What happens to trillions in AIG debt?
March 17, 2009 4:08 PM Subscribe
AIG-in-the-loop-filter: Just how is AIG going to deal with the trillions of toxic debt in their troubled divisions? Give me the possible scenarios.
AIG is rumored to have sold 24 trillion dollars of toxic derivatives to European banks alone. Is that just the tip of the iceberg? I am genuinely curious. How is this debt obligation going to be resolved? That 'line item' (I know it's not actually a line item) alone is enough to implode the European economy from what I've heard and more or less alienate us from our European allies. Are there more AIG 'line items' in the trillions in the China-Asian markets as well? South America? North America? I've heard that Canadian banks largely avoided this debacle. Anyone else avoid it? My real question is seriously...how will this be resolved. Give me the possible scenarios. Constructive detailed plans rather than broadbrush statements, greatly appreciated. (And no... this isn't Barry).
Secondary question. Can AIG spin off its toxic divisions kind of like Philip Morris did from it's Kraft Food division? What happens to a share of AIG stock in the process?
AIG is rumored to have sold 24 trillion dollars of toxic derivatives to European banks alone. Is that just the tip of the iceberg? I am genuinely curious. How is this debt obligation going to be resolved? That 'line item' (I know it's not actually a line item) alone is enough to implode the European economy from what I've heard and more or less alienate us from our European allies. Are there more AIG 'line items' in the trillions in the China-Asian markets as well? South America? North America? I've heard that Canadian banks largely avoided this debacle. Anyone else avoid it? My real question is seriously...how will this be resolved. Give me the possible scenarios. Constructive detailed plans rather than broadbrush statements, greatly appreciated. (And no... this isn't Barry).
Secondary question. Can AIG spin off its toxic divisions kind of like Philip Morris did from it's Kraft Food division? What happens to a share of AIG stock in the process?
Best answer: Where are you getting this $24 trillion number? Googling only gives me this Daily Telegraph article, which cites an EC document that claims that EU banks hold "£16.3 trillion of toxic assets." Converted to USD, that seems to be the $24T you are referring to.
Not sure what they mean by toxic assets though. That's a huge number and clearly represents something like the total notional value of all mortgage-related derivatives. For reference, US consumers have an outstanding home mortgages of $10.5 trillion.
In any case, the loss severity on that $24 trillion will not be 100%. Not by a long shot. But the losses will still be huge. For example, Nouriel Roubini estimates that the US institutions will have losses of $3.6 trillion (these are losses on some tens of trillions of assets). The IMF estimates $2.2 trillion of losses on US-originated assets.
This doesn't have anything to do with toxic assets, necessarily, but AIG has written life insurance with a face value of $1.9 trillion. Just another reference.
None of this directly answers your questions, but I think you are confused about the cumulative numbers to begin with.
Can AIG spin off its toxic divisions kind of like Philip Morris did from it's Kraft Food division? What happens to a share of AIG stock in the process?
This is a complex question. In theory, yes, a stock spin-off is possible. This would be similar to the "bad bank" strategy mentioned for some the distressed banks. But it wouldn't really solve any problems. First of all, the US gov't has a majority ownership in AIG already and has been trying to sell off its good assets as a way to recoup losses in the derivatives book. And the CDS counterparties would likely freak out if they thought their contracts were being separated from whatever value is left at AIG. But I'm no lawyer and only have a passing familiarity with ISDA documentation, so I'm not sure what the counterparties' legal rights are in that case.
posted by mullacc at 6:09 PM on March 17, 2009
Not sure what they mean by toxic assets though. That's a huge number and clearly represents something like the total notional value of all mortgage-related derivatives. For reference, US consumers have an outstanding home mortgages of $10.5 trillion.
In any case, the loss severity on that $24 trillion will not be 100%. Not by a long shot. But the losses will still be huge. For example, Nouriel Roubini estimates that the US institutions will have losses of $3.6 trillion (these are losses on some tens of trillions of assets). The IMF estimates $2.2 trillion of losses on US-originated assets.
This doesn't have anything to do with toxic assets, necessarily, but AIG has written life insurance with a face value of $1.9 trillion. Just another reference.
None of this directly answers your questions, but I think you are confused about the cumulative numbers to begin with.
Can AIG spin off its toxic divisions kind of like Philip Morris did from it's Kraft Food division? What happens to a share of AIG stock in the process?
This is a complex question. In theory, yes, a stock spin-off is possible. This would be similar to the "bad bank" strategy mentioned for some the distressed banks. But it wouldn't really solve any problems. First of all, the US gov't has a majority ownership in AIG already and has been trying to sell off its good assets as a way to recoup losses in the derivatives book. And the CDS counterparties would likely freak out if they thought their contracts were being separated from whatever value is left at AIG. But I'm no lawyer and only have a passing familiarity with ISDA documentation, so I'm not sure what the counterparties' legal rights are in that case.
posted by mullacc at 6:09 PM on March 17, 2009
AIG has written life insurance with a face value of $1.9 trillion.
Whoops, got my numbers mixed up - that number is the area of $2.3T as of 2007.
posted by mullacc at 6:15 PM on March 17, 2009
Whoops, got my numbers mixed up - that number is the area of $2.3T as of 2007.
posted by mullacc at 6:15 PM on March 17, 2009
Best answer: Despite being center-stage the default-swap market is still not well understood. First off, AIG as it is now is toast. Second, the government (Paulson) gang raped the taxpayer for the benefit of their previous employers. Completely unconscionable.
Backing up a bit, who is taking the other side of all these bets and why? The other side is mostly taken by big banks, pension funds, and other investors who actually own an asset (say a pool of mortgages) that AIG has written a default swap on. The primary reason they buy them is to allow them to increase their leverage. If you are a bank, there are legal limts to how much leverage you can employ - say you lend someone $1mm, you have to have 8% to remain solvent. This is what gave us the 10-12x leverage of banks in the past. Now though (well a little while ago), you buy that $1mm pool of mortgages, then AIG sells you insurance on it, so you carry it on the books for $200k, thus requiring only 16k instead of the 80k you needed before. Hence the leverage ratios of 30+.
As we all know now, everyone under estimated the counter-party risk (the risk that your insurance policy will be worthless). In a non-govt-intervention environment, that is exactly what would have happened. The results are that instead of keeping that $1mm loan on the books at $1mm, you have to write it down to current values (say $500k) and then you are insolvent.
So the devil in the details here is that the vast majority of those default swaps that AIG wrote are still in-the-black, in the sense that the underlying has not defaulted and no payment is required. (Think the stocks minus Lehman/Bear etc). However, if the counterparty (AIG) defaults, then most of those contracts require immediate payment. Thus the bullshit "keep pumping money into this sucker" stuff.
So gun to the head prediction about what happens to the rest of them? As awful as it sounds, as owners of this company it is probably best for us to continue to throw money into the blackhole, but the values are not in the trillions, unless more stuff defaults. The key is avoiding the "counterparty defaults" clause that makes the whole shithouse go up in flames.
As for the spinoff - yes, and its likely. Remember - we own this company. it is in our best interest to keep the non-financial-products insurance business alive, and the costs to recapitalize are nothing compared to what we've already sunk into this lemon.
posted by H. Roark at 8:19 PM on March 17, 2009 [1 favorite]
Backing up a bit, who is taking the other side of all these bets and why? The other side is mostly taken by big banks, pension funds, and other investors who actually own an asset (say a pool of mortgages) that AIG has written a default swap on. The primary reason they buy them is to allow them to increase their leverage. If you are a bank, there are legal limts to how much leverage you can employ - say you lend someone $1mm, you have to have 8% to remain solvent. This is what gave us the 10-12x leverage of banks in the past. Now though (well a little while ago), you buy that $1mm pool of mortgages, then AIG sells you insurance on it, so you carry it on the books for $200k, thus requiring only 16k instead of the 80k you needed before. Hence the leverage ratios of 30+.
As we all know now, everyone under estimated the counter-party risk (the risk that your insurance policy will be worthless). In a non-govt-intervention environment, that is exactly what would have happened. The results are that instead of keeping that $1mm loan on the books at $1mm, you have to write it down to current values (say $500k) and then you are insolvent.
So the devil in the details here is that the vast majority of those default swaps that AIG wrote are still in-the-black, in the sense that the underlying has not defaulted and no payment is required. (Think the stocks minus Lehman/Bear etc). However, if the counterparty (AIG) defaults, then most of those contracts require immediate payment. Thus the bullshit "keep pumping money into this sucker" stuff.
So gun to the head prediction about what happens to the rest of them? As awful as it sounds, as owners of this company it is probably best for us to continue to throw money into the blackhole, but the values are not in the trillions, unless more stuff defaults. The key is avoiding the "counterparty defaults" clause that makes the whole shithouse go up in flames.
As for the spinoff - yes, and its likely. Remember - we own this company. it is in our best interest to keep the non-financial-products insurance business alive, and the costs to recapitalize are nothing compared to what we've already sunk into this lemon.
posted by H. Roark at 8:19 PM on March 17, 2009 [1 favorite]
Best answer: H. Roark: Why do you think a spinoff of the Financial Products group is likely? It only seems logical if you thought the government would spin the Fin Products group to itself and then IPO the "good company" for significant cash. But the market has no appetite for a big IPO like that--instead AIG is trying to sell off the good businesses one-by-one (and having a hard time doing that too). Sell the good divisions, use the proceeds to pay back the gov't and shut down Fin Products. A spinoff seems unneccesary.
In fact, AIG CEO Ed Liddy lays out this exact plan in this op-ed published, uh, tomorrow.
posted by mullacc at 8:51 PM on March 17, 2009
In fact, AIG CEO Ed Liddy lays out this exact plan in this op-ed published, uh, tomorrow.
posted by mullacc at 8:51 PM on March 17, 2009
Best answer: By spinoff, I mean more of a dismantling with the aim of isolating the FPD damage as much as possible (very much like the MO/KFT deal). The counterparty-risk landscape would change a lot (I think positively) if the US govt took on the CDS risk, which in many ways is I think similar to the other deals they are doing - backstopping original investors loans.
Think the current outrage is bad about the bonuses? Wait till "the taxpayer" gets left behind holding FPD while Lampert or some other jackass buys the rest of the newly-capitalized company for a song.
posted by H. Roark at 9:58 PM on March 17, 2009
Think the current outrage is bad about the bonuses? Wait till "the taxpayer" gets left behind holding FPD while Lampert or some other jackass buys the rest of the newly-capitalized company for a song.
posted by H. Roark at 9:58 PM on March 17, 2009
Response by poster: Thank you all for your answers. Very much appreciated.
posted by Muirwylde at 1:23 PM on March 19, 2009
posted by Muirwylde at 1:23 PM on March 19, 2009
This thread is closed to new comments.
I just want to see where that number is coming from.
posted by jeb at 5:23 PM on March 17, 2009