Saturday, February 28, 2009

re: AIG

This NYT article (via Atrios) runs down the huge AIG debacle. The first paragraph mentions that losses at AIG are dwarfing pretty much every other company on Wall St., and it's because AIG was an insurance company and not a bank.

As a huge multinational insurance company, with a storied history and a reputation for being extremely well run, A.I.G. had one of the most precious prizes in all of business: an AAA rating, held by no more than a dozen or so companies in the United States. That meant ratings agencies believed its chance of defaulting was just about zero. It also meant it could borrow more cheaply than other companies with lower ratings.

To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities. Unlike many of the Wall Street investment banks, A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps.

These exotic instruments acted as a form of insurance for the securities. In effect, A.I.G. was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses. And because A.I.G. had that AAA rating, when it sprinkled its holy water over those mortgage-backed securities, suddenly they had AAA ratings too. That was the ratings arbitrage. “It was a way to exploit the triple A rating,” said Robert J. Arvanitis, a former A.I.G. executive who has since become a leading A.I.G. critic.

Why would Wall Street and the banks go for this? Because it shifted the risk of default from themselves to A.I.G., and the AAA rating made the securities much easier to market. What was in it for A.I.G.? Lucrative fees, naturally. But it also saw the fees as risk-free money; surely it would never have to actually pay up. Like everyone else on Wall Street, A.I.G. operated on the belief that the underlying assets — housing — could only go up in price.

That foolhardy belief, in turn, led A.I.G. to commit several other stupid mistakes. When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off. Not understanding the real risk, the company grievously mispriced it.

It gets worse. Hopefuly, some of these people end up in doing blue-collar jail sentences, but since we never seem to learn from our mistakes, we're apparently doomed to keep repeating them....

Thursday, February 26, 2009

liars and thieves

Chris Matthews rebuking Darrell Issa for the childish "Democrat Party" thing is not the most impressive thing about this video. (Although it is impressive. And I will be chuckling over "Republicanistical Party" for a while....)

Issa is best known is the guy who initiated the recall of Gray Davis and installed Arnold as Gov of CA. Issa, of course, wanted the gig for himself.

When Issa says the Bush-era deficits, "even including the war [singular instead of plural sic], " the annual deficit was below $400B, he is narrowly correct (except for 2004 and 2008, which were above $400B). However, the costs of the occupations of Iraq and Afghanistan were never once budgeted for, as Congressman Issa is surely aware; they were paid for off-budget in supplemental appropriations bills, specifically for the purpose of making the reported budget numbers look better. Nothing more, nothing less. Everybody in D.C. knows this. Issa was in Congress when this was going on, and he certainly knows the difference between the annual budget and an appropriations (= spending) bill.

It should not surprise anyone that Barack Obama immediately ended this dishonest practice, and thus his annual budget numbers will be appalling by comparison to Bush's. But every single one of Bush's budgets contained vastly more spending than he claimed, so the comparison is not valid. This, also unsurprisingly, will not stop Obama & Congressional Democrats from being villified by the Know-Nothings on talk radio for one second.

Eventually, America will grow sick of being lied to all the time by people looking after their self-interest, and will hold these people accountable.