I’ve revised the post since first putting it up, since the point of the two excerpts (assuming the reporting is correct) is that whle the AIG ratings downgrades did trigger the need to post additional collateral, it did not do so for swaps-related exposures. A senior debt downgrade would lead to the need to put up even more collateral for swaps-related exposures.
The New York Times provided a teeny bit of good news on the AIG front, but AIG needs support, pronto, or it will start unraveling:
But none of those downgrades appeared to lead to events requiring A.I.G. to post billions of dollars of collateral to its swap counterparties. Its swap contracts cite downgrades by Moody’s and Standard & Poor’s of A.I.G.’s long-term senior debt ratings, and such changes had not been announced as of Monday evening. Being downgraded by two other widely watched ratings agencies, and having its standing as a counterparty by Standard & Poor’s downgraded, did not bode well for A.I.G., however.
People briefed on the matter said that if JPMorgan and Goldman Sachs were able to raise a $75 billion credit line by Tuesday, it could avert the all-important debt downgrades by Standard & Poor’s and Moody’s. But it was unclear whether they could put together such a complicated package in time.
A.I.G. has also considered sales of virtually all of its business assets, but conducting such sales quickly would be hard.
The Wall Street Journal gives the other side of the coin:
American International Group Inc. was facing a severe cash crunch last night as ratings agencies cut the firm’s credit ratings, forcing the giant insurer to raise $14.5 billion to cover its obligations….
AIG has been scrambling to raise as much as $75 billion to weather the crisis, and people close to the situation said that if the insurer doesn’t secure fresh funding by Wednesday, it may have no choice but to opt for a bankruptcy-court filing.
“The situation is dire,” a person close to AIG said…..
One sliver of optimism for AIG last night was that much of its exposure is related to credit default swaps….AIG’s counterparties on these instruments include many Wall Street firms, which may have an incentive not to demand more collateral so as not to trigger a wider panic.
But many of AIG’s counterparties are based in Europe and Asia and may have less interest in helping to prop up the firm. The market for credit default swaps is immense, trading against about $62 trillion of debt. Many participants in the largely unregulated market worry that the default of a major player such as AIG could trigger chaos….
Indeed, the company’s woes could pose problems in many corners-a concern that has the federal government on watch. AIG’s massive assets mean that its millions of traditional insurance customers will likely get claims paid, no matter what happens next. But AIG’s shares and debt are widely held, and the firm is used by many companies world-wide to manage a range of risks, including exposure to investments in subprime mortgages. Its demise would potentially make it harder or more expensive for businesses to control their risks.
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Um looks like it's changed:
"Standard & Poor’s downgraded its long-term and short-term counterparty ratings of A.I.G.. and Moody’s cut its rating of A.I.G.’s senior debt, to levels requiring A.I.G. to post collateral of up to $10.5 billion.
People briefed on the matter said that if JPMorgan and Goldman Sachs were able to raise a $75 billion credit line by Tuesday, it could avert an escalating series of collateral calls. But it was unclear whether they could put together such a complicated package in time."
The second paragraph is similar but the first one seems to say that it does trigger it.
Reuters seems undecided:
AIG’s ratings downgrade could force it to post more collateral and nullify insurance contracts, possibly setting in motion a chain reaction that could threaten its survival.
Here is
Bloomberg’s take. Seems like if AIG isn’t already getting a collateral call, they are real close.
Credit Ratings Cut
S&P lowered AIG's long-term counterparty rating three grades to A- from AA-, citing a “combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses.''
The ratings assessor also lowered AIG's short-term counterparty credit rating by two levels to A-2 from the top A- 1+ rating, and cut its counterparty credit and financial strength ratings on most of AIG's insurance operating subsidiaries by three notches to A+ from AA+. The ratings remain on watch for a possible further downgrade, S&P said.
AIG's senior unsecured debt rating was downgraded by Moody's to A2 from Aa3. Moody's said in a statement that its decision was made “in light of the continuing deterioration in the U.S. housing market and the consequent impact on the group's liquidity and capital position due to its related investment and derivative exposures.'' Moody's placed AIG's long-term and Prime-1 short-term ratings on review for possible downgrades.
Calling for Collateral
A downgrade of AIG's long-term senior debt ratings to A1 by Moody's and A+ by S&P would permit counterparties to make additional calls for up to approximately $13.3 billion of collateral, while a downgrade to A2 by Moody's, and to A by S&P would permit counterparties to call for approximately $1.2 billion of additional collateral, AIG said in the Aug. 6 filing.
“If either of Moody's or S&P downgraded AIG's ratings to A1 or A+, respectively, the estimated collateral call would be for up to approximately $10.5 billion, while a downgrade to A2 or A, respectively, by either of the two rating agencies would permit counterparties to call for up to approximately $1.1 billion of additional collateral,'' the filing said.
AIG has already posted $16.5 billion in collateral through July 31. A downgrade could also set off early termination of swaps with $4.6 billion in payments, AIG had said.
WSJ is unambiguous:
American International Group Inc. was facing a severe cash crunch last night as ratings agencies cut the firm’s credit ratings, forcing the giant insurer to raise $14.5 billion to cover its obligations.
FT is apparently catching up on sleep tonight.
Cash and Mikkel,
Thanks for the detail, you may not have seen the update to the post, and I may need to clarify the point. A senior debt downgrade would trigger the swaps collateral requirement. That hasn’t happened yet, but the downgrades of the evening triggered other collateral posting requirements.
This is disgusting. From what I understood, on sunday AIG was offered money by several LBO firms but it was refused because the management would have to step down.
What a infuriating mess! Destroying $175b+ in market value, and now potentially wreaking untold billions more in damage to who knows how many parties because they wanted to keep their jobs?
Then AIG then had the nerve to essentially threaten the fed, which doesn’t even regulate them, with destroying the market if they aren’t given a bridge loan? Now GS and JMP have to find $75b or hope that the counter parties find it in their heart not ask for more collateral?
And adding insult to injury, John Mccain, whose economic guru is Phill Gramm, goes out and says “We will never put America in this position again. We will clean up Wall Street. This is a failure.”
Thanks Yves. With all the craziness it’s hard to figure out what just isn’t clear and what is wrong.
Is there any way to quickly summarize what the practical differences are between a “swaps collateral” requirement and other?
I assume the “swaps collateral” means if they couldn’t come up with the money that is a default trigger…but if they can’t come up with the other collateral then they’ll have to declare bankruptcy and that’d also be a trigger. Am I missing something?
I guess that Thain is the only Wall Street head honcho willing to step aside gracefully. The others are willing to destroy the lives of all their employees in the vain hope of riding the gravy train for a few more weeks …
Yves,
The update must have come in while I was doing my digging. I would not pretend to really understand this stuff more than enough to maybe help out by checking for updates from the usual sources.
BTW, speaking of McCain, is LEH correctly pronounced “LEEman” or “LAYman”? I was watching PBS coverage of this, and it showed McCain saying “LAYman”, and then the WSJ commentator and another likely Republican were saying “LAYman” while the NYT reporter and Nouriel Roubini were saying “LEEman”, which was what I understood to be the case, having never heard “LAYman” before tonight. Are there really variant pronunciations, or have we gone so far down that if McCain developed a lisp, we would be expected to start speaking Cathtilian Englith?
Anybody?
As much as I think the Establishment will try to move heaven and earth to make sure AIG doesn’t fail, I just don’t see how it all comes together without help from the visible hand of the government.
The problem is simple: Due Diligence. There’s no way in hell that anyone, without a backstop from the government, will provide AIG with capital without spending serious time on due diligence given the complexity of AIG’s business. I just can’t see it happening. This process would take at LEAST a month involving well over 100 professionals under normal circumstances. I realize that these aren’t normal circumstances, but how can a company put up capital in good faith without knowing what they’re signing up for? And how can anyone know what they’re providing capital for without serious due diligence – especially for a huge shit sandwich like AIG? Without the government I just don’t see how AIG is saved. There’s just too much risk involved, too much capital needed, and too little time.
Thanks for the updates Yves.
Very confusing but I think your explanation is correct. Very fluid situation though.
As a previous poster noted, AIG was offered a deal, they were too proud to take it.
75 Billion for a bad attitude ? … Put a fork in ’em, they’re done.
PS … AIG , the holding company is domiciled in Bermuda.
No politician will touch that, tax payer money for a Bermuda Co ?
I am not all too familiar with this situation, so I probably sound but very ignorant but…
Earlier today it was $40b and now its $75 because of the downgrades. Why is the number for the credit line so much larger than the ~$14b that AIG might need to post up as collateral. Where did these $40 and $75b figures come from?
Is that $75b a credit line for an expected further write down that would cause another waive for collateral calls?
For the simple minded…..If you carry AAA rated paper(investments) you don’t have to have as much cash on hand versus carrying say….B+ rated paper where you need a higher percentage of money on hand due to higher risk reflected by the rating.
So, every time you get downgraded on your investment rating you therefore have to raise capital holding to cover your lower rated investment paper.
That’s not so bad but….everything is leveraged. Not only do you get downgraded but anyone else holding investments issued by you is affected and they have to raise capital and contend with having their rating lowered thus they have to raise cash to cover.
That’s not so bad but….the investments are made up of derivatives which are not regulated and only PhD(s) in computational physics and a gaggle of lawyers could possibly figure out value for one given date (or hour).
Add that the investments are interconnected and held by State funds, mutuals funds, world funds and funds period then the whole stock market melts down together along with international markets because no one knows what the true values are and therefore no one can be trusted to make good on the investments…..default….turns to liquidation.
Ohh! Well that’s a really obvious explanation that never came to mind. I do feel a little simple-minded for not having thought of it :/
That’s not so bad but….the investments are made up of derivatives
which are not regulated and only PhD(s) in computational physics and a
gaggle of lawyers could possibly figure out value for one given date
(or hour).
Add that the investments are interconnected and held by State funds,
mutuals funds, world funds and funds period then the whole stock market
melts down together along with international markets because no one
knows what the true values are and therefore no one can be trusted to
make good on the investments…..default….turns to liquidation.
It seems to my untrained eye that this may be one of the key points: due diligence is impossible because only a team of string theorists could come up with a figure, which would be as verifiable as String Theory itself, meaning not. Is XYZ worth $100bn, $10bn, -$300bn? Who could say? Is that what killed Lehman [which in German would I think rhyme with redman, more or less, and certainly not rayban], that no one could price it with any degree of confidence?
Cash re pronounciation: NPR called the company, the operator pronounced “Lee-man”. But what the hey, eh?
Is that what killed Lehman [which in German would I think rhyme with redman, more or less, and certainly not rayban], that no one could price it with any degree of confidence?
Revenge of the nerds – Heisenberg’s Uncertainty Principlel.
Another aspect of ‘too big to fail’ is becoming glaringly obvious…These corporations are so big that they can threaten to crash the economy if the government does not step in to save them…as in ‘we need a bridge loan now’.
‘Too big to fail = Big enough to extort the government.’
River
River,
There was an excellent paper by George Akerlof and Paul Romer which described "bankruptcy for looting" and used the S&L crisis as one of four examples. Unfortunately, not free online and I have been unable to locate my copy (hint hint for anyone reading who has it). Abstract:
During the 1980s, a number of unusual financial crises occurred. In Chile, for example, the financial sector collapsed, leaving the government with responsibility for extensive foreign debts. In the United States, large numbers of government-insured savings and loans became insolvent – and the government picked up the tab. In Dallas, Texas, real estate prices and construction continued to boom even after vacancies had skyrocketed, and the suffered a dramatic collapse. Also in the United States, the junk bond market, which fueled the takeover wave, had a similar boom and bust.
In this paper, we use simple theory and direct evidence to highlight a common thread that runs through these four episodes. The theory suggests that this common thread may be relevant to other cases in which countries took on excessive foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust. We describe the evidence, however, only for the cases of financial crisis in Chile, the thrift crisis in the United States, Dallas real estate and thrifts, and junk bonds.
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.
Yves, thanks for the heads up re: the Ackerlof/Romer study. I will see if I can find it but doubt if I will have more success than you.
I saved (from 4-20-08) ‘eight hundred years of financial folly’ by Reinhart/Roghof, which I thought was very good…The paper contains links to other works along the same lines. After study I see no reason that well educated US economists would not realize the outcome of long term indebtedness to other soverign nations…But, as you know, one definition of insanity is ‘doing the same thing repeatedly and expecting different results.’
Thanks for your good work on Naked Capitalisim. I thoroughly enjoy you selection of financial news, your insightful comments, and the majority of comments by others.
http://www.nakedcapitalism.com/2008/04/eight-hundred-years-of-financial-folly.html
River
Akerlof link
http://ideas.repec.org/p/nbr/nberre/1869.html
Just saw the interview with Hank Greenberg by Maria Bartiromo.
Observations:
Hank keeps saying this isn’t a solvency problem but rather a liquidity problem. If that’s the case, however, I think that the private sector would be happy to arrange a high-priced bridge loan to help them out. I suspect that private parties have backed away because they think that AIG has not just a liquidity issue, but a solvency issue as well.
Greenberg was also saying that AIG was a national treasure and that it was in the nation’s interest to save the firm. I think he’s got it backwards. I think AIG is a national abomination and it’s in the nation’s interest for it to fail as a lesson to others who might follow in AIG’s reckless footsteps.
Seeing as Greenberg’s paid millions over the years to lawyers to lobby Congress for reduced insurance regulation, it’s the height of irony that he now comes a begging to the government for a rescue. I say, let it go down. Someone might actually learn something from the lesson.
The Akerlof and Romer “looting” paper can be viewed courtesy of those machines of loving grace,
Google.
Interesting table of contents.
Cash re pronounciation: NPR called the company, the operator
pronounced “Lee-man”. But what the hey, eh?
Dave Reithel,
Thanks. I’m wondering if pronunciation of the company formerly known as “L-whatever” will become a sort of cultural identifier along the lines of of “nuclear” for example.