Tomorrow morning, AIG will report the largest quarterly loss in the history of capitalism. Pity the poor bastards who own that company!
Oh, wait, that’s us. Not only do we own the company, we get to bear its losses. At first, they got a bail-out on onerous terms; then that got modified to be less onerous with more money; then they got yet more money; and tomorrow will be #4. I think. To be honest I kind of lost track.
How could AIG lose $60 billion in the quarter after they became a ward of the U.S. taxpayer? Permit me an analogy.
Picture a (very) high-stakes poker game played by a group of old men, all world-class players who have been playing with one another for decades. One of them — let’s call him “Mr. A” — has one really bad hand, misplays it badly, and gets wiped out. But he has a nephew… OK, maybe that should be an “Uncle”, but I am making this up on the fly… He has a nephew who has very little poker-playing experience, but who has this enormous trust fund and is eager to take Mr. A’s place in the game.
Now, what do you picture happening next?
The players are the large financial institutions; the game is the modern “innovative” financial system; the nephew is the government; and you, dear taxpayer, are the trust fund. Well, you and your descendants. AIG engages in every variant of insurance and financial services, from granddad’s life insurance to grandma’s annuity to your rich cousin’s wealth management. But none of that is why they are “too big to fail”. They are too big to fail because they have sold insurance — called “credit default swaps” — to Goldman Sachs and JPMorgan and Bank of America. This insurance covers various insanely complex financial derivatives based on residential mortgages and whatnot.
Now, these financial firms provide careers to some of the most clever people in the world who spend every waking hour seeking arbitrage opportunities. If the government stands ready to inject billions if certain conditions are met, and there is any way to cause those conditions without getting caught, you can bet your bottom tax dollar that they will find a way. With instruments sufficiently complex that essentially nobody understands them, do you believe this is impossible?
AIG really is a bottomless pit. The question is, when our government finally figures this out, what will happen next?
I honestly do not know.
AIG: Earnings at 6 AM (Calculated Risk)
Black Hole Alert: AIG to Get as Much as $30 Billion More (Naked Capitalism)
Update
Just for the record, the final figure was $61.7 billion. AIG is receiving additonal federal aid to the tune of $30 billion.
Nemo, you’re a genius!
The government has figured it out. Obama, Summers, et al., they know the story. They believe that have to keep feeding the beast because if they don’t, the beast will default on its CDS. And, if this happens, all the other beasts benefiting from AIGS’s CDS will need to be fed as well, and there are a lot of them, with aggregate balance sheets bigger than AIG’s. And if the other beasts don’t get fed, then they will default on their CDS (or fail to meet their capital, reserve or other security requirements), and then more and more beasts will need to be fed.
In feeding AIG, we are simply feeding the system. The government knows this but is afraid to state this plainly and
simply, probably because the truth is so damn ugly. I submit that no one knows what will happen if we stop feeding the beast, but Joe Nocera of the NYT (and others before him) establish pretty plainly that if this happens, the system will receive a bigger shock than when Lehman wasn’t fed. That’s the devil we know.
I agree, Nemo, it is all very disheartening.