Who Plays AIG in the Sequel?

As we watch the water rise toward the top of the government default levees, I am amazed that the market townfolk aren’t panicking, putting their most portable valuables into and on top of their cars and getting out of town.  Maybe they have so much flood insurance that they would actually want the levees to break.

The least likely reason that big market players aren’t heading for the hills is that they think Washington will just increase the debt limit to cover spending they’ve already approved.  After all, that two-sentence, no drama option is only used most of the time, and would have already been used last April or May to avoid the cost and disruption of playing the extension games Treasury had played these last few months.

I do notice how frequently these days I hear the offering levels of CDS (Credit Default Swaps) for US Treasuries.  In other words, lots of people (institutional, corporate “people” as defined by the Supremes) have been buying insurance.  Cheap insurance.

It makes me wonder who is writing that insurance.  After all, the most famous recent new fortunes were made by people that paid pennies (often fractions of pennies, like 15 basis points per annum) to collect dollars when AAA mortgage bonds defaulted.  Not to mention the $360 billion paid out to CDS holders the day Fannie Mae CDS settled.  That was more money lost in one day than the entire two years’ worth of subprime mortgage credit losses in 2007 and 2008.  The best part was that the winners had paid out about $15,000 for a year of insurance that paid $1 million when insolvency was declared.

We still don’t have any disclosure of CDS exposures, nor any requirement that providers of those insurance policies set aside capital to reserve for the risk that they have to pay off.  Those parts of “regulatory reform” went into the trash bin even before Dodd/Frank got a vote.

So it leaves me wondering.  If the current game ends with yet another credit default triggering event, this time for the US Treasury, then who wrote the insurance policies?  Will the banking system freeze up again when the market realizes that JPM or DB or BAC might actually be bankrupt, but nobody knows?

hh

PS Today, the price of that insurance is way up, but still under one penny per dollar of coverage.

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2 Responses to Who Plays AIG in the Sequel?

  1. Phil Vardena says:

    I have just this quick comment: wow!

  2. hhill51 says:

    On another forum, an excellent question came up:
    .
    OMG, hadn’t thought of who pays the CDS. Guess there must be hundreds of billions or more notional value. That could BK some big people! Just another tail risk to think about that now looks like its more in the fat belly than the tail
    .
    My answer:
    .
    Isn’t it obvious who pays?
    .
    Future taxpayers, that’s who. Preferably with direct deductions from wages and salaries, and a national sales tax, since it would be wrong to tax investors or “job creators”, or to rigorously enforce existing income tax laws on those whose income isn’t reported on a W-2.
    .
    Maybe the market is sanguine because the writers of the insurance are too big to fail. If AIG taught them anything, it was that when you’re getting the taxpayer to pony up, the taxpayers get socked for 100 cents on the dollar. Remember that there were a couple of bond insurers who owed on CDS at the same time Lehman/AIG went down, but they weren’t systemically significant. Their counterparties accepted negotiated settlements in the 20 cents on the dollar region.
    .
    But we paid Goldman and Credit Lyonnaise 100 cents on the dollar on the AIG contracts.
    .
    PS The real lesson of any legislated tax break or government giveaway is that you can pay your lobbyists to make it happen again. Witness the fact that the last offshore tax repatriation holiday, just five years ago, resulted in roughly $100 billion coming back to America, allegedly to create jobs. The result? The companies that took advantage of it have offshored more than 100,000 jobs since then, and arranged their corporate income recognition to put three times as much income into tax havens. Now the US Chamber is heavily lobbying to have another offshore repatriation holiday, and the case is being made that it will create jobs in America. Can we really be that stupid?
    .
    Proving once again that buying politicians gives a higher return than any kind of R&D or efficient management or practically anything else a company can do.
    .
    Citizen’s United and the Supremes and their faux-conservative political allies protecting the anonymity of those political expenditures virtually assures those of us who work for a living or own small businesses an even worse future

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