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Billions for AIG to Protect the Speculative Profits of Goldman Sachs/Morgan Stanley
The dysfunction of our financial institutions is almost beyond belief.
In November of 2008 with the nation's economy unraveling, Morgan Stanley and Goldman Sachs (one of the top five U.S. municipal bond underwriters) were infuriating politicians and public finance officials by recommending the purchase of credit-default swaps (CDS) thereby betting against debts of eleven states, including New Jersey, California, Wisconsin, Florida, and Ohio among others. Many of these were municipal bonds that they had originally underwritten. Thereby, through an act of blatant opportunism they were adding to the destabilization of the financial markets already at the edge.
CDS are in effect insurance policies. Insurance policies are normally taken out to cover loss against the occurrence of an event such as fire, or flood, or accident, and so on. But CDS, rather than being called "insurance," became, in the parlance of the Street, "derivatives," making them much more elegant to deal with and for the rest of us much more difficult to understand. They were, in this case, simply insurance bets on the bankruptcy or inability of municipalities throughout the country to meet their debt obligations. A bit like taking out insurance against fire on the house next door and having a lottery on the proceeds should it burn down.
Now to buy "insurance" one would naturally go to an insurance company to cover the risk. And the insurance company would sell you an insurance policy and would set an amount on their balance sheet that would represent a reserve against the potential loss/payout. An insurance company likely to write a policy covering this would be AIG. After all, AIG had become the king of CDS. In all likelihood this was the case for the likes of Goldman and Morgan-Stanley.
Except it gets worse. You see, in the mumbo-jumbo of the term "credit-default swaps," the word "insurance" is not mentioned. And according to the good souls at AIG, if you don't use the word insurance, you don't have to set aside any reserves in case of loss. And if you don't set aside any reserves, you can issue all the CDS the market can bear (understood to be in the range of $400 billion at AIG), cash in the policy premiums as a humongous supplement to your usual insurance business, allowing for zillions in paychecks and bonuses. And of course, if it all comes crashing down you can put up the "systemic risk" flag and your Wall Street friends in Washington will charge to the rescue with taxpayer dollars. (What did Goldman CEO Lloyd Blankfein say to Treasury Secretary and ex-Goldman CEO Hank Paulson when he was party to the discussions on the first AIG bailout, or as Bloomberg reported yesterday, is this also part of the government's refusal "to disclose names of the borrowers and the loans"?.
During his testimony this week, Fed Chairman Bernanke felt compelled to say, and I quote:
"AIG exploited a huge gap in the regulatory system; there was no oversight of the financial products division. This was a hedge fund basically that was attached to a large and stable insurance company, made huge numbers of irresponsible bets, took huge losses"
One knows the folks at Goldman are no fools. Were they going to put good money down for CDS that their counterparty (AIG) might not be able to honor because it made no reserve provisions? Or was the temptation of another big pay day just too tempting not to risk Other People's Money to play the game?
To date we have poured $160 billion into AIG -- this while others see the value of their homes cut in half, the better part of their 401(k)s wiped out, their government services significantly reduced, and other lending institutions diligently try to work out past due credits, taking significant mark-downs and extending due dates to keep industries and corporations alive.
This, as Goldman Sachs and Morgan Stanley are being covered 100 cents on the dollar on their speculative positions of intrinsically flawed CDS derivatives on which they gorged themselves to the bursting point. It is past time that a distinction be made between that part of AIG's business that was a "large and stable insurance company," and that part that was a "hedge fund," or better put, a casino. So the big question becomes, why should AIG's CDS be paid down 100 cents on the dollar when the rest of the country is taking at or near 50% haircut on the value of its assets?
But then again the rest of the country doesn't have those well-oiled K Street lobbyists pursuing their special interests in Washington. They just vote and pay.
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This is a GREAT article and it explains clearly the problem with CDS or credit-default swaps which, when all is said and done is really just another new "financial instrument" gone wild!!
Tiny update from Liddy, yesterday ::: The total for these CDS scams at AIGFP is now $1,600,000,000,000. That's 1.6-trillion USD. (The $400-billion figure was pollyanna optimism.)
Sam Rayburn is laughing his ass off.
Don't forget because it's not insurance you can sell it to people who have no insurable interest in the asset in question!!
Echoes of the Larouche Homeowners and Bank Protection Act of 2007: Take over the banks with FDIC, and separate out their derivative "assets". You gambled, and lost. Too bad. No tax dollars for you.
The Federal Reserve System itself is a Ponzi scheme. One solution----amend the US Constitution to establish a new currency, the American Freedom Note:
All loans, bonds, and govt debt originating in Federal Reserve banks, and all existing Federal Reserve Notes and checking account balances, are cashed out fully in American Freedom Notes to Creditors, who forgo liens, and to depositors and people or institutions holding cash reserves in Federal Reserve Notes. Debtors are then exonerated and assume 100% ownership of all assets, including---and most importantly--- the productive assets of the country.
A fixed quantity of AFNs results from this system-wide exchange and these fresh accounts can be loaned at interest rates determined freely in the market place, with the strict proviso that no fractional-reserve lending is allowed from that point forward.
Over time a natural deflation occurs and the American Freedom Notes, fixed in quantity by this amendment, garner increasing purchasing power.
The financial class will pull us all down in this debacle unless they are paid off, as in this proposal. Those who have been "swindled" through these loans made without consideration on the part of the banking system are rewarded by assuming control of assets.
Greed is forgiven, debt is forgiven, and the fractional-reserve monster is put peacefully to sleep (i.e., no blood in the streets).
The heart of the problem = fractional-reserve banking. A scholarly analysis is given by Jesus de Soto in "Money, Bank Credit, and Economic Cycles".
Don't need to amend the constitution.
The Constitution already gives congress the sole authority of issue money.
Just put the FED under control of the Treasury.
Your concept is about the same as the Lincoln Greenbacks.
Interesting idea to fix the number issued.
I'll have to think about that.
"... the rest of the country doesn't have those well-oiled K Street lobbyists pursuing their special interests in Washington."
Nor do we have friends and former co-workers in control of the US Treasury and Federal Reserve Bank making secret deals behind closed doors on our behalf. The cast of characters in the whole bailout boondoggle is much too chummy and secretive. From a taxpayers'-eye-view, all we can see is money disappearing with no prospect of ever getting it back, and no one is allowed to know where it went! Meanwhile the big-shots of finance take a ride on the old revolving door from Wall Street to Treasury and back (like Hank Paulson) receiving lucrative bonuses in each direction, proving once again that it's not WHAT you know, but WHO you know which counts in this world.
When financial organization create new financial instrument like Credit Default Swaps and other derivatives such as futures contracts, forward contracts, options and swaps , they are so complex in there composition that very few people truly understand what they are. With an insurance instrument, they are govern by a strict set rules according to that particular class of instrument or policies. AIG decided to bet the Credit Default Swaps would never be called in. With no reserve they made huge profits from the paper but could not cover the paper when it bad. I believe that either it was a clear case of fraud, poor management, greed, or all of the above. Maybe its another version of the Ponzi scheme which seem to be very popular these days. This type of fiscal irresponsible is a direct result of deregulation or letting the fox guard the hen house. The stock market is a vital part of the economy however we need to make sure greed doesn't set the standard for trading or investing. You would think after the Saving and Loan crisis, Enron, World Com, Tyco and now the massive Ponzi frauds that we would learn that deregulation is not going to work. AIG is an organization I believe that thought they were above the law, suspicion, they could cover up any loses , the world was stupid or there management was stupid. Its not impossible to correct this problem but in going to be expensive for the taxpayer.
Mr. Learsy
Have you sent this to Obama ?
And lets not forget, Merrill was just caught last week trying to short Ford into oblivion for some profit.
Nice.
Great article Raymond.
It was always a fantasy that you could "insure again investments losses".
Credit Default Swap insurance Must be banned, and invalidated.
Then all investment losses revert to actually losses on stock or bad loans.
We cannot bailout the CDS 600T$ super leveraged debt.
AIG was never that stable anyways. We could see it coming and sure enough it did. People need to look behind the scenes a little more. Same goes for Citi: They have been floundering for years. It does not take a rocket scientist to see what was coming. Unfortunately most people believe in marble tiles than what is behind the facade.
I think the late economist Hyman Minsky well understood the subtle dangers of the poison of greed as it affects our economy. His notion of the genesis of a financial crises presupposes that irrational optimism--plain old greed--is coupled with the appearance of a booming economy, in which both are keying off the other to create a bubble. In other words, as the economic bubble grows, optimism likewise bubbles. With such a bubbling expansion of the economy, inversely, caution and prudence contract. The great lessons of economic history are soon forgotten as the bubble grows in magnitude.
In such a false economy, everything looks good to the greedy—there is no growing danger on the horizon. They believe there is no end to prosperity so that risk and speculation are permitted to grow even more. The Trojan Cassandras are laughed at and called "bubble-heads". Everyone bets that the future will rain down pennies from heaven.
But according to Minsky such an economy has become, already, a fragile economy--and one doomed--since it has made itself vulnerable by the huge growth in debt. It is only a matter of time until a huge contraction (the bubble popping) occurs -- and all hell breaks loose.
What I don't understand is why ... why bail these "gollum type" personalities out. Why even listen to the scare tactics ... we're too big ... if you don't we'll take the economy down with us. Is it not obvious what they are trying to do. They are trying to save themselves and their infrastructure just as it is. They are protecting their lucrative new instruments called CDS's.
As far as the financial institutions are concerned "it was those dirty poor people " who caused this crisis.
The correct thing to do is let them fail. Anything else is throwing good money after bad.
Excellent story, Mr. Leary. I had wondered about the ethics of Goldman selling the CDF's they owned at the same time as they advised their clients to buy them, and they were shorting them on the other side of the house. Your question of why Goldman and AIG should be made whole on these sleezy investments when the rest of us "are taking a 50% haircut" is absolutely right on.l
Eventually, a lot of people are going to be prosecuted under the RICO statute and I hope a slew of them will go to prison. They had a fiduciary duty of fair dealing and it appears they may have gone far far beyond the boundaries into something that may be tinged with fraudulent intent. Eric Holder, go investigate this now. The criminal justice system needs to reassure the American People that fraudulent behavior will be prosecuted even when it reaches into the highest levels of finance and industry from whence our current and our former Secretaries of the Treasury came. Let Goldman go the way of Lehmans, and let the criminal geniuses there be called to account before the bar of justice.
Strange as it may seem, right now there's a lot of trading (and profit-taking) that hinges upon the notion that CDSes will be ... or as the case may be, won't be ... "bailed out." So in other words, while you-and-I are suffering misfortune, a great many people are profiting from our misfortune ... and the more misfortune we experience the more money they make.
You might have asked, "why were farm-workers who make $14,000 a year and who can't even speak English getting $270,000 loans?" Because in effect, the financiers are SELLING default (twenty or thirty or forty times over), and the more defaults occur, the more profit. Yes, I know that what I just said there makes utterly no sense.
Imagine the "Dutch tulip mania," multiply it a million times, and spread it throughout a "multi-national" system whereby no single government is in any position to do anything about it. Then, perversely, look upon THAT as "a sure-fire recipe for failure, which means a sure-fire way for me to make money." Uh huh, that makes no sense either, now does it.
But this is the way that these people think, and I assure you that a great deal of that money that's flowing in from K-Street comes from just this kind of perversity.
Credit Default Swaps insurance are the worst invention ever.
http://www.marketoracle.co.uk/index.php?name=News&file=article&sid=9307
Ban all derivatives, get the bankers focused on Main Street.
I am really happy to finally see good explanations of just what credit default swaps are. I have been intently watching this slo-mo train wreck barreling down the tracks for over three years now (one big reason I have no credit cards or even checking account and bank with a credit union), and all I kept hearing was how vague and mysterious these CDS instruments are.
Nope, it's a scam. Sell insurance on what you don't own and can't back up, then bundle and sell those policies around the globe while keeping the fingers firmly in the ears to quash any rumblings of doubt. The fact that the Goldman CEO was in the room with (former Goldman CEO) Treasury Sec. Paulson when the first AIG deal was hammered out makes one wonder at the conflict of interest, seeing as Goldman had lots of golden eggs in the AIG basket.
Thank goodness we have the Rick Santelli's of the world watching over the integrity of we plebiscites. I'd hate to wake up one day and be staring down a billion dollar federal bailout. How could I sleep at night?
Oh yeah, on my piles and piles of money.
Stay classy Wall Street.
This is an excellent and accurate showing the financial manipulation that has brought down our economic system. CDOs were crafted by JP Morgan bankers to juice up their revenues,/ bonuses by giving this product a name other than insurance not only to befuddle but also to avoid regulation as an insurance product. As AIG was selling this product, their revenue was enhanced and the brokers who were selling it reaped enormous bonuses. Talk about perverse short term incentives.
I am concerned that as the abuses become more accurately documented and outrage increases, that our "leaders"/regulators who we assume are in charge, will not act wisely and revamp the system to prevent future devastating episodes.
It is unfortunate that mainstream investigative media types do not spend time on these important issues.
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