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Sunday, March 15, 2009

This could be interesting:

Two points. One from the New York Times:
From what is known, it certainly does not appear that A.I.G’s trading partners were entirely innocent victims of extraordinary circumstances. A.I.G. was a key player in a type of unregulated derivative called a credit default swap. Such swaps are often defined as a form of insurance because the seller guarantees payment to investors in case their investments go bust. They are not safe insurance in any familiar sense, however, because A.I.G. was not required to set aside reserves in the event of a claim. That is why, when the bubble burst and defaults rose, A.I.G. was unable to make good, provoking the bailouts.

Still, the trading partners knew, or should have known, how dangerous the swaps were. And that is not necessarily the whole story. In the manic years of this decade, credit default swaps took off as a way to bet on the likelihood of default by a firm or an investment portfolio, without having to own any financial interest in the firm or portfolio. That is definitely not insurance, it is gambling. The reason it is not illegal gambling is that, in 2000, Congress specifically exempted credit default swaps from state gaming laws.

The result? Eric Dinallo, the insurance superintendent for New York State, has said that some 80 percent of the estimated $62 trillion in credit default swaps outstanding in 2008 were speculative.
The other from Jim Hoagland:
This much is known from AIG's own pre-bailout quarterly reporting, as pointed out by Henny Sender in the Financial Times on March 7: Of the $446 billion in credit insurance that AIG sold, $307 billion of these securities were bought by European banks.

Why? The best guess I hear is that the banks were not buying insurance at all -- they seem never to have diligently asked if AIG could pay off, which it manifestly could not. They were in effect buying a piece of the firm's AAA rating, which enabled the Europeans to inflate artificially their required credit reserves and lend out ever more of their capital for bigger profits -- until the crash came. Or as financial blogger John Carney has put it, the customers were in on the scam.
Whatever AIG sold, it sure doesn't seem to be an essential part of a well managed financial system. The hi-jinks at AIG deserve much more exposure and scrutiny.



4 comments

By the way, what has former Treasury Secretary Henry Paulson been up to since leaving Treasury? Is he back on Wall Street? Hoagland says "follow the money." I wonder if anyone is following Paulson. If Hoagland is right, then there's a lot of deep doo-doo. I get the feeling that A.I.G. may have the upper hand; if so, why?

By Blogger Shag from Brookline, at 3/15/2009 3:18 AM  

http://www.siliconvalleywatcher.com/mt/archives/2008/10/the_size_of_der.php

The Size of Derivatives Bubble = $190K Per Person on Planet

If that's true, then it is obvious that the cunning plan could never fail. Not.

Looks like it's back to barter.

By Blogger gmoke, at 3/15/2009 4:52 PM  

Here's what I don't get- there isn't $62 trillion in liquidity in the whole world. I've heard an estimate of $10 trillion for the replacement value of the entire US housing stock, yet somehow derivatives based on housing loans are worth six times that?
So isn't a huge percentage of this just people owing each other money in some kind of a circuit? Can't it eventually be unwound, where you cancel some people's debts by canceling an equal amount of the debts owed to them?

By Anonymous SP, at 3/16/2009 4:29 AM  

SP wrote, So isn't a huge percentage of this just people owing each other money in some kind of a circuit? Can't it eventually be unwound, where you cancel some people's debts by canceling an equal amount of the debts owed to them?

To some extent that's true, but probably not entirely.

I think when Lehman was unwound, they did the kind of cancelation thing you're suggesting.

So overall in some sense quite a bit of that notional value isn't really there, but it doesn't mean it's all gone, either.

By Anonymous Anonymous, at 3/17/2009 6:01 PM  

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