As Matt Taibbi explains in his excellent Rolling Stone piece on AIG:
In theory, at least, there’s nothing wrong with buying a CDS [Credit Default Swap] to insure your investments. Investors paid a premium to AIGFP, and in return the company promised to pick up the tab if the mortgage-backed CDOs [Collateralized-Debt Obligations] went bust.
Unfortunately for AIG, lots and lots of CDO’s went bust and they had to pay out more in insurance claims than their entire company was worth. And, who were the customers for this insurance?
Goldman Sachs, it turns out, was Cassano’s [AIGFP’s] biggest customer, with $20 billion of exposure in Cassano’s CDS book. Which might explain why Goldman chief Lloyd Blankfein was in the room with ex-Goldmanite Hank Paulson that weekend of September 13th [2008], when the federal government was supposedly bailing out AIG.
When asked why Blankfein was there, one of the government officials who was in the meeting shrugs. “One might say that it’s because Goldman had so much exposure to AIGFP’s portfolio,” he says. “You’ll never prove that, but one might suppose.”
Market analyst Eric Salzman is more blunt. “If AIG went down,” he says, “there was a good chance Goldman would not be able to collect.” The AIG bailout, in effect, was Goldman bailing out Goldman.
This is a point also mentioned by Frank Rich today.
[AIG] has, in essence, been laundering its $170 billion in taxpayers’ money by paying off its reckless partners in gambling and greed, from Goldman Sachs and Citigroup on Wall Street to Société Générale and Deutsche Bank abroad.
This analysis is lazy but it feels good so everyone is repeating it. Let’s get a couple of facts straight upfront. The reason that AIG went broke was because they had to pay out too many insurance claims at the same time and they didn’t have the capital to meet those obligations. The reason they received a massive amount of TARP-money was so they could pay their claims rather than defaulting on them and causing a massive ripple effect across the economy as company after company discovered that their insurance was worthless and they, too, were broke (or close to it). The entire point of bailing out AIG was so they could pay their biggest customer, Goldman Sachs, and everyone else they sold CDS’s to.
You can call it money laundering like Frank Rich or call it, like Taibbi, “transforming the government into a giant bureaucracy of entitled assholedom.” But, either way, it’s not some giant betrayal for AIG to take TARP money and use it to pay off its claims. What the hell did anyone think they were going to do with the money?
Now, the standard rebuttal to this is ‘why should the taxpayer make Goldman Sachs whole on their bad bets?’ We don’t ordinarily criticize people for betting that their insurer won’t go completely belly up and default on paying their claims. Given the situation we find ourselves in, it might have made sense to give Goldman Sachs a haircut…maybe pay them something less than the full insured amount? But the principle remains the same (even when TARP money went to foreign firms like Société Générale and Deutsche Bank). AIG owed people money. A decision was made that it would cause more problems than it would solve to let all those people go unpaid. That is why AIG was bailed out even though they are not a bank.
I do not intend to defend the actions of AIG or Goldman Sachs by writing this. I could write a long, ranting essay about all the reasons the top executives at those companies should be castrated and boiled in tar. I’m just really tired of reading bogus populist diatribes about the wrong things.
The reason that AIG went broke was because they had to pay out too many insurance claims at the same time and they didn’t have the capital to meet those obligations.
AIG actually didn’t have any capital assigned to this type of insurance. This is insurance fraud, and it’s a crime for a reason.
AIG (and others) made sure that the derivative insurance they were selling wasn’t actually considered insurance by our government, so that they didn’t have to meet the typically stringent capital and reserve requirements for regular insurance.
This isn’t populist rage, it’s insurance fraud. Josh at TPM has been hammering this for awhile.
on AIG’s part, but not according to the law. Insurance by any other name is still insurance. That AIG put no capital behind their loans is not an excuse to default on their claims. Bankruptcy would be an excuse.
Here:
http://ftrsummary.blogspot.com/2005/11/ftr-531-interview-with-lucy-komisar.html
is an interview with Lucy Komisar from October 2005 about AIG and its criminality and its friends in high places.
Curiously, Geithner has roots with Kissinger and Kissinger was on AIG’s board (may still be). It’s amazing how often these guys come up, like projectile vomiting and food poisoning.
At some point you need to take into account exactly what kind of instruments these are. Increasingly these CDOs and CDSs are looking like the “junk bonds” of our era.
“AIG actually didn’t have any capital assigned to this type of insurance. This is insurance fraud, and it’s a crime for a reason.”
Um, no, it’s not. CDS’s, unlike insurance, do not have to be backed by sufficient funds and are not bound by regulation the way insurance is.
I think the problem is the lack of regulation and transparency, in addition to allowing people to bet by buying a CDS that do not have a direct interest in insuring an asset they own.
The other point about insurance is that there has to be an Insurable Interest
All CDS entered into with no underlying debt should be treated as gambling debts, which is what they are, and therefore unenforceable.
you’ve hit upon a failure of regulation. But betting that your neighbor’s house will burn down (or won’t) is not mere gambling if you’ve entered into a legal contractual arrangement to place those bets. The fact that such bets should have been illegal and that AIG should have had capital to show behind its issuance of insurance, do not make it legal for AIG to fail to pay out its obligations. The decision was to let them go bankrupt and default on hundreds of billions in claims or to shore them up and have them pay off as many of those claims as possible.
From an ethical point of view, most people would probably prefer to see all these assholes lose all their money. From a practical point of view, things were much more complicated. Insofar as we want to criticize AIG for paying off claims we should really focus on the decision to bail them out at all. That’s where the debate over this belongs. Once they were bailed out, we all should have known they’d be paying off dickheads that we all hate.
“That’s where the debate over this belongs. Once they were bailed out, we all should have known they’d be paying off dickheads that we all hate.”
As the rhetoric has gotten more heated, people are tending to paint with a bigger and bigger brush.
Not all the people buying CDS’s were asshole greedheads buying for speculation. For instance, if you have a mutual fund or a pension fund or your city buys bonds, it’s just due diligence for them to insure those bonds by buying a CDS.
Thank for continuing your roll of reasonable-ness.
I didn’t have too much of a problem with AIG honoring its outside debts because thru Goldman et al and, even directly, the insured included municipalities and mutual funds that send checks to our parents and grandparents.
I understood and accepted that some of these outside parties would even be foreign banks. I can see that the failure of our government to regulate these shady enterprises should not cause harm to those who relied upon them, whoever they might be, including detestable hedge fund pirates.
Where I drew the line, where I became enraged, was when they started paying out “debts” to themselves. Liddy should have had the good sense to send these boys to the back of the line with a memo that employee contracts would be honored eventually after other obligations were met. Yes, the contracts had payment dates but there were also paragraphs that could be interpreted… blah, blah, blah.
The ranting and raving over the incestuous, circular movement of money thru Wall St. from the Many to The Few is a little absurd. What did the currently outraged think was going on for the last 100 hundred years? Have they only recently realized what game was being played?
Meant, one hundred years. Altho, 100 hundred could be true, too.
“Liddy should have had the good sense to send these boys to the back of the line with a memo that employee contracts would be honored eventually after other obligations were met. Yes, the contracts had payment dates but there were also paragraphs that could be interpreted… blah, blah, blah..”
I agree with you there. He could have also negotiated them down but he didn’t do that, either.
Castrated AND boiled in tar???!?!?
Let’s not go overboard. Just one would be enough.
I’m thinking the boiling in tar would accomplish both objectives…
you and rae are such bleeding-hearts:
The reason they received a massive amount of TARP-money was so they could pay their claims rather than defaulting on them and causing a massive ripple effect across the economy as company after company discovered that their insurance was worthless and they, too, were broke (or close to it). The entire point of bailing out AIG was so they could pay their biggest customer, Goldman Sachs, and everyone else they sold CDS’s to.
There was no reason for tax payers to keep AIG’s customers whole. The bets were highly leveraged – Jerome linked to the Economist’s article last week:
Why not limit the bail out to the bets placed and not the potential gains that could have been – were not AIG (and others) already technically bankrupt?
I read about Paulson’s scheme and I have to admit that the description it too vague for me to really understand how he was placing his bets. He was shorting the housing market through the purchase of credit default swaps and thereby giving himself insanely favorable odds. I get that. What I don’t get is how exactly this was done and who paid out the money.
Me neither. But I felt much more informed after reading Jerome’s and Taibbi’s articles last night.
(Which resulted in my little fluff diary this morning trying to understand the concept of a trillion dollars and more.)
Paulsen bought default swaps on the kind of mortgage backed securities that were packaged and sold by Wall Street. Ironically these swaps were completely mispriced and very cheap, because the investment banks used the sold swaps to create synthetic mortgaged backed securities.
Why did they do that? Well they did that because there was so much demand for supposedly safe sub-prime mortgage paper that Nationwide, Wamu and co. couldn’t create enough of it to satisfy investors’ appetite. So the investment banks created synthetic bonds that consisted (simplified) of a risk-free government bond with a CDS pasted to it. The CDS premium generated the extra yield for investors.
So ironically the investment banks needed people like Paulsen betting against the housing market by buying CDS swaps, because they needed someone to pay the extra yield for the synthetic paper they were issuing.
All things considered, this may very well have been the most insane episode in the history of the financial markets, at least since tulipomania.
errm Paulson of course, not Paulsen.
can you explain how shorting worked in this process?
As the mortgage backed securities fell the default swaps rise. The bulk of Paulson’s position consisted of these very cheaply priced long-term options, rather than shorted securities. While these mortgage backed securities are all a little different, depending on how they were sliced and pasted together, but they all had (have) in common that they are deemed to have defaulted once a certain percentage of the underlying mortgages have stopped paying. So there was no need to to short subprime paper. As the paper crashed, the value of the CDS would rally from let’s say 1 to say 80…
Ah, yes, now I see how he was doing it. I was having a mental block on the speculation end of it.
http://www.independent.co.uk/news/business/news/credit-crunch-the-4bn-killing-765261.html
Very intelligent post. Frank Rich calling Goldman AIG’s “trading partner” is of course simply preposterous. AIG was Goldman’s trading counterparty. With slogans like this, Rich is trying to create the very fire of blind outrage that he then clamors the Obama people are failing to respond to. Rich is far too intelligent not to know better and is clearly veering into Richard Perle territory here: the end, namely ridding the Obama White House of Summers and Geithner, justfying any old lie and any old lynching.
But this all leads back to Booman’s call yesterday for better explanation and “a gun” for Geithner.
Actually there is a gun that so far noone in the administration has wanted to use, presumably for fear of spooking the markets: And that is to explain calmly and in great detail what would have happened without the Fed intervention/banking bail-out last September.
AIG would have defaulted on its payments to Goldman, Morgan Stanley, Deutsche Bank and long list of other counterparties. That would have killed them. So at first this seems to confirm the very point Rich and others are making. However things would not have stopped there: Goldman’s, MS’s, Deutsche’s et al’s counterparties would also have been rendered insolvent by this, since they depended on the continued payment flow as well. As a matter of fact the entire financial system would have gone insolvent.
And in reality it HAS gone insolent, since giant Fed lending and the bail-out were needed. Not only GS was indirectly bailed out, but so was everybody’s local savings bank. And everybody’s money market account.
So if Goldman deserves to pay a haircut on its claims for the bail-out, so does every other bank, and so does any firm and individual using a bank, in other words everybody. Which is how we come full circle to the “innocent” taxpayer.
We have all individually been bailed out by the collective (Fed/Congress) since the system has in fact blown up.
Now, I frankly get a lump in my stomach when I think what the markets will do in response to Geithner (or Obama or Summers) using this “gun”.
That is however the situation and I would imagine that making that clear, would calm down the hysterics in DC and in the media quite quickly. But, as long as things are as precarious as they are, at what price?
Ultimately though, this will need to be explained to the country. Else too many self-righteous fantasists will spring up.
Would seem safer though to do it when the stock market is 20% higher…
You are right, Boo, that this is the way TARP is supposed to work. But let’s not forget that the TARP itself was strongarmed onto the American people, and was widely (and accurately) perceived as a kind of extortion by those who foresaw precisely what Rich is now pointing out. It would be stupid to deny there WAS a financial emergency when Paulson came to Congress with his ransome note, but, as many respected economists warned at the time, there were fairer and better ways of addressing the crisis than TARP. According to Paulson, it was my way or the highway. Congress did get a few concessions in there, like Schumer’s idea of paying out the money in installments, or some semblance of oversight, but what got passed was ultimately not very different from Paulson’s originl idea.
Rich is reflecting the politics of the present direction, and the dangers for Obama and the country, not whether the TARP plan is being followed in a technically correct manner.
One result of CDOs (and the CDSs that insured them) is that bankers, insurers, and hedge-fund managers gained the ability to grow the money supply, which previously was the Fed’s purview. When leverage went from 1:10 to 1:30 (and in the case of CDO-Squareds, 1:600), a sharp investment banker could become his own Fed, printing his own money. This is the $50 trillion in excess money that is now sloshing around the global economy, slowly deflating while it tries to find a safe haven, and inevitably devaluing our currency. Those spikes in oil & mineral futures? Same “new” money, looking for a place to park.
It says a lot about Alan Greenspan that he didn’t recognize his loss of this authority. Randians just aren’t that smart.
As a Randian he may well have thought that this loss of authority was a good thing, a sign that the Fed was being superseded by the the permanent equilibrium of a newly-found “natural order”…
So when do we hear about Sach’s 2008 and 2009 bonuses??
Shockingly I agree with this. AIG is an insurance company and it has gone bust, but if the parties it ensures get nothing then they go bust in a domino effect that would probably get anyone dependent on modern civilization (like someone with medical issues or allergies) killed.
Where we part is I think the regulatory and criminal screws need to be put to AIG and AIG should survive SOLEY to pay out it’s creditors then be liquidated. Those credits need to be paid less than the full amount perhaps varying by how badly they themselves are off and how much criminal activity THEY did, but AIG needs to be kept on life support until it’s safe for them to die. But we don’t need to be giving them face lifts or chocolates during the life-support phase.
I don’t think we part at all. I agree with you 100%. If there is any difference it might be that I don’t consider paying out retention bonuses that were agreed on in January 2008 to be giving ‘chocolates’. It’s distasteful, but it’s payment for services rendered and not a true bonus in the classic sense.
This is it exactly. Claiming these retention payments are bonuses is totally inaccurate. They are the salaries of employees for services rendered. Basically, the employees get paid the bulk of their salary on one day. Passing a Taxpayer Outrage Tax on these salaries is clearly unethical and immoral. Many of these employees had nothing to do with the failure of AIG, and quite frankly, I’m not sure you can even point to the people who did. I’m more inclined to blame a failure of the politicians to learn from Enron’s mistakes and passing legislation allowing this fiasco to happen in the first place.
I’m actually not talking about the bonuses. I am fully aware that they are small in the long view. I understand they are a way for AIG’s people to cheat some on their taxes by having lower salaries, and that they are being taxed now is to defeat AIG’s little dodge which I think is good. I don’t think it’s unethical OR immoral. Is it legal? That’s a different question.
Since I can’t ed, I have to Re myself here… anyhow, does the Zombie Bank plan allow for the eventual liquidation of AIG? I suppose we need to wait for the details but the goal needs to be to effectively remove these companies from the board with a minimum of damage so we can start over clean and somehow guard against this happening when Republicans return to power.
DeLong’s answer about valuation is flippant and not at the same time:
“A: Then we have worse things to worry about than government losses on TARP-program money–for we are then in a world in which the only things that have value are bottled water, sewing needles, and ammunition.”
What does recovery mean here? The market was probably closer to an “actual” value of 8000 than 12000 since the gains from the Bush years were basically hollow financial tricks. At what point does he think they are going to re-inflate the bubble?
I have no idea how tax law applies to retention payments, but I know that the employees do pay federal income tax on them. On another board, it came out that even the littlest of employees often received these retention payments. I don’t think they were simply a means of dodging taxes. Again, if someone was to tell you that your yearly salary was going to be taxed 90% – 100% because they didn’t like how your employer managed his business, is that ethical and moral? I don’t like the military industrial complex, but I wouldn’t support taxing the individual soldiers in such a fashion.
Again, for the sake of full disclosure, my brother is a well paid code monkey for AIG and received most of his pay in the way of a retention payment. He is not the uber-rich, nor a greedy sob, nor even remotely responsible for the fiasco that is AIG. Why do you think it is moral and ethical to essentially take his entire salary?
Yeah, he probably did. So, it’s ok to take the salary of people who make more than you?
Yeah it’s OK since they benefit more. However, that’s quite above the normal wage and sounds unlikely.
said they didn’t need the payout from AIG since they bet that AIG would fail anyway and made money from being right.
Here’s where the problem came in and it is an inherent part of the way hedge funds are run. Persons who had no risk could buy premiums to insure against the risk that credit obligations would not be paid. So a third party could bet $22 million in premium payments for a face value of $1 billion.
The outrage that folks are sensing is that that third party did not get $22 million from AIG, nor a negotiated amount between $22 million and $1 billion but got the full $1 billion for doing nothing more that paying AIG $22 million.
In addition, there is potential fraud if AIG was using different internal units to reinsure other units and was accounting for the transactions differently in the units so as to make assets in individual appear greater than what they actually were.
Finally, there is the possibility of AIG’s offshore reinsurance units hiding transactions beyond the purview or US or European regulators.
I really don’t think any blanket statements are possible until Eric Holder’s white collar crime folks have a thorough investigation of AIG — which, since the US government is a 80% shareholder, they should have no difficulty doing.
I wonder if FOIA applies to government actions regarding AIG.