AIG's Speculative CDS Bets 9 comments
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Did you know that AIG (AIG) has a Blog Relations department? For real. They sent out a big email earlier today, which wound up in places as varied as Dealbreaker and Welt Online, taking issue with the WSJ's story about them this morning. Unfortunately, they seem incapable of writing in English, and even if you do try to decipher what they're saying, it seems to be little more than "this isn't news, it was on page 117 of our 10-Q".
The notional amount attributable to the cash settlement portion of the AIG Financial Products multi-sector credit default swap portfolio has been consistently included in the total AIG Financial Products multi-sector credit default swap exposure in AIG's SEC filings and is explained on page 117 of AIG's Quarterly Report on Form 10-Q for the period ending September 30, 2008.
I did end up talking to a human at AIG about this, since I wondered whether the company actually had any substantive issues with the WSJ story. It turns out that there is one big issue -- that the amount of money in question is not $10 billion, as the Journal would have it, but...
...and there AIG goes quiet. They're happy to tell you that the $10 billion is a notional amount, and not a mark-to-market loss: it's AIG's maximum possible loss, and the insurer does not at this point "owe Wall Street's biggest firms about $10 billion", as the Journal says. But AIG won't tell us how much it does owe on this book, so it's impossible to tell whether its actual mark-to-market loss is close to $10 billion or not.
AIG is not disputing the main thrust of the story, which is that AIG Financial Products was stepping far beyond its remit as part of an insurance company. Most of the credit default swaps written by AIG were real insurance: they were sold to banks who held the securities in question and wanted to hedge their exposure.
But this $10 billion book wasn't insurance at all, it was outright speculation. And now the US government is having to put up billions of dollars in collateral against those bets -- bets which have gone very sour indeed.
I'm calling this one for the Journal. There might be a few minor errors when it comes to the specifics, I don't know. But the big picture is clear. AIG insured banks, and it was necessary to bail out AIG in order to prevent a much larger domino effect caused by those banks not being paid out by their insurer. At the same time, however, there's no reason to bail out the bits of AIG which were simply making speculative bets on the credit markets -- and indeed there's no reason why a triple-A insurer such as AIG should ever be making such speculative bets in the first place.
How much have those speculative bets cost? AIG won't say. This time last month, it held a quarterly conference call, and in the slides for that call, on page 15, it gave some numbers for its total CDS exposure -- both insurance and speculative. AIG wrote $71.6 billion of protection on multi-sector CDOs, and its mark-to-market loss, as of September 30, was $30.2 billion. That's all we know so far. In October, that loss surely went up substantially; the loss on the speculative CDS might be much greater, in percentage terms, than the loss on the insurance CDS. But it's probably safe to say that at a minimum, AIG's mark-to-market losses on its speculative bets -- losses for which the government has to provide collateral -- are at least $4 billion or so.
That's a lot of taxpayer money to put to use bailing out an insurance company's prop desk. And given AIG's recalcitrance in coming up with hard numbers which might contradict the Journal's reporting, I do wonder why the Blog Relations department was so keen to send us all this note. They might have been better off just keeping quiet, frankly -- especially when their formal statement is so incredibly stilted.
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This article has 9 comments:
Hey, I have an idea...let's bring the guy who built the bomb back into the building and see if he can dismantle it for us. We'll call him a consultant and pay him a bunch of dough!
This stuff makes Big-P's head hurt so I can't talk about it any longer but I do have another idea for you boys...
I'm going to hammer the futures market at two specific points today (just because I can) so you might do well to position yourselves on the short-side in front of those "specific" periods of "selling pressure" today.
Both time periods are listed on my BLOG but I'll list them here as well.
Expect some real nastiness into the 12:15 through 1:00 period (est) and again into 2:35 est. as I "lean on them" BIG-TIME!!!
Yes, I can predict the market...but since I'm the one moving it I can't claim brilliance (or even a crystal ball)
That's how you make REAL money...
Big-P
AIG was beyond stupid to have killed themselves off via CDS exposure (and purely speculative CDS plays should be illegal....period), but if you believe the company needs to be sold in pieces to pay off the debt -- it's hardly helpful for financial journalism to run their weekly "another reason AIG is evil" stories.
But for many years before this blew up a lot of exposure was taken in synthetic form, it was far easier than buying the assets, the line was that many investors preferred their exposure in synthetic form. It was regarded as a normal type of investment.
AIG was not the only insurance company to get sucked into this zero sum game: however, they were the only one that put themselves in the position of being required to post collateral.
NEW YORK, December 10, 2008 – American International Group, Inc. (AIG) has issued the following statement regarding an article that appeared today in The Wall Street Journal:
“A story in today’s Wall Street Journal incorrectly reports that AIG has a previously undisclosed obligation to counterparties of about $10 billion. The Journal’s story relates to AIG Financial Products’ multi-sector credit default swap portfolio. Included within that $71.6 billion portfolio (notional amount as of September 30) is approximately $9.8 billion of swaps that were sold as credit protection on “synthetic” securities. The swaps on these synthetic securities are also referred to as “cash settlement” or “Pay As You Go” (PAUG) swaps because they are settled in cash as and when losses are taken.
The majority of the multi-sector CDS swaps were written as “physical settlement” swaps, where AIG is required to physically buy the underlying collateralized debt obligation (CDO) bond in the event of a CDO credit event.
The $9.8 billion notional amount does not represent a loss to AIG or a debt it owes to counterparties. It represents the notional value of the maximum potential cash settlement portion of the multi-sector portfolio. Cash settlement swaps have lower liquidity risk because they are PAUG. A credit event on a physical settlement swap requires AIG to buy the total underlying CDO tranche in an amount equal to AIG’s full notional exposure whereas a PAUG contract only obliges AIG to pay losses on that tranche as and when they occur therefore reducing the cash impact.
AIG is addressing its exposure to its entire multi-sector CDS portfolio through its existing credit agreement with the Federal Reserve Bank of New York. As previously announced, AIG and the Federal Reserve have funded the Maiden Lane III facility, which has negotiated agreements to settle $53.5 billion of AIG’s $71.6 billion CDS portfolio.
The notional amount attributable to the cash settlement portion of the AIG Financial Products multi-sector credit default swap portfolio has been consistently included in the total AIG Financial Products multi-sector credit default swap exposure in AIG’s SEC filings and is explained on page 117 of AIG’s Quarterly Report on Form 10-Q for the period ending September 30, 2008.”
# # #
American International Group, Inc. (AIG), a world leader in insurance and financial services, is the leading international insurance organization with operations in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services and asset management around the world. AIG's common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.
Reuters just ran a story where the CEO of Liberty Mutual goes on the record to call out AIG by name for slashing prices and backs it up with an example (biz.yahoo.com/rb/08121...). Hank Greenberg (not unexpectedly) chimes in too. I've seen lots of references by other industry CEOs to AIG doing this but this is the first time they've been called out by name and on the record and backed up by an example.
So what does the govt do now that its blank check is causing AIG to miss-behave? Insurers have already been slammed by poorly performing investments. If AIG is/starts systematically slashing prices (no real evidence of this cited in the press yet) and starts hurting insurers' underwriting results too (2008 wasn't a great year on this front already), the govt would quickly be in a damned-if-you-do, damned-if-you-don't situation a la the automakers.
On Dec 11 04:19 PM Insurance_nerd wrote:
> When will the govt finally pull the plug on AIG? Isn't the systemic
> risk vastly reduced now that the CDS exposures has been dealt with
> after the latest bailout restructuring? How big of a counterparty
> does AIG continue to be for banks?
The bailout restructuring only provided reserves enough to deleverage and thus avoid more downgrades which would end all other business. The counterparty risk isn't gone. The MBS market needs to return to a reasonable liquidity which will only happen after the vast majority of homes destined for foreclosure have already been squeezed out of the market whether through foreclosure or legitimate refinancing arrangements that don't later still fall into foreclosure again. So, for now we're on the hook.