Tuesday, November 24, 2009

OUR TOP STORY TONIGHT : Yippee-ki-yay Mr. Bankfiend, the 2% solution

'Money, it's a gas
Grab that cash with both hands
And make a stash

Money, it's a hit
Don't give me that
Do goody good bullshit

Money, it's a crime
Share it fairly
But don't take a slice of my pie
-Pink Floyd

'There is only one basic human right, the right to do as you damn well please. And with it comes the only basic human duty, the duty to take the consequences.'
- P.J. O'Rourke

'Paranoia is knowing all the facts.'
- Woody Allen

'The secret is there are no secrets.'
- Unknown

'You can't handle the truth.'
-Colonel Nathan Jessup

I hereby proclaim my intention to seek a constitutional convention whereby we the people will move to implement the Garrett Morris amendment.

This amendment will seek to codify the following:

All terrestrial broadcasts of Bubblevision and Hee Haw will hereby include captioning for the learning impaired.

In accordance with this act all references, including but not limited to, the terms delineated below, will be accompanied by the italicized caption:

GDP, percentage organic and percentage synthetic as well as comparative GNP and GDI metrics

U3 unemployment , SGS Alternate Unemployment Rate

BLS Benchmark revision , cumulative
job discrepancy relative to ADP on a 1yr, 5yr and 10 yr basis

In addition all government statistics will include a cumulative revision total on a 1-yr, 5-yr and 10-yr aggregate basis showing past month revisions.

Seasonal adjustments on all reported statistics will be announced separately from the raw data.

Whenever a government official states that we have a strong dollar policy a Family Feud style X will appear over their face.

OER, Birth-Death Model, hedonic regression and imputation will be stricken from all official records.

'I'm a risk manager and I've been that for a long time, a lot longer than I've been CEO. I live 98 percent of my time in the 2 per cent probabilities. I live always in the worst case.'
-Lloyd Bankfiend

'When Goldie took Trader Hank aside during one long weekend to inform him that AIG was systemic, it was clear that a tough hard decision had to be made to liquidate in order to forgive past debts ... unfortunately it turned out to be a bankster jubilee.'
-Anonymous Monetarist

The Garrett Morris amendment would gapfill about half of Bankfiend's '2%' fat tail.

The other half seems to be rising of its' own volition.

When Timmy G recently mumbled that CDS was not the raison d'etre for the AIG bailout and 'Mad Dog' Feinberg said 'I'm looking at you Goldie' even the most anesthetized folks got their pencils out.

Coincidentally, Jaime (shine on you crazy) Dimon was immediately wheeled out as a possible successor given Geithner's opprobrium, proclaiming that he would love to serve his country beyond taking out the Spooz offer.

One fellow with yellow Number 2 extended , via NakedCapitalism blog, is Thomas Adams, at Paykin Kreig and Adams LLP, a former managing director at Ambac and FGIC.

He states:

'The business that caused AIG to blow up was the same that caused the bond insurers to blow up – collateralized debt obligations backed by sub-prime mortgage bonds (ABS CDOs). This was actually one of the few business that AIG Financial Products had in common with the monolines. AIG didn’t participate in municipal insurance, MBS or other ABS deals, which were all important for the monolines.

Certainly, AIG was larger than any of the bond insurers, but in aggregate, the bond insurers had a tremendous amount of ABS CDO exposure, which at the peak was probably over $300 billion. Despite AIG’s claims to have withdrawn from subprime at the end of 2005, we have identified particular 2006 deals with substantial subprime content that AIG most assuredly did guarantee.

In addition, the monolines had exposure to many other assets classes that AIG did not which created chaos for the holders of those bonds when the monolines were downgraded. The chain reaction risk of the bond insurers was arguably greater, when you throw in the damage to the aucton rate securities market, which was rooted in the muni market. In 2007, MBIA had over $650 billion of par insured, Ambac had about $500 billion, FSA had about $380 billion and FGIC had about $300 billion. Throwing in CIFG and XLCA, the total insured par of the monolines was about $2 trillion – this amount certainly would qualify as large enough to be “systemic risk” if the insurers were allowed to fail.

In contrast, while AIG’s aggregate insured par was greater, the only portion that really presented a systemic risk exposure was the CDS and structured finance exposures, which had an aggregate par exposure of about $400-500 billion. a persuasive argument could be made that the monolines were just as intertwined in the financial system as AIG and, thanks to their municipal exposure, presented as great or greater a systemic risk to the financial markets and the economy.

Yet AIG was bailed out and the monolines were not.

So what happened? How did the monolines get dropped and AIG get rescued? The popular reason given has been that AIG was so big that they affected all segments of the economy, whereas the monolines were only midsized and not critical to the economy. I believe that SIGTARP repeated this version of events last week. I understand that Treasury Secretary Geithner last week repeated this notion and added new information – that he was concerned about the cascading risk of AIG’s non CDS exposure.

While this produces a bigger par exposure for AIG, these other areas did not have the huge risks of loss, have largely remained functional, and did not have the issue of collateral posting. The risk were at the parent level, at AIG FP; the bulk of AIG’s business was written by regulated subsidiaries whose claims-paying ability would not be impaired by an AIG FP failure. So, in my view, this is a fairly weak, after the fact argument. A more plausible case might be made that AIG also had a securities lending business that had sprung a $20 billion leak, but that wee problem hasn’t gotten much mention in the official defenses.

I have a different interpretation. I should note that I am a former employee of a bond insurer, so I admit to a bias. However, my general perspective had been, until recently, that neither AIG or the bond insurers should have been rescued.

When I was at FGIC, Deutsche Bank, Lehman, Bear and UBS were all over my company with sales coverage for CDO deals. But we never heard much from Goldman. I was actually surprised to see that they were so big with John Paulson’s CDO adventures (as recently disclosed in “The Best Trade Ever”), because I never thought they were that big in the CDO market.

One big reason I didn’t know Goldman was so big in CDOs – they didn’t work with the monolines.

Goldman wanted their counterparties to post collateral so they would have protection against corporate downgrades. The monolines refused to have collateral posting requirements in their CDS contracts. The rating agencies supported them in this position on the argument that maintaining their AAA rating was “fundamental to their business”.

AIG, on the other hand, agreed to collateral posting requirements. in fact, they used this as a competitive advantage – they got more business because of it and marketed their flexibility on this issue to the banks.

There were two key distinctions between the monolines and AIG – first, AIG had other businesses, whose losses could threaten AIG’s financial guarantee business while monolines promised to pay claims first, to protect investors.

(More on that below. -AM)

Second, AIG had a history of negotiating before they paid claims (there is an interesting history with a ABS film receivables deal where AIG refused to pay, while the monolines covered similar deals and did not have the same “out” in their policies. This deal did serious damage to AIG’s reputation in the ABS market and shut them out of many deals). So despite their AAA rating, AIG was not as trusted by the structured finance and CDS market – there was a fear that AIG would wiggle out of their obligations in a way that the monolines would not.

All of the other banks got comfortable with the monolines not having to post collateral for CDS trades because of their AAA ratings. Goldman never did.

Of course, Goldman was one of the few banks that clearly set out to profit from shorting CDOs. They obviously realized that if their CDS counterparty was on the hook for a lot of ABS CDOs that were going to blow up, the insurance provider would likely get downgraded. If the downgrade of the insurer was very likely, the only way the short-CDO strategy worked was if the insurer would post collateral.

So Goldman only used AIG, who would provide protection against their downgrade, which Goldman knew would happen because they were stuffing AIG with toxic ABS CDOs.

The banks that used the monolines for their ABS CDOs were making a major error by taking on the monoline downgrade risk without protection, especially if they knew that the ABS CDOs were toxic. So I suspect that most of the banks did not really know that the ABS CDOs would be as toxic as they turned out to be.

This is, of course, what happened. The ABS CDOs blew up, the bond insurers got downgraded, the banks that used them got crushed because their hedges against their CDO risks were now in jeopardy. A death spiral between the monolines and the banks ensued (the ARS meltdown added to the troubles).

Goldman didn’t care, because they had collateral posted by AIG once AIG got downgraded..

All of the banks who faced the monolines had to start considering commutation deals with the monolines because it was obvious the monolines did not have enough capital to cover all of the CDO losses. In these commutations, the banks accepted payments as low as 40 cents on the dollar.

Most of the monoline ratings troubles had unfolded earlier in 2008 – many of them had been downgraded, several commutations had already occurred by the time of the AIG bailout.

AIG managed to put off the threat of serious downgrade for a long time, despite the junk in their portfolio (as 2008 progressed, it was a mystery to me and many others why the monolines were being downgraded but AIG was not). While AIG had been downgraded to AA some time earlier, this hadn’t caused much of a disruption because the real trigger for collateral posting was if they went below AA. For a variety of reasons, this wasn’t a threat until September of 2008.

I hate to get sucked into the vampire squid line of thinking about Goldman, but the only explanation I can think of for why AIG got rescued and the monolines did not is because Goldman had significant exposure to AIG and did not have exposure to the monolines.

(Welcome to the party Mr. Adams. Yippee-ki-yay Mr. Bankfiend. -AM)

When it became clear that AIG could face bankruptcy, Goldman’s plan to profit by shorting ABS CDOs was threatened. While they had the collateral posted, thanks to the downgrades, this collateral could be tied up or lost if AIG went bankrupt. This was a real crisis for Goldman – they thought they had outsmarted the subprime market with their ABS CDOs and outsmarted all of the other banks by getting collateral posting from AIG when they got downgraded.

But if AIG went away, this strategy would have blown up and cost Goldman billions.

All of this is essentially factual and based, for the most part, on public information.

This leads me to conclude that the bailout was prompted by fear mongering and deliberate strategies and manipulation on the part of Goldman and a few select others, to make sure that AIG would be bailed out to protect their trades in shorting ABS CDOs.

AIG, Goldman and ABS CDOs were tied together at the center of the crisis. From Goldman’s perspective, all of the other participants were secondary – they had no exposure to the monolines and they were probably hedged against the other banks. The only loose end was the collateral posted by AIG.

(Hence the doublemint bailout, Hoocoodanode? -AM)

The final question that this raises for me: would it have been cheaper for the government and the taxpayer to have bailed out the bond insurers instead of AIG? The total amount of CDOs and credit default swaps that would have needed to be guaranteed would have been smaller and the number of investors across the market that would have benefited would probably have been larger. The auction rate securities market, the muni market, the investors that held bond insurer exposure to MBS and ABS would have all benefited. None of these markets were aided by AIG’s bailout.

But a bond insurer bailout would not have helped Goldman much and the AIG bailout did.'

AM here :Have had the pleasure(?) of sitting in front of squints at a rating agency concerning a'third'a billion securitization, being pitched a sovereign risk CDS for an energy project and having Morgan once backstab my sponsor with an offer I couldn't refuse but did. Within that context was once regaled with a story about the monolines that highlights the fear that should cause Goldie insomnia.

Mr. Google couldn't come up with a corroborating hit so will present it as told to me.

Lloyd's of London insured the British version of 'Who Wants to be a Millionaire' prior to the franchise's global expansion. It was sufficiently profitable for Lloyd's, so when the show went to the United States they continued the coverage. In the UK when a contestant won the audience wasn't necessarily pleased. Brits understand that they live in a class society and often winners were met with derision.

In the United States of course winners are celebrated because for the most part folks all believe that some day they too could be rich.

So wouldn't you know it, the US show had a lot more winners than its UK counterpart, so much so that Lloyd's refused to pay. As a result S&P came up with their FER rating, which I always considered to be the height of cynicism, namely that a monoline would pay first and sue later. (Reminds me of Chris Rock's routine albeit adjusted .. you are supposed to pay!)

The point being: the '2% probability' that should be of greatest concern to Goldie is if enough regular folks recognize that the Pareto curve applies to them also, that in fact we do live in a class system, that there are two Americas, and that they shouldn't support really rich folks policies unless of course they are really rich ... for if that tipping point were reached ... well then ...the 'jig would be up' Goldie.

They and their sycophantic enablers know it, future policy actions should be seen within that prism.

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