AIG's Dangerous Collapse and A Credit Derivatives Risk Primer

safe haven ^ | 9/17/08 | by Daniel Amerman

[Flavius]

While it may look superficially similar to the recent implosions of such investment giants as Fannie Mae, Freddie Mac and Lehman, the takeover and bailout of AIG is quite different, and means that the market is entering the next and even more dangerous phase. What is driving the fall of AIG - and potential government losses that may far, far exceed the $85 billion bailout announced late on September 16th - is not mortgages or real estate (directly), but fears that AIG's huge, global credit-default swap positions will unravel. The $62 trillion dollar credit derivatives market is 50 times the size of the subprime mortgage derivatives market, and is indeed larger than the entire global economy.

[Brian S. Fitzgerald]

Does this have a higher probability than the hadron collider going awry?

[Flavius]

hell yeah

collider is benign

[beebuster2000]

btt

[Nervous Tick]

It’s clear now: we’re all doomed. Doomed.

But I have a question about gold.

If it’s such a great investment, then why in the world would anyone want to take my worthless fiat money dollars in exchange for their gold?

Say, for example, all the gold vendors that advertise on the website from which you posted your article?

I mean, wouldn’t that be a stupid investment on THEIR part?

I would feel terrible, duping an imbecile out of their gold for mere fiat currency. I prolly couldn’t live with myself. That’s the only thing stopping me, actually.

[Flavius]

you know everything so why are you asking questions

[Toddsterpatriot]

The $62 trillion dollar credit derivatives market is 50 times the size of the subprime mortgage derivatives market, and is indeed larger than the entire global economy.

The size of the market is just more proof that we're doomed.

[Nervous Tick]

>> you know everything

I don’t mean to be pedantic, but I have to gently correct you: I know ALMOST everything, but not ABSOLUTELY everything.

Seriously, I totally don’t understand why anyone would sell gold, if gold was so valuable and currency collapse was imminent.

It simply doesn’t make sense. Can you enlighten me?

[Toddsterpatriot]

If it’s such a great investment, then why in the world would anyone want to take my worthless fiat money dollars in exchange for their gold?

Now you've done it! The gold sellers are just gonna keep all their gold and stop running those commercials on CNBC. You know, with the guy from Law and Order (now he's on SVU). CNBC will go under without the advertising. I won't be able to see how the market is doing.

I'll be doomed and out of touch!

[Mr. Bird]

For example, if your firm is being paid $12 million to guarantee payment of a $500 million loan for ten years, and your group assumes there is a 4% chance of having to pay out $250 million on that guarantee, then your expected losses are $10 million - and your firm's expected profit is $2 million.

Without putting too fine a point on it, every word of this statement is untrue, including "and", "a" and "the".

I'll allow for some semantic quibbling, and maybe the author has the right knowledge and just can't convey it properly, but: if I insure a payout of $250 million, my exposure is $250 million, regardless of the probability of that necessity.

If I am a casino owner and accept the risk on someone placing a $1000 bet on a number on the roulette wheel, my expected loss is not one 35th of the $1000. I have a very good chance of winning the $1000, but my exposure is still $35k.

Again, giving the benefit of the doubt, maybe the author is saying that in such a derivative arrangement, the guarantor actuarially determines an expected risk (which is a portion of the total).

[Nervous Tick]

>> The gold sellers are just gonna keep all their gold

Sux, don’t it? I’m already noticing that the number of people selling gold is shrinking (or, at least, growing at a decreasing rate).

I have a secret plan though. I’m going to buy canned food and ammo. I think I’ll be OK as long I don’t get them confused.

[Flavius]

im not sure why your asking about gold
but glen back is pimping it

i imagine that the ponzi scheme works that this worthless pieces of paper are exchanged for shiny metal that is overpriced due to panic buying

eventually when the next ponzi scheme is unraveled and paper currency is arbitrarily strengthen which will happen due to happy faces coming onto tv saying its all clear now we mortgage our credit into infinity so go ahead buy more paper

at that time value of gold will plummet and you can get back more of the worthless paper your asking about

but you already knew this
so again why are you asking about gold when its a credit/currency ponzi scheme that is perpetrated

but here this may interest you

http://en.wikipedia.org/wiki/Ponzi_scheme

[stockpirate]

I am sorry but does anyone else think its wrong for the gov’t to bail out this company with our tax money...is the gov’t going to bail me out if my business colapses...I think not. I say we should have let them go “BUST” after all if you make bad business decisions. The outcome is “supposed” to be bad.

[Nervous Tick]

Thanks!

[Flavius]

well not sure why your thanking me or your being sarcastic i cant tell

anyway fun reading is about Savings and Loans, it was same gig
poor people got loans, it failed it got bailed out

now due to global economy its same kind of a thing just i guess bigger

also gold has been driven up and it will driven down again
the trick to getting extremely wealthy is to obviously catch these moves

[Flavius]

well if you believe this guy, the reason they are bailing out AIG is because if they dont, no one knows which corporate debt is held by what bank that may go bankrupt

which would result in banks not sending any money to other banks because of potential of banks going bankrupt

thus stopping global economic banking system which i guess would be bad

[Retain Mike]

The instrument may be different, but the failure is traditional. Insurance companies should make their money from insuring risk. However, having all this money around as reserves for losses is always tempting. Good management is able to beat back the group that always arises with the perpetual brilliant insight that if they just made more money on their investments then they could underwrite more aggressively and capture greater market share. Bad management always embraces this fallacious notion, ignoring insurance professionals who council wiser underwriting and careful risk control measures with clients. Of course, the latter steps are not nearly as exciting.

[who_would_fardels_bear]

If you read further the author clearly states that the firm that is being paid $12 mil to insure $500 mil most likely has similar insurance relationships with 499 other firms.

So the 4% is not 4% of the $500 mil, but 4% of $250 bil.

In which case everything he says makes perfect sense.

[Flavius]

i get it, but they have been doing this every 10 yrs that i can remember

borrow money from Japan, Savings and Loans, crash...

now we borrow from China, and have a nice happy Global Derivaties crash

id really like to get onto next one id like to retire like the smart boys from these Streets

[6SJ7]

Does this have a higher probability than the hadron collider going awry?

One could form a black hole sucking in everything on this planet. The other is just a science experiment.