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peterbirksFinancial journalism is closer to investigative journalism than it is to political journalism. Most of what you want to write, the companies don't want to tell you. In this sense, Sarbanes-Oxley is a blessing -- if you have the time and patience to plough through 400 page-plus filings with the SEC.
However, it remains sadly true that companies can explode (or implode, see "blows" and "sucks") with little warning, simply because it's often not compulsory to reveal the stuff that is important.
Over the years it's struck me that there are two recurring causes of mysterious blow-ups in the financial sector. And they aren't complicated. One is thinking something is "safe" because it hasn't gone wrong in the past (remember the "zeroes" part of split-investment trusts?) without realizing that, if you change the ground rules, then the outcome can change too.
The second is borrowing short and lending long.
It's taken a little while to figure out quite where it went wrong for AIG, which is reporting multi-billion losses quarter after quarter. It's not as if it's Bear Stearns, Lehman Bros or MBIA, whose businesses to a significant degree were in complex derivatives and some rather dubious guarantees. AIG is an insurer, for heaven's sake. How has it got caught up in a subprime mass of toxicity?
And, lo and behold, it turns out to be a combination of "that's a safe money-making number, no need to worry about that" and "lending long and borrowing short".
Life assurers, like fund managers, have lots of money. It isn't their money. The idea is that they make more with it than they promise their customers. Most life policies have a combination of savings and insurance.
Life assurers invest that money (the premiums) in bonds, debt and equities. So far, so safe. We haven't headed into derivatives land yet.
Now, here's where it gets interesting. Once you (AIG) own those equities, there is something else that you can do with them. You can lend them to other institutions (hedge funds and the like) who want to go short on a stock. You charge them a fee for this and they also have to deposit collateral with you. You can then invest this collateral in something safe, generate even more interest, and make more money than you would have than if you had left your securities in the cupboard.
These are the so-called "securities lending units" and AIG has a number of these. Securities lending is one of those boring backwaters of life assurance. It's safe and it isn't monitored that closely because, well, what could go wrong?
What could go wrong is that the securities lending units decided to up their returns a bit by investing the collateral prvided by shorting hedge funds in some triple A-rated derivatives with maturity dates some time in the future. $78bn-worth, to be precise. And, hell, they were insured against default with the bond insurers, in case the derivatives happened to go tits up. Which they wouldn't, because they were triple-A rated...
Unfortunately, the credit crunch resulted in the mark-to-market valuation of these derivatives (some of which are turning out not to be quite as triple-A as had been assumed) being marked down to $64bn. And the securities lending units are seeing the hedge funds returning stock to them and, please could they have their collateral back? Except that, er, the collateral is tied up in these derivatives. AIG's securities lending uinits committed the simple error of borrrowing short and lending long, and, because it was in the "safe" securities lending section, no-one even noticed that it was happening. So, they've borrowed $78bn on rollover terms, and invested that money long-term and, if they sold it now, they would only get $64bn for them. There's a pickle.
And the last thing that the lending units wants to do is sell those derivatives, because AIG insists that in the end they will "come good" (see the argument that this is a liquidity crisis rather than systemic).
Anyhoo, yesterday AIG, which has already swallowed $3.9bn of the $14bn markdown in its figures, has adopted a different tactic. It's promised $5bn in backing to the securities lending units (to pay off the hedge funds if they return shares and ask for their collateral back, rather than rolling over into a new deal). Previously, AIG had 'only' guaranteed $500m.
These are very big numbers, but AIG obviously hopes that, simply by saying that the backing is there if needed, then it won't be needed. It is, in other words, a renewed hope that this crisis is not systemic.
How likely to succeed is AIG's "the money is there" strategy? Well, if AIG had owned LTCM a decade ago, it would have worked. I suspect that this is the hymn sheet from which the number crunchers at AIG are singing. But, if defaults on mortgages (we are back in the fundamental ground of the whole crisis here -- how much 'real' money has disappeared?) continue to grow; if Americans hand back their keys in their hundreds of thousands, then AIG has merely postponed the evil day.
So, there you go. Just because something hasn't failed before, that doesn't mean you should put $78bn into it. And, if you do, make sure that the $78bn is yours, rather than someone else's. And, if it is someone else's, make sure that you don't have to pay them back next Monday if they ask for the money....
________
However, it remains sadly true that companies can explode (or implode, see "blows" and "sucks") with little warning, simply because it's often not compulsory to reveal the stuff that is important.
Over the years it's struck me that there are two recurring causes of mysterious blow-ups in the financial sector. And they aren't complicated. One is thinking something is "safe" because it hasn't gone wrong in the past (remember the "zeroes" part of split-investment trusts?) without realizing that, if you change the ground rules, then the outcome can change too.
The second is borrowing short and lending long.
It's taken a little while to figure out quite where it went wrong for AIG, which is reporting multi-billion losses quarter after quarter. It's not as if it's Bear Stearns, Lehman Bros or MBIA, whose businesses to a significant degree were in complex derivatives and some rather dubious guarantees. AIG is an insurer, for heaven's sake. How has it got caught up in a subprime mass of toxicity?
And, lo and behold, it turns out to be a combination of "that's a safe money-making number, no need to worry about that" and "lending long and borrowing short".
Life assurers, like fund managers, have lots of money. It isn't their money. The idea is that they make more with it than they promise their customers. Most life policies have a combination of savings and insurance.
Life assurers invest that money (the premiums) in bonds, debt and equities. So far, so safe. We haven't headed into derivatives land yet.
Now, here's where it gets interesting. Once you (AIG) own those equities, there is something else that you can do with them. You can lend them to other institutions (hedge funds and the like) who want to go short on a stock. You charge them a fee for this and they also have to deposit collateral with you. You can then invest this collateral in something safe, generate even more interest, and make more money than you would have than if you had left your securities in the cupboard.
These are the so-called "securities lending units" and AIG has a number of these. Securities lending is one of those boring backwaters of life assurance. It's safe and it isn't monitored that closely because, well, what could go wrong?
What could go wrong is that the securities lending units decided to up their returns a bit by investing the collateral prvided by shorting hedge funds in some triple A-rated derivatives with maturity dates some time in the future. $78bn-worth, to be precise. And, hell, they were insured against default with the bond insurers, in case the derivatives happened to go tits up. Which they wouldn't, because they were triple-A rated...
Unfortunately, the credit crunch resulted in the mark-to-market valuation of these derivatives (some of which are turning out not to be quite as triple-A as had been assumed) being marked down to $64bn. And the securities lending units are seeing the hedge funds returning stock to them and, please could they have their collateral back? Except that, er, the collateral is tied up in these derivatives. AIG's securities lending uinits committed the simple error of borrrowing short and lending long, and, because it was in the "safe" securities lending section, no-one even noticed that it was happening. So, they've borrowed $78bn on rollover terms, and invested that money long-term and, if they sold it now, they would only get $64bn for them. There's a pickle.
And the last thing that the lending units wants to do is sell those derivatives, because AIG insists that in the end they will "come good" (see the argument that this is a liquidity crisis rather than systemic).
Anyhoo, yesterday AIG, which has already swallowed $3.9bn of the $14bn markdown in its figures, has adopted a different tactic. It's promised $5bn in backing to the securities lending units (to pay off the hedge funds if they return shares and ask for their collateral back, rather than rolling over into a new deal). Previously, AIG had 'only' guaranteed $500m.
These are very big numbers, but AIG obviously hopes that, simply by saying that the backing is there if needed, then it won't be needed. It is, in other words, a renewed hope that this crisis is not systemic.
How likely to succeed is AIG's "the money is there" strategy? Well, if AIG had owned LTCM a decade ago, it would have worked. I suspect that this is the hymn sheet from which the number crunchers at AIG are singing. But, if defaults on mortgages (we are back in the fundamental ground of the whole crisis here -- how much 'real' money has disappeared?) continue to grow; if Americans hand back their keys in their hundreds of thousands, then AIG has merely postponed the evil day.
So, there you go. Just because something hasn't failed before, that doesn't mean you should put $78bn into it. And, if you do, make sure that the $78bn is yours, rather than someone else's. And, if it is someone else's, make sure that you don't have to pay them back next Monday if they ask for the money....
________
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no subject
Date: 2008-06-27 09:46 pm (UTC)no subject
Date: 2008-06-29 02:18 pm (UTC)Well, I think it's the same topic. Sometimes it's difficult to tell with Hutton.
Ango-Saxon Capitalism® seems to have reached something of an impasse here. In theory, ownership of shares in a company should be perfectly coterminous with interest in that company's welfare. In practice, pension funds seem to get whacked with all sorts of externalities to do with their own capital ratios and what-not, and insurance companies, if you are correct, seem to be taking a similarly loopahula view on asset management. Since I'd imagine that, between them, these two groups own a substantial chunk of FTSE100 equity, the prognosis is not good.
Not so sure I'd blame the hedge funds for taking advantage of idiocy, though.