Josh Asks Why Geithner Doesn't TellJosh Marshall wants to know why Secretary Geithner can not tell us who the beneficiaries of the AIG bailout are.
We are now several month into this and some people still do not 'get it'. I'll try to give a slow but simple answer to Josh's question.
AIG signed insurances against bond defaults in form of Credit Default Swaps in a notional value of more than $450 billion. Some insured bonds defaulted and AIG paid out for these insurances. As it did not have the money to do so, the Bush and Obama administrations decided that the taxpayer should pay.
Up to November $150 billion were given to AIG and on Monday another $30 billion. But AIG still has $300 billion of CDS exposure and will likely make more high losses on that.
When Lehman Brothers went bankrupt -a 'credit event' - people who had insured their holdings of Lehman bonds asked their insurers to pay for their losses. Such a credit event was also triggered when Fannie and Freddie were taken into receivership.
AIG which had written insurances for the debt of those entities faced a big payout and the taxpayer had to cough up the money.
What is the moral justification for this?
It was morally okay because the people and institutions insured by AIG were justified to expected the payout as their 'assets', i.e. Lehman bonds had really lost value. They had hedged a real risk like you do when you pay for fire insurance on your house. Insured you are right to expect a payout when your house burns down.
But their is another group of people and institution who got money from the taxpayer through AIG.
This second group never ever owned a Lehman or Freddie or Fannie bond. But they also had bought insurance from AIG against the default of these bonds. These people never invested in 'assets'. They payed a small monthly fee to AIG for a lottery slip and when Lehman failed they had a huge win. They went to AIG, pointed to the 'credit event' and demanded the payout. AIG obliged and the taxpayer gave the money.
Some may ask:
"While it is easy to understand the moral case for bailing out real bondholders that insured against default, what is the moral case for paying out to people who made pure bets? These people never owned a fire insured house at all. Why do they get taxpayer money when my house burns down?"
"If they had be given back the money they payed for the lottery slips, i.e. the small monthly insurance premium, that would probably be understandable, but why do the taxpayers pay out the lottery win when the private lottery organizer is bankrupt?"
Simple answer to those simple questions: Because the administration says so.
There are big numbers behind this.
In an FT Insight column Satyajit Das gives us some:
Lehman Brothers defaulted with around $600bn in debt implying a maximum loss to creditors of that amount. In addition, according to market estimates, there were CDS contracts of around $400bn-$500bn where Lehmans was the reference entity. Market estimates suggest only about $150bn of the CDS contracts were hedges. The remaining $250bn-$350bn of CDS contracts were not hedging underlying debt.
To pick that apart:
Of a total of $600 billion real bonds owned by slots of people only $150 billion were credit insured. When Lehman bonds defaulted, owners of $450 billion of its debt lost all their money.
Owners of $150 billion of that debt did not lose any money. They were payed out the insurance they had contracted and the insurers (backed by the taxpayers) carried the loss.
The total economic loss was $600 billion, $450 billion by bond owners and $150 billion by insurances. $600 million left the monetary system - poof.
But on top of that there were written insurances with a notional value of $250-$350 billion that insured people who never had the insured asset but were only playing the lottery. These people demanded money from the insurer and indeed they were payed.
This part of the 'event' did not have a real economic loss. No money left the system.
Instead money was payed from the insurer toward the insurance holder, the buyers of CDS'. As the insurer was backed by the taxpayer every one and his/her children now pays for the enormous lottery win for a few people, who had risked very little. This is money that is moving from the bottom of the society to the top in unprecedented amounts.
What is the moral justification for this?
There is none.
Who are those people who are getting huge payouts from the taxpayer for risking little?
We know of one likely beneficiary, John A. Paulson of Paulson&Co Inc, a hedge fund that in November gave a party for his partners and employees:
Dinner? Jumbo crabmeat & avocado, paired with 1999 Haut-Brion; and Colorado rack of lamb with tarragon jus and parmesan polenta cake, paired with 1999 Chateau Margaux and 1999 Lafite-Rothschild (which can fetch more than $500 a bottle).
Paulson's company had made lots of profits as it bought insurances (i.e.lottery tickets) for the event that mortgage bonds would fall in value.
Paulson & Co. can surely afford the luxury. The $36.1 billion hedge fund famously racked up billions of dollars in profit by betting against subprime mortgages. ... The firm’s event arbitrage funds, with $19.1 billion in assets under management, are up more than 19 percent for the year in the unleveraged fund and 30 percent on Paulson Advantage Plus, which is levered 1.5 times.
Investors to Paulson's fund must bring at least $10 million to be allowed entry. Those are rich people. They now feast on the money every taxpayer is pressed by the administration to come up with.
Earlier Josh Marshall at TPM wondered where the taxpayer money goes. Secretary Geithner did not answer the question when he was asked by Senator Cantwell. Now Josh proposes a compromise and only wants to asks Geithner for the reason why they can not tell us.
Dear Josh the reason is simple.
AIG still has $300 billion in CDS exposure. If the Lehman quote of 1/3 real insurance and 2/3 lottery bets is the same with those CDS, which is likely, than a few rich people are waiting for a $200 billion free payout from the taxpayer.
Geithner does not want you or anyone else to know who profits from this scheme without having risked any real money. His rich friends do not want you to know that they are racking in billions of dollars in lottery wins that cost them little money and that the taxpayers are paying out because the private lottery operator went bust. They will pay off Geithner when his job is done and he finally gets kicked out.
People in the known and within the business are not likely to explain this. Satyajit Das, who has an MBA and is a risk consultant and author of lots of books about derivatives. He gave the Lehman numbers above. But his next sentence following the above quoted ones is:
The losses on these CDS contracts [i.e. the lottery part] are additional to the $600bn.
Of course they are NOT. These are not losses. No money from those bets is leaving the monetary system. This is money moving from many persons at the bottom to very few at the top.
Geithner and his masters fear that if the public knew or understood that, they would probably only get the costs of the lottery slip disbursed - if at all.
They want the big one. AIG has still $300 billion at risk that you and your kids will have to pay for.
They want it. And they are getting it. And there is nothing you can do about that.
