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There are a lot of articles written about AIG. Approximately $120 billions of taxpayers money were loaned to AIG to keep it afloat. Most of this money probably will never be paid back. Roughly $105 billions went straight from AIG to Wallstreet firms. Now the two key players, Henry Paulson, former Secretary of Treasury under President Bush and Former CEO of Goldman Sachs, as well as Tim Geithner, former Chairman of New York Federal Reserve Bank and the current Secretary of Treasury, denied that they were involved. Both claimed that they were not involved in the decisions, not standing in the sidelines but are busy on other things.
The questions to ask are:
- What caused AIG to suffer such a big loss?
- Why selectively bailout AIG, but not Lehman, Merill Lynch, Bear Sterns, Wachovia, Washington Mutual, as well as 140 regional and local banks that went bankrupt in 2009?
- Who benefited from $105 billions?
- Why were they paid for 100% of their bets that went bust?
AIG is a insurance company. In addition to engaging in the traditional insurance business including life, home and auto insurance, it is the largest insurance company for CDO's. As I said in the other article, CDO is a financial products created by "securitizing" assets (資產證卷化). I should explain the term "securitization."
We all know homeowner mortgages. In the past, the banks that issued these mortgages usually hold them or sell them to another financial institutions. Very rarely would an individual buy these loans or mortgages. Well, engineers are not the only one who innovate new products. Wallstreet has a term called financial innovation. They keep on innovating new financial products every day. Securization (證卷化) is one of their innovations. Through securitization, the banks pool the loans or mortgages together, partition them into small slices, which is a form of CDO's, and sell them as bonds. To get good ratings for these securitized assets, the banks send a small set of samples to a number of rating agencies, such as Moody, Standard and Poors, etc, and choose the one that gives them the best rating. So pretty quickly the rating agencies learned to adapt to Wallstreet's desire. Then the Wallstreet banks will sell the well rated securitized assets as bonds to the public. What we see is the so called mortgage-backed security with AAA rating. They look like bonds and sold like bonds. Sounds pretty secure to me (I don't own it). Many individuals, mutual funds, pension funds and foreign governments bought them because they are AAA rated. Some foreign buyers thought the ratings were done by the U.S. government. Recently, when they re-rate those AAA mortgage backed security, only 30% remained in AAA rating. The rest received A-, B even C ratings. Since the financial crisis, the banks have trouble to sell thee mortgage backed securities. So a lot of those rotten assets are still sitting in the banks’ books today. That’s why the banks are not out of the woods yet.
What are the other forms of CDO? Well, auto loans, business loans, credit card debts, account receivables, etc. The list goes on and on.
Wall Street banks are big exporters also. They export financial products to foreign buyers. In the height of their activities, they export $50 billions U.S. dollars each month. That amounts to $600 billions USD per year, or 18兆 新台幣 a year.
What are the benefits of CDO's?
Well, in the past, only the financial institutions are buying and selling mortgages. Individuals are rarely involved. Now any individual or institution, foreign or domestic, can buy CDO's because they are traded like bonds. The more buyers there are, the better the money flow. And money flow is good for the capital market.
Why did CDO become toxic? Take mortgage backed security as an example, all of a sudden the banks, who issue the mortgages, don't need to hold the mortgages any more. In other words, they are not liable if the borrowers fail to pay back the mortgages. The banks make money from mortgage transaction fees and from servicing the mortgage payment. They no longer care about the credentials of the borrowers. So they start to push more people to buy houses. That’s why the housing market kept on going up and up, eventually it went over the roof. When they run out of qualified people, they start to push anyone, regardless of their credit standing or having jobs or not, to get mortgages. As long as they can get good ratings for those mortgage backed security, they can always sell them to someone. But the CDO’s made of these mortgages are really rotten inside. They will go bust any time. Eventually the buyers will stop buying them. That's why the banks are still saddled with a lot of unsold, rotten CDO's.
OK. I spent enough time explaining CDO. Now I need to explain CDS. As I said, CDS is a form of insurance. The key difference from the auto insurance or the homeowner insurance is that one can buy insurance against an asset he/she doesn’t own. It’s like you can buy auto insurance or homeowner insurance against someone else’s car or house. If the car or the house gets damaged, you get paid. And there is no limit on how many people can buy insurance against the same CDO. So, theoretically you could have 100 people buying insurance against the same house that is about to fall apart. AIG grew rapidly to become one of the biggest insurance companies by selling CDS, even though it may not have enough reserve to pay for the assets it insured.
Both CDO’s and CDS’s are not regulated, i.e., they do not have to be traded through the public exchange board. The government agencies have no account of how much they are and who hold them.
At the time of the financial crisis in the fall of 2008, apparently all the major Wallstreet banks hold a large amount of CDS’s, sold by AIG. If AIG bankrupted, Wallstreet banks stood to lose tremendous amount of money, threatening the survival of some, if not all of them. Although some of them argued that they would have survived without government help, Geithner claimed that they all would have failed.
In viewing of this, the Department of Treasury engineered the AIG bailout with the help of New York Federal Reserve Bank by loaning approximately $120 billions (or $180 billions) to AIG. In minutes, $105 billions went to Wallstreet Banks, of which Goldman Sachs was the biggest beneficiary. Goldman got $12.9 billions, Bank of America $12 billions, Citigroup $2.3 billions, even the French and German banks got paid.
Wallstreet banks got paid 100 cents for each dollar they were owed. Remember these CDS’s are unregulated. They were not guaranteed of certain values. If the insurer goes bankrupt, the buyers of the insurance should only be paid for whatever they can savage. Let’s say 10 cents or 30 cents for a dollar. Now they are paid 100 cents for a dollar. The taxpayers are asking why. No wonder Geithner and Paulson are on the hot seat.
Why did the government bail out AIG? If AIG failed, it could have dragged down a slew of Wallstreet banks, causing the whole financial market to freeze. Companies, even if they have sufficient money in the banks, may not able to pay their employees because their banks are frozen. Individuals may not be able to cash checks. The chain effect will be difficult to imagine.
Why did the government bail out AIG alone, but let Lehman fail? Good question. Many people asked this question. Lehman was a direct competitor of Goldman. So were Merrill Lynch and Bear Stern.
Why didn’t the government bail out other Wallstreet firms such as Merill Lynch? Merill was bought by Bank of American at the fire sale price in the last minutes. So officially it didn’t go bankrupt. The same went with Bear Stern, Wachovia and Washington Mutual. By letting other banks absorbing these financial institutions, the financial industry was able to function normally.
Why did the Fed allow 140 regional and local banks to fail in 2009? Because they are not too big to fail. The impact of their failures are limited. So FDIC takes over them initially and sell them to other banks later on.
Is there regulation for CDO’s and CDS’s now? No, not really. At least not yet. Wallstreet banks profited tremendously from trading CDO’s and CDS’s. They lobbied adamantly against any regulation.
**老孫
The questions to ask are:
- What caused AIG to suffer such a big loss?
- Why selectively bailout AIG, but not Lehman, Merill Lynch, Bear Sterns, Wachovia, Washington Mutual, as well as 140 regional and local banks that went bankrupt in 2009?
- Who benefited from $105 billions?
- Why were they paid for 100% of their bets that went bust?
AIG is a insurance company. In addition to engaging in the traditional insurance business including life, home and auto insurance, it is the largest insurance company for CDO's. As I said in the other article, CDO is a financial products created by "securitizing" assets (資產證卷化). I should explain the term "securitization."
We all know homeowner mortgages. In the past, the banks that issued these mortgages usually hold them or sell them to another financial institutions. Very rarely would an individual buy these loans or mortgages. Well, engineers are not the only one who innovate new products. Wallstreet has a term called financial innovation. They keep on innovating new financial products every day. Securization (證卷化) is one of their innovations. Through securitization, the banks pool the loans or mortgages together, partition them into small slices, which is a form of CDO's, and sell them as bonds. To get good ratings for these securitized assets, the banks send a small set of samples to a number of rating agencies, such as Moody, Standard and Poors, etc, and choose the one that gives them the best rating. So pretty quickly the rating agencies learned to adapt to Wallstreet's desire. Then the Wallstreet banks will sell the well rated securitized assets as bonds to the public. What we see is the so called mortgage-backed security with AAA rating. They look like bonds and sold like bonds. Sounds pretty secure to me (I don't own it). Many individuals, mutual funds, pension funds and foreign governments bought them because they are AAA rated. Some foreign buyers thought the ratings were done by the U.S. government. Recently, when they re-rate those AAA mortgage backed security, only 30% remained in AAA rating. The rest received A-, B even C ratings. Since the financial crisis, the banks have trouble to sell thee mortgage backed securities. So a lot of those rotten assets are still sitting in the banks’ books today. That’s why the banks are not out of the woods yet.
What are the other forms of CDO? Well, auto loans, business loans, credit card debts, account receivables, etc. The list goes on and on.
Wall Street banks are big exporters also. They export financial products to foreign buyers. In the height of their activities, they export $50 billions U.S. dollars each month. That amounts to $600 billions USD per year, or 18兆 新台幣 a year.
What are the benefits of CDO's?
Well, in the past, only the financial institutions are buying and selling mortgages. Individuals are rarely involved. Now any individual or institution, foreign or domestic, can buy CDO's because they are traded like bonds. The more buyers there are, the better the money flow. And money flow is good for the capital market.
Why did CDO become toxic? Take mortgage backed security as an example, all of a sudden the banks, who issue the mortgages, don't need to hold the mortgages any more. In other words, they are not liable if the borrowers fail to pay back the mortgages. The banks make money from mortgage transaction fees and from servicing the mortgage payment. They no longer care about the credentials of the borrowers. So they start to push more people to buy houses. That’s why the housing market kept on going up and up, eventually it went over the roof. When they run out of qualified people, they start to push anyone, regardless of their credit standing or having jobs or not, to get mortgages. As long as they can get good ratings for those mortgage backed security, they can always sell them to someone. But the CDO’s made of these mortgages are really rotten inside. They will go bust any time. Eventually the buyers will stop buying them. That's why the banks are still saddled with a lot of unsold, rotten CDO's.
OK. I spent enough time explaining CDO. Now I need to explain CDS. As I said, CDS is a form of insurance. The key difference from the auto insurance or the homeowner insurance is that one can buy insurance against an asset he/she doesn’t own. It’s like you can buy auto insurance or homeowner insurance against someone else’s car or house. If the car or the house gets damaged, you get paid. And there is no limit on how many people can buy insurance against the same CDO. So, theoretically you could have 100 people buying insurance against the same house that is about to fall apart. AIG grew rapidly to become one of the biggest insurance companies by selling CDS, even though it may not have enough reserve to pay for the assets it insured.
Both CDO’s and CDS’s are not regulated, i.e., they do not have to be traded through the public exchange board. The government agencies have no account of how much they are and who hold them.
At the time of the financial crisis in the fall of 2008, apparently all the major Wallstreet banks hold a large amount of CDS’s, sold by AIG. If AIG bankrupted, Wallstreet banks stood to lose tremendous amount of money, threatening the survival of some, if not all of them. Although some of them argued that they would have survived without government help, Geithner claimed that they all would have failed.
In viewing of this, the Department of Treasury engineered the AIG bailout with the help of New York Federal Reserve Bank by loaning approximately $120 billions (or $180 billions) to AIG. In minutes, $105 billions went to Wallstreet Banks, of which Goldman Sachs was the biggest beneficiary. Goldman got $12.9 billions, Bank of America $12 billions, Citigroup $2.3 billions, even the French and German banks got paid.
Wallstreet banks got paid 100 cents for each dollar they were owed. Remember these CDS’s are unregulated. They were not guaranteed of certain values. If the insurer goes bankrupt, the buyers of the insurance should only be paid for whatever they can savage. Let’s say 10 cents or 30 cents for a dollar. Now they are paid 100 cents for a dollar. The taxpayers are asking why. No wonder Geithner and Paulson are on the hot seat.
Why did the government bail out AIG? If AIG failed, it could have dragged down a slew of Wallstreet banks, causing the whole financial market to freeze. Companies, even if they have sufficient money in the banks, may not able to pay their employees because their banks are frozen. Individuals may not be able to cash checks. The chain effect will be difficult to imagine.
Why did the government bail out AIG alone, but let Lehman fail? Good question. Many people asked this question. Lehman was a direct competitor of Goldman. So were Merrill Lynch and Bear Stern.
Why didn’t the government bail out other Wallstreet firms such as Merill Lynch? Merill was bought by Bank of American at the fire sale price in the last minutes. So officially it didn’t go bankrupt. The same went with Bear Stern, Wachovia and Washington Mutual. By letting other banks absorbing these financial institutions, the financial industry was able to function normally.
Why did the Fed allow 140 regional and local banks to fail in 2009? Because they are not too big to fail. The impact of their failures are limited. So FDIC takes over them initially and sell them to other banks later on.
Is there regulation for CDO’s and CDS’s now? No, not really. At least not yet. Wallstreet banks profited tremendously from trading CDO’s and CDS’s. They lobbied adamantly against any regulation.
**老孫
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