Tuesday, September 16, 2008

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Plundering the Pile of Gold

by Reb Akiva at Mystical Paths

When an extremely complex operation breaks, it's difficult to explain or even see all the details. Like a huge splash in an already busy pond, the waves combine with all the other activity to wash against the boats, wildlife, and shore in different ways, but impacting all.

"How the Masters of the Universe ran amok and cost us the earth" is the first serious essay giving good insight without burying us completely in every technical detail. Yet in short it says, not content to just pick up the gold lying all around, the masters of investment kept grabbing and digging for more, until they dug the dirt right out from under themselves.

I mean, come on, AIG is the worlds largest insurance company. Having worked in a major insurance company corporate office for many years, I can tell you stability is their key operating principle. For if you're going to pay policy claims 10, 20, or 50 years from now, you have to be taking the customer premiums now and investing them in long term stable investments - like real estate. (Though many readers bells probably went off when I wrote real estate, that's not the problem here.) Invest in land development or putting up a new office building, recoup profits 20 years later.

But AIG couldn't see past the pile of gold that the investment firms were digging into. (Hey, you're fellow CEO's are getting billion dollar stock options, why can't you?) Now, they may not have been an investment bank, but they did think a bit and come up with a way to get into the game. They (along with others) created investment insurance. Specifically called a "credit swap", they would cover the risk on the big mortgage investment bundles for only 5% of the deal. Which sounds fine and dandy when there is no risk, it's free money! But when there is not only risk but active failures in progress, suddenly AIG has to actively cover the payouts and show that it can cover the 30% failure rate going on.

Of course, it can't. 5% payments don't cover 30% failure. Hence "AIG needs an immediate infusion of $75 BILLION with a B dollars." And who's going to take on that risk which "AIG told investors in December that it estimated valuation losses on its credit default swaps for October and November at just over $1bn. AIG has scrapped the adjustment because market conditions mean it cannot “reliably quantify” the figure."

That's how an insurance company goes down. It writes policies with an unknown risk and doesn't set the premium at a level to cover the risk that comes up. But one of the dams that has been holding back a complete financial flood has been the "insurance" covering the failures. Now it is 100% clear the insurance is completely and woefully inadequate, and the failure to cover is going to take down the insurance writers as well.

But it get worse. As the dam is crumbling, like people standing by watching a levee fail in the recent hurricanes, they're grabbing anything they can to throw into the breech...

(Mish's Global Economic Trends)
New York Gov. David A. Paterson (D) is going to violate regulations and allow AIG to borrow up to $20 billion from its subsidiaries. Timothy Geithner, president of the Federal Reserve Bank of New York approves this transaction. New York state insurance superintendent Eric R. Dinallo claims "At this point the insurance companies are financially strong and solvent and fully able to meet any claims." In the proposed swap-o-rama the spokesman for the superintendent claims "We're not going to allow them to put junk in the place of good stuff." (as if he has any clue).

Here's the Deal: If the "insurance companies are financially strong and solvent" why do they need to raise $75 billion in another all night poker game with every rule in the book being broken to do so?

What's At Risk? : Life insurance policies, retirement annuities, and those with policy coverage against all manner of calamities, from financial to natural disasters are put at risk just so AIG can make good on a bunch of derivative bets gone bad.

Right now, illegally and with the regulators watching and nodding in agreement as it happens, lot's of bank deposits, life insurance savings and any unencumbered cash held in the system .... i.e. real life savings and earnings .... has suddenly been made available by the weekend rule changes by the Fed and US treasury. They are now being swept into accounts that hold the other side of the derivative trades.

The firewalls against fraud have been torn in expedience "to save the system from itself". ...There will be nothing left but the empty husk when the locusts and other assorted parasites have finished.


While writing for some years about the coming financial crisis, this is the most upsetting and frightening article I have written. This is the dam breaking and peoples savings getting washed away, without them even knowing it (YET). Because it's a low speed disaster, it doesn't seem quite real. There seems to be time to wait until tomorrow. With investments, hey, they almost always recover (though it may be some years).

But now we're talking about billions or even trillions of dollars, and our accounts to be used to cover impossible high risk debts under the assumption that things will stabilize and the money will be able to be returned before we need it.

Will all the "coverages" of the system protect you as these grabs fail to recover? But, a bank run (or insurance / investment run) will make things worse. So one must judge whether self protection is worth the risk of adding to the systemic pressure.


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1 comments:

Shiloh said...

Great article. The unraveling sadly will get much worse. 2009 will be a very bad year for finances.

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