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How banks depend on AIG

Robert Peston | 16:40 UK time, Tuesday, 16 September 2008

Ken Lewis, the chief executive of Bank of America, said yesterday that "I don't know of a major bank that doesn't have some significant exposure to AIG".

American International buidling, New YorkSo AIG's need to raise billions in new capital to shore itself up has sent shockwaves through global markets and helped to undermined the share prices of many banks.

But how exactly are banks "exposed" to AIG?

Light is shed by an insightful bit of research by Sandy Chen of Panmure Gordon.

He has found the following paragraph in AIG's US regulatory filing:

"Approximately $307bn (consisting of corporate loans and prime residential mortgages) of the $441bn in notional exposure of AIGFP's super senior credit default swap portfolio as of June 30, 2008 represented derivatives written for financial institutions, principally in Europe, for the purpose of providing regulatory capital relief rather than risk mitigation. In exchange for a minimum guaranteed fee, the counterparties receive credit protection with respect to diversified loan portfolios they own, thus improving their regulatory capital position."

If you managed to read to the end of that, your reaction is probably "you what?"

Well, I'll tell you what.

AIG is saying here that it has insured $307bn of corporate loans and prime residential mortgages that are on the balance sheets of banks, mostly European banks.

The banks have bought this insurance to protect themselves against the risk that these loans would go bad, that borrowers would default.

Their motive for doing so was to reassure their respective regulators - such as the FSA for UK banks - that these loans are of minimal risk.

And the benefit of doing that was that they could lend considerably more relative to their capital resources.

But if AIG is in trouble, then doubts arise about whether it would be able to honour the financial commitments it has made through these insurance contracts (which, for those of you who like to learn the lingo, are called super senior credit default swaps).

In fact, in a wholly mechanistic way, the downgrades of AIG's credit rating that we saw last night automatically increased the perceived riskiness of loans made by banks that have insured credit with AIG.

Which means those banks' balance sheets become weaker - and that could mean that they'll be forced by their regulators to raise additional capital.

So there's a widespread view among bankers that the US Treasury and the Federal Reserve simply can't allow AIG to fail, in the way that they felt that they could allow Lehman to collapse into insolvency.

If AIG went down, a number of banks' balance sheets would be mullered - there would a dangerous risk to the stability of the global financial system.

Or to put it another way, AIG is so pivotal in the global financial system, it can't be consigned to the dustbin of history in a precipitous way.

PS. For those of you who currently have the willies about HBOS, its exposure to AIG is not life threatening.

What's currently doing for HBOS's share price is blindingly obvious: it provides 20% of all UK residential mortgages; the UK housing market is the major vulnerability of the UK economy; if there's a sharp rise in the number of homeowners defaulting on their mortgages, HBOS would incur significant losses, especially on self-cert, buy-to-let and loans with a high loan-to-value ratio.

But HBOS has recently raised £4bn of new capital to cushion itself against the impact of just such a debacle.

So there is more fear than reason underlying the success of the short-sellers in driving down HBOS's share price - although the short-sellers will claim a modest victory in the decision by Standard & Poors to lower HBOS's credit ratings by a smidgeon.

But HBOS's ratings remain pretty strong. And the rating cuts shouldn't lead to a sharp increase in the cost of its finance or to an exodus of those who provide that finance.

UPDATE 19:25

I suspect that Sandy Chen has found only a part of AIG's credit protection business, since I am told that US banks are more exposed to AIG than are European banks (which is not what the regulatory filing spotted by Chen shows).

And here's a compelling wrinkle. AIG writes its credit default swaps contracts (its loan insurance business) through a French banking subsidiary.

Even so, the possible collapse of AIG isn't a French problem. What AIG needs to obtain is financial support from the American taxpayer at the top holding company level in the US - and it would then use these funds to recapitalise the French bank it owns.

What this shows is the fearful complexity of AIG's corporate structure, which just adds to the difficulty in negotiating a rescue.

Comments

  • Comment number 1.

    Governments and central banks can do a lot more. They all have to tighten regulation, cut interest rate and pump more money into the system. They have to break this cycle.

    What is happening is not in the interest of any one as this will lead to dramatic fall in oil price (Opec needs money as well, so each member will break the quota) also counties with manufacturing bases will suffer as Westerns cannot afford to buy what they produce.

  • Comment number 2.

    So now is the time to form an orderly queue and buy HBOS shares?

    Fortune favours the brave..

  • Comment number 3.

    I've been waffling on for years about the dangers of over-pricing property.
    I think the idea is catching on.

  • Comment number 4.

    The clue in the above is the three small words "prnicipally in Europe". The people who lose biggest out of the collapse of AIG are the European banks. And, from a certain perspective, it is very much not in the interests of the US to pay for the rescue of the competition. It would be preferable to allow the US banks to move in for the kill. Logically, it would fall to the Europeans to rescue AIG. The two big questions, though, are 'who pays' (no one government would have the funds, which therefore requires European co-operation), and 'how is it legally done' (there might be accusations of state aid if it is not handled correctly). I'm glad I didn't take the devil's dollar...

  • Comment number 5.

    Interesting.

    I'd read speculation earlier that if the US govt were prepared to let an investment bank fail there was no way they would rescue an insurance company (that's got to be a hard sell to a suspicious public that one).

    If they don't and AIG really are in that much trouble things could be about to take a serious turn for the worse according to this...

  • Comment number 6.

    The demise of this one will really put the cat among the pigeons.
    At least it might flush out where some of the other phantom assets lie.
    Sooner rather than later would be a good thing otherwise this drip drip effect could go on for years.
    As mortgage defaults will continue and not decrease for a long while so the position of this insurance company will continue to deteriorate.
    There is no way any government can afford to prop up an unknown like this.
    There must be many more we don't yet know of.
    This one today which one tomorrow.

  • Comment number 7.

    a story for you Robert. AIG insured ETF company ETF markets in the UK. due to the problems trading in many etf's were suspended today, affecting thousands of retail investors in ETF's (in ISA's etc)

    It is doubtful if their investments are now worth anything or whether they can get their money back through their brokers such as hargreaves landsdown and iii.

    This is an early indicator of the type of harm a failure of AIG could cause to the man in the street so to speak.

    I'll post more on my blog later tonight

  • Comment number 8.

    didn't AIG ask for $40bn from the feds?

    And when declined, suddenly "found" $20bn down the back of the sofa?

    This is the mark of moral hazard King warned us of, not only did AIG want the feds to bail it out, it also wanted them to fund it so it could continue trading business as normal.

    I guess now its sold those $20bn of assets its profits will be less this year, ah diddums.

  • Comment number 9.

    Why not just let the failed banks and insurance companies sink or swim. Market forces are ultimately the most efficient way of correcting this mess. It will be painful for some, but ultimately better for everyone else who has not been greedy and wreckless.
    The government did nothing to intervene when it was blindingly obvious that the piggy bank was being raided and now they are acting all surprised. It's a joke and raises the question if the banks were lining the politians pockets to turn a blind eye.
    I certainly do not have much sympathy toward the current suffering of the casinos..I mean banks.

  • Comment number 10.

    AIG like Lehmans should be allowed to fail.

    The alternative is yet another government bailout to try to keep a broken system afloat.

    Soon we're going to have most of the financial sector owned or at least propped up by the state.

    Are we still a capitalist country, or do we know trust talented people like Gordon Brown and Alistair to centrally plan our economy like a communist state?

  • Comment number 11.

    Interesting comment on HBOS. I have an offset mortgage with them in which my savings exactly offset the mortgage. This is great for me 'cos I've effectively got an interest free loan. The reason I'm reading as much as I can about them is that the only way this can go bad for me is if the bank goes bust and I lose all my savings but the bank still gets to keep the mortgage.
    Your comments on HBOS are reassuring but I know that in the past the thing that's damaged banks is not their balance sheet but a run on their savings. How is HBOS fixed if people (like me) start withdrawing their savings?

  • Comment number 12.

    Robert

    Let me get this right. AIG provide insurance on loans made by banks to cover the banks in the event of default on the loans and this totals 371 billion dollars.

    You say "their motive for doing so was to reassure their respective regulators - such as the FSA for UK banks - that these loans are of minimal risk.

    And the benefit of doing that was that they could lend considerably more relative to their capital resources".

    Wait a minute. The banks are using the "security" of loans they have made, to make more loans! You know that sounds insane don't you? It means the banks have been extending credit left, right and centre with absolutely nothing to cover themselves if any of these loans turn out to be bad!

    Of course, if the loans are bad the last thing the banks should want to do is collect on the insurance from AIG as this exposes AIG to the danger of collapse, which would be bad for all the banks concerned. Isn't it actually in the interests of AIG and their creditors to maintain the myth that AIG will pay out if a claim is made, which would keep AIG in business and maintain the ability of the banks to lend more money on the basis of valueless securites!

    The credit crunch has shown that the whole banking system is bonkers, and your blog shows that the regulator was responsible by allowing loans made by the banks to be considered as an asset instead of a liability if insurance was obtained. The very size of the insurances obtained should have rung alarm bells everywhere!

  • Comment number 13.

    So - What is seen as the least costly work-through by the Fed? At the moment it appears to be holding onto the bucket of money and looking to relucantly propping up something in the future, maybe, subject to just what the impact is seen to be.

    This looks like a forest fire fight. Lehman is a fire corridor left to burn out. That says the Fed by no means thinks the fire has finished, the expectation is a lot more to come. It says quite clearly that Lehman was not at the top of the list of problems. Thats quite a situation.

    There must be a very long and interesting list at the Fed. Thing is all, we hear about the British based banks from the UK government and BoE is largely soothing comments which have questionable credibility until proved otherwise.

    When viewed alongside other repeated mixed messages from the government that can't help restore confidence, and it's not money, its confidence, which is in short supply.

    Can't see this disappearing quickly and at a domestic level can't see negative equity problems disappearing for years, bound to cause significant recovery problems and resentment.

    Not convinced with arguments that food prices etc will fall significantly, stablise maybe. Too many shockwaves in the system for a comfortable drop - this looks like the new scene. Bit irrelevent if oil drops temporarily, longterm demand will continue to climb. Going to be some very unhappy voters in the West. How many government changes to come in Europe?

  • Comment number 14.

    for all those calling for more regulation, this is a timely warning. What the research report says is that AIGFP has built up a portfolio of 307bnUSD - presumably that is the principal insured not the value of the swaps - mainly because of regulation. Without the regulation on what is considered "Capital reserves" AIGFP would have a considerably smaller portfolio and the money it made in the past was simply a regulatory arb where paying the fee to AIGFP was less than the perceived opportunity cost of cash equivalents on the balance sheet. Note it is mostly European banks that look like they will get hit...

    It also shows the weakness of relying on Credit Swaps in the OTC market inside of a properly margined exchange.

  • Comment number 15.

    First a massive vote of thanks and admiration to Robert Peston. When does the poor man even sleep at the moment. Every news bulletin on radio or TV I am waiting to hear what he has to say. I'm sure I'm not alone in weighing everyone else's views against his. I would much appreciate knowing his views on whether the state HBOS share price might lead to any kind of takeover and who the candidates might be. Can't imagine who would have the strength right now to take on an institution of that size in its current state of uncertainty. I did not take up the rights issue when it was offered but am thinking now might be the time to nip in?

  • Comment number 16.

    "We're all doomed".

  • Comment number 17.

    AIG can simply not fail, if they do then let it be known the Premiership Football will again be in tatters. Who is going to support Man Utd now as AIG are the or were the official sponsors of one of the most supported clubs in the world.

    On a serious note, is downright scary when an Insurance company is eroding confidence in the financial market. Words escape me what to say...how can a company who has holding assets of more than a trillion dollars and shareholders’ equity of about $79.7bn go to the wall?

    Can someone please explain?

  • Comment number 18.

    Robert, It was great to see you defend the good name of HBOS at 6 o'clock. As a loyal employee of many years, it is great to see someone in the public eye actually standing up and defending the company rather trying to destroy it or make money from its share price.

  • Comment number 19.

    AIG reminds me of the Lyoyds re insurance scandle of the 80s, when the insurers were insuring themselves.

  • Comment number 20.

    12. At 5:57pm on 16 Sep 2008, busby2 wrote:
    The banks are using the "security" of loans they have made, to make more loans! You know that sounds insane don't you? It means the banks have been extending credit left, right and centre with absolutely nothing to cover themselves if any of these loans turn out to be bad!

    This sounds to me like paper chasing paper with neither having the backing of anything solid .

    Sounds just like what happened - let's see - about 70 years ago.

    Another depression would be really depressing - especially if we should have learnt from history and prevented its repetition. However greed , governmental indifference/collusion and complicated manoeuvring brings us back full circle.

  • Comment number 21.

    Good story, Robert, and well explained. Of all the news that has come out so far during the credit crunch, this is probably the scariest of the lot.

  • Comment number 22.

    Fine work, Pestoni - good to see you earning your money.

    How on earth did we get to a situation where so much risk was parcelled up into a single point of failure where it is now 'too big to fail'?

    Fools rush in...

  • Comment number 23.

    AIG were paid to take on risks the Banks didn't want. What did AIG do with all these premiums? Invest it in Bank shares? Or repackaged sub prime debt? Did the banks take this investment and repackage some more debt that was in turn insuraned by AIG?

    Sounds like Frankenfiance!

  • Comment number 24.

    On an earlier post, I asked how a bank failure could have been described only a few days ago as unthinkable but it has now been allowed to happen. In the past few minutes, I have been watching people on business news expressing concern about the oil price dropping below 100USD/barrel. It seems only a few weeks ago that these same people were complaining that high oil prices were unjustified but something we were 'going to have to live with' for the foreseeable future.

    There seems to be no consistency and I, as an outsider and something of a novice, am beginning to wonder whether some of these people have the slightest idea what they are talking about.

    As to AIG, even if a rescue plan does come together before the end of the day, will it be enough to satisfy claims arising from Ike as well?

  • Comment number 25.

    #8 The $20billion 'down the back of the sofa' as you put was liquid assets lodged with state of New York. Yes it is bending the rules but, apparantly, it is within the grace of the govenor of New York to grant. Atleast 25 other states who where asked are so close to insolvency that they had to decline!

    However...

    The offer from New York state is/was conditional upon AIG raising the additional funds it has declared as needing to stave of immediate bankruptcy. The figure mentioned is reported to be an additional $70billion.

    Forbes is currently reporting (19:30) that

    a/ the Fed has saod 'no-can-do'.

    b/ the private banks eg Goldman Bank of America etc neither have the funds to do it individually NOR DO THEY HAVE THE FUNDS COLLECTIVELY.

    AIG gets to be a dead man walking until about lunch time tomorrow (our time) at which point it will file Chapter 11.

    Then...BOOM!

  • Comment number 26.

    What's really amazing is that this could just be
    the tip of a huge debacle in the credit swap
    market, which is valued at a staggering $43 trillion.
    (A link I found shows the figure at $45 trillion,
    I got the lower figure from the New York Times.)

    There is more about it in this article,
    which while not from an authoritative source,
    at least shows the outlines of the problem.

    If AIG, which only insures $307B can cause a
    major disruption by its present difficulties, what
    about the other $42.7 trillion?

    Perhaps someone who is a financial "pro"
    (which I am not) could tell us if this is a looming
    threat.

  • Comment number 27.

    Think of Tommy Cooper....

    House........cards..............cards...............house.........sand..................pyramid scheme!!!

    Disappeared...."Jus' like that!!!"

    A house of cards built on sand that's propping up the biggest pyramid sales scam ever....

    oh dear!

    If AIG 'gozunder tomorrow'....we'll all be out of a job!

  • Comment number 28.

    It seems like the only thing preventing complete meltdown of the banking system is the Fed propping up AIG lending them taxpayers money.

    I wonder how long before they go back and ask for another $50B? It seems to me that they are living on borrowed time.

    Seriously, we are looking at a complete collapse before xmas - I do not see how it can be avoided.

  • Comment number 29.

    Re Post 14

    Regulation is not an excuse for financial stupidity by banks. To suggest in any way regulation is the cause of the current problems is flawed.

    It is probable that the overreliance of the UK on the financial sector has compromised the UK governments capability or desire to set strict enough regulations, particularly in the retail banking sector. That has almost certainly been exacerbated by the hands-off mentality. It is all about balance.

    If the USA wishes to cook it's economy there is little that can be done here in the UK to stop it. It is inevitable that the overheat of the Worlds most influential economy damages the UK and Europe. The point is what could have been done, or can be done to limit the impact in the UK. In a global banking system that has to be limited but we seem to have imported the USA mindset lock stock and barrel and it is clear that in the face of an admitted lack self discipline by banks that regulation has to be put in place by the government and this one has failed in that to date.

    Politically this government appears to have wanted to be a Little America, whether it is war or finance.

    Please can somebody explain how a economy which has a financial sector as it's central activity is well placed to recover when that sector is severely compromised. For the last 30 years successive UK governments have allowed the destruction of all but the finance and service sectors (bar farming which has been subsidised due to european politics). I don't buy the Brown Darling claims that the UK is well positioned, its baloney.

    It is also interesting that this situation reveals that the EU probably needs a common financial regulatory body to deal with the current banking system which is just not going to happen.

  • Comment number 30.

    Clearly we hope that the Fed can assist in getting AIG through this impasse and things get back on an even keel...and yet,

    What on earth will happen 'the day after tomorrow' ? Will they suddenly see the blinding light as the scales fall from their eyes and say 'Yes, we have been mighty foolish chasing short - term growth with an unsustainable and risky business model. From now we will be as dull, boring, unexciting, respectable and as prudent as that Gordon Brown fellow from across the pond.., and even more competent'.

    Somehow, I am not holding my breath...

  • Comment number 31.

    Robert I suspect that you think AIG is going down but won't say so. I also suspect that the Fed will not be as worried about the prospect of this happening as some think because European banks (if your report is accurate) are those that are largely exposed to an AIG collapse. This is all pretty spooky stuff, but the thing is, what ever the repercussions AIG should not be propped up. If this current 'market' for financial transactions has finally proved to be unsustainable then so be it. If some of these huge financial institutions have been doing 'incestuous dealings' in order to sustain the illusion that 'all is well' then they deserve to go under. Bleak Wednesday perhaps?

  • Comment number 32.

    Ouch! Ah well, so much for the blind leading the blind in financial services land by saying that the "worst of the credit crunch" is over last week.

    It will take months, possibly years to unwind every live derivative trade, insured by banks with monolines and large composite insurers like AIG and then to pare these risks back so that every particpating bank and financial service institution with them knows PRECISELY what their risk exposure is in value and asset class terms.

    It is easy with 20:20 vision to reflect, but what really is coming home to the ordinary man in the street are questions about just what

    a) The Shareholders of lending and investment companies were doing allowing their Directors to run their business, when clearly they did not have a clue about where their actual risks lay.

    b) The Directors of these institutions were doing. They have morphed over the last 20 years from risk averse, credit trained people, sober and boring, to sales and marketing focused aggressive leaders intent on growth in a deregulated market at all costs, especially with less focus on real risk.

    c) The Auditors of these institutions were actually doing. Were they just "auditing what was said" or "what they found"? Did they really understand the complex layers of regulation and risk management?

    d) The insurers were actually insuring? If the banks did not understand the risks, and the auditors signed the accounts off, for shareholders, who also did not know the risks, then how can insurers rely on the information they based their underwriting decisions on. After all, certainly in the UK, the Auditors are only accountable in their Audit Report to the Shareholders and Directors.

    e) The Regulators were doing. Regulating a market that is riddled with "holes" of all sorts is an interesting art. Could their regulations cover these holes. Sadly, on recent events, not.

    f) The public did in their behaviours (me included). We feasted on easy credit, and debt must eventually be repaid. Not a great time to hoard cash and reduce debt and when the spectre of unemployment and recession looms.

    As the old saying goes " We get what we deserve". We need to prepare to deserve pain and hardship.

  • Comment number 33.

    Considering the financial disaster that we're all going through here, I wonder if the folks at the Labour party conference next week will all be singing along to their anthem..."Things can only get better".
    I doubt it, but I'd love to see it.

  • Comment number 34.

    Bloomberg (21;30) are now reporting that the Fed IS in negotiations to 'assist' in an AIG bailout. All well and good... now sell that to the US taxpayers!

    More to the point, try the rest of the world.

    If the Fed keeps taking on debt like this, at which point does the credit rating of the good ol' US of A get marked down from AAA+?

  • Comment number 35.

    Interesting to note that if AIG falls then the price of oil will also drop.
    http://news.bbc.co.uk/1/hi/business/7619319.stm
    Barrel of oil is now set at $90 brent and crude. Why is this price not being reflected at the pumps in the UK?

    Sadly it shows that once price goes up on something it very rarely goes down...this winter is going to be a long, dark and a very bloody cold one for many of us.

  • Comment number 36.

    Out of interest, does anybody have an idea of how exposed Lloyds might be? Are any of AIG's liabilities underwritten in London?

  • Comment number 37.

    This has gone far enough.

    Much as I enjoy seeing HBOS suffer they are a well capitalised bank and are not going to fail.

    While you may also be taking pleasure at seeing the bankers squirm chew on this. You're employer has a bank account. It may be in credit or they may be using their overdraft. Either way, no bank, no pay cheque.

    Banks pay tax, lots of it. If they don't pay it you will.

    Bank employees pay tax, lots of it. Ditto.

    As for the fat cat shareholders they are mainly the companies investing you're pension funds. Did you realise that indirectly you are one of the Northern Rock shareholders that lost money?

    Keep talking down HBOS and we all stand to lose.

  • Comment number 38.

    Apparently, AIG has big operations in China...
    perhaps an international bailout is in the works?

  • Comment number 39.

    @ HanifRehman - comment 35

    The price of oil may be coming down, but it's a little premature to expect the price to fall at the pumps commensurately:

    1. The price you see quoted is not the spot (immediate delivery) price, but a 3-month delivery.

    2. The price has only just dropped to this level in the past few hours! You expect that to be reflected at the retail level within the same time frame?

    Get real!

  • Comment number 40.

    35 and 39, the exchange rate also plays a prt because oil is bought in dollars which we have to buy.

    so when oil was usd120 a barrel and the exchange rate was 2. dollars to the pund, oil was actually costing 60 quid.

    now oil may have dropped to usd90 but the exchange rate has also altered so the change in price isn't as big as it looks when you track back to sterling. It's dropped in sterling but not as much as the impression of how much it's dropped.

    Also, the price dropping is bad. Opec recently reduced production so the price should have stabilised. The reason it's still dropping is because US consumption is dropping as it moves into recession and a recession in the US is bad news all round.

  • Comment number 41.

    Hello... this Rumour Control:

    Newsnight are now reporting that Fed suppot will be in the form of 'conservatorship'.

    Wall St, the US taxpayer and the rest of the world are being asked to accept the NATIONALISATION of AIG!

    AIG shareholders/investors just got torched.

    The US taxpayer is now into the rest of the world to the tune of $700billion and that's just the credit default swaps!

    I have posted before many times since last November atleat... beware those credit default swaps...

    being right doesn't mean i like being right

  • Comment number 42.

    So now we know what AIG stands for and tomorrow we will know if it still stands for it. I just want to use this opportunity to say hello to all the people out there who were so optimistic a year ago about the whole bubble thing and who are so optimistic right now about it all and who will be so optimistic tomorrow. In the meantime the long overdue correction is well underway and as long as it happens, why should I even bother?

  • Comment number 43.

    AIG should be allowed to go to the wall. The idea that something is 'too big to fail' is mere hocus pocus invented by the managers who are happy to 'privatise profits and socialise losses.'

    Unless businesses which make risky decisions, playing fast and loose with 'opm' (other people's money) in the name of a quick couple of million are allowed to go belly up, the world and industry will never learn.

    'Greed is good' will continue to be the motto and pay stuctures and compensation for the 'profit centres' will never be reviewed.

    Let AIG fail, it may mean a short term horror story, but it will teach the risk management departments of these investment banks and insurance houses what goes wrong when excessive, reckless risk taking is actively encouraged.

  • Comment number 44.

    Our Dorian Gray Banking system managed to keep its true pictures off balance sheet, with the face saving products from mega insurance companies, covering , its AAA's with the latest fashion statement from the fat cat walk

    Thanks to the Credit Enhanced Recycled Narcism [CERN]experiment we shall soon discover the origin of Big Bankers by coliding them at enormous velocitys with central bankers to discover the theoretical "moreon particles "that preceded the rapid expansion of a singularity into an AAA's causing gullibleayesation of the whirled economy

  • Comment number 45.

    I wonder why any part of AIG's schemes wasn't re-insured?

  • Comment number 46.

    Quote from #9
    Why not just let the failed banks and insurance companies sink or swim.


    In a moral society, we would. Unfortunately, we don’t live in a moral society.

    Instead of taking responsibility for looking after our own wealth, as we should, we abnegate the responsibility and demand that the government assumes it for us. That means that we’ll blame the government if they allow a bank to fail and the only way you can get even with a government is to vote it out.

    The problem is that a politician desires his job more than any other person on the planet. To you, your job is a way of paying the bills. To a politician, it’s a way of setting the world right, of creating the world (or at least the country) in their own image, of showing their mother that they are worthy of her love after all. A politician would rather have you rip their heart out and eat it before them than to threaten (with genuine prospects of success) to vote them out of office. This explains why and how our democracy has been hijacked by pressure groups – from those (minorities) that object to fox-hunting to the health fascists that impose smoking bans, they all wield disproportionate power because the politicians can’t abide the prospect of losing their votes.

    The one thing a politician can bet on is that if they allow a bank to close they’ll pay with their job. Twenty years ago, what corporate Japan desperately needed was for a few of its many incompetent banks to go bust but the Japanese Government refused to allow it to happen. AND IT WORKED - at least for the ruling party (who have been in power virtually un-interrupted since). Unfortunately, it’s resulted in a miserable economic environment that has blighted the lives of at least two generations since, including those that would have suffered more (initially) had the banks been allowed to fold. And all because the politicians needed to keep their jobs. All in the name of democracy.

    It was Churchill who said that Democracy was the worst form of government – except all the rest. His clever quip hides the fact that the best form of governance we’ve managed to come up with so far is, nevertheless, still fundamentally flawed. What is right for society is what is right for society – not what a majority, or even a powerful minority, says is right. What is right for our society now is that those banks run by gambling idiots should be allowed to close (with the chief gamblers paying for their criminal negligence with prison terms and the loss of their fat pensions). This would act as a deterrent to the other gamblers to ensure they put (and keep) their houses in order and to other investors to ensure that they take on the responsibility that, ultimately is theirs alone, and make sure that they invest in well run institutions.

    What is ironic is that 99% of the comments I’ve seen on this subject call for more controls, more government intervention, more opportunities for the government to protect the gamblers from the consequences of their actions. WE DON’T NEED MORE PROTECTION PEOPLE, WE NEED LESS! What we need is for the bankers (have I misspelled that?) to pay for the consequences of their actions in the way that I would if I were to gamble with the future of my business the way they have gambled with theirs.

    But still, it’s just easier to leave our (collective) money where it is and trust that the Government will do our job for us. We just shouldn’t be surprised when we get "the financial chaos that we deserve". Wasn’t that a famous quote too?

  • Comment number 47.

    @37 - Yes, we are all exposed to the collapses of these major companies.

    However we are not to blame. We pay a fortune in fees to institutional investors to manage our pensions.

    These institutional investors, on behalf of all of us, have large shareholdings in many companies. The responsibility that comes with that (as with any large shareholder) is to ensure that they understand the risks of the companies they are investing many billions of pounds in, and question where they perceive that the company is taking irresponsible risks. Clearly this is not happening, so what are they doing with all those fees?

    I'd suggest that the institutional investers are woefully (possibly criminally) negligent, and that must change.

  • Comment number 48.

    AIG = "All Insurance Gone", eh.

    Surely a watershed is about to be reached here. And I for one would be interested in any informed comment about the amount of debt being racked up by the US tax payer and what happened in Argentina a few years back. Are there any parallels?

  • Comment number 49.

    Well, someone beat me to the Man U bit.
    But, banks aren't the only ones who depend on AIG. They're the owners of the world's largest aircraft leasing company, and also run operations at a number of US ports.

    http://en.wikipedia.org/wiki/Aig

  • Comment number 50.

    Prices rarely follow straight line curves, but smooth the graph of price and time of HBOS' share price and you see it's due to hit zero before Christmas. Apart from the worries listed by Robert Peston and the possibility that someone wants to buy HBOS for a song, perhaps the share price is factoring in the possibility of much worse house price falls than anyone has suggested. Were prices to fall to say 40% of the peak, so many people would be in negative equity that HBOS' loan book would be largely unsecured. In Japan, worse happened (1989-2005). House prices in London peaked (2007) at 11-15 times (depending on area) their value in the early 80s
    while general prices went up by about 2.3 times. I wonder if the Nationwide CEO who talked about the 25% peak to trough fall in the present house price decline is trying Canute-like to create facts more optimistic than the tide of history allows.

  • Comment number 51.

    #29, Actually regulation IS the reason for the existence of alot of these derivatives. CDOs exist because of the regulatory difference between credit risk and interest rate risk. Pension funds, insurance companies, money market funds are allowed to take interest rate risk but are restricted on credit risk. These structured products allow them to earn a few extra basis points - which in their world is like being a genius.

    Some people were blaming credit rating agencies when in fact virtually none of the CDOs are defaulting, they are paying out less because their underlying assets are worth less. In the crazy regulated world it is OK for pensions to invest in products that pay out nothing just not for them to invest in products that promise alot then pay out nothing.

    #32, well the values for these "risks" and the assets are determined by mark-to-market which is why we are in a liquidity spiral. People start dumping the assets, price goes down. Then the value of your reserves - which is based on the market value of the assets - goes down so you sell more to raise cash which causes the prices to go down etc.

    Finally, the way to work through this is to let prices work their way down. Banks need to go bankrupt as do insurers. House prices need to go way down. But in an election year in the US and one close in the UK + national protectionism in Europe there is little chance of that.

  • Comment number 52.

    What an uninsightful article, after all AIG is an insurer of the universe. Why shouldn't we let the whole gamut of insurance claims be wholly tranparent and defined.

    If banks can buy credit fault insurance from AIG, then, why can we not wait for these banks to put forth their claims. So we can see how solvent AIG is?

    AIG is not reverting to his true business self when it is now claimimg relief from the Government to meet its purported obligations. I have yet to see an underwriter getting ready to indemnify the insured or the beneficiaries until the event had occurred. E.g. death or car accident.

    If the bigger problem is the protection of the more traditional policy holders i.e. those who bought life insurance etc. Perhaps there should immediate legislation to ring-fence AIG's assets to meet the requirements of non-"senior credit default swap portfolio" customers.

    These are tough times we do not need to be pretentious on defending "stability of the global financial system". When this goal was never in the minds of the Banks or AIG in the first place. If the banks are nover invested in ensuring that their housing loan portfolio maintain a certain level of credit worthiness. But expect AIG be ready to indemnify them. This tantamount to an almost "fishy" situation.

    It is time to prioritise the different needs of AOG's policy holders. Those involved in CDSs go to the bottom of the all claimants on AIG's demise. IF you think this is tough and draconian, let us call it a "war on illiquidity". We need a financial equivalent pf Gitmo to isolate these "financial terrorists" from the more peaceful and purposeful citizens of the world.

  • Comment number 53.

    Word is the Fed just blinked. This is what happens
    when one has been stumbling around in a dark
    basement for years, and suddenly someone opens
    a door and the cold light of day shines down there.

  • Comment number 54.

    Interesting.

    I hear not a word on the auditors. What have all the auditors been doing all these years? Didn't they notice the mess that the Lehmans, the Merryl Lynchs, the AIGs were creating?

    Problem, dear readers, is that out there, in the rarefied world of the Boardrooms, there is a cosy chumminess that exists between the "regulator" and the "regulated" making so-called audits a big fat charade.

    So, when the bubble of fraud and skullduggery becomes too full to hold any longer, the only people who are, progressively, surprised, frustrated, stunned, scandalised and, finally, left standing helplessly holding the bills and the trewn tatters and peices, are you and me. Everyone else has either covered himself with an insurance or landed on a parachute.

    In the meantime, the free marketers will lie low for the public "rage" to subside before they once again orchestrate their collective song and dance on the efficiencies of a no-holds-barred, free-to-loot system that, once again, gets going with the nod-and-wink of our so-called "representatives".

    Yet another vicious cycle gets initiated. See ya folks, circa 2015 or, if luck holds out, 2020, when the next meltdown occurs.

    All this while, of course, the self-appointed guardian of the world, US of A will go about preaching the great benefits of a control-free economy to the “less-developed” nations of the world: privatise banking, privatise insurance, don’t have any government stake in any of these industries. Read: let us loot them first. You can “save” them later as, you know, they would be “too big to let go”.


  • Comment number 55.

    No more bail outs. Free market and free fall all part of the risk. The business world is realigning itself back to balance - human intervention will just prolong the agony and inevitable ground we are suppose to hit.

  • Comment number 56.

    This is another example of Buchwald's Syndrome, named after the famous American humorist Art Buchwald.

    One of his most famous lectures (I remember it still) was his mock despair that governmental officials would put him out of business, because he was incapable of creating ANYTHING as outlandishly stupid and comical as what they were doing on a daily basis.

    The modern version is Jeff Foxworthy, who declares, 'Ya know, I just can't make this stuff up!'.

    Mr. Peston's account must be accurate, because it's just too bizarre to fabricate!

    In the morning, I'm calling my Senators. No way, Jose, should we (who are working 60+hour weeks just to keep up) be called upon to bail these clowns out.

    All those banks, and AIG, and the central banks, need to start the process of writing down all those assets to something approaching real, sustainable market value.

    Not our job to keep the balloon inflated! The fools who created this mess will walk away with millions in cash in their pockets, unless bankruptcy is declared.

    Heaven help us all.

  • Comment number 57.

    Since most of you know 100 times as much
    as me about the world financial system (or what
    is left of it,) I ask the following question:

    Would you rather be in cash or gold? If cash,
    then what currency?

  • Comment number 58.

    Panmure's observation is more a product of diligence. He read the 10-Q.

    Hopefully he got his clients out on reading the March 2008 10-Q which said:

    "Approximately $335 billion (consisting of corporate percentage and prime residential mortgages) of the $469 billion in material swap portfolio as of March 31, 2008 represented derivatives written for financial institutions, principally in Europe, for the purpose of providing regulatory capital relief rather than risk mitigation. In exchange for a minimum guaranteed fee, the counterparties receive credit protection with respect to diversified loan portfolios they own, thus improving their regulatory capital position."

    The words look remarkably familiar.

  • Comment number 59.

    Seems like the US govt has delivered an early Xmas present to it's residents by rescuing AIG for 85bn for an 80% public state. Sadly, again its the taxpayer who is at a greater loss, how can they justify a rescue package of such size?

    Where did the US Fed Reserve get such a loan? Is it paper money chasing paper money?
    What is the guarantee that this will be tied to any secure assets apart from the goodwill of the tax payer?

    Again the directors of such a company must be very pleased with themselves, pocketing huge personal funds and then going cap in hand to the govt to bail them out. Just wish I could open a business as such and do the same.

    As for my comment on oil, major companies have huge reserves of oil and its amazing that there is no 3month turn around at the price at the pumps in fact its less than 3 days for the price to go up.

    What we need in this country is a way to monitor the price of oil against inflated prices. We need a regulator to honestly measure this value rather than the govt taxing us all to death.

    We need better infrastructure if it takes 3month for a price correction for oil then surely that is pretty poor. I do feel that the likes of Shell, BP et al have better infrastructure and the price of oil should be reflected a lot faster once it drops.
    As many of you I'm not a financial expert in any sense or an oil investor but just an avg Joe who keeps getting shafted by the govt over taxes.

    Anyway...I hope my US pals enjoy the AIG early xmas present.

  • Comment number 60.

    NickyBics:
    There's no such thing as a (customer's) free lunch! you are likely to be better off with separate mortgage and savings. You are being charged a premium for the whole of your mortgage and you are getting a premium on the smaller amount of your 'deposits'. If you do the math I expect that their premium is better than yours!
    Do HBOS account for this type of deal as £X deposit and £Y loan? - for HBOS it could look like a free lunch as you are providing the capital that allows them to lend to you. What do their capital ratios look like if you account for their offset deals as Y-X loans and no deposits? (Or is this insured with AIG?)

  • Comment number 61.

    I remember very well that as far back as early 2005, "The Economist" newspaper was already raising a lot of questions about the business and management structures of AIG.
    I also remember reading that well over 10% of AIG' was owned by a company registered in Panama, called "Starr International", headed by Mr Greenberg, a former CEO of AIG and that some part of AIG's executive's compensation was also paid by that company.
    I doubt many US taxpayers know anything about this, but it would be very interesting to know if that block of shares is also included in the 80% stake they are taking over.

  • Comment number 62.

    Well analysed article. What will happen to the US Current Deficit if the US Govt starts pouring billions into sinking firms and and a never ending war in Afganistan and Iraq?

  • Comment number 63.

    Wow, nationalisation! Welcome to the USSA - the Union of Soviet Socialist America!

  • Comment number 64.

    Wow, nationalisation! Welcome to the USSA - United States Of Socialist America!

  • Comment number 65.

    Robert, if the US authorities have understood anything they will be using their newly acquired ownership rights to forensically examine AIG's swaps insurance. If they have any sense they will be recruiting the specialists needed to do this from around the world; I suspect the capacity to do this thoroughly and independently is severely limited - it would be interesting to hear your view on this.

    If the US authorities approach it in this way it will show a proper appreciation of what is needed to manage risk in the global economy. A combination of political astuteness and economic wisdom is desperately needed and has been in short supply. And it will also be an indicator and test of Paulson ability to operate independently of the Republican establishment. He is a true insider but I detect a willingness to serve a higher purpose - I hope I am right.

    The US nationalisation of AIG is the best opportunity to date to dig deep and establish the true level and location of debit toxicity. I hope that financial journalists such as yourself will be watching closely to see who goes in and how hard they go in.

  • Comment number 66.

    A point commented by others but worth repeating - I feel anyway - is the effect on the US.

    The US is - and this seems almost impossible to say - in danger of losing out as top dog. In 2 years time the US financial system will be huge but not seen as invincible.

    Is this the financial version of the already witnessed entrepeneurial, political and aspirational march East?

    Just at the moment investment in VAST quantities is required in the East - we find our pockets empty. Are we going to see them disregard the West?

    How are Asia-Pacific placed? Where is the liquidity?

  • Comment number 67.

    Thank you Robert Peston...you manage to make this dry, dull technical stuff fascinating.
    But i'm shocked (and no doubt niaive) about the role of the regulators here. What is their purpose if all the banks have to do to 'disguise' the true level of risk in these loans is just to insure them - hence giving a distorted view of their financial health - hence allowing them to do it again and again and again.......

  • Comment number 68.

    Oh well, looks like I was wrong. It would appear that the Fed are in the business of saving the world. Still, I wonder how Bush will sell spending $85bn on saving the banking system (and hence the economy) of their main trade competitor?

    I feel sorry for McCain (who surely now cannot win) and Obama (who surely now would not want to win).

  • Comment number 69.

    The US seems to walking a tightrope in selecting who to support and who to let drop - as for AIG it seems they may have had an ace up their sleeve given potential ties to the US Security - AIG founder Cornelius V Starr's links to OSS in WW2 are well known - if they continued to the present day then the collapse of AIG would be unthinkable for the US.

    The Governor of New York, David Paterson, said AIG had so many business interests it would be hard to predict how widespread its bankruptcy would have been felt.

    "Its tentacles go further in to the avenues of business, as in mortgages, as in credit, as in hedge funds, as in countless ways that affect consumers, that affect drivers, that affect homeowners, affect passengers," he said.

    Tentacles indeed.....just goes to show that it aint what you know but who you know and what your telling them is still going strong.

  • Comment number 70.

    DEVALUATION OF CURRENCY IS THE NEXT STAGE OF THE CREDIT CRUNCH.

  • Comment number 71.

    Correct me if i'm wrong but the fedral reserve isn't the US government at all, its run my the major banks.

    Also Its a bit disengenuous to say they paid billions of pounds for it when in fact they created that many billion pounds from thin air, thereby devaluing the dollar by that much and taxing people using the dollar as a method of saving as it becomes worth less.

    This is very very worrying.

  • Comment number 72.

    It's 'mullahed', from mullah,, not 'mullered'. Sounds as if you've had a muller lite attack.

  • Comment number 73.

    Something about this childres tale rings a bell!

    An emperor who cares too much about clothes hires two swindlers who promise him the finest suit of clothes from the most beautiful cloth. This cloth, they tell him, is invisible to anyone who was either stupid or unfit for his position. The Emperor cannot see the (non-existent) cloth, but pretends that he can for fear of appearing stupid; his ministers do the same. When the swindlers report that the suit is finished, they dress him in mime. The Emperor then goes on a procession through the capital showing off his new "clothes". During the course of the procession, a small child cries out, "But he has nothing on!" The crowd realizes the child is telling the truth. The Emperor, however, holds his head high and continues the procession.

    "http://en.wikipedia.org/wiki/The_Emperor%27s_New_Clothes"

  • Comment number 74.

    The entire concept of this "shell game" is astonishing to me. Institutions have used a lot of very grey maneouvers to offer the appearance of being responsible and solvent. I am sure the expensively dressed people at the top of AIG had overinflated compensation packages, and became super-wealthy cooking up these schemes to scratch each other's backs, and bilk the public out of all they could get. This entire financial crisis, although all analysts claim it is "complicated" to explain, is based solely and completely on greed. Now this greed will ultimately be rewarded by a save from the exact same people who have been its victims, the taxpaying public. By underwriting these failures, governments are tacitly condoning their practises. Will they "save" me if my small business fails?

  • Comment number 75.

    Today the US government bailed out AIG, an insurance company, said to be going bankrupt. The cost to the American taxpayer $85 Billion Dollars. Just the beginning, not the end.

    In the following story keeping in mind the theory; "the price a willing seller will ask and a willing buyer will pay".

    Around 1968, for those of you who can remember, Three Little Piggys (aka: 2 Real Estate brokers, and 1 Property Tax Assessor) decided to milk the system.

    The First Little Piggy offered his tract home for sale to the Second Little Piggy at an inflated price. The Second Little Piggy offered his nearby tract home for sale to the First Little Piggy at an inflated price.

    Both offers were accepted at the inflated prices. The homes were located within a tract of homes but separated with other homes between.

    The Third Little Piggy doing his job as "Property Tax Assessor", and utilizing the willing seller, willing buyer theory, assessed both sold homes and others in the vicinity at the higher level. The result, a new price point was established for all the homes in the tract.

    Well, you know how Pigs are. They cannot keep their mouths shut. Oink! Oink! Oink! Pretty soon the whole country knew how to "beat the system", and did.

    This was of course very popular with home owners throughout the country. That's about the time when everyone's wife took a job as a real estate agent (soon to become brokers). (Sorry, my chauvinistic side is showing.)

    But wait you say - "Where are the Real Estate Regulators?" The answer is obvious. They are elevated from the ranks of Real Estate Brokers.

    But wait you say - "What has this to do with AIG." They insured the loans. Remember?

    But wait you say - "Where are the Insurance Regulators?" The answer is obvious. They are elevated from the ranks of Insurance Agents.

    For you young people who cannot grasp this evolving catastrophe. Try, for God's sake try.

    This didn't happen in the 1800's. It happened 40 years ago and the greed spread until all became blind.

    I had hoped the balloon would burst in the 80' and 90's, but they escaped. Now although a few of the biggest Wall Street sharks have been eaten by bigger ones, it looks like another escape. God help our children. Merrill Lynch saved by Bank of America, Wow! Shark feeding frenzy. Who's feet are coldest on who's back?

  • Comment number 76.

    Did the Fed leave it till too late to bail out AIG? Yes, I believe so.

    When a person is drowning, you throw the life line without questioning or waiting to find out whether the chap in the water will now start to learn swimming or what stroke he is going to adopt. I believe, they have let the things too late. Early diagnosis and treatment is essential to improve chances of recovery. Lesson for the future?

    Systemic corrections are required and should be brought in place in a controlled and thought out manner. The hysteria being generated needs to be mitigated by proper and timely assurances by the pundits.

  • Comment number 77.

    Yep.. we're all doomed, destroyed, and demolished. =(

  • Comment number 78.

    AIG is a great company, but i am sad that it will not be the sponsor of Man UTD anymore

  • Comment number 79.

    There should be an international bank, possessing the world's funds, from which all other banks can borrow, in which all spending is monitored and appropriated by a committee of twenty-four individuals, that are also responsible for assessing the situation of famine, disease, poverty, etc around the globe, sitting as representatives of their departments.

    Secondly, we need to return to the gold standard as it is the only effective means of controlling inflation, with all other methods having proved inefficient over time, as new styles of currency, with no source or standard with which to create value, constantly enter the market place, and product manufacture requires much stricter controls.

    Therefore, all gold must be centralised and controlled by administrators with proper authority (think new democracy) who will use their knowledge of current affairs to construct a more balanced world using the value of gold and its subsequent spinoff currency.
    We must accept that the 'superficial' wealth of the planet can only remain at £8 trillion, unless new gold is discovered, and make as much as we can of that fact.

    Additionally, this bank might also control the outlet of diamonds and platinum, so as to increase the wealth of the planet by standardising the value of those products also.

 

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