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Posts Tagged ‘credit default swap’

If you bought AIG stock about ten days ago, you could have quadrupled your money by today.  It doesn’t make much sense, does it?  Why are people buying AIG while the U.S. Congress sounds like they are about to eat AIG for lunch?  There is either some serious irrational exuberance going on among investors or maybe these investors all know something we don’t know.  Is it that they know that AIG is too big to fail, and that whatever happens the government is compelled to save them or else they and we will all disappear into some kind of financial black hole?  Maybe buying AIG stock really is a sure bet – then again, maybe not.

The current uproar over spending about 165 million in bonuses for AIG employees sort of distracts us from the real issue about AIG.  It is certainly puzzling why AIG management felt OK in giving out the bonuses; most companies in similar situations would have called their employees into a meeting and said, “Look, the company didn’t have a very good year, so we are asking you all to tighten your belts, and so forth…” It’s the kind of  standard speech you give employees before you tell them they don’t get a bonus this year. It’s happening all over the country.  So why did AIG go ahead and give out these massive bonuses?  Could it be because they are smug in the knowledge that they are too big to fail?  Is that what their counterparties believe too?

The AIG counterparties, the people who purchased credit default swaps (CDS’s) (basically insurance against people defaulting on their mortgage loans) and collateralized debt obligations (CDO’s) (basically sliced and diced toxic mortgages), expect to be paid off.  Some of these, like Deutche Bank, UBS, Goldman Sachs, Merrill Lynch, and others have already received over $108 billion. All from our TARP money.  But can we be sure that AIG has come clean? Are there other holders of CDS’s or CDO’s who are yet to paid off? Were there other types of CDS’s, for example, CDS’s for credit card defaults, or CDS’s for commercial real estate defaults?  I wonder how the future is looking for those? (Hint: not good.)

To make things even murkier, it seems that there were a lot of investors who bought credit default swaps who never bought the corresponding CDOs. Yes! They essentially placed a bet that people would default on their mortgages without even buying the mortgages themselves! Having won their bets, the AIG counterparties now want to be payed off. This is better than Las Vegas, isn’t it? One would think that when a company starts providing insurance to people on assets that they don’t even own then they have left the realm of insurance and have entered the world of outright big stakes gambling.  The AIG people have essentially become bookmakers, and AIG’s multimillion dollar bonus babies took the wrong bets.

The Bush administration allowed AIG and many major banks to play no-rules capitalism – and they lost really, really big.  The problem is that they then came crying to the government, meaning us, and pleaded for a bailout.  And we gave it to them.  That was our mistake. We should have realized that any company that is “too big to fail” is also too big to be allowed to exist.  We become vulnerable to the stupidity and greed of its executives and in the end, they win and we lose.  The solution is to do to AIG what we did many years ago to Ma Bell – break them up.  Slice and dice AIG into ten or twenty independent mini-AIGs, just like we did with the phone company.  Then if one fails we don’t care; the others can take up the slack.  If there is one lesson we should take away from this worldwide economic collapse it is that we need to always keep an eye out for companies that might be “too big to fail”, and when we do identify them we must step in immediately and break them up into smaller, independently viable companies.

It’s not to late to apply that lesson to AIG, and a couple of our big banks too, while we are at it.  Now is the time to begin the deconstruction of these dangerous behemoths. The worst thing we can do is to simply shovel money into institutions that are “too big to fail”, because, inevitably, they will fail again – and guess who is going to pay (again)? The only sure way to save ourselves and AIG is, paradoxically, to destroy AIG.  Too big to fail is too big to exist.

Too big to fail is too dangerous to even be allowed to exist.

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