Wednesday, July 08, 2009

One More Piece of the AIG Puzzle

Well-written article here which helps to explain the detonation and implosion of AIG.

Long story short: things were OK with AIG Financial Products (AIGFP) until the company shifted from insuring corporate bonds and began insuring consumer debts. Even that was not destructive--until those debts were largely high-risk mortgages.

Key element: nobody, but nobody, imagined that the price of US housing would drop all at once, in all parts of the country. In other words, nobody expected the black swan, except one un-named Goldman Sachs mid-level analyst.

The president of AIGFP is (more or less) fingered as the culprit in the article. But there is one interesting detail:

What no one realized is that Joe Cassano, [the President of AIGFP] in exchange for the privilege of selling credit-default swaps on subprime-mortgage bonds to Goldman Sachs and Merrill Lynch and all the rest, had agreed to change the traditional terms of trade between A.I.G. and Wall Street. In the beginning, A.I.G. F.P. had required its counter-parties simply to accept its AAA credit: it refused to post collateral. But in the case of the subprime-mortgage credit-default swaps, Cassano had agreed to several triggers, including A.I.G.’s losing its AAA credit rating, that would require the firm to post collateral. If the value of the underlying bonds fell, it would fork over cash, so that, for instance, Goldman Sachs would not need to be exposed for more than a day to A.I.G. Worse still, Goldman Sachs assigned the price to the underlying bonds—and thus could effectively demand as much collateral as it wanted. In the summer of 2007, the value of everything fell, but subprime fell fastest of all. The subsequent race by big Wall Street banks to obtain billions in collateral from A.I.G. was an upmarket version of a run on the bank. Goldman Sachs was the first to the door, with shockingly low prices for subprime-mortgage bonds—prices that Cassano wanted to dispute in court, but was prevented by A.I.G. from doing so when he was fired. A.I.G. couldn’t afford to pay Goldman off in March 2008, but that was O.K. The U.S. Treasury, led by the former head of Goldman Sachs, Hank Paulson, agreed to make good on A.I.G.’s gambling debts. One hundred cents on the dollar.


Goldman, Sachs.

The outfit which shorted CDO's while pumping them to its customers.

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