Bailing Out AIG’s Counterparties

Gretchen Morgenson joins us in looking at the bailout of AIG as a bailout of their counterparties:

“A.I.G. nearly barreled off the cliff last September, when it couldn’t meet its obligations to customers who had bought a version of derivatives called credit default swaps. Such swaps are like insurance policies; bondholders buy them to protect themselves from default on various forms of debt. When A.I.G. couldn’t meet the wave of obligations it owed on the swaps last fall as Wall Street went into a tailspin, the Federal Reserve stepped in with an $85 billion loan to keep the hobbled insurer from going bankrupt; over all, the government has pledged a total of $160 billion to A.I.G. to help it meet its obligations and restructure operations…

Some $440 billion in credit default swaps sat on the company’s books before it collapsed. Its biggest customers, European banks and United States investment banks, bought the swaps to insure against defaults on a variety of debt holdings, including pools of mortgages and corporate loans. Because of the way A.I.G. wrote its swaps, and because the company had a double-A credit rating at the time, it did not have to put up collateral to assure its customers that it would be able to pay on the insurance if necessary. Collateral would be required only if A.I.G.’s credit rating were cut or if the debt underlying the swaps declined.

Both of these “unthinkable” events occurred in 2008. Suddenly, A.I.G. had to cough up collateral it didn’t have.

So, you see, the rescue of A.I.G. also involved a bailout of its many customers, none of whom the insurer or the government is willing to identify.” (emphasis added)

Let’s just call this part III of read it here first NYT edition.

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Previously: iBanks Grabbed $50 Billion in AIG Bailout Cash (March 7th, 2009) http://www.ritholtz.com/blog/2009/03/ibanks-grabbed-50-billion-in-aig-bailout-cash/

Backdoor Bailouts for Goldman Sachs? (March 5, 2009) http://www.ritholtz.com/blog/2009/03/backdoor-bailouts-for-goldman-sachs/

Solvent Insurer / Insolvent Insurer (March 4, 2009) http://www.ritholtz.com/blog/2009/03/solvent-insurer-insolvent-insurer/

Source: A.I.G., Where Taxpayers’ Dollars Go to Die GRETCHEN MORGENSON NYT, March 7, 2009 http://www.nytimes.com/2009/03/08/business/08gret.html


Originally published at The Big Picture blog and reproduced here with the author’s permission.