 people generating $3,000,000,000 in mostly pure profit. What do you think this special 400 people got in bonus. Lets say to be conservative they got 10% of the profits or some $300,000,000 or some $7,500,000 in bonus per employee.
I’d say that was a free lunch. Especially since the tax payers are on the hook for their derivatives er bets or insurance products.
What a country.
“Chalk another win up for the Free Lunch crowd!”