There is a new press release up at the Fed on its latest loan to troubled insurer AIG (hat tip Dealbreaker):
The Federal Reserve Board has authorized the Federal Reserve Bank of New York to borrow securities from certain regulated U.S. insurance subsidiaries of the American International Group (AIG), under section 13(3) of the Federal Reserve Act.
Under this program, the New York Fed will borrow up to $37.8 billion in investment-grade, fixed-income securities from AIG in return for cash collateral. These securities were previously lent by AIG’s insurance company subsidiaries to third parties.
As expected, drawdowns to date under the existing $85 billion New York Fed loan facility have been used, in part, to settle transactions with counterparties returning these third-party securities to AIG. This new program will allow AIG to replenish liquidity used in settling those transactions, while providing enhanced credit protection to the New York Fed and U.S. taxpayers in the form of a security interest in these securities.
How much this means depends on the price at which the Fed takes the collateral from AIG. It appears AIG is unable to sell certain instruments at prices it likes, and so is parking them at the Fed. Ahem, do we believe the prices the Fed is using to value this paper? If AIG can’t unwind them, one must wonder what they are really worth (although in this credit crunchy environment, it is possible that decent paper isn’t fetching very good prices. But when will more favorable markets return, pray tell?).
Another not-so-pretty aspect of this development is more obvious: $85 billion wasn’t enough? Did AIG misrepresent its cash needs, or not have a good enough grasp of its near term liquidity requirements? Or was this simply something a tad more defensible, that the market seized up on paper that would normally be salable?
And reader Marshall had another reason to take a dim view:
That they’ve got a new loan just tells me that we’ve truly crossed the Rubicon. No restraints any longer. Just stuff everything with money, money, money and forget about how much debt you have. It’s going to be like this until after the election I think. No deliberations, it just gets done.
When I read of the loan, I had assumed it was a parent company loan to cover AIG’s credit default swaps exposure. Tomorrow is settlement day on Lehman CDS. AIG was a major protection writer, and unlike investment banks, which claim to have hedged their positions (although offsetting swaps are the only means to do so, since the underlying cash bonds are, in the vast majority of cases, illiquid), there is no reason to think AIG did so, or at least did so consistently.
The Lehman settlement is expected to require dealers who wrote guarantees to pay out between 80 and 85 cents on the dollar. Lehman had $128 billion of bonds as of its last balance sheet, but CDS written are typically a big multiple of the value of the underlying bonds. That’s a long winded way of saying AIG could be writing some very big checks very soon.
But this is a different issue. Tomorrow, as they say, is another day.
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I thought the proposition was that AIG had more than enough asset coverage for solvency, that it was just a liquidity issue. If now it needs *another* $37.8 billion so soon after the previous injection… how confident are we this is a liquidity issue at all?
I mean, a liquidity short-fall of over $110 billion? I haven’t done the math, but does that sound viable. AIG’s book value earlier this year was only $100 billion… (I don’t know if a more updated number is available). What’s left?
And on a related note, if $85 billion bought the US taxpayer 80% of AIG first time around… what does another $37.8 billion buy us?
Can anyone explain how long the settlement process takes? I know that there is an auction to set prices and then…well whatever.
But if things go horribly wrong (or right) will we know in a few hours, a few days…weeks?
Seems to me things have already gone terribly wrong. Turn off the money spigot…
no, no, it’s not so bad, see if one reads the press release carefully, we see that it is actually the Fed who is borrowing this dodgy paper from AIG. The cash payment from the Fed to AIG is really just collateral. So it is the Fed’s obvious desire to collect dodgy paper that is motivating this deal, not the cash to AIG.
Or at least that’s the story our very own Ministry of Truth is telling us.
And we trust them don’t we? Why else would they word in this tortured way?
Pardon me for an off topic post, but I was curious about business failures in The Great Depression and since AIG is a failed business, this study just offers a little social background:
Date: March 10, 1933
To: President Franklin Roosevelt
From: President's Economic Council
Re: Overproduction of Goods, Unequal Distribution of Wealth, High Unemployment, and Massive Poverty
Dear Mr. President,
In order to help you make recommendations to Congress as to possible solutions that could be taken to solve the current economic crisis we have collected data on several factors that may have contributed to the economic collapse. This letter will provide you with information over the overproduction of goods, unequal distribution of wealth, high unemployment, and massive poverty and it is our hope that you will be able to use the information to develop programs that will assist the citizens on the United States of America.
The economy is producing more goods than can be purchased and consumed. The consequences of this economic trend are evident in this evidence gathered by our committee during recent research.
Automobile production has been reduced from 411,000 cars a month in 1929 to just 89,000 a month in 1932. The average American no longer makes enough money to buy a new car.
1 billion barrels of oil were produced in 1929. This year oil refineries will produce only 800,000 barrels.
Farm production outpaced demand to such a high degree that the price of wheat dropped from $1.37 to 61 cents a bushel in 1930. Prices are presently so low that wheat farmers are now losing $1.50 on every acre they plant. Some farmers are destroying agricultural goods to try to raise prices by reducing supply.
Contracts for building new homes and apartments are down 80 percent since 1929. At the same time, several million Americans have become homeless because they cannot afford housing.
One reason consumers lack purchasing power is the unequal distribution of wealth. Indicators of the concentration of wealth are apparent in this evidence gathered.
1 percent of the population has 59 percent of the national wealth. 33 percent of the national wealth is held by 12 percent of the population. 87 percent of the people own just 8 percent of the national wealth.
92 percent of all American families have incomes of $2,500 or less. 36,000 families share $9.8 billion a year: $2.5 million per fami8ly or a thousand times as much as the other 92 percent.
The wealthy tend to spend money on luxury items rather than basic necessities. The general lack of wealth in the population accounts for the low sales of automobiles, vacuum cleaners, refrigerators, and other durable consumer goods.
The huge oversupply of workers has encouraged employers to cut wages. Workers' wages have dropped by 40 percent since 1929. Women working in Brooklyn's clothing industry are paid $2.39 for a 50-hour week. Union miners in Pennsylvania, West Virginia, and Kentucky make $10.88 a week.
One man, Samuel Insull of Chicago, sits on the board of directors for 150 different companies with a combined 50,000 employees and 3,250,000 customers. On New Year's Day in 1932 the value of the securities for these companies was $3 billion. Insull is protected day and night by 36 bodyguards.
The unemployment rate has been growing since 1929 when the stock market crashed. The unemployment rate has now reached extraordinary levels. The nature of the problem is apparent in this evidence.
In 1920 only 49 businesses per 10,000 failed. In 1932 the business failure rate reached 155 per 10,000.
Corporate profits have dropped from $10 billion three years ago to just $1billion in 1932.
As corporate profits have fallen and businesses failed, companies have laid off workers. Today the unemployment rate stands at an all-time high of 23.5 percent; nearly one of every four workers is unemployed.
13 million people are out of work. Millions of others have had their hours severely cut.
In Lowell, Massachusetts, once the center of the American textile industry, the unemployment rate is 90 percent. In Akron, Ohio, the unemployment rate is 60 percent; in Cleveland, Ohio, 50 percent; in Toledo, Ohio, 80 percent. There are 1 million workers without jobs in New York City. Every week another 100,000 workers across the country lose their jobs.
One Arkansas man walked 900 miles looking for work.
A Manhattan employment agency advertised fro 300 jobs; 5,000 people applied.
Americans throughout the nation are suffering from economic hardship and the lack of basic necessities. The difficulties they face are apparent in the evidence gathered:
Over 60 percent of Americans are now categorized as poor by the federal government.
Nine million savings accounts have been wiped out since 1930. With thousands of banks failing and closing their doors, hard-working, honest people have lost their financial safety nets.
273,000 families have been evicted from their homes in 1932.
There are two million homeless people migrating around the country. They include farmers forced off their land because of the severe drought and low prices for agricultural good, men unable to find jobs in industries, and women with young children in search of food and shelter.
New York social workers report that one fourth of all schoolchildren are malnourished. In the mining counties of West Virginia, Illinois, Kentucky, and Pennsylvania, the proportion of malnourished children may be as high as 90 percent.
A Kentucky miner says that some people in his state have been surviving on wild greens such as violet tops, wild onions, and forget-me-not wild lettuce.
>> Sorry about the length, just thought it was an interesting archive thing.
Yves, I have been looking around cyberspace and watching developments with the other eye, trying to spot news about the short selling ban being lifted. No joy, no news.
Did you hear anything about the ban today? Thanks…
On the CDS fallout; I’ve read that there is some 60 trillion in nominal amounts written. I’ve also read that the nominal amount of CDS contracts written is (much) larger than the underlying amount of bonds
Would it be an idea if the government(s) just nix:
1) All contracts where the buying party does not own the underlying bonds
2) All contracts where the buying party has bought more in nominal CDS contracts than they own nominally in the underlying bonds
Wouldn’t that take all gamblers out of the CDS market, improving the stability of the markets substantially?
Kind regards, thanks for the great site,
RDO
River,
The last I heard, from a fund manager buddy a few hours ago, is that it ends at 11:59 PM tonight. In fact, he reported that other fund managers were attributing the late in session stock plummet to the lifting of the ban, although I see no logical way to connect those events (what mechanism? why a dramatic change in a short time frame for a move announced, what, a week plus in advance?). But I have no links at hand. This is a SEC matter, it should be in a press release at their site.
I’m very curious how BAC will do tomorrow. Presumably underwriters of today’s offering will be doing the best they can to defend $22, while short-sellers will probably out in waves.
I wonder who wins… too bad I’m not brave enough to actually make a financial bet on it, one way or the other.
Evidently nobody will do repo with AIG. It would help to know exactly what repos didn’t roll, to find out whether the problem is the collateral quality (doubtful) or fears of getting caught up in a bankruptcy filing by AIG. AIG may not be able now to sell large positions owing to fear of a busted settlement. The gov’t may as well nationalize AIG outright if no one will trade with them.
There is confusion here over two different sorts of loans.
Like all insurance companies who are long term holders of stocks and other securities AIG’s subs lend securities to short sellers. This ‘loan’ is an absolute transfer of title but with the lender–the AIG sub in this case–retaining the right to sell the security at any time. Selling the security would break the loan and require that 3) the short seller return the borrowed security (this is the third choice), 2) lead to a settlement failure because the sub does not have the security it lent or 1) replacement of the sold security with another borrow. This makes the AIG subs bad counterparty risks–like Lehman.
The Fed is replacing the AIG sub’s exposures to short sellers with an exposure of a different type to themselves where they simply take the securities on to their own books in exchange for providing collateral to AIG.
So, AIG returns 37 billion worth of collateral to short sellers who return 37 billion worth of securities to AIG who lend it to the Fed in exchange for 37 billion worth of collateral.
See also http://tinyurl.com/4tlm6j
Another $37B ? I guess $85B just doesn’t buy as much spa treatment as it used to.
Where is all this money going???
Who are the counterparties on the other side of these CDSs? Where are they parking all of this liquidity?
Who has the list of who owes who? Each institution knows who they owe and vice versa. All of these CDS need to be made public so the taxpayer can know where our money is going!
Another $38Bn to AIG.
It is becoming clear that no amount of “money” will stop the imminent rupture of the supply chain.
No amount of dismal mathematics left/right/armageddon will provide food on the shelves or gas for the car.
Somebody has turned off the supply.
Who was providing that supply?
I have no fight with the Communist Party of the Peoples Republic of China. I cannot. I have never met a member of that Party.
But apparently they met with Hank Paulson, not yesterday, but many years ago, when he was the CEO of Goldman Sachs. That was when Hank Paulson sold America.
Hank said “I AM GOLDMAN SACHS I CAN DELIVER TO YOU A PARTNERSHIP OF AMERICA AND CHINA…….BETWEEN US WE CAN RULE THE WORLD….LET’S TRADE….”
If you were looking for the man who “SOLD AMERICA” look no further.
Hank was happy; with unconfined joy he proceeded to accumulate $500m tax free. In Hank’s mind America was a collection of individuals who, like Hank, would sink or swim. The problem was and is that Hank is a psychopath, unconnected to Humanity, Community, State or Nation. Hank just doesn’t get it. Hank is incapable of “getting it”. Hank is mentally ill.
Hank gambled America. Hank lost. Hank doesn’t care. Hank has his money.
The good news is WE don’t have to lose.
Even the Communist Party of the Peoples Republic of China don’t want nuclear war. They to have too much to lose.
So, the supply will be turned on again, even if that means different rules.
The beginning of the “New Rules” will be a meeting of all world leaders and a resolution that;
No State/Nation will recognise derivative obligations. All contracts for derivates are VOID. A limited time for the accounting will be available, after which, those who do not declare their positions may return to the Casino and play out the rest of their lives.
Then, when the positions are known every State/Nation will take the pain appropriate to that State/Nation.
Global trade will continue but “Globalisation” will be seen for the Casino of human misery that it is, including all of the pop star evangelists/cheerleaders who think that there is a one world solution to all ills.
Like it or not this is the end of an age.
Let’s hope it doesn’t end in war.
OK, so how much exactly did they spend on that junket to California?
The Federal Reserve Board has authorized the Federal Reserve Bank of New York to borrow securities from certain regulated U.S. insurance subsidiaries of the American International Group (AIG),…Under this program, the New York Fed will borrow up to $37.8 billion in investment-grade, fixed-income securities from AIG in return for cash collateral.
The Orwellian spin regarding who is the borrower and who the borrowee is pretty absurd.
THAT’s where the money went today. Got an update from the NY Fed this morning:
“New York Fed offers $37.50 billion through its Term Securities Lending Facility”
So, this was done through the TSLF.
“Would it be an idea if the government(s) just nix:
1) All contracts where the buying party does not own the underlying bonds; 2) All contracts where the buying party has bought more in nominal CDS contracts than they own nominally in the underlying bonds”
The US federal government has legal authority under the commerce clause of the US constitution to void all swap contracts. The state governments do not because the contracts clause to the constitution prevents states from passing laws modifying contracts that pre-date the law. And the takings clause to the US constitution does not prevent the US federal government from voiding contracts because the US Supreme Court has previously decided that contracts are not “property” and so not protected against a “taking”.
I think the US federal government should void all swaps, swaptions, and any other derivative contract except exchange traded options and futures on equities and debt. If this renders banks or insurance companies insolvent, that is good because then the US government can seize all equity in them, and if they’re insolvent enough, seize all debt too.
Bernie Sanders in the Senate proposed an excise tax on banks to punish them for their sins. The Senate rejected Sanders proposal by voice vote, so we couldn’t hold the vote against them. An excise tax is fine, but we need more.
It is time for populists to look out for the people, and not be paniced into helping Paulson’s friends in banks and Paulson’s goldmans sachs stock in his family foundation and his kids trusts.
“The state governments do not because the contracts clause to the constitution prevents states from passing laws modifying contracts that pre-date the law.”
That’s not right. Most swaps were written by people who knew they weren’t sufficiently capitalized to make good selling protection under a swap. That makes the contracts fraudulent, so the states could void the contracts on grounds of fraud.
October 8, 2008
The Federal Reserve Bank of New York announced today that it is in discussions with PIMCO regarding asset management services in support of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve’s existing credit facilities to help provide liquidity to term funding markets.
The New York Fed continues to consult with market participants on the operational aspects of the facility.
http://www.newyorkfed.org/newsevents/news/markets/2008/an081008.html
— C. Neil
“That’s not right. Most swaps were written by people who knew they weren’t sufficiently capitalized to make good selling protection under a swap. That makes the contracts fraudulent, so the states could void the contracts on grounds of fraud.”
States can also void derivative contracts as illegal insurance contracts.
“Ahem, do we believe the prices the Fed is using to value this paper?”
Ahem … do we even KNOW what prices the Fed is using to value this paper? While “transparency” is one of the memes being spouted as a “lesson learned” (just as it was in 1934), the Fed is anything but transparent.
A few months ago, a Bloomberg reporter asked the simple question as to whether the Fed’s junk assets are valued at cost or market. Unable to get a straight answer, he FOIA’d the Fed’s accounting manual. When he finally got it, portions of it were REDACTED. (Ergo, at cost, not market!)
I also understand that the Fed does not comply with the auditing standards that would be demanded of publicly-traded companies.
Let me be blunt: at ‘mark-to-market’ asset valuations, I think Weimar Ben is bankrupt. And I’ve got half a mind to file an involuntary Chapter 7 bankruptcy petition to liquidate the Federal Reserve. I look forward to posing, arms crossed and chiseled jaw jutting, in front of the boarded-over doors of the Marriner S. Eccles Building. You’ll recognize my Roubini-autographed tinfoil hat, as I torch a hundred-dollah “Federal Reserve Note” to light a cigar (or a blunt; whatever).
However, I’m holding off till tomorrow evening, to see how Benny’s balance sheet has ballooned this week. Evidently young Ben is “doubling down” in a quite literal sense. I just didn’t think he would do it in the space of two months. But in the midst of the greatest looting spree in history, anything goes.
Just don’t leave me here singing that old tune: “I fought the Fed, and the … FED WON!”
— Juan Falcone
eh said, “The Orwellian spin regarding who is the borrower and who the borrowee is pretty absurd.”
Most Securities Lending Agreements are ‘undisclosed’. The borrower has no idea who the lender is and the lender has no idea who the borrower is. The lender of securities (the client) is considered the borrower of cash or treasuries in exchange for stock collateral. The borrower of stock, of course, puts up collateral through his broker. The commercial contract that they sign is not with each other but rather the Agent Lender intermediary. The contract (Master Securities Lending Agreement) is on line at http://tinyurl.com/3svq94
Hi
Where can we go to find out which counterparties have settled and for how much?
I would have thought that this information would be public.
Cent21: According to the AP article I’m looking at in my local newspaper (The Columbia Daily Tribune), it was $440,000. Eric Dinallo is quoted, but I’ll mostly paraphrase: Sounds crazy, but they wanted to get together to “ensure that the $85 billion could be as greatly as possible paid back…” I don’t want to dig up the AP article through Google, but this is accesible:
http://online.wsj.com/article/SB122348485787515823.html?mod=googlenews_wsj
A link in the Links section earlier today made reference to Bubble Wages; here we got the Bubble Sensibility that goes with it. I don’t like to use the terms “kleptocrats” and “oligarchs” because they connote, to others, conspiracy theories – and I am not into conspiracy theories. I am into class and ideology, but I’m too weary to make any case about that here. Still, people as outraged as I am (maybe some of you aren’t – what’s half a mill in the context of $115 billion, machts nichts as we’d say in Radland -) but if you are, then ask yourself: Are there no economic crimes at all which merit a visit to Siberia … metaphorically speaking, I assure you. Prisoners deserve light and heat and clean air and three squares a day ….)
Gut the company and take everything it is worth; anyone in managment who wants to keep their job may do so at twice the fed min wage plus healthcare benefits and even two weeks paid vacation. Don’t like it? Find another job elsewhere. Here in Flyover country, a fulltime gig at twice min wage plus health benefits and paid vacation is nothing to sneer at….
anonymous at 9:49 said, “Where can we go to find out which counterparties have settled and for how much?
I would have thought that this information would be public.”
You would be wrong. If it were public there would be nothing to prevent counterparties from dealing with each other directly. Also, the burden of paperwork would be overwhelming: “It has been proposed that the requirement to disclose data relating to the underlying loan allocations by principal lender will be directed to each security borrower for credit monitoring and capital sufficiency/deficiency purposes. Therefore, while the transmission of this data will not require the booking of individual loans by principal by broker/dealer securities lending desks, broker-dealers will retain records pertaining to each principal lender and the underlying loan allocations by principal lender in accordance with existing regulations. This approach will satisfy the concern that agent lenders have regarding the risk of disintermediation through disclosure and the dramatic transactional volume impact that booking the individuals loans would have, and will further address concerns expressed by regulatory representatives of the need of securities borrowers to maintain required records on a principal lender basis.”
http://tinyurl.com/3kud6t
light a cigar (or a blunt; whatever)
That reminds me of Greenspan’s irrational exuberance! Maybe the way out of this mess is to legalize marijuana, or would that be unethical?
AIG wrapped a lot of AAA CDO paper and was the counterparty on a number of interest rate swaps. With their recent downgrade, they are now forced to post more collateral on these contracts. I’m fairly certain that’s where this cash is going. It’s not a loss unless AIG ultimately defaults as counterparty. It’s just additional collateral that’s required under the contracts to be posted if the counterparty is below a certain rating.
As for the idea to void all derivative contracts, I’m not even sure how to respond to that. Talk about chopping off the head to cure a headache.
The whole corporate structure, with a myriad of subsidiaries, muddies the waters. Adding bailout on top of rescues, along with junkets, is hard to take. What kind of shell game is AIG playing?
“As for the idea to void all derivative contracts, I’m not even sure how to respond to that. Talk about chopping off the head to cure a headache.”
As best I can tell, the real profit from derivatives is in end-running the regulatory costs associated with providing banking or insurance services. By end-running these regulations, especially the capital requirements, hedgies and others have been making big profits and imposing externalities on the public. The whole point of regulation is to prevent lenders/insurers from defrauding customers and imposing externalities on third parties. If the only real profits from derivatives are from evasion of regulations and taxes, they should be void. And going forward, they should be criminalized.
Juan Falcone,
I dare you to file an involuntary C& to liquidate the Fed!
Bold and Audacious! Touche!
signed,
Author of "Don't Fight the Fed, You Just Might Win" Futures mag, Sept 2001
So Dave Raithel, ‘kleptocrat’ and ‘oligarch’ are terms of positional advantage which do not imply any conspiracy per se. If you are senior management at GS or JPM, if you are able to call them personally in real time, and if in doing so you can get a favorable policy action which enhances your position, that’s not a ‘conspiracy,’ it’s simply doing business like any other business—except very, very few have the credentials to engage in _that_ kind of business. If one is, say, the CEO of JPM and can knife BSC in the back while never facing any investigation from any public or private authority for forcing the firm over the ledge (and I think that is not to strong a summary of that particular incident), clearly different rules are in play regarding legal constraint and public oversight than for schmucks on trading desks spreading bad rumors to move their positions. And so on. Personally, I don’t do conspiracies.
‘If you are senior management at GS or JPM, [if you are able to call the SecTres or Fed Chair on their personally at any time of the day or night,] . . . .’
Isn’t simply that:
1. The $85 billion was used to pay AIG’s swap obligations as Protection Seller on the half zillion CDSs that were triggered and unsettled on the day the Fed lent them the cash
2. When AIG delivered cash to the swap counterparties, it rec’d in exchange delivery of the wounded bonds that were the subjects of the CDS. Face value in sum: 85 billion, but “market value” (guesstimate): 37.5 billion.
3. This left AIG no less insolvent than it was the day before the 85 bil loan, but the half zillion CDS obligations have been honored.
4. So now the Fed is rejuicing AIG so latter is in a position to deal with new obligations as new CDS trigger.
5. The new loan seems to be a repurchase agreement via the Auction Term Loan Facility. Fed is purchasing the 37.5 bil mkt value in wounded bonds AIG rec’d in settling its CDS for dollar credits.
Hopes to either see AIG fulfill the repo and buy the bonds back when mkt value has risen (assuming AIG survives). Or if AIG fails to fulfill the repo the fed can hold the bonds, collecting whatever interest and pricipal gets thrown off, and perhaps selling them into a post doomsday secondary mkt for more than the crisis level 37.5 bil.
6. Thus it’s not that the first 85 bil disappeared into a hole. It was used precisely as it was intended — to settle trigged swaps. One supposes the 85 bil figure was arrived at by examining the settlement calendar.
Now there will be more. It seems the Fed — which now controls 80% of AIG, after all — is intent that AIG does not default on its swaps.
One might think of it as a corporate parent merely shifting capital to a subsidiary.
Does anyone know the total amount of CDS AIG had outstanding when the 85 bil loan was made. That amount is likely to be the total loans we’ll see the Fed make as it bails its latest acquisition.
If this is Greek in your ears, you’ll find a more elaborate and yet homespun account of same at http://www.newcombat.net.
what you should take away from this transaction is that stock loan/repos/rehypothecation, critical machinations of the industry, are getting very difficult to execute in this environment. these were functions that iBanks/the shadow banking industry have executed well in the past. but now, as the powers-that-be have emasculated the industry, a back-up arrangement clearly has not been planned or instituted. consequently, the fed finds itself taking over yet another function of the capital markets.
i suspect aig may not be the only one going to the fed for its custodial banking functions. i’m wondering about gm’s big pension plan.
anonymous said…”what does another $37.8 billion buy us?” Last slice of the lemon.