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The International Writers Magazine - Our Tenth Year: US Today

CDOs - The Other Shoe
Dean Borok

If you believe that this is the end of endlessly shoveling money into the AIG black hole, think again. The other shoe has yet to drop.

AIG was forced by political pressure to reveal the names of the banks it has paid to fulfill its obligations with regard to the CDO credit default swaps, insurance policies against default of the worthless sub-prime mortgage securities. Here are some of the policyholders who were paid off:
Goldman Sachs – $12.9 bn
Société Générale - $11.9 bn.
Deutsche Bank - $11.8 bn.
Barclays Bank - $7.9 bn.
The above, totaling $45 bn. is just a partial list. These policies were presumably paid at 100% of the face value of the contracts. In addition, AIG paid $27.1 bn. to other bondholder at a discount to be released from outstanding contracts. AIG paid out another $43.7 bn. to satisfy obligations of its securities lending program, where it loaned shares, which were used in short selling operations, for a fee.

AIG, though legally subject to regulation by the New York Insurance Department, which compels insurance companies to set aside reserves to pay off insurance policies, benefited from a loophole that classified these contracts not as insurance policies but as financial instruments. Therefore they didn’t bother to set aside reserves.

The SEC didn’t regulate them either. AIG just wrote policies on the sub-prime mortgage-backed securities and pocketed the money, assuming that since the securities were rated AAA by the rating agencies, they couldn’t fail. They just pocketed the money as profit. Easy money. It later was revealed that the rating agencies were in the pocket of the bond issuers.

These contracts weren’t cheap. In order to protect themselves from the bonds defaulting, the banks paid a high premium: $500,000 plus 25% of the nominal price of the bond. Billions. Hundreds of billions. When the bonds defaulted, the banks presented the policies for payment.

AIG didn’t have anywhere near that kind of coin. Nobody does. They were prostrate. Fortunately for AIG, the U.S. Secretary of the Treasury was Hank Paulson, who happened to be the former CEO of Goldman Sachs. Paulson arranged for AIG to get the bailout, and the first creditor to be paid was Goldman Sachs.

Since then AIG, who are the slickest operators in the universe, have been stringing along the Treasury Department like a game fish, the same way Madoff strung along the SEC. These regulators are divided into two categories: boy scouts who don’t have a clue and paid operatives of the banks.

I’m not going to cry crocodile tears for the taxpayers. Every step of the way they were apprised as to what was going on. The politicians told them, "We are going to end regulation of business". Did you think they were kidding? They said, "America is all about getting rich". Did you think they were kidding?

(Let me ask you this. If they said they were going to end police presence in your neighborhood and rely on the enlightened self-interest of citizens, would you believe that?)

You can’t cheat an honest man. Madoff said, "Don’t ask me what I’m doing". His suckers, er, clients, said, "Whatever he’s doing, I don’t want to know. He’s putting money in my pocket". They forgot the old maxim of "There’s no honor among thieves".

Now AIG is insisting on paying $160 mn. in bonuses, yet, to the traders who sold these policies to the banks. With a straight face, they are saying "We have a contract with these agents. We have to respect our obligations".

No you don’t. You can refuse to pay them and let them sue you if they really feel they earned the money. AIG has been nationalized and the interest of the taxpayers has to be factored into the equation. If you contracted a guy to fix your roof and the rain came into your living room in buckets, the contract would not be legally binding, right?

I worked in the insurance industry for a while, and I know who would be a perfect fit to throw out that bum, Liddy, and replace him at AIG. The person I am thinking of is a French insurance CEO, and he turned around a company that, though much smaller, was faced with exactly the same issues AIG is. Also, he works for peanuts, relatively speaking, because he is philosophically against the ethic of greed. But I can’t say his name because I signed a confidentiality agreement, and if I shoot my mouth off too much I will wind up in a world of shit.

The problem today is, most people have never had a real job or done any kind of business. Financial writers are hired right out of journalism school, and they are set up by the newspapers as instant gurus. Politicians and bureaucrats are processed like Kraft cheese slices and then slapped into assembly line sandwiches. It’s "Brave New World", where you’re classified as Alpha, Beta or Delta. This system is not going to end until the whole thing crashes completely, because people are not geniuses. Anything but. The schools are churning out MBAs and MAs which are worth nothing because the grade inflation has reached such a critical mass that professors give out As and Bs to students just for showing up in class. What kind of education do you call that? I overheard a couple of newly minted attorneys discussing the bar exam:
"I did OK on the multiple choice, but I had a real problem on the written part of the exam". Knowing this guy, I bet! Next time you have to go to court, remember that.
Then they go into the labor market and they think they’re still in school. No, worse, they think the employer is in loco parentis, and they expect to be indulged 100%.
Forget it, kid, I ain’t your freakin daddy.

A long time ago this old industrial guy, Jack Callari, was complaining to me about the low quality of workers he had to hire. He told me "I hate to say it, but what this country needs is a good depression." Well, it’s here. People are going to have to work their way up the ladder. Former Japanese finance minister Eisuke Sakakibara put it succinctly: "After the recession is over things will be very different. The American age is over". The only problem is, there aren’t any well-paying industrial jobs like there used to be. MBAs are going to be working in coffee bars, and glad to have the work. As for the diploma, you can frame it and hang it up next to your AIG shares.

But that isn’t the worst of it. I was saving the best for laffs. Here’s the other shoe. Remember the credit default swaps? Well, the figures released by AIG show their exposure going forward to still be in the neighborhood of 2 trillion dollars. At the rate of $160 billion a year, we should have it paid off around 2020.

© Dean Borok March 20th 2009

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