Punchinello’s Chronicles

July 9, 2009

The Waste of the AIG Bailout

Filed under: Surely a Jest?,View from the Bottom — Punchinello @ 3:28 pm
Tags: , , ,

What exactly is AIG (American International Group, Inc.)? This was one to the largest insurance companies in the world, and we, the taxpayers, paid out around $182-BILLION (That’s Billion with a “B”!!) to rescue them from bankruptcy. Why? What the hell do they even do? And did we win? Have we made the world a better place with all that money?


The very simplified explanation is this: You put money in the bank. The bank lends it to someone to buy a house. Hopefully, that home-buyer is responsible. Now the bank has an IOU on the house. Your bank also has no money, since they gave it to the person to buy the house.

To quickly get back the money (not waiting on the 30-year mortgage), your bank sells the IOU to a Wall Street investment bank, or to Fannie Mae or Freddie Mac. All of these big banks are allowed to turn the IOU into an investment item — a security.

When you turn an IOU between a home-owner and a bank into an investment, you “securitize” the debt. You turn it into a security that can be bought and sold in the stocks and bonds markets. We won’t get into the fact that now your bank can lend out the money they got from the investment bank all over again. Maybe another home loan, car loan, student loan? It’s a never-ending cycle.

A security is backed by something. If you get financing to buy a TV, you secure it with collateral. You sign over the deed to your ranch, or your living room furniture, or the title to your car. So if you don’t pay for the TV, the person lending you the money can come in and take the collateral (security), sell it, and get back their money.

“Mortgage-backed securities” means that the IOU people invest in with pension fund money is “backed” by (secured by) the actual mortgage on an actual house. In theory, the mortgage is based on the ability of the home-owner to pay off the loan.

Now suppose Bank of America or Goldman Sachs wants to buy up tons of IOUs from little banks all over the country. They want this because then the big banks will get the interest payments, not the little banks. They’ll sell those securitized mortgages on the world markets. Investors in Belgium, China, India, South America all have a chance to buy securities.

Remember; when those world investors buy the securities put out by Morgan-Stanley, Lehman Brothers, Bank of America and so forth, the investors trust the companies to be honest! They trust the investment banks to issue real and legitimate securities. They trust that someone has actually verified there’s a real house, and that a loan was given to someone that could pay it back.

What if the banks don’t really trust all this? What if they know it’s all a scam and a house of cards?

They get insurance!

What kind of company would be willing to insure that world-class securities are really going to be paid? Who would insure the “fact” that Local Bank lent money to John Smith to buy a house, and that John Smith really is going to pay that mortgage? (Or pay that student loan, car loan, or all those credit cards?)

Hah! It just happens that AIG said, “We will insure those IOUs! We will guarantee that if someone can’t pay off a loan, that will NOT affect the value to the IOU! We will insure that little old ladies in Pittsburgh won’t lose their investment.”

In short, AIG wrote insurance policies on all the securities being created by the investment banks. They were gambling on the idea that NO MATTER WHAT, if some one or two people couldn’t pay a mortgage, they would be only one or two problems. And even then, the banks would take the houses and re-sell them (foreclosure) to get back the money.

What’s interesting is that AIG only said they would insure all this! They claimed they would insure all this! Since they were pretty much the largest insurance company in the world, who wouldn’t believe them?

Goldman Sachs, that’s who!

And Goldman Sachs is one of the biggest investment firms in the world! They controlled billions and billions of dollars in securities (IOUs)! Those billions of dollars were in pension funds, retirement funds, investment portfolios. And some of those pension funds were for entire state employee unions, teachers’ unions, auto-worker unions, and so forth.

Worried; Goldman Sachs demanded that AIG actually show them the money! “If you’re going to insure all these IOUs that we bought from countless local banks, and if something goes wrong, we’d like to know for SURE that you have the money to cover our collective asses! Show us the money!”

And at that point, AIG had to actually show that they had enough real money to really and truly cover any and all losses IF something ever went wrong.

They didn’t, for a variety of additional related reasons.

And suddenly, everyone else who was insured by AIG got worried. They too, wanted to know what would happen if it turned out the IOUs (home mortgages, car loans, student loans) weren’t paid back! What would happen if a mortgage went into “default,” and the home-owner couldn’t pay their loan?

Nobody knew. It was a mystery!

At that point, the world discovered that AIG was playing a Ponzi game, right along with every other major financial institution. AIG was basically insuring more than they could possibly ever pay out in case of a problem. The company was not “liquid.” They couldn’t equal the debt they had with “liquid” money — real money they could get right away.

The “liquidity” problem was the same one you or I might have. Let’s say we own a home worth $200,000. We get a paycheck each month for $5,000. At the end of the month, we have $0 in the bank because we paid all our bills and bought a new TV. Suddenly, the car falls apart and we need to come up with $400 to fix the problem.

Liquid money means real cash we can get to pay for the car problem. It doesn’t matter that we have a “net worth” that includes our house. We can’t quickly turn the house into cash, so it is not a “liquid” asset.

Same with AIG. They had lots of real estate, boats, houses, planes, buildings, and investments. But they didn’t have enough cash “in case” there was a problem with the investment banks.

So they declared insolvency. And at that moment, knowing that the world’s investments might not be really “secure,” the entire financial industry panicked.

We gave AIG $182 BILLION dollars to cover their ass “in case” lots of people couldn’t pay their IOUs (mortgages, student loans, car loans). And today, Bloomberg reports:

July 9 (Bloomberg) — American International Group Inc., the insurer bailed out four times by the government, will likely have no value left for private shareholders after repaying the U.S., Citigroup Inc. said. The stock dropped 21 percent.

“Our valuation includes a 70 percent chance that the equity at AIG is zero,” said Joshua Shanker, an analyst at Citigroup, in a note to investors late yesterday cutting his price target on the New York-based insurer by more than half.

Outgoing Chief Executive Officer Edward Liddy is under pressure from lawmakers to sell assets to help repay the $182.5 billion rescue package that was required to prop up the insurer after losses on credit-default swaps tied to U.S. home loans. The company said last week that other derivatives, backing about $193 billion in assets for European banks, could have a “material adverse effect” on AIG’s results.”

Bottom line: You and I just threw $182 BILLION dollars down the toilet into the garbage! “Maybe” we’ll actually get that money back (the government will, not you and me). But when it’s all paid back, AIG will be worthless.

This was the company that was “too big to fail,” according to the government. Just like GM. Just like Chrysler. Just like every other massive world-level mega-corporation. And now, after all is said and done, it’s worthless.

But the good news being reported today is that GM, now government owned, is emerging from bankruptcy. They (somehow) will now be worth something. What? Nobody knows…it’s a mystery!


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