To understand why the US Federal Government has loaned American International Group (AIG) just under $85 billion to keep it afloat, one must understand the arcana of high level corporate insurance and finance.
AIG, more correctly a segment of AIG, the Financial Products group, has been issuing and carrying insurance for big investment houses on their investments since they took over Drexel Burnham Lambert’s derivative group when Drexel burned up in the late 80’s in the junk bond scandal. Remember Michael Miliken?
Needless to say to keep up appearances (read: Profits) AIG had to bet on both sides of the equation in any finance or insurance deal. This is what insurance companies do: Insurance is nothing more than a bet that you won’t get into a car accident, or burn down your house. Actuaries are the ones who make book on the likelihood of something bad happening.
Part of AIG’s Financial Products offering was insurance that Collateralized Debt Obligations (CDO’s) wouldn’t go into the shitter. CDO’s were pools of securities packaged by investment banks, based on paper they bought from mortgage lenders. See Financially Counter-intuitive posted yesterday for the 411 on what happens when a side of bacon and a box of rocks gets financed for a mortgage.
Until recently, the bond rating organizations, like Moody’s or Standard and Poor’s would rate these CDO’s, called super-senior deals, as AAA, meaning, The Safest. With AIG providing insurance on the deal, guaranteeing the rate of return, the securities were about as safe as you could get. Of course there would be the occasional loss, but AIG figured that it could only be a billion or so.
Meanwhile another AIG holding, International Lease Finance Corporation was up to its armpits in leasing passenger aircraft. ILFC is the largest (by dollar) lessor of aircraft to the airlines of the world. We know what kind of money swamp airlines are, but Wall Street is looking at ILFC as one of the assets of AIG that might actually be worth something.
As auditors started poking into the most egregious mortgages and the collateral underneath them ("Whaddya mean a side of bacon and box of rocks own a two-storey house in Scottsdale? Were you friggin’ high when you wrote this loan up?") the underpinnings of super-senior deals started to look very wobbly. AIG, handling both ends of the deal and the insurance on the deal, started to wobble too.
However, AIG is also the largest commercial and industrial insurer in the US. AIG does car insurance to individuals, along with life insurance and fixed annuities for the retired. Naturally all these moving parts are tied to each other, as accountants do a shell game with losses from one area being covered by profits in another and insured by yet another.
By May 2008, AIG reported that they held more than $20 billion dollars worth of potential dog poop in a bag. This figure probably included a property owned by a side of bacon and a box of rocks in Scottsdale.
Now, as to why the US Federal Government bailed AIG out is simple. AIG couldn’t get financing to keep going. All the banks, brokerages and investment houses that helped propel AIG to the top of the heap suddenly looked at their own balance sheet and said they couldn’t afford the risk. Phones were answered with "AIG who? Never heard of ’em".
The US government could not afford the holder of the savings and insurance for millions of citizens to go Tango Uniform. Wall Street created the beast and now the US taxpayer is bailing AIG out with loan guarantees.
Consequently the US taxpayer owns just under 80 percent of a company that holds at least $20 billion worth of toxic loans, aircraft leases in a time of declining revenues, a pervasive insurance business, the retirement funds of millions of citizens and a board of directors that in all likelihood have Golden Parachutes the size of Montana.
So far, nobody has been fired, stripped of their bonuses and stock options, or driven naked through the streets at the wrong end of a bullwhip. This will never happen, as the high finance folks are the ‘base’ and we all know that the base protects itself, at the same time as it suckles at the government teat.
It all tracks back to mortgage lenders doing a wink and a nod to Wall Street, doing a wink and a nod to the insurers and a wink and a nod back from the regulators, meaning the SEC and the US Government.
The financial meltdown isn’t a crisis of confidence, or an adjustment, or a swing in valuation. It’s fraud and fault of regulators who let this nonsense happen with a wink and a nod to the ‘base’.
RoadDave 