How Stupid was AIG Management?
AIG has published its 10-K for last year, and it is depressing, even more depressing than the horrifying $99.3bn loss for the year. We know that a lot of the $173bn taxpayers have poured in went to deal with their naked Credit Default Swaps. This 10-K shows us the losses from another disastrous financial ploy. Why do these people still have jobs?
AIG classifies its CDSs into two main groups. The Regulatory Capital Portfolio consists of CDSs written primarily for European banks guaranteeing payment of parts of their loan portfolios. Under applicable law, banks are required to maintain a specific amount of capital to support their lending activities. If the loans are guaranteed, say by an AIG subsidiary like Banque AIG, a French Bank, the protection buyer can reduce the amount of required capital, and then increase its lending.
The total of this portfolio at year’s end was $234.4bn, down from $378.7bn at the end of 2007. This figure is a notional amount; it represents the maximum amount of loss which could be incurred on the CDSs. Not to worry, says AIG. The regulatory problem has changed, and this portfolio will be worked off without any serious risk of loss. The WSJ disagrees. Oh, and let’s not judge the wisdom of this kind of regulatory practice, that’s so partisan and backward looking and blaming and stuff.
The other substantial part of the CDS portfolio is the Arbitrage Portfolio, which at the end of 2008 totaled $63.1bn, down from $148.6bn the previous year. This is the crud even AIG admits is troubled, and big chunks of the first $85bn we donated to AIG went to post collateral with counterparties. At 9/30/08, the total collateral posted was at least $32.8bn, and the notional amount outstanding was about $135bn.
The Fed used some more of our money to take care of about half of the problem in this portfolio. In December, the Fed set up a new Special Purpose Vehicle, called Maiden Lane III, to buy up $62.1bn notional value of this junk.
Through December 31, 2008, AIG Financial Products Corp. terminated CDS transactions with its counterparties and concurrently, ML III purchased the underlying multi-sector CDOs, including $8.5 billion of multi-sector CDOs underlying 2a-7 Puts written by AIG Financial Products Corp. The NY Fed advanced an aggregate of $24.3 billion to ML III under the ML III Senior Loan, and ML III funded its purchase of the $62.1 billion of multi-sector CDOs with a net payment to AIG Financial Products Corp. counterparties of $26.8 billion. AIG Financial Products Corp.’s counterparties also retained $35.0 billion, of which $2.5 billion was returned under the shortfall agreement, in net collateral previously posted by AIG Financial Products Corp. in respect of the terminated multi-sector CDS.
Your tax dollars at work. The $63.1bn notional amount of CDSs still on the books? AIG won’t even estimate losses there, or the amount of additional collateral that might be required.
The Securities Lending Program. The second disaster is called the Securities Lending Program. AIG pledged securities owned by its insurance company subsidiaries in exchange for cash, agreeing to pay interest. It used the cash to buy residential mortgage-backed securities (RMBS), which paid higher returns than the rate AIG was paying for the cash. At the end of August, 2008, the lenders wanted their money back, about $69bn, but the RMBS couldn’t be sold for enough to pay off the debt. That was a problem.
The solution? Maiden Lane II. This entity bought the RMBS portfolio of $39.3bn. ML II got a loan from the Fed of $19.5bn, and paid $19.8bn to the insurance companies. I can’t figure out how much this cost the insurance companies. Let’s hope it wasn’t enough to impair their capital structures.
How stupid is this? A big part of AIG’s CDS portfolio insures protection buyers against failure of mortgage backed securities. Another part of AIG goes out and buys a bunch of mortgage backed securities. Competent management might have thought of hedging against losses in both portfolios. AIG apparently believed the shouters at CNBC and the cheerleaders on Wall Street who said housing could never lose value. They doubled up on the RMBS.
Why are these people still employed?