AIG might pay back $170 billion of its $182 billion bailout.

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Here is a great article from Slate written by Daniel Gross, a writer from Newsweek. Definitely worth a read.

A quick except:

"When you look at the financial markets as a whole, the post-crisis bailout efforts have worked out better than expected. Many of the financial market guarantees were lifted without having been used, and the Treasury is turning a profit on the central component of the TARP. But AIG has so far loomed as a gigantic rebuttal to the optimists, a symbol of everything that went wrong.

But it turns out that the efforts to prop up AIG are also working out much better than expected. AIG still owes the Fed and the Treasury a combined $127 billion. But—surprise!—AIG is paying a lot of its debts back. And there's a not too far-fetched scenario in which we come close to breaking on our reluctant investment in the company."

Want to know how? Read the full article here: Here's a surprise: AIG might pay back $170 billion of its $182 billion bailout.

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Systemic risk of life insurance company failure

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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."

Read the full March 6 Draft whitepaper titled: AIG: Is the Risk Systemic?

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AIG's Municipal Counterparties

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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.

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AIG reveals who we are bailing out

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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.

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AIG CEO Letter to Geithner

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Letter from AIG's government appointed Chairman and CEO Edward Liddy to US Secretary of the Treasury Geithner:

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.”

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PIMCO - IO Feb 2009 Gross Beep Beep

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PIMCO - IO Feb 2009 Gross Beep Beep: "PIMCO’s advice to policymakers is as follows: you can’t bail out everyone, yet economic recovery is not possible unless certain critical asset sectors are not only reliquefied, but rejuvenated in price. The prior Administration’s focus on the banks has been critical but unidimensional. The shadow banking system with its leverage and financial innovation, powered a near 25-year global economic expansion, but it is the delevering of those hidden quasi-banks that is now threatening its petrification. Policymakers should not focus entirely on one-off bailouts of large real estate developers, municipalities, or even credit card issuers like they have with Citi, BofA, and AIG. Rather, they should recognize that supporting critical asset prices such as municipal bonds, CMBS, and even investment grade corporate bonds is a necessary step towards eventual economic revival. Capitalism at its philosophical and practical center depends on credit, and while new loans can be and are being advanced via the banking system, it’s a much more difficult task to force shadow banks to lend. That lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist. The original focus of the TARP was on asset prices, but the prior Administration quickly lost its way or perhaps its"

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How to not let this happen again

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Allowing Lehman Brothers to collapse had such severe systemic effects that the global financial system went into cardiac arrest and is still dealing with the aftermath.

How do we set up a sytem to eliminate the risk of (another) global financial meltdown? In their FT.com article 'A proposal to prevent wholesale financial failure', NYU Stern students Lasse Pedersen and Nouriel Roubini have devised a way to avoid the "worst financial crisis since the Great Depression."

Bail-outs of major financial institutions are based on a fear that their collapse would cause havoc, with collateral damage to the real economy. Examples include the Bear Stearns, Fannie, Freddie, AIG, and Citi­group.

The current system is "vulnerable to financial contagion when big banks (or many small ones) go bust. This is the systemic risk. The root of this problem is that "banks have little incentive to take into account the costs they impose on the wider economy" if their failure prompts a liquidity crisis.

"This is akin to when a company pollutes as part of its production without incurring the full costs of this pollution. To prevent this, pollution is regulated and taxed."

How do we reduce both the moral hazard and the cost of bail-outs in the event of a liquidity crisis? Impose a new systemic capital requirement and systemic insurance program. Once systemic risk can be measured, it can be managed.

Banks already use standard risk-management techniques internally to weigh how much each trading desk or division contributes to the overall risk of a bank. But the authors suggest that these same ideas should be used to evaluate the banks themselves. They set out their ideas in an NYU Stern project on restoring financial stability.

"First, the regulator would assess each bank’s systemic risk. The higher it is, the more capital the bank should hold. This would seek to ensure that the banking system as a whole had sufficient capital relative to the system-wide risk. This is just like the headquarters of a bank charging each trading desk or division for use of economic capital measured by its contribution to overall firm risk.

Second, each institution would be required to buy insurance against its systemic risk – that is, against its own losses in a scenario in which the whole financial sector is doing poorly. In the event of a pay-off on the insurance, the payment should not go to the company, but to the regulator in charge of stabilising the financial sector."

What happens then? A market-based estimate of the risk the develops (the amount of theinsurance premiums). Second, each bank would have an incentive to limit systemic risk (via lower insurance premiums). Finally, it would reduce the fiscal costs and the moral hazard of government bail-outs (because the company does not get the insurance pay-off).

Since the private sector may not be able to put aside enough capital for all the systemic risk insurance, government could provide part of it. Government already provides such partnership on insurance with the private sector in terrorism insurance.

"Unfortunately bank regulation, such as the Basel accord, ignores systemic risk since it analyses the risk of failure of each bank in isolation. It seeks to limit the probability of failure by each bank, treating isolated failures and systemic ones in the same way (and also ignoring how much a bank loses if it fails). However the move by many large banks to lever their balance sheets with similar mortgage-backed securities is more dangerous than if they had made loans to diverse borrowers."

More broadly, a systemic crisis that feeds on itself is more dangerous than the isolated failure of smaller banks. A small bank will probably be taken over with a smooth transition of operations – it does not bring down the economy.

"We believe our proposal offers several advantages by explicitly addressing systemic risk based on tools already in use by private companies to manage internal risks. Our proposal is a better way to deal with the trade-off between letting a large institution go bust (Lehman, for example) and causing a global cardiac arrest of the financial system or being forced to spend trillions of dollars of taxpayers’ money to bail out such systemically critical institutions."

The writers are professors at NYU Stern School of Business and the proposed regulation of systemic risk is part of the NYU Stern project Restoring Financial Stability: How to Repair a Failed System (John Wiley & Sons, 2009)

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Key report on financial reform

Image via WikipediaImage via WikipediaImage via WikipediaFrom The Economist - An important new report on regulating the financial industry released Thursday (Jan 15) should play a crucial role in shaping the financial reform agenda.


The Group of Thirty’s “Financial Reform: A Framework for Financial Stability” is important both because of the concreteness of its 18 recommendations and because of who was involved. The authors were led by Paul Volcker, Tim Geithner, Larry Summers, and Jean-Claude Trichet, (president of the European Central Bank).

Banks:

• banks deemed systemically important would face restrictions—in the form of “strict” capital requirements—on high-risk proprietary activities, that is bets made using their own money
• strongly encourage investment banking arms of banks to focus on client businesses, such as merger advice, rather than trading
• separating these needed because they seem “unmanageable in financial conglomerates"
• also require raising the level at which banks are well-capitalised
  

Non-bank financial institutions:

• pools of private capital that live on borrowed money should have to register with a regulator and produce regular reports, disclosing things such as leverage and performance.
  
• biggest of them would even be subject to capital and liquidity standards.
  
• bank-like regulation for money-market funds
  
• legislation in America to set up a mechanism for dealing with non-bank failures

Other key issues:

• Central banks should be more involved in supervising banks—but to safeguard integrity the role of chief firefighter should be played by others once trouble ignites. Central bankers “need to be more concerned about financial stability, but less involved in crises,”
• formal system of regulation for over-the-counter derivatives, such as the type of credit swaps that sank American International Group
• urges regulators to force banks to hold on to a significant portion of credit risk when they package loans into securities and sell them on, in order to curb reckless underwriting of mortgages and other debt.
  
• calls for a rethink of certain accounting principles that may exacerbate downturns through pro-cyclicality, including the practice of marking assets to the current market value;
  

The other important message is that a global crisis requires a global fix. Mr Volcker was typically modest, insisting it was more an agenda for discussion than a hard-and-fast blueprint. But, given his closeness to Mr Obama, it is hardly far-fetched to imagine much of it becoming official policy. All that talk of the biggest overhaul of financial regulation since the 1930s just took a step towards reality.
"

Citi's 'slow, grudging nationalization

Image via WikipediaCan Citigroup survive? - Nov. 24, 2008: "Citi's 'slow, grudging nationalization'

Monday's massive rescue package hasn't solved Citigroup's problems, says bank analyst Christopher Whalen.

(from Fortune Magazine) -- In just a few days Citigroup went from trouble to trauma as its stock price plunged amid sweeping layoffs and deep losses on some of its more esoteric assets. When news reports swirled that the megabank was considering a sale of part or all of the company, it was clear that Citi was singing from the same hymnbook as firms like Lehman Brothers, Wachovia and AIG had before they fell. The public's only question: What would the end game look like?

Now we have our answer - a government agreement to shoulder hundreds of billions of dollars in possible losses and inject billions of dollars into the bank. FORTUNE checked in with bank analyst Christopher Whalen, co-founder of Institutional Risk Analytics and a prescient critic of Citigroup (C, Fortune 500) since 2003, when he said its riskier, higher-return strategy made it more vulnerable than its banking peers.

Here are some excerpts. This one is well worth a read of the full article.

Fortune:

Does this plan solve Citi's problems?

Whalen: This does nothing more than temper the problem, but, no, it hasn't solved anything.

Fortune:

How does this rescue plan differ from the other bailouts we've seen in the past few months?

Whalen: The accurate term for what the government has done is "open bank assistance." It's similar to what the FDIC had to do when it was clear that Wachovia could no longer go on, except there is not a ready buyer in this case. The other big financial institutions have had parties willing to pick up the assets, but you won't see that with Citi. This bailout is more like a resolution. That means that the government essentially has to take control of Citicorp and become more and more involved with its operations until the bank ultimately is nationalized.

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MetLife Spooks Investors - Forbes.com

MetLife Spooks Investors - Forbes.com: "Insurance stocks plunged Wednesday after MetLife annouced it would be raising capital, cutting jobs and withdrew its 2008 earnings guidance due to the dramatic downturn in the world financial markets.

In an effort to provide some semblance of certainty to nervous investors, MetLife (nyse: MET - news - people ) pre-annouced its third-quarter results, which it said will be hurt by a drop in investment income and fees due to the turmoil in the global financial markets.

In a separate announcement, MetLife said it would sell common stock to bolster its capital amid rising losses on investments. The offering of 75 million shares priced late Wednesday at $26.50, raising nearly $2 billion.

MetLife also promised Wednesday an unspecified number of job cuts by the end of the year.

By the end of Wednesday's highly volatile trading session, MetLife shares fell 26.8%, or $9.87, to $27.00.

"We are in these unprecedented times," Steve Kandarian, MetLife's chief investment officer, said on a call with investors Wednesday, according to the Associated Press. "I think we're as well positioned as anyone in our industry for these times, but we are not immune, nor is any other of our peers."

Those peers fell accordingly. Prudential Financial (nyse: PRU - news - people ) dropped 6.9%, or $3.22, to $43.29, and Lincoln National (nyse: LNC - news - people ) fell 8.5%, or $2.59, to $27.97.

Insurance companies have been among the hardest hit by the recent turmoil in the financial markets. American International Group (nyse: AIG - news - people ) was bailed out by the government, and investment manager and life insurer Hartford Financial Services (nyse: HIG - news - people ) got a much-needed capital infusion from Allianz of Germany. (See "Hartford Recovers With Help From Allianz.")

The mortgage insurance unit of Genworth Financial (nyse: GNW - news - people ) was downgraded recently by Standard & Poor's after its parent company announced that the unit may be on the block. (See "S&P Docks Genworth Mortgage Insurance Unit.")

Over the past month the SPDR KBW Insurance ETF (amex: KIE - news - people ) has fallen 35.9%.

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Dividend Stocks - The Dividend Daily » Blog Archive » The Bailout Precedent was Set in 1998, but That’s Not the Point

Dividend Stocks - The Dividend Daily » Blog Archive » The Bailout Precedent was Set in 1998, but That’s Not the Point: "It has become abundantly clear that no one learned a single thing from the collapse of Long-Term Capital Management. Every single entity involved in our current crisis should be absolutely ashamed of themselves, from the Fed that insisted on a record number of consecutive interest rate cuts, to the mortgage lenders who forgot the most basic rule of lending, to the investment banks that used huge leverage with derivatives schemes to game a clearly inflated housing market, to the insurers like AIG who backed the mortgage products that weren’t worth the paper they were printed on.

The precedent of government intervention had already been set, but the most egregious part of this situation is that no one learned their lesson afterward."

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