Gtarras

Can We Insure Against Systemic Risk?

thanks for your views Tom, I am in total agreement with all you said here.

the issue of the systemic insurance is extremely interesting, and has been discussed at various blogs this week. I think it deserves a lot of attention. Simple reason: the backstops that AIG, monolines, SIVs etc were providing to the investors in the past few years are gone. These guarantees, or, in case of SIVs, high rated conduits, were a huge source of liquidity. I am not sure how big exactly, but I would say easily in the single digit trillions of dollars, and maybe even more. My personal, very soft estimate (i have spent ten years in the structured finance area, and dealt with SIVs) is more than $10 trillion of liquidity provided (on aggregate, i am looking at SIVs, guarantors etc).

With this source gone, no wonder money is not flowing through the system. banks are lending but this "shadow banking" source is gone or severely wounded. The FED increased the monetary base, but the money is still not flowing. How will it come back? I dont know. Thats the reason I believe, this topic deserves a lot more attention it is getting.


On Jul 15 05:07 PM Tom Armistead wrote:

> AIG agreed to post collateral and the requirements increased if they
> were downgraded. As of this moment 3% of the bonds they insured
> is not paying, so the losses of 50% they took via Maiden Lane were
> far in excess of what the losses are going to be. They set themselves
> up to guarantee the market value of the securities. MBIA doesn't
> post collateral and is still afloat after taking far more serious
> losses.
>
> Systemic risk if viewed as financial catastrophe risk is difficult
> to insure for the fact that all the losses happen at once which the
> insurance mechanism can't handle. Paying for example bond insurance
> losses over the life of the bond without posting collateral somewhat
> improves the possibility of making it work.
>
> Ultimately society as a whole, ie big government, is responsible
> to pick up the pieces and get things rolling again in the event of
> a financial catastrophe. Long-term it might be more effective to
> admit this, set up an FDIC like mechanism Depression type loss scenarios.
> The premiums or taxes would have to be segregated and accumulated
> over time to pay for the big one, or the government could simply
> print money to fund it. The premiums if proportionate to the systemic
> risk created by the activity would be a deterrant to excessive risk
> taking.
>
> Since the government is the insurer of systemic risk it makes sense
> to formalize the arrangement and specify how it works in advance,
> rather than making it up like Paulson as he cruised around with his
> Bazooka picking the winners and losers.

Can We Insure Against Systemic Risk?

Well, Michael Lewis.... I'd be very careful believing what he has to say, as he prefers sensational journalism to fact checking.

I too was under impression that AIG was not offering to post collateral, but the latest facts show that they were (for example, google AIG internal memo, which resurfaced couple of weeks ago, where they specifically say how much they'd have to post for each of their counterparty). When I saw it, I could not believe myself. I was under impression that their problems were due to the downgrade (they'd have to post as well), but it looks like they were even more suicidal.


On Jul 15 01:43 PM Fund Insider wrote:

> Acccording to Michael Lews (a prolific writer on Wall Street greed)
>
> AIG went against industry practice and refused to post collateral
> to dealers when they first started trading CDS (selling insurance).
>
> It is this lack of collateral obligation that allowed them to run
> amok writing unlimited amounts of insurance, they didn't need any
> collateral at hand to fund them. At some point they had to do it,
> but could only do so with govt help to fund the collateral payments
> to Goldman, etc.
>
> Interesting read
> www.vanityfair.com/pol...
>
> On Jul 15 01:26 PM Gtarras wrote:

Can We Insure Against Systemic Risk?

Here are two major points nobody mentions:

1. AIG was brought down not by the REAL losses on these tranches, but by mark-to-market SWINGS. It was offering to post collateral through a mechanism called CSA, if prices went too far against the protection buyer. Other players like AIG (monolines), did not offer these margin posting service.

2. It is still not clear whether the real losses that AIG will suffer will be enough to wipe out its capital. For example, MBIA seems to be ok in this regard.

The CSA offer from AIG was a suicide. Their exposures were close to $1 billion in each deal, with VERY ILLIQUID deals 5-8 years in maturity. With this type of setting, if a price on your tranche jumps from 10 bps to 100 bps, you get slaughtered. (they clearly thought it would not happen.)

For example, if you sell 5y protection, $10 mill exposure on a liquid name and things go against you, i doubt you'd suffer that much.

Thats the reason its critical that this systemic risk issue is brought up. NOBODY is big enough to withstand this type of hit (except the govt). Of course, there was a reason the banks wanted to unload these tranches- to free up capital. Easy fix would be to make changes in Basel to view these types of exposures as "capital light".