Solvent Insurer / Insolvent Insurer

Forget the good bank/bad bank, I have an even bigger beef with this INSANE absurdity: Why are the taxpayers making good on hedge fund trades gone bad?I cannot figure that one out.

When AIG first faltered, there were two companies jammed under one roof. One was a highly regulated, state supervised, life insurance company. In fact, the biggest such firm in the world.

The other firm was an unregulated structured finance firm, specializing in credit default swaps and other derivatives.

The first firm was Triple AAA rated. They had a long history of steady growth, profitability, excellent management. They made money (as the commercial goes) the old fashioned way: They earned it.

This half of the company held the most important insurance in many families’ financial lives: Their life insurance.  When an AIG policy holder passed away, the company paid off the policy, providing monies that are used to pay off mortgages, kids colleges, and surviving spouses life time living expenses. Given the importance of this payment, one can see why it is crucial to make sure there are sufficient reserves to make good on the promise of the life insurance policies. The actuarial tables used were conservative, the accounting transparent. The policy payoffs rock solid, utterly reliable.

AIG, this insurance company, was well run. It made a steady income, provided a valuable service to its clients.

It was also very solvent.

The other part of the firm was none of the above. It was neither regulated nor transparent. It existed only in the shadow banking world, a nether region of speculation and big bets on derivatives. This part of the company engaged in the most speculative of trading with hedge funds, banks, speculators, gamblers from around the world. Huge derivative bets were placed, with billions of dollars riding on the outcome. It served a far more limited societal function than the Life insurance portion, other than a legal pursuit of profit.

This part of AIG was nothing more than a giant structured finance hedge fund. Despite the fact this hedge fund had no rating, no supervision or oversight, it managed to trade off of the Triple AAA rating of the regulated half of the firm. Somehow, it wastreated as if it was Triple AAA, regulated and guaranteed by the government.

This was nothing more than a giant scam, perpetrated by the people who were running the AIG hedge fund.

It was exempt from any form of regulation or supervision, thanks to the Commodities Futures Modernization Act. This ruinous piece of legislation was sponsored by former Senator Phil Gramm (R), supported by Alan Greenspan (R), former Treasury Secretary (and Citibank board member) Robert Rubin (D), and current presidential advisor Larry Summers (D). It was signed into law by President Clinton (D).  It was the single most disastrous piece of bipartisan legislation ever signed into law.

As you might have guessed by now, this portion of AIG is the INSOLVENT half.

here is th question that every single taxpayer should be asking themselves: WHY AM I PAYING $1000 TO BAIL OUT THIS GIANT HEDGE FUND?

Of all the many horrific decisions that Hank Paulson made, this may be the worst. A very special description, given his track record of incompetence and cluelessness.

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What should have been done?

Simple: When we nationalized AIG, we should have spun out immediately the good, solvent life insurance company. The hedge fund should have been wound down in an orderly fashion. Match up the offsetting trades, the rest go to zero. End of story.

You as a credit default swap gamblor have no reaosnable expectation that anyone is going to make good on your bets with another hedge fund. That is was under the roof of a legitimate insurance company is irrelevant.

Right now, we are into this clusterfuck for $166 billion, an every last penny of it is needless waste.

Taxpayers should not be bailing out hedge fund trades. This garbage must insanity immediately.


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

5 Responses to "Solvent Insurer / Insolvent Insurer"

  1. Anonymous   March 6, 2009 at 8:15 am

    I work in the insurance business and you have nailed the situtation exactly. I use the term financial casino to describe their non-insurance activites. Thank you for the clarity.

  2. Anonymous   March 6, 2009 at 10:57 am

    DO NOT ALLOW THE FEDERAL GOVERNMENT TO TAKE OVER AIG.In regards to AIG, the Federal Government has three apparent options1. Continue to fund AIG’s shortfall2. Let AIG fail3. Administer a Federal Government take over AIG and accept all of AIG’s liabilitiesThe benefit of Option 1 is that it allows the government to keep AIG alive with the hope that it eventually stabilizes. In doing so, the government has mitigated its direct risk by only exposing itself to the money that it has lent to AIG, which is considerable, but only a fraction of AIG’s suspected liabilities. The problem with Option 1 is that it potentially is delaying the inevitable and in the meantime is burdening the Federal Government with significant debt.Option 2 may be very painful and it is not clear what the total ramifications would be associated with AIG’s failure and the eventual unwinding of the Credit Default Swap market, but it might be the most appropriate option.Option 3 has the potential to bankrupt the Federal Government because even the Federal Government does not have the resources to cover all of AIG’s suspected liabilities, which are rumored to be several times the GDP of the United States due to the interconnectivity of the financial industry and the role that AIG (the Federal Government under Option 3) would play as being the ultimate “backstop” for these non transparent commitments.It is important to note that the Federal Government does not fully understand the magnitude of AIG’s liabilities and has demonstrated this lack of understanding in its assessment of AIG’s risk in the first bailout. The Federal Government should not be entirely faulted for this poor risk assessment because AIG does not fully understand the extent of its own liabilities, and therefore is not able to fully disclose all of these liabilities to the Federal Government.The point is that magnitude of AIG’s risk is extremely large and very unclear and the Federal Government should not step into the role of ownership of AIG because the Federal Government will have no ability exit this role and this role could potentially bankrupt the Federal Government.There may be more options. They would need carefully consideration and honest deliberation prior to engaging.

  3. Sacrifice   March 6, 2009 at 11:28 am

    Dear Barry:While I agree that this is a [email protected]*&% for the taxpayer, shareholders, and citizens of the US, you fail to address thecounter party repercussions of simply zeroing out the off balance sheet liabilities and assets of AIG.Simple solutions are compelling, however, a simple zero on AIG would likely zero or near zero every sophisticated,large and hedged counter in the US and the developed world including: all the large banks, insurance companies,pension funds, etc.Everyone hates bankers, but we have met the enemy and they are us.IMHO

  4. benoit   May 5, 2009 at 9:20 am

    Very interesting analysis. At this stage, insurers have been less affected by the crisis than banks. Is it because the way there solvency is calculated is quite complex? Is anyone here familiar with how to calculate a life insurance company’s solvency ratio? Apparently the way it is calculated in the US and in Europe are different. I would be happy to better understand solvency 1 and solvency II. If anyone knows a good book dealing with this issues, please let me know.