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From AIG's website, a whitepaper on the Systemic Risk in the insurance industry. Certainly, AIG is wrapping themselves in the cover of their industry by speaking of the industry's Systemic Risk. But whether it is the entire industry at risk or just AIG and some others, the acknowledgment of systemic risk in such a direct way is striking:
"A significant rise in surrender rates – inspired by consumers’ needs for cash or because of rumored or real failure of insurance companies – could be disastrous. Because of widespread loss of liquidity, the industry would struggle to raise adequate cash to meet surrender requests. A “run on the bank” in the life and retirement business would have sweeping impacts across the economy in the U.S. In countries around the world with higher savings rates than the U.S., the failure of insurance companies like AIG would be a catastrophe."
Barclays $7.0 Deutsche Bank 6.4 BNP Paribas $4.9 Goldman Sachs $4.8 Bank of America $4.5 HSBC $3.3 Citigroup $2.3 Dresdner Kleinwort $2.2 Merrill Lynch $1.9 UBS $1.7 ING $1.5 Morgan Stanley $1.0 Societe Generale $0.9 AIG International Inc. $0.6 Credit Suisse $0.4 Paloma Securities $0.2 Citadel $0.2 Total $43.7
Municipalities listed on Attachment C received a total of $12.1 billion from AIGFP between September 16, 2008 and December 31, 2008 in satisfaction of Guaranteed Investment Agreement (GIA) obligations. GIAs are structured investments with a guaranteed rate of return. Municipalities typically use GIAs to invest the proceeds from bond issuances until the funds are needed.
Confused? We all are. Read this to learn what Financial Derivatives are.
Severe valuation losses on the super senior multi-sector credit default swap portfolio of AIG Financial Products Corp. (AIGFP) triggered collateral provisions in the swap contracts, creating a liquidity crisis for AIG in September 2008. The Federal Reserve Bank of New York (FRBNY) provided an emergency $85 billion loan to AIG to meet short-term cash needs. The aid received by AIG helped avoid severe financial disruptions by providing liquidity to important financial institutions and municipalities.
Using funds from the emergency loan, financial counterparties listed on Attachment A (all attachments are posted online at http://www.aig.com/Related-Resources_385_136430.html ) received a total of $22.4 billion in collateral relating to CDS transactions from AIGFP between September 16, 2008 and December 31, 2008. This amount represents funds provided to such counterparties after the date on which AIG began receiving government assistance. The counterparties received additional collateral from AIG prior to September 16, 2008.
FT.com / China - China lost billions in diversity drive: "China has lost tens of billions of dollars of its foreign exchange reserves through a poorly timed diversification into global equities just before world markets collapsed last year.
The State Administration of Foreign Exchange, the opaque manager of nearly $2,000bn (€1,547bn, £1,429bn) of reserves, started making huge bets on global stocks early in 2007 and continued this strategy at least until the collapse of the US mortgage finance providers Freddie Mac and Fannie Mae in July 2008, according to analysts and people familiar with Safe’s operations.
By that point Safe had moved well over 15 per cent of the country’s $1,800bn reserves into riskier assets, including equities and corporate bonds, according to people familiar with its strategy.
Safe never discloses its holdings except to the top Chinese leadership so it is impossible to know exactly how much it has lost from diversifying before markets crashed.
But judging from the subsequent fall in global stock prices and a conservative estimate that Safe held about $160bn worth of overseas equities, Chinese"
In the first quarter of 2008, prior management took significant retention steps at AIG Financial Products. These arrangements were designed at a time when AIG Financial Products was expected to have a significant, ongoing role at AIG, and guaranteed a minimum level of pay for both 2008 and 2009. (Due to losses at AIG Financial Products, a senior manager will receive about 43% of his 2007 expected level for 2008.) Some of these payments are coming due on March 15, and, quite frankly, AIG’s hands are tied. Outside counsel has advised thatthese are legal, binding obligations of AIG, and there are serious legal, as well as business, consequences for not paying. Given the trillion-dollar portfolio at AIG Financial Products, retaining key traders and risk managers is critical to our goal of repayment. This is all discussed in more detail in the attached “white paper.”
Derivatives are financial contracts (financial instruments) whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, stocks, residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions). Credit derivatives are based on loans, bonds or other forms of credit.
Derivatives can be used to mitigate the risk of economic loss arising from changes in the value of the underlying. This activity is known as hedging. Alternatively, derivatives can be used by investors to increase the profit arising if the value of the underlying moves in the direction they expect. This activity is known as speculation.
Because the value of a derivative is contingent on the value of the underlying, the notional value of derivatives is recorded off the balance sheet of an institution, although the market value of derivatives is recorded on the balance sheet.
Three major classes of derivatives:
1. Futures: Contract to buy or sell an asset on or before a future date at a price specified today. It is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold. (Similarly, but with an important difference, a forward contract is a non-standardized contract written by the parties themselves.)
2. Options are contracts that give the owner the right, but not the obligation, to buy or sell an asset. (A call option is an option to buy, a put option is an option to or sell). The price at which the sale takes place is known as the strike price and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. If the owner of the contract exercises this right, the counterparty has the obligation to carry out the transaction.
3. Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies/exchange rates, bonds/interest rates, commodities, stocks or other assets.
Wikipedia is criticised for being unreliable and suceptible to manipulation. But say what you will about Wikipedia, if you want to get a feel for what Financial Derivatives are then take a look at this: Wikipedia - Financial Derivatives
1997 article by Cato Institute seemingly arguing for less regulation of Financial Derivatives: 10 Myths about Derivatives
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