AIG: for want of a shoe—and some common sense
I have no way to judge whether this NY Times piece about AIG is correct or not. I’ve grown so leery of the Times’ veracity that I automatically doubt it. Nevertheless, it seems to be a good description of how it was that this particular firm got into so much trouble, and why it has required three bailouts—so far.
The insurance company’s problems originated in a small London division that dealt with “financial practices” rather than conventional insurance. Ironically, the rest of the company was (and still is) doing well. But that’s merely a moot and academic point, because the “financial practices” of the so-called “go-go financial wizards” in charge of that small London group managed to seed their creative products (known as “credit-default swaps,” which essentially were uncapitalized insurance for bad mortgages) around the world.
This is how it was done:
How did banks get their risk measures low? It certainly wasn’t by owning less risky assets. Instead, they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G., and the collateral triggers made the bank portfolios look absolutely risk-free [because of AIG’s triple-A rating]. Which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets. This practice became especially rampant in Europe. That lack of capital is one of the reasons the European banks have been in such trouble since the crisis began.
And how is it that people were so stupid as to buy (literally) into it? Once again (we’ve heard this many times before, but it never ceases to amaze me): they thought housing prices would always go up, so the bills would never come due.
There’s much more of interest in the article—you should read the whole thing. It reminds me, however, of the old proverb:
For want of a nail the shoe was lost.
For want of a shoe the horse was lost.
For want of a horse the rider was lost.
For want of a rider the battle was lost.
For want of a battle the kingdom was lost.
And all for the want of a horseshoe nail.
The original bad mortgages are the horseshoe nail.
As I’ve admitted before, I’m no financial expert. It seems to me, however, that AIG’s problem are at least partially the result of two factors I just yesterday did some reading and writing on: First, the repeal of Glass-Steagall which repeal allowed insurance and investment banking to commingle. Second, the at-best incompetent rating agencies: surely even if AIG started off AAA once it became clear what risks they were taking someone should have down-graded them – before the crisis hit the fan, not after.
Wasn’t this problem exactly what the original TARP was supposed to be about? The government was going to buy all those toxic assets (like CDS) so as to remove their poison from the financial system. That might not have been any cheaper than bailing and re-bailing and re-re-bailing AIG (what’s $250B among friends?) but surely it would have been cheaper than bailing and re-bailing AIG plus Citi plus BofA plus goodness knows who else.
Because they’re geniuses, neo. At least they think so. It turns out that they were fools and naifs, because they believed their own bullsh!t, and never thought to question the prevailing dogma that everyone in the industry apparently believed. They personify the term sophomoric, literally “foolishly wise.” Over to you, Mitsu.
Of course, “global warming” predictions are good as gold, because, as liberals never tire of telling us, “everyone” involved with climate research believes that too. So despite the inherently much greater flakiness of the field, we should believe the secret computer models and implement hardy leftist chestnuts as policies. Please.
What had happened to the AIG management that could have prevented this? See this, for example,
Had Greenberg been there, history would have been different.
I work with Insurance companies in the day job and when this whole mess with AIG first came to the forefront, the rumuors were that if the Gov did not bail these people out, the european banks would have toppled like a stack of dominoes putting at risk even some of the countries themselves. So, I find this believable.
As for JC’s comment, I believe that if Greenberg had still been in charge it would not have been as rampant but they still would have been at risk.
I was thinking I got this link from you. Anyway, It’s a good in depth on the same thing. Really opened my eyes:
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?print=true
I can’t make myself read the entire NYT piece by one Joe Nocera. It has the usual trigger verbiage early on: “hubris…greed…scam….” They make me doubt whatever conclusions he may reach. He failed to blame Cheney, though, so I guess that’s progress.
Re hubris, greed, and scams, see Obama and the Dems.
It doesn’t help that the ratings agencies gave good ratings to a lot of that debt. It’s like running a race where the course marshals send you down the wrong path–you go the wrong way, but you do it in good faith.
Not all the players in the debacle were malicious money-grubbers whose greed outpaced their sanity.