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AIG Huge Loss


Uccmal
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61 B.... A record loss for one Q or year or whatever.  The question that is coming to my mind is where exactly has the money gone.  They are stating that it is a combination of investment losses, writedowns, and restucturing charges.  I have not read the report as I consider it a waste of time but I am curious. 

 

We were not in an inflationary environment prior to this blowout so it didn't just disappear:

1) Investment losses - AIGs loss must be someone else's gain?  Who out there now has 20-30 B sitting on the sidelines, probably invested in Treasuries or Munis at the moment.

2) Writedowns - This is more understandable and may not involve a direct counterparty, at least not one that exists any longer - In this case the value applied to something may no longer exist, perhaps the top third of that house price. 

3) Restructuring charges - Letting people go - this cant be that great since the insurance businesses are still in reasonable shape -

 

I am just having a hard time getting my head around this whole thing. 

 

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They sold more than $400b nominal of CDS. Extrapolate from FFH's gains on just $20b of CDS and you get a sense of what went wrong. Best part is that the clowns who ran their Financial Products division in London that sold these CDS got paid their millions in bonuses before these losses were recognised.

 

Cheers.

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They got paid after the bail out, about 400 million in tax payer dollars split amongst 400 "key" employees.  Maybe they'll make it back on volume.  Of course by the time the risk in cds actually became miss priced they probably weren't allowed to write anymore business. 

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From a going concern view, AIG is dead in the water without government capital and loan guarantees.  Has the government given indications that AIG will be put into run-off?  Will AIG be allowed to continue writing new business?  It is obvious that government intervention which subsidizes AIG's cost of capital for new business will distort the marketplace.  If one views AIG as GoodCo and BadCo (containing CDS derivatives, etc), is the government subsidizing just BadCo or GoodCo as well? 

 

-O

 

They sold more than $400b nominal of CDS. Extrapolate from FFH's gains on just $20b of CDS and you get a sense of what went wrong. Best part is that the clowns who ran their Financial Products division in London that sold these CDS got paid their millions in bonuses before these losses were recognised.

 

Cheers.

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In case you missed this today. From Bernanke's comments to the Senate Budget Committee:

 

“If there’s a single episode in this entire 18 months that has made me more angry, I can’t think of one, than AIG,” he said. “AIG exploited a huge gap in the regulatory system. There was no oversight of the financial products division. This was a hedge fund, basically, that was attached to a large and stable insurance company, made huge numbers of irresponsible bets, took huge losses. There was no regulatory oversight because there was a gap in the system.”

 

AIG Said to Pay $450 Million to Retain Swaps Staff (1/27/09) -- There's more about compensation in the article - like $1M a month to Joseph Cassano for consulting - He earned $280M since 2000, while building a $500B portfolio of CDS including $61B in sub-prime.

"The financial products business was founded in 1987 by ex-employees of Drexel Burnham Lambert, the securities firm that helped popularize “junk- bond” investing before it collapsed."

 

http://www.bloomberg.com/apps/news?pid=20601087&sid=a4iG4N0ZcsTU&refer=home

 

And JP Morgan announced they made $5 Billion in Profit on $88 Trillion in Unregulated Derivatives Speculation...

 

My guess is the government's willingness to support AIG stems from the fact the money is going from AIG directly back into mostly US banks.

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Yeah, supporting AIG contracts supports the rest of system - cannot just shut down AIG for old stuff.  But why are they being allowed to write new business?  What rational manager in customer organization, can satisfy "prudent man" rule if relies on AIG as counterparty going forward?  Should be in runoff already.  Let Berkshire and other insurers who didn't kill their company with derivatives liabilities, grow their business.  AIG 'investment' for world financial system is case of watering the weeds instead of the crops/flowers.

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As I understand it, the various insurance companies of AIG are partitioned to a certain extent from the parent as each need to maintain their own capital levels. Those companies, again from what I am understanding from those within the industry, are solvent. The issue with AIG is the boneheads effectively insured many times more debt than actually existed. That is what needs to be propped up. The insurance subs capital was not affected by this directly (though, indirectly, as AIG has been tainted, customers are leaving).

 

I have not heard of the AIG parent selling off any of the subs to raise funds. It would seem to be a classic case of the companies being more valuable to the Prems and Warrens of the world, who do have capital, than to AIG. Full disclosure is that I have only followed this superficially and others will likely be able to better inform.

 

-Crip

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Crip, I think I read something a while back mid-2008 or maybe even earlier, about AIG getting an exemption from partitioning of reserves, essentially allowing them to use huge amount of reserves ($60b comes to mind) of insurance operations to support increased capital requirements of non-insurance ops.  I'm not a follower of AIG and may be all wrong, but that was impression I got from general news.

 

I've just got a problem with bad operations, which has to include AIG at top level where insurance and non-insurance operational units are both overseen, tainting good ones - both within AIG, and keeping good operations with other management groups from replacing bad ones.

 

Would have made a lot more sense, eg with banks, to have put huge capital into the best banks so they could expand lending to fill in for the worst banks having reduced lending capacity.

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Each national regulator where AIG operates will have 'tied' reserves, to back the business done in that country. But most national regulators also allow derivative 'netting' to include the notional amounts, which effectively transfers that 'tied' reserve to head office in return for a head office derivative receivable. And if head-office craters .... those head office derivative receivables become worthless. IE: You're suddenly UW with a near zero reserve.

 

As Canadian regulators typically don't permit the inclusion of notional amounts, the Canadian exposure is limited to the MTM - which limits the Canadian contagion.

 

Most folks haven't realized how adversely volatile AIG really is, & why.

- Essentially every time there's a 'normal' UW loss almost anywhere in the world it will require a new fed bail-out as there's no reserve. And we're approaching spring/summer when weather gets more volatile. One disaster almost anywhere and ?

- That AIG head-office derivative receivable is now a fed obligation untill the last head-office derivative matures, & while the buyer of a unit will effectively substitute their credit rating for AIG's - they will not reassign those head-office derivatives as the fed rating is better than theirs. IE: Free reinsurance, in huge quantities, for a very long time.

 

WEBs weapon of mass destruction ?

 

SD

 

 

 

 

   

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Quick mechanical example:

 

Assume head-office (HO), & 3 seperate legal entity subs: Asia (A), Europe (E), Canada ©. Each sub controlled by the local regulator, & each sub holding an asset reserve to back poilcies written in that market - assume 104% of the liability for Asia, 102% for Europe, and 103% for Canada. Assume hed office has 50 in assets & that local regulators generally defer to the 'home' US regulator.

 

Assets: A (104), E (102), C (103), HO(50)

Liabilities: A (100), E (100), C (100), HO(40)

Equity: A (4), E (2), C (3), HO(10)

 

Now assume HO decides to do CDS's with the market. There is relatively little risk involved, & material additional income - so they do it using 10 of equity & get 2 of premium. What happened ? They securitized the equity. Because this is off BS, HC liabilities stay at 40, assets increase to 52, & equity increases to 12 (20% increase). The original equity investment is still there, but its now really zero because of the additional 10 of off BS liability. Bonuses get paid.

 

Assume the P(x) of having to actually pay the 10 of HO equity is 5%. The strategy is working, there is no bad experience, so go to 200 in CDS notional value [10/.05] over 2-3 years. Bonuses get bigger.

 

What works for the HO portion of equity also works for subs, & HO is doing fabulously well. HO issues A, E, C a high yield internal receivable for their equity & does 180 in new CDS notional value [9/.05] over 1-2 years. Regulators have little say as the equity is 'cushion' & the credit rating of AIG is better than the equity they've given up. What happened ? 380 in CDS notional value, supported on 19 of equity in generally poorer investments (assumes cash from the premiums pays bonuses, raises, etc). Bonuses continue.

 

AIG has a series of off BS liabilities at varying terms to different counterparties. As A,E,C are seperate legal entities they are also potential counterparties, therefore some of the A,E,C assets could go into this scheme. Requires regulatory approval, but the 380 of existing CDS exposure will be less risky as its now supported by 19 of equity + some assets. Assume the home regulator permits 100% of assets

 

C's regulator baulks, & wants MTM on the equity investment. A & E's regulator defer.

4120 in new CDS notional value [206/.05] over 2-3 years & bonuses get really big. What happened ? 4500 in CDS notional value, supported on 225 of equity, HO is so big a part of the CDS market its now a price setter, A & E's assets to support their business is illiquid, & there's extreme reliance on the premium cash flow continuing.

 

Markets start tanking, the P(x) goes from 5% to 10%. The 4500 of CDS notional value now requires 2250 to support it, & AIG is technically insolvent as it only has 225. Worse still, the 225 is rapidly falling as AIG is having to make good on its promises. Major names start falling & AIG starts selling. Premium declines & P(x) increases to 15%. AIG hits up the fed

 

Assume the fed did mirror swaps to get the HO derivatives out of A & E & prevent these units from collapsing. The units then go on the block. Assume A gets sold. A's buyer would have 104 of assets (a fed backed notional CDS notional value of 2600) and 100 in liabilities, but would have to take all the liquidity risk on those liabilities suddenly claiming (hurricane, etc). IE: You would not pay much, but if the fed didn't sell - that liquidity risk would be theirs as well.

 

There is a lot more here than meets the eye.

 

SD

 

 

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