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Ruling that could impact future bailouts

slo1
Posts: 4,361
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6/15/2015 10:34:22 PM
Posted: 1 year ago
Great read from the recent court ruling from Greenberg the CEO of AIG when it almost went belly up. A little 50 person division decided to inaccurately price credit default swaps. They were on the hook for almost 1/2 trillion of dollars of CDS when the housing market imploded and they had clearly not collected that much in premiums to cover it.

The Feds step in and strong arm a 80% stake in the company leaving 20% to the shareholders and Hank Greenberg. Fed can't own equities so they create holding trust. This ruling says that is a no no.

If the Fed did not step in and pay 100% of AIG's claims against the CDS's there would have been a domino effect. AIG would have become insolvent and many of the companies it was insuring would have been insolvent. Arguably the Great Recession would have been Great Depression II without the AIG bailout. The entire fiasco was not all AIG's fault. The risky mortgages were the foundation but AIG as the insurer to many of those bundled investments of bad mortgages gave too much comfort to companies as they were a AAA rated behemoth Insurer at the time. They prided themselves on underwriting and being conservative at pricing risk. This 50 person division decided to deviate from that tenent.

http://www.nytimes.com...
ironslippers
Posts: 513
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6/16/2015 12:03:53 AM
Posted: 1 year ago
CDSs are not insurance otherwise they would have been regulated as such. So AIG need not back the CDSs. This also gave AIG the power to sell multiple CDSs for each MBS/ABS. I Have seen nothing regarding new regulations on such products.

I Believe the 2008 crash heralded a great depression thinly papered over as recession through corporate and poverty welfare at the cost of a shrinking middle class.

Though letting the to big to fail, fail would have been catastrophic it would have been short lived 5-7 yrs. Instead we will live in a bubble prone recession for 20yrs +.

Reinstating the Glass Steagall Act was a great start to getting US financially healthy, it was again overturned during the last budget crisis.

MHO
Everyone stands on their own dung hill and speaks out about someone else's - Nathan Krusemark
Its easier to criticize and hate than it is to support and create - I Ron Slippers
slo1
Posts: 4,361
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6/16/2015 10:01:23 AM
Posted: 1 year ago
At 6/16/2015 12:03:53 AM, ironslippers wrote:
CDSs are not insurance otherwise they would have been regulated as such. So AIG need not back the CDSs. This also gave AIG the power to sell multiple CDSs for each MBS/ABS. I Have seen nothing regarding new regulations on such products.

That is not accurate. While it was not regulated like an insurance product, it was a risk type product. If I were Bear Sterns and I had a bond from X party that is paying me 7% interest for 10 years and I was worried that X party was at risk of defaulting, I would buy a Credit Default Swap from AIG. During the life of the bond, I would make a payment to AIG and if the x party defaulted on the bond AIG would be on the hook of reimbursing me on my losses from the bond default.
http://www.investopedia.com...

AIG was most definitely had to back the CDS's they sold as they were legal contracts. They either pay what they agreed when the bonds and packaged mortgages and other investment products were defaulted upon or they go insolvent. In this case since they did not have enough capital to meet their contractual obligations they would have gone insolvent if the Fed did not step in. It gets much more complex when one starts trading CDS's as a derivative. The CIO of JPMorgan lost $2 billion trading CDS's on the market, but that is irrelevant to what AIG was holding when all their debt instruments they were insuring via CDS's started defaulting.

It is not regulated, but it should be regulated like insurance.

I Believe the 2008 crash heralded a great depression thinly papered over as recession through corporate and poverty welfare at the cost of a shrinking middle class.

Though letting the to big to fail, fail would have been catastrophic it would have been short lived 5-7 yrs. Instead we will live in a bubble prone recession for 20yrs +.

Well if this ruling stands, which it probably won't, it will eliminate the newly found method of taking over a company like they did AIG and they don't have as many options to stop financial and insurance company failures when everything hits the fan.

They would have to give AIG a low interest loan in which the leadership of the company who caused the mess is rewarded.

As far as whether the depression/recession would have been shorter, longer, or same duration whether the gov did or didn't intervene that is a much much bigger discussion.

Reinstating the Glass Steagall Act was a great start to getting US financially healthy, it was again overturned during the last budget crisis.

MHO
ironslippers
Posts: 513
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6/16/2015 1:49:06 PM
Posted: 1 year ago
At 6/16/2015 10:01:23 AM, slo1 wrote:
At 6/16/2015 12:03:53 AM, ironslippers wrote:
CDSs are not insurance otherwise they would have been regulated as such. So AIG need not back the CDSs. This also gave AIG the power to sell multiple CDSs for each MBS/ABS. I Have seen nothing regarding new regulations on such products.

That is not accurate. While it was not regulated like an insurance product, it was a risk type product. If I were Bear Sterns and I had a bond from X party that is paying me 7% interest for 10 years and I was worried that X party was at risk of defaulting, I would buy a Credit Default Swap from AIG. During the life of the bond, I would make a payment to AIG and if the x party defaulted on the bond AIG would be on the hook of reimbursing me on my losses from the bond default.
http://www.investopedia.com...

AIG was most definitely had to back the CDS's they sold as they were legal contracts. They either pay what they agreed when the bonds and packaged mortgages and other investment products were defaulted upon or they go insolvent. In this case since they did not have enough capital to meet their contractual obligations they would have gone insolvent if the Fed did not step in. It gets much more complex when one starts trading CDS's as a derivative. The CIO of JPMorgan lost $2 billion trading CDS's on the market, but that is irrelevant to what AIG was holding when all their debt instruments they were insuring via CDS's started defaulting.

Wasn't AIG reselling or outsourcing through other investment derivatives all or part of the CDSs, gambling that not all MBSs would collapse or at least not simultaniously?

It is not regulated, but it should be regulated like insurance.

I Believe the 2008 crash heralded a great depression thinly papered over as recession through corporate and poverty welfare at the cost of a shrinking middle class.

Though letting the to big to fail, fail would have been catastrophic it would have been short lived 5-7 yrs. Instead we will live in a bubble prone recession for 20yrs +.

Well if this ruling stands, which it probably won't, it will eliminate the newly found method of taking over a company like they did AIG and they don't have as many options to stop financial and insurance company failures when everything hits the fan.

They would have to give AIG a low interest loan in which the leadership of the company who caused the mess is rewarded.

As far as whether the depression/recession would have been shorter, longer, or same duration whether the gov did or didn't intervene that is a much much bigger discussion.

If you care to pontificate Ill listen

Reinstating the Glass Steagall Act was a great start to getting US financially healthy, it was again overturned during the last budget crisis.

MHO
Everyone stands on their own dung hill and speaks out about someone else's - Nathan Krusemark
Its easier to criticize and hate than it is to support and create - I Ron Slippers
slo1
Posts: 4,361
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6/16/2015 4:50:05 PM
Posted: 1 year ago
At 6/16/2015 1:49:06 PM, ironslippers wrote:
At 6/16/2015 10:01:23 AM, slo1 wrote:
At 6/16/2015 12:03:53 AM, ironslippers wrote:
CDSs are not insurance otherwise they would have been regulated as such. So AIG need not back the CDSs. This also gave AIG the power to sell multiple CDSs for each MBS/ABS. I Have seen nothing regarding new regulations on such products.

That is not accurate. While it was not regulated like an insurance product, it was a risk type product. If I were Bear Sterns and I had a bond from X party that is paying me 7% interest for 10 years and I was worried that X party was at risk of defaulting, I would buy a Credit Default Swap from AIG. During the life of the bond, I would make a payment to AIG and if the x party defaulted on the bond AIG would be on the hook of reimbursing me on my losses from the bond default.
http://www.investopedia.com...

AIG was most definitely had to back the CDS's they sold as they were legal contracts. They either pay what they agreed when the bonds and packaged mortgages and other investment products were defaulted upon or they go insolvent. In this case since they did not have enough capital to meet their contractual obligations they would have gone insolvent if the Fed did not step in. It gets much more complex when one starts trading CDS's as a derivative. The CIO of JPMorgan lost $2 billion trading CDS's on the market, but that is irrelevant to what AIG was holding when all their debt instruments they were insuring via CDS's started defaulting.

Wasn't AIG reselling or outsourcing through other investment derivatives all or part of the CDSs, gambling that not all MBSs would collapse or at least not simultaniously?

Their operations with CDS's was almost 100% one sided, meaning they were writing contracts to protect other parties.

The also had a securities lending division that rather than being a good insurance company and investing in short term Tbills they decided to get in the mortgage back security rage. That was collateral monies that they needed to give back when the securities they lent out were returned. They should have went conservative, instead they lost it in MBS's. This was partly why they were downgraded by Moody's.
http://www.bloomberg.com...

Now pile on their CDS loses and they did not have enough liquidity and would have went under. All this did not happen overnight. It was a process that really hit the fan when Lehman went under.

It is not regulated, but it should be regulated like insurance.

I Believe the 2008 crash heralded a great depression thinly papered over as recession through corporate and poverty welfare at the cost of a shrinking middle class.

Though letting the to big to fail, fail would have been catastrophic it would have been short lived 5-7 yrs. Instead we will live in a bubble prone recession for 20yrs +.

Well if this ruling stands, which it probably won't, it will eliminate the newly found method of taking over a company like they did AIG and they don't have as many options to stop financial and insurance company failures when everything hits the fan.

They would have to give AIG a low interest loan in which the leadership of the company who caused the mess is rewarded.

As far as whether the depression/recession would have been shorter, longer, or same duration whether the gov did or didn't intervene that is a much much bigger discussion.

If you care to pontificate Ill listen

I wouldn't even know where to begin. The entire credit default market was something like $26 trillion dollars during the crisis. It was estimated alone that the Lehman bankruptcy required $365 Billion payouts for CDS's. Could you imagine the possible dominoes if AIG went insolvent and did not pay its CDS obligations and what kind of pay outs could have been triggered in the full $26 trillion CDS market?
http://www.washingtonpost.com...

I don't think anyone really knows, but I think it would be safe to say the liquidity crisis would have been much much deeper and longer.

Reinstating the Glass Steagall Act was a great start to getting US financially healthy, it was again overturned during the last budget crisis.

MHO