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Thursday, April 2, 2009

The Truth Behind AIG

Making Bernie Madoff Look Like The Artful Dodger Since at Least 2005

I knew something was fishy when I worked out the details on AIG's "Securities Lending" program. It sucked the whole institution into a long bet on rising housing prices, in an irresponsibly unprotected position. My one-year-old nephew's got better risk management than that. It just didn't add up.

Well, dear turns out I had no idea.

"AIG was a Ponzi scheme plain and simple," says a new report from Institutional Risk Analytics, "yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community."

That's right friend...our intuition was right on with this one. So grab yourself a cup of coffee, mute the television, and get ready to take a peek under the Emperor's Kimono.

What we're going to see truly might shock you...or...if you're like me, it'll just make your blood boil and wonder how you can "opt-out" of funding any more bailouts.

AIG...A Black Hole for Your Tax Money

So we'll start with some of AIG's less egregious sins. Namely selling Credit Default Swap contracts on GM bonds...and in doing so, indirectly driving GM into bankruptcy.

Here's how that works...

If I understand it correctly, Obama gave GM sixty days to negotiate with its bondholders. Either they take a "haircut" on the value of their bonds, or a "debt-for-equity" swap. But neither seems likely at this point. Why? it happens, GM's bondholders bought CDS protection from AIG. And as the government's made perfectly clear over the last few months, AIG counterparties can expect their CDS contracts to be paid out at 100 cents on the dollar. What's more, bankruptcy recovery on bonds is rarely - if ever - zero. Lehman bonds were worth about ten cents on the dollar...even after the biggest bankruptcy in history.

So GM's bondholders are staring down the barrel at two grossly different opportunities. On the one hand, they could do the right thing - at least in terms of taxpayer bailout money - and take a haircut on their assets. That would mean taking a serious hit on the value of their bonds...something that would be necessary just to make GM solvent.

But on the other hand, they're looking at recovering 100%+ on the exact same bonds. Granted, through means of indirect taxpayer extortion, but nonetheless; a profit. And as we said yesterday, these guys are in the business because they love money, not because they feel a duty to their government or their people. (ed.: We could likely say the same thing about Washington at this point.)

And remember, President Obama vowed that the American auto industry would indeed survive...even if they're forced into Chapter 11 bankruptcy. That means any money paid out by GM in the aforementioned recovery process would need to be replenished by taxpayer dollars in order to get the company back up to speed.

So effectively - thanks to AIG - the taxpayers could end up bailing out GM twice...on the hook for paying to make GM's bondholders whole, but also indirectly paying for any recovery they make on those bonds post-bankruptcy.

Now...if your already steaming mad...and if you're worried about your blood pressure...well, you might just want to skip this next session...

AIG: The Ponzi Scheme Laid Bare

Because this is the big one folks.

The proof that AIG was just one big Ponzi the books for the whole global financial system. If AIG really was bailed out because of "systemic risk," then it was bailed out because the system risked being exposed for how insolvent it truly was.

If the "systemic risk" was failure and a collapse in the global credit markets, then it holds that AIG was merely preventing an incontrovertible fraud that disguised this ugly truth.

The major hat-tip here goes to the whistleblowers at Institutional Risk Analytics, and you can find their full report here.

Basically, they wanted to know why AIG would ditch the highly profitable business of writing Property and Casualty (P&C) insurance policies in favor of the highly risky CDS business. It just didn't add up.

So they spent a few months, "interview[ing] a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem."

It all started with reinsurance...and a form of communiqué known as "side letters"...

"In the regulatory world, a 'side letter' is perhaps the most insidious and destructive weapon in the white-collar criminal's arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless."

Reinsurance is a common practice in the insurance industry...where one insurer will offset another insurer's risk on his own books for a fee. But once side letters are involved, all bets are off.

At that point, reinsurance essentially becomes a show...a "window dressing" that helps keep accountants and regulators at bay while you get down to the business of making money - never mind those pesky safeguards.

Oh yeah, and it nullifies your CDS contracts...

"There are two basic problems with side letters," says the IRA report, "First, they are a criminal act, a fraud that usually carries the full weight of an '"A'" felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided."

Did this practice hit AIG's CDS business? It's highly, highly likely according to the report from the IRA...

"Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple."

But the evidence might be harder to come by...largely thanks to our government's ham-fisted approach to the situation..., "Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing."

As for a resolution...or perhaps a recovery following fraudulent conveyance...

"Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG's operations."

However Did We Get Here?

With US$200 Billion of our dollars already crammed down AIG's craw, and more fraudulent "bailout" on the way before we even inspect the legality of AIG's CDS contracts, I just want to know how the hell we got here in the first place.

This isn't the kind of America they told me about when I was in school. And they're not even covering it in the media. What happened? When did we become the United States of AIG?

But then I took a look at AIG's campaign contributions over the last few years and it all became perfectly clear. I wish I had US$9 million kicking around to subsidize measures that would have prevented utter financial collapse, rather than provoking one.

Sadly, it's often the culprits of financial collapse - the AIG's the Goldman's and the Madoff's - that have the money necessary to buy "democratic support" for their continued shenanigans. This stuff won't be stopping any time soon, but I'm taking steps to make sure it doesn't cost me a dime...are you?

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