AIG: The systemic risk of too big to fail

Cory Doctorow at Boing Boing recently posted a leaked memo from AIG to the Treasury in support of their request for another $30B. You can read the whole memo here.

The size and scope of the AIG business operations are breathtaking. The systemic risk associated with letting them fail is frightening, to say the very least. And, we find that the notional value of their derivatives risk is $1.6 Trillion covering 1500 corporate, governmental and institutional clients.

This is a sobering document in so many ways. The notion of creating financial behemoths that are "too big to fail" will go down in history as the single most foolish policy endeavor of our time. Undoing the excesses of this policy and restoring a functioning system will probably be regarded as the greatest accomplishment, if it can be done at all.

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Why are we allowing this company to

operate like this? Wipe out the remaining 20% equity ownership and start an orderly liquidation and unwinding of the damage. This is blackmail plan and simple.

Allowing it to continue in this state is extremely dangerous. I don't buy this crap about a 'run on insurance' policies. Most people would not be surprised by a complete takeover of AIG and the dissemination of information is much quicker and wide spread than in the 1930's.

Time for antitrust?

Break them up into regional baby AIGs.....

Moral hazards would not exist in a system designed to eliminate fraud.

Maximum jobs, not maximum profits.

I getting tired of people saying "we

can't let AIG collapse". Complete "nationalization" is not a collapse. Investors have to start taking "haircuts". Stop treating this supposed "risk takers" with kid gloves. OMG, if they take a haircut they are going to stop investing. F*ck that. Wipe out the remaining 20% - tell counterparties that sorry you are not getting 100% on CDS and based on that information let them re-value their crap assets.

M&A und Anti-Trust

Where has the FTC been for the past 15 years? Isn't that the group that has allowed so much consolidation via acquisition to occur (using debt financing)? Now, we have not only "too big to fails," but also "too big too succeeds." Again, another failed regulator.

dupe and did not read it that way

This is a dupe post, I saw this AIG systemic risk argument and posted it AIG used fear to get latest bail out.

Then, read the actual risk amount, not the total amounts. they are less than the bail out money.

Now that you mention it...

I do recall your earlier post and also reading the Bloomberg article. It does refer to the 21 page memo, but does not provide a link, and then jumps around with reports from hither and yon, all over the world. When I read the memo itself, I just never equated it with the Bloomberg article. In hindsight, this post should really have been a comment on your earlier post.

Having said that, if you read the memo it is compelling to consider the gigantic size of AIG's business, and the implied systemic risks it presents.

the memo is good

In fact if I see a news article, I try to find the original source because the news article is a reporters interpretation of the information. So this "dupe" is a "good one".

I am reading the memo. This is what I see in this document. They are trying to equate the derivatives, the CDSes of AIG with their insurance division. I believe even a full bore bankruptcy of AIG would guarantee those life insurance policies.

So, in other words, and those are all of the business sector areas where AIG is health, profitable, one doesn't need to have risk to any of those AIG businesses, yet could easily wipe out the shareholders, the management and most importantly, all of those CDSes, toxic derivatives which are just this financial unit division in London.

One could also break up AIG and just put into receivership just that derivatives division.

So, the memo is trying, in my view, to present their entire business when simply stop feeding the CDS ponzi scheme wouldn't have to affect any of the other businesses that AIG is involved with.

So, AIG is using their stable, profitable $19 trillion dollar life insurance business as a "threat" to keep feeding the Ponzi scheme CDS derivatives part of their business in my view.

I feel better.

I think you can see how I never put your post and the memo at Boing Boing together. The only correlation is the casual mention of the 21 page memo in the Bloomberg article (which I hope you will agree was not really that well written, IMHO).

But let's go further. I'm not sure any coercion is going on here since the shareholders of AIG are essentially wiped out at this point. The stock is worthless, practically speaking, the former shareholders have already taken their losses. The US taxpayers are now the majority shareholders.

A commenter at Boing, Boing named "Oskar" explained it best:

The thing is, when you sell insurance, like AIG has, there is someone on the other end buying it. That buyer is counting on getting that money back if worse comes to worse (after all, they did pay for it, so they have a right to it). If AIG goes under, suddenly all of those people who are counting on that money if things go bad, will no suddenly not have that protection. They will not be able to pay back their dept, and they will go under along with their creditors.

Add to that the peculiar way credit default-swaps work. Say company B bought CDS protection from AIG on company X. You pay $2 million a month, and you get $60 million from AIG if X defaults. Two months later, X looks much shakier than it did when you bought protection, so now you can sell protection on $60 million for $4 million instead of 2. So you sell that protection to company C.

Now, every month, company C pays you (company B) $4 million, and you pay AIG $2 million, and you pocket the difference. But notice that you're completely hedged, you'll never have to pay nothin'. If X defaults, you'll owe $60 million to C, but you'll get that from AIG, so there's no worry there!

These chains can get very long, and if there's even one break, the whole thing collapses. If AIG can't pay you the $60 million, you can't pay C their $60 million, and C can't pay D their $60 million, and so on. If AIG defaults, it would bring down a huge number of companies, and would not unlikely completely destroy the financial system.

We can't let AIG fail. I know, it sucks, but that's simply reality.

Oskar makes a few typing errors which we all accept in the blogoshpere. But his/her? explanation reinforces the dilemma faced by decision makers. This is only looking at things from the AIG perspective. What is the perspective from Citigroup, JP Morgan Chase, Bank of America, Wells Fargo, and on and on. That's my point. Too big to fail, WTF????? Wouldn't you like to be a fly on the wall at Treasury when these things are discussed?

At this point

Given that, hadn't we better assume that the financial industry, such as it is, has ALREADY FAILED? And maybe get going on something more scientific and modern (less based on chaos) to replace it?

Moral hazards would not exist in a system designed to eliminate fraud.

Maximum jobs, not maximum profits.


the issue is different with CDSes. They are corrupt and do not imply the guarantees like regular life insurance, annunities and so on do.

It's a different service, a different sector and they let unlimited CDSes be assigned to one one in their right mind would do that and then argue "oh you can't let these fail"...of course we let these nonsensical derivatives fail.

What I'm saying is one isolates AIG, i.e. they break it up and sector off, isolate these very CDSes and their financial division and that is the thing to wipe to zero.

The rest of the company should be "let free" because it's fine, profitable.

What I'm saying is AIG is using their other businesses when the obvious thing is to break it up, isolate the risk ...
i.e. if the insurance division has no connection to the CDSes division there is no "fear of fight"....

and then wipe out these derivatives. Also, this is the EU argument as I understand it, to do regulation first in order to stop more of these insane, mathematical fiction structured finance "products" not be allowed to be continued to "sell". Stop the gambling first, then clean up the resulting mess.

Breaking up is hard to do.

My earlier comment was meant to be a response to you Robert; I thought I had clicked the reply arrow. Anyway, let me say that I absolutely agree with you, these companies should be broken up and reorganized back to regulatory constraints of the mid-1990's, at least.

I really don't like the Obama economic team as you probably have construed from earlier posts and comments. I see too many personal connections to the root of the problem to instill confidence in their ability or even desire to advocate realistic solutions to our problems.

Still, the Treasury, or even the administration, isn't the authority to break up these monopolistic (terroristic?) entities. It is up to Congress to do that. Perhaps an executive order to stop the trading of the derivatives for some period of time while the various governmental regulatory agencies have time to assess where we all are collectively would be helpful.

But let's not forget how we got into this predicament in the first place; the pursuit of free market fundamentalism! The previous administration and the Congress supporting them pursued objectives that have come back to bite us in the arse, e.g. this one, as reported by DDay.

In the long run, it is a competition of beliefs and the reversal of ideologies that is at stake here. There are a lot of populist voices of reason and common sense here at EP. But I defer to the inimitable Digby to summarize the current challenges to common sense and the level of commitment we need to maintain, in order to change the status quo.

who is the doer on a break up

I believe the doer is the administration. Now where does it fall exactly I'm not so sure. Corporations are like "persons" instead the state where they incorporated while the Federal Government can regulate banking.

I'm not sure in this case who controls AIG, but since they were effectively nationalized, I believe it's the U.S. treasury.

I just went looking for information, who really is minding the store and didn't find an article that was clear on the authorities.

I'd rather see the mid 1970s

The last time we, gasp, had state-based usury laws.

Moral hazards would not exist in a system designed to eliminate fraud.

Maximum jobs, not maximum profits.

I'll stick my neck out and call bull

First, the entire chain would not go down. It's reasonably certain that either someone in the chain will have the financial means to pay off on the bet, or an enterprising lawyer will figure out how to declare the entire chain (or large parts of it) null and void. My guess is that option #2 is far more likely than option #1. There's precedent for it. When Lehman Bros went down, 75% of the whole of the counterparty claims (hundreds of billions) were resolved at auction for a small fraction of the notional amount. The unsettled swaps were either toast (out of the money) or assigned to other counterparties. So all these claims of systemic risk are incredibly specious. Second, so someone, somewhere gets the short end of the stick. Isn't that a novel experience for bondholders (sarcasm). It used to be that if you were the holder of a bad bond, you ended up as an unsecured creditor in bankruptcy, or, in the case of a corporation, you could end up as a stockholder. But now, all of a sudden, since you've deliberately paid for unregulated "insurance" to avoid regulatory restraint, you're demanding to be made whole? That's what really galls me about this whole process. It's thievery on a massive scale, with the parties to the theft engaged in an elaborate con game invoking systemic risk. It's nothing of the sort. The players on Wall Street should be hauled off to jail and the so-called regulators fired for incompetence.

I'm with you Bro'.

Seed, I'm from the same personality type as you. But if you have played high stakes poker, then you know we (euphemistically speaking) are holding the short stack. The time to call the bluff was 6/7 months ago. They didn't call it then, and now the financial players hold the strong position. So, while we can agree that the entire chain would not go down, it is anyone's conjecture how much of the chain could go down.

Like you, I would have castrated the bastards months ago, bondholders be damned. But that wasn't the direction taken so we (you, I and other like minded individuals) need to stand back and assess the table odds. Systemic risk is a possibility, no doubt. How probable? Eh, I'm not sure, it's anyone's guess.

Congress has the constitutional authority to change the rules of the Casino we are playing in. If I were in the Treasury I'm not so sure I would be calling a lot of bluffs right now. I think I would be waiting for legislative consensus to catch up with the current reality. Then I would be "all in" to coordinate policy with the "public" interest, including public flogging of players and regulators that got us into this mess in the first place.

I wish I had heard any

I wish I had heard any policy maker saying that too big to fail is a bad thing. I haven't heard it. And consider that the solution to several blow-ups has been to combine the entities into even bigger "bigs". I think the gov likes "big" because there are then fewer entities to regulate (less footwork you know).

Senator Bernie Sanders said it