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Your Starter For 10
Mar. 4th, 2009 12:38 pmSurely I am not the only person bemused by the fact that some University Challenge Contestants have been found to be ineligible. I mean, surely this is a field in which asking questions of students is positively encouraged? How hard is it for the first question to be "Are you still a student?"
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There's been some entertaining revelations in the land of AIG. I remember this time last year when at work we were agape that the company had managed to lose $5bn in a quarter. In Q4 2008 they showed that the previous year was merely a warm-up, and that, when it put its mind to it, it could lose more than $60bn. How, you might think, is this possible?
A good question; one that I asked. First, a little bit of history. These losses are nothing to do with ordinary insurance. They all stem from AIG Financial Products, a subsidiary set up by Hank Greenberg (sacked in 2004) and expanded heavily under Martin Sullivan (sacked in 2008). What AIG FP did was guarantee collateralized debt obligations (CDOs). In other words, it wasn't dissimilar to what the monoliners like MBIA did with collateralized mortgage obligations. Party A would buy a CDO from Party B and would insure with AIG against it defaulting. It paid AIG a premium, and AIG set aside some capital to show that it could pay up if the CDO defaulted.
You can see how this could be a nice moneyspinner. You get paid premiums on stuff that you don't believe will ever default. Your reputation is good, so the person buying the cover (or, more strictly, the regulator) doesn't say "c'mon, show us the cash". At one point AIG had about $450bn in liabilities on these CDOs. But, hell, so what, this would be $4.5bn a year income at 1% failure rate estimate. Money for old rope.
It all started going pear-shaped when AIG got downgraded by the rating agencies. This means that your word ain't so good. Instead of having to post, say $5bn in collateral, you have to post $40bn (because these CDOs had also become 'more likely to fail'). Now, that kind of money often doesn't prove easy to find when no-one likes you any more.
Fortunately for AIG, it had reached the "too big to fail" state of nirvana that all companies strive to achieve. Because, if it can't guarantee those CDOs, and it goes under, then all the holders of the CDOs go "naked", which means that they, in turn, have to find extra capital. So the Fed steps in with a bailout.
So far, not so problematic. Eventually these CDOs would unwind, and, even if we have a 10% default rate, AIG is "only" $45bn in the hole. A far cry from the $150bn which it has begged for to stay functioning. So, what the hell happened?
This is where it gets interesting, and puzzling. The "solution" thought up by the Fed when it loaned AIG $30bn in November was to establish a special purpose vehicle called Maiden Lane III. This SPV would buy the CDOs from the counterparties and rip up the credit insurance written by AIG, thus reducing AIG's capital requirements.
Shortly after the creation of Maiden Lane III, the Fed approached about 20 counterparties. We have to assume these included the senior investment banks. By December 31 (we know this because we have now seen the figures), Maiden Lane III had paid out $29.5bn for CDOs with a face value of $62bn, and AIG paid $32.5bn to terminate the credit insurance, booking a loss in 2008 of $21bn on the deal.
Now, I might have got this wrong, but it looks to me as if the 20 counterparties walked away with all their money. Now, these CDOs might have been worth 95 cents on the dollar, or 90 cents on the dollar, but their mark-to-market at the time was less than 50 cents on the dollar. What they most certainly were not worth is 100 cents on the dollar. And yet this is what they were paid.
The net impact of this is that AIG basically took on its own shoulders all the losses at mark-to-market from these CDOs. The counterparties got $62bn of liquidity that they would not otherwise have had, at a time when they would certainly have expected $50bn with a smile.
If my interpretaion is correct, this is a staggering waste of the US taxpayers' money. The counterparties have been given a get out of jail free card, with, in effect, a hundred dollar bill attached.
And that is how you can lose $60bn in a single quarter. Liquidate assets at the bottom of the market, and pay the counterparties top dollar to do so. Madness.
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+++++++++++
There's been some entertaining revelations in the land of AIG. I remember this time last year when at work we were agape that the company had managed to lose $5bn in a quarter. In Q4 2008 they showed that the previous year was merely a warm-up, and that, when it put its mind to it, it could lose more than $60bn. How, you might think, is this possible?
A good question; one that I asked. First, a little bit of history. These losses are nothing to do with ordinary insurance. They all stem from AIG Financial Products, a subsidiary set up by Hank Greenberg (sacked in 2004) and expanded heavily under Martin Sullivan (sacked in 2008). What AIG FP did was guarantee collateralized debt obligations (CDOs). In other words, it wasn't dissimilar to what the monoliners like MBIA did with collateralized mortgage obligations. Party A would buy a CDO from Party B and would insure with AIG against it defaulting. It paid AIG a premium, and AIG set aside some capital to show that it could pay up if the CDO defaulted.
You can see how this could be a nice moneyspinner. You get paid premiums on stuff that you don't believe will ever default. Your reputation is good, so the person buying the cover (or, more strictly, the regulator) doesn't say "c'mon, show us the cash". At one point AIG had about $450bn in liabilities on these CDOs. But, hell, so what, this would be $4.5bn a year income at 1% failure rate estimate. Money for old rope.
It all started going pear-shaped when AIG got downgraded by the rating agencies. This means that your word ain't so good. Instead of having to post, say $5bn in collateral, you have to post $40bn (because these CDOs had also become 'more likely to fail'). Now, that kind of money often doesn't prove easy to find when no-one likes you any more.
Fortunately for AIG, it had reached the "too big to fail" state of nirvana that all companies strive to achieve. Because, if it can't guarantee those CDOs, and it goes under, then all the holders of the CDOs go "naked", which means that they, in turn, have to find extra capital. So the Fed steps in with a bailout.
So far, not so problematic. Eventually these CDOs would unwind, and, even if we have a 10% default rate, AIG is "only" $45bn in the hole. A far cry from the $150bn which it has begged for to stay functioning. So, what the hell happened?
This is where it gets interesting, and puzzling. The "solution" thought up by the Fed when it loaned AIG $30bn in November was to establish a special purpose vehicle called Maiden Lane III. This SPV would buy the CDOs from the counterparties and rip up the credit insurance written by AIG, thus reducing AIG's capital requirements.
Shortly after the creation of Maiden Lane III, the Fed approached about 20 counterparties. We have to assume these included the senior investment banks. By December 31 (we know this because we have now seen the figures), Maiden Lane III had paid out $29.5bn for CDOs with a face value of $62bn, and AIG paid $32.5bn to terminate the credit insurance, booking a loss in 2008 of $21bn on the deal.
Now, I might have got this wrong, but it looks to me as if the 20 counterparties walked away with all their money. Now, these CDOs might have been worth 95 cents on the dollar, or 90 cents on the dollar, but their mark-to-market at the time was less than 50 cents on the dollar. What they most certainly were not worth is 100 cents on the dollar. And yet this is what they were paid.
The net impact of this is that AIG basically took on its own shoulders all the losses at mark-to-market from these CDOs. The counterparties got $62bn of liquidity that they would not otherwise have had, at a time when they would certainly have expected $50bn with a smile.
If my interpretaion is correct, this is a staggering waste of the US taxpayers' money. The counterparties have been given a get out of jail free card, with, in effect, a hundred dollar bill attached.
And that is how you can lose $60bn in a single quarter. Liquidate assets at the bottom of the market, and pay the counterparties top dollar to do so. Madness.
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