The Wall Street Journal reports in a story frustratingly sketchy on key details that AIG has sprung another leak, or more accurately, had an ongoing leak that has just now come to light. The amount at issue, $10 billion, seems small compared to the $150 billion the insurer has already managed to extortsecure from the government.
But now it gets interesting. First, the $10 billion is outside the $150 billion in various facilities on offer, begging the question of how AIG will come up with the dough. Second, the losses resulted from “speculative trades,’ not customer business gone bad, which is what the insurer previously said caused its losses. And these trades took place within the now-notorious credit-default-swaps-writing financial products group.
The risk controls on the financial products team were apparently non-existent. The size of the profits it was reporting should have lead to heavy scrutiny. That sort of result is generally the result of considerable risk-taking, either market risk or reputation risk (i.e., you are fleecing your customers and they might wake up and come after you, as they did with Bankers’ Trust, putting the bank on a terminal slide).
From the Wall Street Journal:
American International Group Inc. owes Wall Street’s biggest firms about $10 billion for speculative trades that have soured…
The details of the trades go beyond what AIG has explained to investors…AIG has said that its trades involved helping financial institutions and counterparties insure their securities holdings. The speculative trades, engineered by the insurer’s financial-products unit, represent the first sign that AIG may have been gambling with its own capital….
AIG’s financial-products unit, operating more like a Wall Street trading firm than a conservative insurer selling protection against defaults on seemingly low-risk securities, put billions of dollars of the company’s money at risk through speculative bets on the direction of pools of mortgage assets and corporate debt…
The fresh $10 billion bill is particularly challenging because the terms of the current $150 billion rescue package for AIG don’t cover those debts. The structure of the soured deals raises questions about how the insurer will raise the funds to pay the debts. The Federal Reserve, which lent AIG billions of dollars to stay afloat, has no immediate plans to help AIG pay off the speculative trades…
AIG’s problem: The rescue plan calls for a company funded largely by the Federal Reserve to buy about $65 billion in troubled CDO securities underlying the credit-default swaps that AIG had written, so as to free AIG from its obligations under those contracts. But there are no actual securities backing the speculative positions that the insurer is losing money on. Instead, these bets were made on the performance of pools of mortgage assets and corporate debt, and AIG now finds itself in a position of having to raise funds to pay off its partners because those assets have fallen significantly in value…
Some of AIG’s speculative bets were tied to a group of collateralized debt obligations named “Abacus,” created by Goldman Sachs.
The Abacus deals were investment portfolios designed to track the values of derivatives linked to billions of dollars in residential mortgage debt. In what amounted to a side bet on the value of these holdings, AIG agreed to pay Goldman if the mortgage debt declined in value and would receive money if it rose
Funny how so many roads lead to Goldman.
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Perhaps another case in which nationalization was the second best alternative to a Chapter 11. Maybe we should learn a lesson from this before we rush into a Detroit bailout with half-baked measures. Let the courts not the politicians sort it out.
But yes, by all means, please pay out those bonuses to AIG management and let them have these covert meetings in posh facilities. It is clear beyond reproach that they oh so deserve them. It just doesn’t end. Why are management at AIG still walking around in anything other than orange jump suits….
“But there are no actual securities backing the speculative positions that the insurer is losing money on. Instead, these bets were made on the performance of pools of mortgage assets and corporate debt”…and that the Washington Senators would beat the Harlem Globetrotters by a wide margin…
What about last week’s $55,000,000,000 gift to AIG? That didn’t seem to get much coverage at all.
Why don’t Bernanke give the small room next to the printing press to AIG. They can print any amount they wish. Really sick of these dumb people loosing so much money in such little time.
Anonymous, re: setting up a small room next to the printing press…. it seems they heard you.
:*FEDERAL RESERVE CONSIDERING ISSUING OWN DEBT – WSJ
– According to the report, Fed officials have approached members of congress to discuss the plan to fund trillions of dollars of lending
– Untill now , all debt Federal debt has been issued by the Treasury dept”.
I’m going to love to hear what they intend to back this debt with…
story out just about an hour or so.
omfg, will yves & other prominent econ bloggers PLEASE get chris whalen to explain his cds #s clearly enough that the msm can pick up the story.
taxpayers cannot be saddled w/ an *insane* amount of debt because politically connected buyers of unregulated insurance (e.g., goldman sachs) want to avoid taking a huuuge hit from counter-party bankruptcies…
caveat bleep bleep bleeping emptor.
it's enough w/ this nonsense, already…
I’m going to love to hear what they intend to back this debt with…
I don’t think there is any backing. This is just like the Fed offering CD’s. The Fed gets its own cash liabilities back, and the bank gets a time deposit.
It seems like it can only drain current reserves from the system, and lock in a specific interest rate for the term. I’d like to understand why they want to do this, but I have a guess.
Also, if the Fed and Treasury were working closely together, as I assumed they were, this should be functionally identical to what they could already do with their combined powers.
This is the opposite of quantitative easing, in a way. It seems a little circular when you’re doing quantitative easing at the same time, if you’re purchasing longer-dated Treasury debts.
I have a strong hunch this means they intend to do the quantitative easing through the purchase of other securities, like FNMA or even corporates, and will match their term structure by issuing CD’s.
Synthetic CDOs again?
Further rumination on the above, this would make for clearer bookkeeping and help isolate Treasury from some of the damage if things get really ugly. Kinda clever, and I hope the authority’s granted.
Almost all roads lead to Goldman nowadays, be it Wall Street, Insurance, Capitol Hill – and apparently it’s so ingrained in the DC culture that forefathers of US will be standing up and taking notice of how one firm has become the new focus of all actions taken. Wall street is the new Wild Wild West.
The other possibility I can think of is that they’d like to put a floor under short-dated government debt, or help out the floor on the FFR, which has thus far totally failed and turned into negative seigniorage; -0.78% today, sweet.
It’d be coincident with the negative yields we hit in trading today, which lends some credibility. But I don’t see why this would be an appealing policy goal, so I think my earlier thoughts are the most likely explanation.
I am confused NDK. Wouldn’t someone have to buy those CDs? I think that is the problem that we are really going to have to face, the world is going to stop buying our debt….unless we force them. What incentive is there for the world to continue to prop up our increasingly vacuous economy?
Thank God they had those retention bonuses. Could you imagine how bad it would be if they had people who did not know what they are doing?
I am confused NDK. Wouldn’t someone have to buy those CDs? I think that is the problem that we are really going to have to face, the world is going to stop buying our debt….unless we force them. What incentive is there for the world to continue to prop up our increasingly vacuous economy?
We don’t know who they’d offer the CD’s to, Anonymous, but it’s very clear there’s no shortage of people eager to lend money to the Federal Government right now.
A lot of this buying is forced and mechanical. Countries that operate with a pegged currency, for example, have basically no choice. They can either let their currency appreciate, or stop exporting much to us. Neither is likely an acceptable choice for domestic reasons there. CIC is petrified. Full Treasury money market funds have no choice but to buy as well, as their own assets soar as retail gets scared.
There’s just such serious market dislocation that we have desperate borrowers and desperate lenders who are unable to come to terms with each other at prevailing interest rates. It’s really ugly.
The Fed can in effect forcibly make a market by absorbing the risk on its own balance sheet, but their balance sheet looks awful already. Issuing CD’s would make it slightly less awful in most scenarios, which is why I’m in favor of this move, if they’re going to make all their other moves. Which I’d not have done, but we’re pretty far down that road already.
I’m feeling more neoclassical by the day, dude.
Another posited source of forced buying that I omitted, and one more germane to the AIG explosion topic at hand, is T-bills might be the only accepted collateral posted under most CDS contracts. I don’t have any clue here, though other commentators here should.
Another question for you NDK, along the same line. From what I am reading it seems that the only reason that the world is stillloaning us money is because of the Reserve Currency status of the American dollar. What I remember of my macro economics tells me that the trillions going out the door in the past few months are going to hammer the underlying value of the dollar world wide…it just hasn’t come around again on the guitar…. If indeed the US has to “sell” over a trillion in the next 12 months to keep up the pretense of not being bankrupt, how in heck is that going to happen in the evolving world climate?
My take says that soon after Obama takes office there will be another “Brenton Woods” meeting and the American dollar will no loner be the Reserve Currency.
Your thoughts?
If indeed the US has to “sell” over a trillion in the next 12 months to keep up the pretense of not being bankrupt, how in heck is that going to happen in the evolving world climate?
If they didn’t, we’d all have to take the pain now, at a particularly inopportune moment, and everyone’s shown ample willingness to delay and worsen the inevitable to date. Bretton Woods 2, as this has been called particularly by Setser, has been remarkably resilient despite it having an obviously awful outcome.
My take says that soon after Obama takes office there will be another “Brenton Woods” meeting and the American dollar will no loner be the Reserve Currency
This would be the ideal outcome for the long run, and I’d like to see it. I wouldn’t bet on it, though, because of the immense systemic risk it poses.
Zugzwang…
NDK…thanks for your responses to my questions…and for encouraging me to learn a new word…Zugzwang.
I think that there are a significant number of folks in the world that would disagree about the systemic risk that kicking America in the arse would cause. I think that the countries whose national debt goes “underwater” because of our systemic failings don’t have much to lose by worrying about what might happen if things don’t change.
Time will tell….I think within 6-9 months at most we will have a period of world wide introspection…..I have no money to bet on my scenarios, sorry.
Buyers will be lining up to buy gov.CDs. Mak’em maturable in say…20 years, where the holder has to pay the government to take them back.
I don’t know why you’re making fun of AIG, we all have a 79% non-voting position in it…..I expect those profits to start rolling in any day now as soon as we get past these minor hiccups. Best part is that we won’t incur any legal fees in defense of the cash infusions.
I don’t know why you’re making fun of AIG, we all have a 79% non-voting position in it…..I expect those profits to start rolling in any day now as soon as we get past these minor hiccups.
8.5 Trillion and counting….is a minor hiccup. I dread to think what a serious problem is. Though no doubt if that kind of thinking, is what is running the system, we will soon find out.
AIG/Goldman and CDS’, yet again.
No wonder Paulson negotiated immunity, first, after all he has no conflict of interest here at all. Imagine what would have happened to his trust funds of Goldman stock , if IAG had gone down…..he might have to work for a liveing instead of stealing….
I still dont understand how come AIG isnt making the folks at AIGFP available for interviews or making their names public. How is it that a corp loses billions and billions, yet, nobody knows who these peopele are????
Yes and more. The productive segments are more than sick and tired of these elitists wizards
screwing over the people and the country’s economy.
Until these Dens of thieves and crooks have their their assets stripped,put on a Devil’s Island nothing, and handed basic Soc. Sec. level when return, nothing will change. Would tell them they’re lucky they’re not getting shot at sunrise too.
smart independent