Revenge of the Black Swan
"The models suggested that the risk was so remote that the fees were almost free money. Just put it on your books and enjoy the money."
--Tom Savage, President, AIG's Financial Products
The second part of the 3 part series is now posted, A Crack in The System. This section gets into the details as to how AIG got so buried in the credit default swaps (CDS) business.
How to Pay for National Health Insurance
Since the government has spent such an inordinate amount of taxpayer money cleaning up after the Wall Street ne’er-do-wells and the giant mess they made, there is not a whole lot of money left over for other projects.
Once such legislative work was National Health Insurance. Surveys have shown that a significant majority of Americans support this. It was one of the key planks that President-elect Barack Obama ran on.
Well, no worries over the lack of funding for health care. I have figured out a simple way to insure that every man woman and child int he US is covered by health care insurance. I took a page from the cleverest of the financial engineers on Wall Street, and all it took was a little of that street magic and derivative-based hocus pocus.
Jon Markman: Buffett in Trouble?
I'm not so sure I believe the wild speculation part of this (last para), but I know Jon Markman, and he is a thoughtful and sober guy.
Shares of Warren Buffett's insurance holding company are on the ropes this month, plunging 30% in part because the famed investor dabbled in an area of the market he has long publicly derided: derivatives. And due to a tangled web of financial relationships, they may be taking Goldman Sachs shares down with them.
Why Bailouts Attract Handout Seekers
“The biggest surprise was how quickly it went from ‘I don’t need this,’ to ‘How do I get in?
-Michele A. Davis, Treasury Department, head of public affairs
A truisim of all bailouts: Enormous amounts of taxpayer cash attracts all manner of unsavory, undeserving characters. What was supposed to be a narrow and limited attempt to reduce the systemic risk of a financial collapse has become a taxpayer funded free-for-all.
Like hyenas trying to steal the kill from a lion, the mere scent of this enormous pile of loot starts attracts the scavengers. They cannot help themselves, for it is their essence, and who they are.
Like the dreaded 17 year locust, Lobbyists too, are swarming the capital, consuming everything in their path. Never before has a trillion dollars been authorized so quickly. Never before has so much money been spent with so little oversight, controls, or transparency. Now, on top of the negligent manner in which this money has been thrown about, we have the latest jackals attracted by the scent.
WAPO: Treasury Illegally Repeals Tax Law
We learn from WaPo that the Treasury Department slipped through a $140 billion tax windfall to US banks -- in theory repealing 1986 legislation, passed by Congress and signed by President Reagan.
The likely illegal change was aggressively lobbied for by banking officials, who sought to take advantage of the market turmoil and credit crisis.This is an ongoing issue we have witnessed in every prior bailout: Opportunism knows no sense of decency.
AIG's New Plan: Restructuring is now $125 Billion
The original $85 billion dollar package is now 70% higher, at $125 billion. Bloomberg reports it could easily scale up to $150 billion.
The U.S. will cut the original $85 billion loan that saved the New York-based insurer in September to $60 billion, buy $40 billion of preferred shares, and purchase $52.5 billion of mortgage securities owned or backed by AIG.
Yves Smith does a full blown analysis in the cafe.
AIG: We Need More Money
And so, more errors of these emergency bailouts begins: Once committed to the initial $85 billion dollars, what choice does nation have but to throw good money after bad.
Down the rathole:
AIG is asking the US government for a new bail-out less than two months after the Federal Reserve came to the rescue of the stricken insurer with an $85bn loan, according to people close to the situation.
AIG’s executives were on Friday night locked in negotiations with the authorities over a plan that could involve a debt-for-equity swap and the government’s purchase of troubled mortgage-backed securities from the insurer.
People close to the talks said the discussions were on-going and might still collapse, but added that AIG was pressing for a decision before it reports third-quarter results on Monday.
AIG’s board is due to meet on Sunday to approve the results and discuss any new government plan, they added.
The moves come amid growing fears AIG might soon use up the $85bn cash infusion it received from the Fed in September, as well as an additional $37.5bn loan aimed at stemming a cash drain from the insurer’s securities lending unit.
AIG has drawn down more than $81bn of the combined $122.5bn facility. The company’s efforts to begin repaying it before the 2010 deadline have been hampered by its difficulties in selling assets amid the global financial turmoil.
Un-frickin-believable . . .
AIG in talks with Fed over new bail-out
FT, November 8 2008 00:36
The Thundering Herd . . . "Were Pigs"
“The mortgage business at Merrill Lynch was an afterthought — they didn’t really have a strategy. They had found this huge profit potential, and everybody wanted a piece of it. But they were pigs about it.”
-- William Dallas, founder of Ownit Mortgage Solutions, a lending business in which Merrill bought a stake a few years ago.
There is a monster Gretchen Morgenson piece in the Sunday Times, titled, How the Thundering Herd Faltered and Fell. Its about the rise and ignomius fall of Mother Merrill.
How did it happen? Bad mortgages.
TYPICAL of those who dealt in Wall Street’s dizzying and opaque financial arrangements, Merrill ended up getting burned, former executives say, by inadequately assessing the risks it took with newfangled financial products — an error compounded when it held on to the products far too long.
The fire that Merrill was playing with was an arcane instrument known as a synthetic collateralized debt obligation. The product was an amalgam of collateralized debt obligations (the pools of loans that it bundled for investors) and credit-default swaps (which essentially are insurance that bondholders buy to protect themselves against possible defaults).
Synthetic C.D.O.’s, in other words, are exemplars of a type of modern financial engineering known as derivatives. Essentially, derivatives are financial instruments that can be used to limit risk; their value is “derived” from underlying assets like mortgages, stocks, bonds or commodities. Stock futures, for example, are a common and relatively simple derivative.
Among the more complex derivatives, however, are the mortgage-related variety. They involve a cornucopia of exotic, jumbo-size contracts ultimately linked to real-world loans and debts. So as the housing market went sour, and borrowers defaulted on their mortgages, these contracts collapsed, too, amplifying the meltdown.
The synthetic C.D.O. grew out of a structure that an elite team of J. P. Morgan bankers invented in 1997. Their goal was to reduce the risk that Morgan would lose money when it made loans to top-tier corporate borrowers like I.B.M., General Electric and Procter & Gamble.
Regular C.D.O.’s contain hundreds or thousands of actual loans or bonds. Synthetics, on the other hand, replace those physical bonds with a computer-generated group of credit-default swaps. Synthetics could be slapped together faster, and they generated fatter fees than regular C.D.O.’s, making them especially attractive to Wall Street.
Michael A. J. Farrell is chief executive of Annaly Capital Management, a real estate investment trust that manages mortgage assets. A unit of his company has liquidated billions of dollars in collateralized debt obligations for clients, and he believes that derivatives have magnified the pain of the financial collapse.
“We have auctioned billions in credit-default swap positions in our C.D.O. liquidation business,” Mr. Farrell said, “and what we have learned is that the carnage we are witnessing now would have been much more contained, to use that overworked word, without credit-default swaps.”
The whole piece is worth a read . . .
How the Thundering Herd Faltered and Fell
NYT, November 8, 2008
Open Thread: What Now?
Ok, we have the Presidential election behind us, and ugly NFP yesterday (more to come) even more Bailouts soon (more AIG, more GM, who knows what else).
Market volatility still remains crazed, and we are nearing key levels of support. Earnings have been punk. The consumer is MIA. Credit is improving, Housing still stinks, and the deleveraging seems to be never ending. The Eliot Wave folks are waiting for a nasty wave 4 (or is it 5?) and
While Greenspan Slept
This Bloomberg special report may have slipped by unnoticed last week during all of the market mayhem. Its worth reviewing, as it places blame not only at the feet of Alan Greenspan, but Arthur Levitt and Robert Rubin as well.
Ten years ago, Wall Street was enjoying a bull market fed by a booming dot-com industry, a Fed chairman, Alan Greenspan, who trusted the market to correct its own ills, and a Congress amenable to lightening the touch of regulators.
In 1998, the imminent collapse of hedge fund Long-Term Capital Management forced the Fed to organize a bailout by Wall Street. Investment banks had loaned the fund billions and were among counterparties in more than $1 trillion in derivative contracts used to hedge investment risks.
That same year Greenspan, Treasury Secretary Robert Rubin and SEC Chairman Arthur Levitt opposed an attempt by Brooksley Born, head of the Commodity Futures Trading Commission, to study regulating over-the-counter derivatives. In 2000, Congress passed a law keeping them unregulated.
Levitt said he went along with concerns by Greenspan and Rubin that Born's action might throw derivatives contracts into "legal uncertainty.'' He said he now regrets that he didn't press a presidential advisory group "to take a closer look'' at the issue. Rubin said in an interview that ``you could have had chaos'' if Born's plan found existing derivatives contracts invalid because they weren't traded on an exchange. Both Born and Greenspan declined to comment.
Outstanding credit-default swaps, derivative contracts used to hedge or speculate on a company's debt, would grow to $62 trillion from $631 billion in 2001. While the swaps spread risk, as intended, they also helped spread fear. Ninety percent of the trades were concentrated in the hands of 17 banks, according to the Federal Reserve Bank of New York. That left them exposed to losses if one failed, as Lehman Brothers did in September, and contributed to the unwillingness to lend to each other that's at the center of the recent credit squeeze.
Its worth reading in its entirety . . .
Greenspan Slept as Off-Books Debt Escaped Scrutiny
Alan Katz and Ian Katz
Bloomberg, Oct. 30 2008