If you want to understand the deals that wiped out AIG, the best place to start is the website of the New York Fed. In the financial statement of Maiden Lane III, published last April, we see the gory details of the three largest CDO investments - Max 2008-1, Max 2007-1, and TRIAXX 2006-2A - acquired from AIG's banks at par. Those deals, which totaled $10.7 billion, offer a template for evaluating the other sham transactions in the portfolio.
Initially, the business deal between AIG and the banks was that AIG sold credit default swap protection. Banks buy credit default swaps for two reasons: They want to slice and dice their credit risk, and/or they want to hide something. Here's a simple, fairly innocuous, illustration: Suppose you're a banker who tells his client, Procter & Gamble, "We want to expand the relationship and do more business with you." P&G then says, "Fine, lend us $100 million." Back at the office, your senior credit management says, "The maximum risk exposure we approve for P&G is $80 million." How do you keep in P&G's good graces? You lend the company $100 million, and simultaneously offload $20 million in risk exposure by purchasing a credit default swap from another bank. P&G's understanding is that you've lent them $100 million.
When Deutsche Bank bought a credit default swap from AIG in 2008, its primary motivation was not to slice up the credit risk, but to hide virtually all of it. Max 2008-1, a CDO that Deutsche arranged and closed on June 25, 2008, was huge. The total debt issue was $5.8 billion, of which 94%, or the entire $5.4 billion Class A-1 tranche, was covered by one credit default swap issued by AIG Financial Products. The Class A-1 tranche was considered "supersenior" because it was ahead of two other tranches, both originally rated Aaa, which totaled $200 million. (The remaining $200 million worth of debt was rated Aa, A and Baa at closing.)
Put another way, Deutsche Bank did not bring Max 2008-1 to "the marketplace," where investors might consider buying the deal on its own merits. By normal standards, the "market" for this CDO never really existed. Nor did Deutsche sell the deal to AIG, which could have assumed both the risks and rewards of owning a huge CDO. (In all fairness, we do not know where the remaining 6%, or $400 million, of less-senior tranches ended up. Deutsche could have kept them in inventory to be stuffed into a yet another CDO.)
Almost all circumstances surrounding Max 2008-1 seem weird. We do not know much about the $5.4 billion Class A-1 tranche, except that it was never downgraded below its initial Aaa rating. Yet, according to Deutsche Bank, AIG and Maiden Lane III's accountants, the underlying value of Max 2008-1 collapsed within a matter of months. By the time that the government agreed to acquire the CDO at par, the Class A-1 tranche purportedly had a negative "mark-to-market" of $2.5 billion. (As noted earlier, accountants, both for AIG and the Fed, determined that that there was no market benchmark for valuing any of the CDOs.) So did AIG turn over $2.5 billion in cash collateral to Deutsche? No. It turned over $4 billion, as revealed in AIG's filing with the SEC, dated May 15, 2009.
Among the hundred plus CDO deals to which AIG extended credit protection, the only ones which received collateral postings in excess of the "negative market-to-market" were the two biggest: Max 2008-1 and Max 2007-1, as revealed in the SEC filing of May 15, 2009. Together, those two CDO tranches had a par value of $7.5 billion and a "negative market-to-market" of $3.5 billion at the time Maiden Lane III closed. But AIG had already turned over $5.6 billion in collateral to Deutsche Bank, $2 billion more than what anyone thought to be necessary.
Everything about Max 2008-1 suggests that the parties were not acting on an arms-length basis, that they had something to hide. A deal rated Aaa doesn't decline in value by 40% within months after closing and still retain its Aaa rating. (The more junior tranches received moderate downgrades on March 19, 2009.) A cash-strapped insurance conglomerate does not turn over $2 billion in excess cash collateral for no reason. AIGFP had unsuccessfully struggled for the better part of a year to establish an agreed-upon method for calculating the amounts of cash collateral postings on these credit default swaps. It seems more than a little odd that it would choose to expand this problem with a credit derivative more than twice the size of its next largest CDO exposure. And it seems especially odd that it would close such a deal in June 2008, one month after Moody's and S&P had downgraded AIG, and issued warnings that further downgrades could be coming.
What becomes obvious, after reviewing Max 2008-1, Max 2007-1, and TRIAXX 2006-2A, is that these deals never could have been done but for AIG's willingness to assume the lion's share of the credit risk.
TRIAXX 2006-2A was a $5 billion deal, of which AIGFP assumed $3.2 billion, or 64%, of the credit risk. AIGFP provided credit protection in three different tranches, all of which were rated AAA at closing. The sole underwriter and arranger for the $5 billion CDO, which closed in December 2006, was an outfit called ICP Securities LLC, a private firm owned by its employees. In retrospect, it seems remarkable that AIG would have assumed such a large exposure in a deal structured by a relatively small private company. Nonetheless, ICP was able to sell its deal into the marketplace, if that's the correct way to characterize it. Of the $3.2 billion in credit protection sold by AIG, $2.5 billion was purchased by Goldman Sachs, another $0.4 billion was acquired by an affiliate of Dresdner Bank, and $.03 billion was acquired by a company of unknown origin, called CORAL Purchasing (Ireland) Limited. All of this information was disclosed by AIG to the SEC on May 15, 2009.
The Aaa ratings at TRIAXX 2006-2A remained in effect at the time AIG collapsed, and at the time the CDOs were sold at par to Maiden Lane III. Nonetheless, Goldman had demanded, and received about $1 billion in cash collateral postings prior to the date when the New York Fed took the exposure off of AIG's books. About a month after Maiden Lane III closed out its books for the year, on December 31, 2008, TRIAXX 2006-2A suffered a downgrade, to Caa.
Those eight-month-old public disclosures are very incomplete, but they reveal a lot. They indicate that these CDO deals were not, by any stretch of the imagination, conducted on an arms-length basis, and that these transactions took forms that were designed to conceal the true economic interests of the parties. I'm always amazed by what people, especially people not from the financial world, don't know. Big banks are not like the Pentagon or the Coalition Provisional Authority. Billion dollar amounts do not just slip through the cracks. There is no way that the very top people at AIG and Deutsche Bank would not be thoroughly briefed about every aspect of a $5.4 billion credit default swap for a CDO called Max 2008-1.
The newly disclosed information, which reveals the redacted parts of AIG's May 15, 2009 filing, serves to confirm what we already realized. At AIGFP's CDO business, nothing was what it seemed.
They also lobbied for the Commodity Futures Modernization Act of 2000, which allowed banks to trade their crooked insurance in secret and exempted from all supervisory authority. And to help grow the hurricane, then CEO of Goldman Sachs Hank Paulson made a personal plea to the SEC to allow banks to leverage more money against their capital. As much as $4,000 for every $100 in capital they held.
Congressional hearings were nothing but a sham as well. The real culprits here are SEC and congress and anyone who stands in the way of bring back financial regulations in the future.
This seems doubtful, but, even if partially true, the ML III audited financial statement for the year ended December 31, 2009, due in April, will be a controversial one.
It's because insiders speak using industry terms rubes don't understand. Let me connect the dots for you: we don't speak your language. It sounds important, and we want to understand, but we have to research the terms you use, which is more than a dictionary definition and it's just too much work or surpasses the attention span of the ordinary person, who in the end is probably only going to understand 1/3 of your message.
Can you summarize a paragraph of a concept using generic terms? i.e. A bank is buying fire ins. on a house they don't own which is already burning down, and the real asset holder(bank) is selling at full price to someone else. (they will later claim that the buyer should have known better, after all, "I am a scorpion, thats my nature", while simultaneously claiming that the taxpayers shouldn't be allowed to know (they paid possibly 5X the value) because the taxpayer wont be able to sell it to another idiot to recoup losses.
I understand somewhat what you are trying to convey here. Yves Smith (nakedcapitalism.com) has written about it, and does a paragraph in layman's terms for the rubes.
It is vitally important that this message is understood so it can spread, our whole future depends on it.
It really is the tip of the iceberg, and we are heading for it.
That analogy created far more misunderstanding among the public than understanding.
"It really is the tip of the iceberg, and we are heading for it. ..."
The AiG bailout melted a great deal of the "iceberg" almost instantly, and continues to melt it.
From Bloomberg:
"Goldman Viewed as Favored by Regulators, Fed Says (Update2)"
http://www.bloomberg.com/apps/news?pid=20601087&sid=aLVEy7hav7kc&pos=7
"‘“Counterparties received par -- which is politically sensitive -- but necessary given the economics of the deals,” Vicente wrote. “That’s something you just can’t explain in a press release because it involves understanding of why the deals don’t have isolated risks (for example, I believe one counterparty had shorted AIG risk in order to balance their AIG exposure on the CDS deals, so tearing up the trades left them exposed with no hedge, etc.)”"
The key point is, ironically, parenthesized.
Counterparty shorted AIG risk against their AIG exposure, removing the exposure on the CDSs left them unhedged? Really? The Fed bought that hook, line and sinker?!
Seems, while the Fed was ripping up the contract hedge against the exposure, the counterparty wouldn't need to hedge AIG exposure because the US government was funding and implicitly guaranteeing AIG.
So what was the hedge? A Texas hedge?
Further, why would the counterparty be left unhedged? Surely the financial gurus could create a hedge with a new derivative? But the key element missing from their ability to transact on the insurance was that the huge player to take the other side was no longer taking on new deals. The counterparty couldn't lay off their new bet cheaply on greater fool, AIG.
Sham on them!
GS hedged their AIG exposure prior to the Federal Reserve becoming involved. It cost them at least 100 million dollars. No tears for them?
$100 million loss offset by $13billion payout? Yes, I am crying about how much of my taxes will be going to pay for that.
Maybe someday soon something will be done about it, before the world economy collaspes and widespread chaos prevails, which would make all the financial crimes effectively impossible to prosecute.
In the meantime board members (a.k.a. president, CEO, COO, CFO of other companies and politicians' spouses) have also moved-on to enjoy their accolades, fat board stipends, and reminiscent about those great golf outings, fun-filled trips and lavish retreats.
The ones licking their wounds are the stock-holders, workers and communities where these corporations were located.
This has been America's business model for the last two decades. Because of this 'insider' transfer of wealth, the average retirement nest-egg of hard-working workers has hardly grown, and likely declined. And all we-workers do is blame unfair trade competition, out-migrations of jobs, immigrants and the H-1B visa holders.
"...Joseph St. Denis, wrote in a letter to the House Committee on Oversight and Government Reform that in early September 2007, he learned that AIG's financial-products unit had been asked for billions of dollars in collateral related to derivatives it had sold.
"I was gravely concerned about this," Mr. St. Denis wrote. The derivatives, known as credit-default swaps, protect buyers against the risk of default on other investments, and AIG believed the likelihood of making payouts was remote. Mr. St. Denis wrote that the valuation model of one of AIG's trading partners "apparently indicated" that, in fact, the unit "was in a potentially material liability position."
Mr. St. Denis wrote he wasn't personally involved in the valuation of the swaps at the unit. In the last week of September 2007, Mr. St. Denis wrote, the unit's head, Joseph Cassano, said he had "deliberately excluded" Mr. St. Denis "because I was concerned that you would pollute the process."
In the letter, Mr. St. Denis said he resigned on Oct. 1, 2007 ..."
Keeps boiling down to the virtual economy --- BLOATING UP ON ABSURD SO CALLED "PRODUCTS"
BASED ON NOTHING, THE Republicans fought for until the bittelr End --- destroying the REAL ECONOMY.
It's like a bunch of Warlocs surrounding a bunch of young guys (read effective labotomy) at a betting table, betting on which gambler will win.
There should be a limit as to how many young people go into this industry. Such as through incentives to become a Primary Care Physician.