PDA

View Full Version : More on AIG...


kevinquinnyo
30th March 2009, 09:44 AM
Read this article. (http://seekingalpha.com/article/128390-exclusive-big-banks-recent-profitability-due-to-aig-scam)

[...]In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JP Morgan Chase (JPM), Citi (C), and BofA (BAC), regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary. [...]

The part about the ISDA confused me. The economic jargon is cryptographic for a layman like me.

But basically, the "profits" of major banks in Jan/Feb, are probably phony, if this article's assertions are correct.

Does anyone else think this is pretty screwed up?

mhaze
30th March 2009, 11:25 AM
Read this article. (http://seekingalpha.com/article/128390-exclusive-big-banks-recent-profitability-due-to-aig-scam)

[...]In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JP Morgan Chase (JPM), Citi (C), and BofA (BAC), regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary. [...]

The part about the ISDA confused me. The economic jargon is cryptographic for a layman like me.

But basically, the "profits" of major banks in Jan/Feb, are probably phony, if this article's assertions are correct.

Does anyone else think this is pretty screwed up?

Yes. From your link:
on the list of adhering parties (http://www.isda.org/isdacloseoutamtprot/protocollistalpha.asp), AIG takes front and center stage (together with several other parties that probably deserve the microscope treatment).
So - in simple terms, ISDA (http://www.isda.org/), which is the only effective supervisor of the Over The Counter CDS market, is giving its blessing for trades to occur (cross) below where there is a realistic market bid, or higher than the offer. ....The curious timing of this decision and the alleged abuse of CDS transaction marks by and among AIG and the big banks, is striking to say the least

Puppycow
31st March 2009, 12:44 AM
But basically, the "profits" of major banks in Jan/Feb, are probably phony, if this article's assertions are correct.

Does anyone else think this is pretty screwed up?

Yes, and sort of.

The problem is, if you don't bail out most of these banks, the financial system collapses. Each bank that goes down will cause huge losses for its counterparties, and the FDIC will have to pick up the tab anyway. Companies employing millions of workers will go out of business, and basically, the world will end by about 2012. In the meantime, you will have to dig up worms and eat them to survive. :boxedin:

Puppycow
31st March 2009, 12:54 AM
The economic jargon is cryptographic for a layman like me.

CDS: credit default swap
CDO: collateralized debt obligation
GS: Goldman Sachs
DB: Deutsche Bank
IB: investment bank (I think)
AIG-FP: AIG Financial Products
PnL: profit and loss(?)

soylent
31st March 2009, 02:22 AM
Further digested:

CDS: credit default swap - "Insurance" on some form of debt or bond.

Naked CDS: CDS not attached to any underlying asset - The equivalent of you buying fire insurance on someone elses house because you know they're a smoker and you want to place a side-bet on them burning their house down; the seller of the CDS is taking the other side of the bet.

CDO: collateralized debt obligation - A bundle of car loans, credit card loans, tranches of mortgage backed securities and other loans. Pays out dividends from the money repayed on these loans. Comes with an almost completely opaque 400 page manual describing the contents and modelling the behaviour of this security.

MBS: mortgage backed security: A pool of mortgages split up into tranches. Senior tranches get first dibs, then comes the mezzanine tranche and finally the junior tranche which only gets payed if all other tranches get payed. The riskiers tranches pay higher dividends if there are no defaults and may pay nothing at all.

Tranche: Bucket/slice.

Debt-to-equity ratio: A measure of leverage/gearing - e.g. if you have $500 invested in stocks, but $400 of those are borrowed you have a debt-to-equity ratio of 4. In the good times your profits will be amplified by a factor 5, in the bad times so will your losses. Lehman brothers and Bear-Stearns had levered up around 30 to 1 when they imploded.

MTM: Mark-to-market accounting - To value an asset, for accounting purposes, by looking at what others are trading it for and using that value.

Level 3 asset bucket: Where banks put all their dodgy investments, because after all, they're not trading so the price is unknown and MTM can't be used. MBSs and CDOs go here. The reason they're not trading is because of the fundamental disagreement in price between what the market is willing to buy them at and what the banks are willing to sell them at; possibly caused by the TARP(which was supposed to buy $750 billion in dodgy assets but never did).

Stated income loan: Liar loan - a loan that allows you to make up any random number as your income without anyone bothering to check.

NINA loan: The epitome of bad lending practices that occured at the height of the housing bubble - it stands for No Income, No Assets.

No recourse loan: E.g. a mortgage where the only recourse of the lender is to reposess your house.

Jingle mail: What people do when the house is worth less than they owe on their mortgage and their mortgage is of a no recourse type. Send in your keys and walk away.

Perverse incentive: An incentive to behave in a way that is misaligned with the interest of the public or the company you happen to recide in. E.g. paying someone a commision on each mortgage regardless of the underlying soundness of the mortgage. As you're not holding on to the mortgage the incentive is to give any old hobo you can find a mortgage, regardless of ability to repay.

Arbitrage: Taking advantage of a difference. E.g. borrowing short at 3% and lending long at 6%(the sort of thing a bank is supposed to be doing). E.g. buying in bulk cheaply and repackaging/redistributing and selling at retail price(what stores do).

kevinquinnyo
31st March 2009, 09:24 PM
Further digested:

CDS: credit default swap - "Insurance" on some form of debt or bond.

Naked CDS: CDS not attached to any underlying asset - The equivalent of you buying fire insurance on someone elses house because you know they're a smoker and you want to place a side-bet on them burning their house down; the seller of the CDS is taking the other side of the bet.

CDO: collateralized debt obligation - A bundle of car loans, credit card loans, tranches of mortgage backed securities and other loans. Pays out dividends from the money repayed on these loans. Comes with an almost completely opaque 400 page manual describing the contents and modelling the behaviour of this security.

MBS: mortgage backed security: A pool of mortgages split up into tranches. Senior tranches get first dibs, then comes the mezzanine tranche and finally the junior tranche which only gets payed if all other tranches get payed. The riskiers tranches pay higher dividends if there are no defaults and may pay nothing at all.

Tranche: Bucket/slice.

Debt-to-equity ratio: A measure of leverage/gearing - e.g. if you have $500 invested in stocks, but $400 of those are borrowed you have a debt-to-equity ratio of 4. In the good times your profits will be amplified by a factor 5, in the bad times so will your losses. Lehman brothers and Bear-Stearns had levered up around 30 to 1 when they imploded.

MTM: Mark-to-market accounting - To value an asset, for accounting purposes, by looking at what others are trading it for and using that value.

Level 3 asset bucket: Where banks put all their dodgy investments, because after all, they're not trading so the price is unknown and MTM can't be used. MBSs and CDOs go here. The reason they're not trading is because of the fundamental disagreement in price between what the market is willing to buy them at and what the banks are willing to sell them at; possibly caused by the TARP(which was supposed to buy $750 billion in dodgy assets but never did).

Stated income loan: Liar loan - a loan that allows you to make up any random number as your income without anyone bothering to check.

NINA loan: The epitome of bad lending practices that occured at the height of the housing bubble - it stands for No Income, No Assets.

No recourse loan: E.g. a mortgage where the only recourse of the lender is to reposess your house.

Jingle mail: What people do when the house is worth less than they owe on their mortgage and their mortgage is of a no recourse type. Send in your keys and walk away.

Perverse incentive: An incentive to behave in a way that is misaligned with the interest of the public or the company you happen to recide in. E.g. paying someone a commision on each mortgage regardless of the underlying soundness of the mortgage. As you're not holding on to the mortgage the incentive is to give any old hobo you can find a mortgage, regardless of ability to repay.

Arbitrage: Taking advantage of a difference. E.g. borrowing short at 3% and lending long at 6%(the sort of thing a bank is supposed to be doing). E.g. buying in bulk cheaply and repackaging/redistributing and selling at retail price(what stores do).

Thanks for your diligence, but this is actually the part that went over my head:

The ISDA Close-out Amount Protocol (the “Protocol”) offers market participants an efficient way to amend their 1992 ISDA Master Agreements to replace Market Quotation and (subject to the parties’ elections) Loss with Close-out Amount. In addition by adhering to this protocol certain amendments are deemed to be made to credit support provisions published by ISDA and (subject to the parties’ elections) certain sets of definitions and are set forth in annexes 1 to 14 of the protocol text.

The Protocol will apply to all transactions that incorporate the covered 1992 ISDA Master Agreements, regardless of the date such transaction is entered into (unless the relevant Confirmation contains sufficient language to exclude the effect of the Protocol in accordance with Section 4(c) of the Protocol).

The ISDA Close-out Amount Protocol is open to ISDA members and non-members. There is no cut off date for adherence. ISDA reserves the right to designate a closing date of this protocol by giving 30 days notice on this site.

soylent
1st April 2009, 05:37 AM
The ISDA Close-out Amount Protocol (the “Protocol”) offers market participants an efficient way to amend their 1992 ISDA Master Agreements to replace Market Quotation and (subject to the parties’ elections) Loss with Close-out Amount. In addition by adhering to this protocol certain amendments are deemed to be made to credit support provisions published by ISDA and (subject to the parties’ elections) certain sets of definitions and are set forth in annexes 1 to 14 of the protocol text.

The Protocol will apply to all transactions that incorporate the covered 1992 ISDA Master Agreements, regardless of the date such transaction is entered into (unless the relevant Confirmation contains sufficient language to exclude the effect of the Protocol in accordance with Section 4(c) of the Protocol).

The ISDA Close-out Amount Protocol is open to ISDA members and non-members. There is no cut off date for adherence. ISDA reserves the right to designate a closing date of this protocol by giving 30 days notice on this site.

OK, lets try and parse this.

ISDA - International Swaps and Derivatives Association, a trade organization for people who are in the bussiness of selling over-the-counter swaps and derivates(such as CDS).

OTC(Over-The-Counter): Traded between private entities rather than over an exchange.

Derivatives: financial contracts or financial instruments whose value is derived from something else, known as the underlying. The underlying can be almost anything, it can be any kind of asset, credit, index or even weather.

There are 4 major types, forwards, futures, options and swaps.

Forwards: An agreement to do a transaction at a future date.

Futures: A contract that entitles the bearer to take possession of a standardized amount of an underlying asset at a future settling date. E.g. allows farmer Bob to lock in the price he gets for his expected production of corn in advance or an airline to lock in the price it has to pay for oil next year.

Options: Put options give you the option of selling at the old price; for a fee someone else bears the risk of the underlying going down in price. Call options give you the option of buying at the old price; for a fee someone else bears the risk of price increases in the underlying.

Swaps: Two parties agree to swap one stream of cash-flow for another. E.g. the buyer has a bond issued by GM and they're worried they're not going to repay, so they go to AIG and ask to buy a Credit Default Swap which would force AIG to replace the cash-flow from the GM bond if they fail to repay.

ISDA Master Agreements: a standardized contract for derivates contracts.

Determining Party: Non-defaulting party or the party who wasn't the affected party.

Market Quotation: A measure of how much payment is owed when the agreement is terminated. An agreement can be terminated in several ways, including default of the counter-party, default of an underlying debt instrument(e.g. a mortgage backed security). Market Quotation can be selected under the 1992 ISDA Master Agreement. It's based on quotations from leading dealers.

"A Market Quotation is determined on the basis of quotations from leading dealers (i.e., Reference Market-makers) in the relevant market selected by the party determining a Market Quotation"

"If fewer than three quotations are provided (i.e., a Market Quotation cannot be determined) or a Market Quotation would not (in the reasonable belief of the party making the determination) produce a commercially reasonable result, Loss will apply in respect of the relevant Terminated Transaction or group of Terminated Transactions."

Loss: Another valuation method based on calculating losses and costs in connection with the agreement on the relevant date. This was often the back-up method for when it was difficult to get a Market Quote(e.g. the market fundamentally disagrees with banks about the worth of CDOs and MBSs; that's why the market is illiquid and nothing is trading).

"the Determining Party would simply calculate its total losses and costs in connection with the ISDA Master Agreement as at the relevant date. Certain guidelines were provided for this calculation but it was essentially a subjective test."

Close-Out Amount: A new valuation method that attempts to avoid the unreasonable results produced by Market Quote in peculiar circumstances. Introduced as an amendment in the 2002 agreement.

"A number of cases highlighted the fact that Market
Quotation could, in certain circumstances, produce
unreasonable results. See, for example, Peregrine
Fixed Income Limited v Robinson Department
Store plc and Enron Australia Finance Pty Limited
(in Liquidation) v Integral Energy Australia. For this
reason, ISDA has replaced the choice of Market
Quotation and Loss in the 2002 Agreement with a
single payment measure on early termination, being
the Close-out Amount. Close-out Amount attempts
to combine the favourable elements of both Market
Quotation and Loss. It also attempts to cover certain
issues that arose in litigation on the meaning of those
terms.
Accordingly, in calculating its Close-out Amount, the
non-defaulting party is required to calculate the amount
of its losses and costs that are, or would be, incurred
(similar to the 1992 Loss measure) in replacing or
providing the economic equivalent of the payments
and deliveries under the terminated transactions that
would have been required but for the early termination
(similar to the 1992 Market Quotation measure).
The defi nition of Close-out Amount goes on to provide
a number of factors that the Determining Party may
consider in assessing its losses and costs. Again,
these provide a balance between the methods used
in assessing Market Quotation and Loss in the 1992
Agreement. For example:
(a) quotations from third parties, such quotations
being permitted to take into account the
creditworthiness of the Determining Party;
(b) relevant market data provided by third parties; and
(c) information of the type referred to in (a) and (b)
from internal sources.
However, there is an important over-riding
determination in assessing the Close-out Amount.
The determining party must always use commercially
reasonable procedures to produce a commercially
reasonable result.
A number of market participants have recently
preferred specifying Loss in the 1992 Agreement. This
is probably for a combination of two factors – recent
litigation questioning the applicability of Market
Quotation in particular circumstances and the ability
to apply a more subjective test in assessing damages
payable under the 1992 Agreement. Loss has enjoyed
a settled meaning, particularly following the decision
of Australia and New Zealand Banking Group v
Societe Generale. Arguably, the overarching principal
of ‘commercially reasonable procedures to produce a
commercially reasonable result’ in the new defi nition
of Close-out Amount makes it less attractive than the
current formulation of Loss. It adds uncertainty to,
or at least a check on, the calculation made by the
determining party on an event of default or termination
event. The new defi nition of Close-out Amount may
also require adjustment to the measures that market
participants use to calculate mark-to-market exposure
on a periodic basis during the course of normal trading."

Right. The 2009 Close-out protocol appears to be an amendment that allows both parties to agree up front to use Close-Out Amount valuation in case a counterparty defaults(e.g. Lehman) or in case one party wants to terminate early(e.g. AIG-FP trying to unwind all those credit default swaps it has issued).

I can't tell you if it's a good idea or not and I don't understand how close-out amount valuation works in any detail, but I hope that helps a bit.

mhaze
1st April 2009, 06:37 AM
Yes, and sort of.

The problem is, if you don't bail out most of these banks, the financial system collapses. Each bank that goes down will cause huge losses for its counterparties, and the FDIC will have to pick up the tab anyway. Companies employing millions of workers will go out of business, and basically, the world will end by about 2012. In the meantime, you will have to dig up worms and eat them to survive. :boxedin:Seems to be you are acknowledging to a strategy of propping up not just fake valuations, but imaginary asset base underlying that.

Meanwhile the rats are scurrying off the ship with the remaining treasure?