AIG Faces $10 Billion

Get Ready You will Need some Financial Coaching For Boomers

in Losses on Bad Bets

By SERENA NG, CARRICK MOLLENKAMP and MICHAEL SICONOLFI

American International Group Inc. owes Wall Street’s biggest firms about $10 billion for speculative trades that have soured, according to people familiar with the matter, underscoring the challenges the insurer faces as it seeks to recover under a U.S. government rescue plan.

The details of the trades go beyond what AIG has explained to investors about the nature of its risk-taking operations, which led to the firm’s near-collapse in September. In the past, AIG has said that its trades involved helping financial institutions and counterparties insure their securities holdings. The speculative trades, engineered by the insurer’s financial-products unit, represent the first sign that AIG may have been gambling with its own capital.

The soured trades and the amount lost on them haven’t been explicitly detailed before. In a recent quarterly filing, AIG does note exposure to speculative bets without going into detail. An AIG spokesman characterizes the trades not as speculative bets but as “credit protection instruments.” He said that exposure has been fully disclosed and amounts to less than $10 billion of AIG’s $71.6 billion exposure to derivative contracts on debt pools known as collateralized debt obligations as of Sept. 30.

AIG’s financial-products unit, operating more like a Wall Street trading firm than a conservative insurer selling protection against defaults on seemingly low-risk securities, put billions of dollars of the company’s money at risk through speculative bets on the direction of pools of mortgage assets and corporate debt. AIG now finds itself in a position of having to raise funds to pay off its partners.

The fresh $10 billion bill is particularly challenging because the terms of the current $150 billion rescue package for AIG don’t cover those debts. The structure of the soured deals raises questions about how the insurer will raise the funds to pay the debts. The Federal Reserve, which lent AIG billions of dollars to stay afloat, has no immediate plans to help AIG pay off the speculative trades.

The outstanding $10 billion bill is in addition to the tens of billions of taxpayer money that AIG has paid out over the past 16 months in collateral to Goldman Sachs Group Inc. and other trading partners on trades called credit-default swaps. These instruments required AIG to insure trading partners, known on Wall Street as counterparties, against any losses in their holdings of securities backed by pools of mortgages and other assets. With the value of those mortgage holdings plunging in the past year and increasing the risk of default, AIG has been required to put up additional collateral — often cash payments.

AIG’s problem: The rescue plan calls for a company funded largely by the Federal Reserve to buy about $65 billion in troubled CDO securities underlying the credit-default swaps that AIG had written, so as to free AIG from its obligations under those contracts. But there are no actual securities backing the speculative positions that the insurer is losing money on. Instead, these bets were made on the performance of pools of mortgage assets and corporate debt, and AIG now finds itself in a position of having to raise funds to pay off its partners because those assets have fallen significantly in value.

The Fed first stepped in to rescue AIG in mid-September with an $85 billion loan when the collateral demands from banks and losses from other investments threatened to send the firm into bankruptcy court. A bankruptcy filing would have created losses and problems for financial institutions and policyholders all over the world that were relying AIG to insure them against the unexpected.

By November, AIG had used up a large chunk of the government money it had borrowed to meet counterparties’ collateral calls and began to look like it would have difficulty repaying the loan. On Nov. 10 the government stepped in again with a revised bailout package. This time, the Treasury said it would pump $40 billion of capital into AIG in exchange for interest payments and proceeds of any asset sales, while the Fed agreed to lend as much as $30 billion to finance the purchases of AIG-insured CDOs at market prices.

The $10 billion in other IOUs stems from market wagers that weren’t contracts to protect securities held by banks or other investors against default. Rather, they are from AIG’s exposures to speculative investments, which were essentially bets on the performance of bundles of derivatives linked to subprime mortgages, commercial real-estate bonds and corporate bonds.

These bets aren’t covered by the pool to buy troubled securities, and many of these bets have lost value during the past few weeks, triggering more collateral calls from its counterparties. Some of AIG’s speculative bets were tied to a group of collateralized debt obligations named “Abacus,” created by Goldman Sachs.

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The Abacus deals were investment portfolios designed to track the values of derivatives linked to billions of dollars in residential mortgage debt. In what amounted to a side bet on the value of these holdings, AIG agreed to pay Goldman if the mortgage debt declined in value and would receive money if it rose.

As part of the revamped bailout package, the Fed and AIG formed a new company, Maiden Lane III, to purchase CDOs with a principal value of $65 billion on which AIG had written credit-default-swap protection. These CDOs currently are worth less than half their original values and had been responsible for the bulk of AIG’s troubles and collateral payments through early November.

Fed officials believed that purchasing the underlying securities from AIG’s counterparties would relieve the insurer of the financial stress if it had to continue making collateral payments. The plan has resulted in banks in North America and Europe emerging as winners: They have kept the collateral they previously received from AIG and received the rest of the securities’ value in the form of cash from Maiden Lane III.

The government’s rescue of AIG helped prevent many of its policyholders and counterparties from incurring immediate losses on those traditional insurance contracts. It also has been a double boon to banks and financial institutions that specifically bought protection on now shaky mortgage securities and are effectively being made whole on those positions by AIG and the Federal Reserve.

Some $19 billion of those payouts were made to two dozen counterparties just between the time AIG first received federal government assistance in mid-September and early November when the government had to step in again, according to a confidential document and people familiar with the matter. Nearly three-quarters of that went to French bank Société Générale SA, Goldman, Deutsche Bank AG, Crédit Agricole SA’s Calyon investment-banking unit, and Merrill Lynch & Co. Société Générale, Calyon and Merrill declined to comment. A Goldman spokesman says the firm’s exposure to AIG is “immaterial” and its positions are supported by collateral.

As of Nov. 25, Maiden Lane III had acquired CDOs with an original value of $46.1 billion from AIG’s counterparties and had entered into agreements to purchase $7.4 billion more. It is still in talks over $11.2 billion.

Job Cuts, Factory Slump Probably Worsened:

Coaching For Boomers

U.S. Economy Preview

By Bob Willis

Nov. 30 (Bloomberg) — The recession engulfing the U.S. economy deepened this month as employers slashed more jobs and manufacturing contracted at the fastest pace in a quarter century, economists said before reports this week.

Payrolls shrank by 320,000 workers in November, the biggest one-month drop since the 2001 terrorist attacks, according to the median estimate of economists surveyed by Bloomberg News before the Labor Department’s Dec. 5 report. The jobless rate may have jumped to 6.8 percent, the highest level since 1993.

Employment may keep deteriorating as the credit crunch continues to bite, with Goldman Sachs Group Inc. analysts forecasting a 9 percent unemployment rate by late 2009. The worsening outlook prompted President-elect Barack Obama to craft a plan to save or create 2.5 million jobs in two years to stave off what he called a “crisis of historic proportions.”

“All signals point to a very weak labor market and further weakening,” said Dean Maki, co-head of U.S. economic research at Barclays Capital Inc. in New York. “We should expect a large stimulus program shortly after Obama takes office.”

The 11th consecutive drop in payrolls would follow a 240,000 decline in October and bring the total number of jobs eliminated so far this year to 1.5 million. Factories probably reduced staff by 80,000 workers, according to the survey median.

The jobless rate was 6.5 percent in October.

The employment report, the second issued since Obama was elected president on Nov. 4, is likely to intensify pressure on policy makers to come up with additional stimulus plans.

Cutting Forecasts

As economic data deteriorated and financial markets slid, economists at Goldman last week were among those marking down their estimates for gross domestic product. The economy will shrink at a 5 percent annual rate this quarter and decline at a 3 percent pace in the first three months of 2009, Goldman’s chief U.S. economist Jan Hatzius said in a note.

The world’s largest economy contracted at a 0.5 percent pace in the third quarter and consumer spending fell at 3.7 percent rate, the biggest tumble since 1980, the government said last week.

Obama has named an economic team that includes New York Federal Reserve Bank President Timothy Geithner as Treasury Secretary-designate and former Fed Chairman Paul Volcker as head of a new White House economic panel aimed at reviving the economy.

“My first priority and my first job is to get us on the path to economic recovery,” Obama, 47, said Nov. 25 as he announced his team.

Factory Slump

Manufacturing, which accounts for about 12 percent of the economy, shrank in November for a fourth consecutive month, a report from the Institute for Supply Management may show tomorrow. The group’s factory index probably fell to 37, the lowest level since July 1980, from 38.9 the prior month, according to economists polled. A reading of less than 50 signals a contraction.

U.S. automakers have been particularly hard hit as sales dropped to the lowest level in almost two decades. General Motors Corp., under pressure after Congress delayed action this month on aid to the industry, said it will idle plants in Michigan, Ohio, Kansas and Missouri for an extra week in January.

“We are all expecting the year 2009 to be a very low year in terms of demand, not only in the United States, but globally,” Carlos Ghosn, chief executive officer of Nissan Motor Co., said in a Nov. 19 interview on Bloomberg Television. “We may be facing a couple of difficult years, with very low demand.”

Services Decline

Service industries, which account for almost 90 percent of the economy and range from mortgage lending to retailing and restaurants, also contracted in November, economists forecast another report from the ISM will show on Dec. 3.

The group’s non-manufacturing index fell to 42 last month, the lowest reading since records began in 1997, according to the survey median.

Financial firms are at the forefront of the slump in services. Citigroup Inc., the U.S. bank with the most employees, said this month it plans to eliminate more than 50,000 jobs and cut expenses as the global economy contracts. Chief Executive Officer Vikram Pandit has already cut 23,000 positions.

                         Bloomberg Survey

=================================================================
                        Release    Period    Prior     Median
Indicator                 Date               Value    Forecast
=================================================================
ISM Manu Index            12/1      Nov.      38.9      37.0
ISM Prices Index          12/1      Nov.      37.0      32.0
Construct Spending MOM%   12/1      Oct.     -0.3%     -1.0%
Productivity QOQ%         12/3       3Q       1.1%      0.9%
Labor Costs QOQ%          12/3      3Q F      3.6%      3.6%
ISM NonManu Index         12/3      Nov.      44.4      42.0
Initial Claims ,000’s     12/4    Nov. 29     529       540
Cont. Claims ,000’s       12/4    Nov. 22     3962      4025
Factory Orders MOM%       12/4      Jan.     -2.5%     -4.3%
Nonfarm Payrolls ,000’s   12/5      Nov.      -240      -320
Unemploy Rate %           12/5      Nov.      6.5%      6.8%
Manu Payrolls ,000’s      12/5      Nov.      -90       -80
=================================================================

Complete Coverage of the Global Financial Crisis                             

Coaching For Boomers

Spotlight Issues

by Rankby Date

• 

  Sweeping Rescue: U.S. Government Backstops Citigroup’s Toxic Assets

  PrintPrint
• 

  Fed Announces New $800bn Facilities: How Effective Will They Be?

  Print

  Roubini: To address the increase in real short term market rates the Fed and other central banks have already undertaken quite unorthodox monetary policy moves. To address the even more severe increase in real long term market rates the Fed and other central banks will have to undertake even more radical and unorthodox policy actions:
  • Nov 25: Fed took two new steps to unfreeze credit for home buyers, consumers and small businesses, committing up to $800 billion. The central bank will purchase as much as $600 billion in debt issued or backed by government-chartered housing-finance companies. It will also set up a $200 billion program to support consumer and small-business loans (Bloomberg)
  • Treasury will provide $20 billion of credit protection to the Federal Reserve in connection with its $200 billion Term Asset Backed Securities Loan Facility (Paulson)

  Roubini On What More Needs To Be Done:

  • The Fed and other central banks that used to be the “lenders of last resort” have become the “lenders of first and only resort” as banks don’t lend to each other, banks don’t lend to non-bank financial institutions and financial institutions don’t lend to the corporate and household sector
  • In spite of the Fed becoming the lender of first and only resort (even the corporate CP market is now being propped by the new Fed facility) there are still major problems that remain seriously unresolved in short term money markets and short term credit markets:

  1. Libor spreads are rising again in recent days; and they are still very high – at the 3 month maturity – compared to what they were before this liquidity crunch

  2. Banks and other financial institutions are still not lending to each other in spite of lower spreads as they need the liquidity received by the Fed and they worry about the solvency of their counterparties

  3. Only banks and major broker dealers have access to these facilities and thus most of the shadow banking system does not have access to this Fed liquidity

  4. Market spreads are still rising and the availability of short term credit is becoming tighter as banks increase interest rates on credit cards, student loans and auto loans and make such loans in scarcer supply

  5. Only rated investment grade corporate have access to the commercial paper facility leaving millions of speculative grade or non-rated firms in an even bigger liquidity and credit squeeze

  6. Securitization of credit cards, auto loans, student loans is currently dead

  Even “Crazier” Monetary Actions:

  • But even more desperate or “crazier” monetary actions are needed to address the increase in real long term market rates. These actions are needed to prevent deflation from setting in, to reduce the credit spread (the difference between long term market rates and long term government bond yields) and to reduce the yield curve spread (the difference between long term government bond yields and the policy rate)

  1. The Fed could commit to maintain the Fed Funds rate down to zero for a long period of time: since long term government bond yields are – based on the expectation hypothesis – equal to a weighted average of current short term government bond yields and current expectations of what those short term bond yields will be for the foreseeable future a commitment to keep the Fed Funds rate down to zero for a long time will affect expectations of future expected short rates and could reduce long term government bond yields

  2. The Fed could do what it last did in the 1950s: directly purchase long term government bonds as a way of pushing downward their yield and thus reduce the yield curve spread.

  3. Radical actions could take the form of: outright purchases of corporate bonds (high yield and high grade); outright purchases of mortgages and private and agency MBS as well as agency debt; forcing Fannie and Freddie to vastly expand their portfolios by buying and/or guaranteeing more mortgages and bundles of mortgages; one could decide to directly subsidize mortgages with fiscal resources; the Fed (or Treasury) could even go as far as directly intervening in the stock market via direct purchases of equities as a way to boost falling equity prices.

  4. Finally, the Fed could try to follow aggressive policies to attempt to prevent deflation from setting in: massive quantitative easing; flooding markets with unlimited unsterilized liquidity; talking down the value of the dollar; direct and massive intervention in the forex to weaken the dollar; vast increase of the swap lines with foreign central banks (an indirect and disguised form of forex intervention) aimed to prevent a strengthening of the dollar; attempts to target the price level or the inflation rate via aggressive preemptive monetization; or even a money-financed budget deficit

  • The problem with many of these “extreme” policy actions – as well as some of the ones described above to affect the relevant spreads – is that they were tried in Japan in the 1990s and the last few years and they miserably failed: once you are in a liquidity trap and there are fundamental deflationary forces in the economy as the excess aggregate supply of goods is facing a falling aggregate demand it is very hard even with extreme policy actions to prevent deflations from emerging

How to build yours

Washington’s $6.3 trillion bailout

By Forbes.com

For all the fury over Treasury Secretary Henry Paulson’s $700 billion emergency economic relief fund, it seems downright puny when compared with the running total of the government’s response to the credit crisis.

According to CreditSights, a research firm in New York and London, the U.S. government before last week had put itself on the hook for some $5.5 trillion in an attempt to arrest a collapse of the financial system.

And Washington committed $800 billion more Nov. 25, bringing the total to about $6.3 trillion.

The Federal Reserve last week promised an additional $200 billion in loans to purchase new asset-backed securities and $600 billion direct obligations and mortgage-backed securities of government-sponsored entities such as Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs). The Treasury Department is providing $20 billion to help fund the $200 billion pool, but the Treasury’s portion is already included in Uncle Sam’s tab.

The multitrillion-dollar estimate includes many of the solutions cooked up by Paulson and his counterparts Ben Bernanke at the Federal Reserve and Sheila Bair at the Federal Deposit Insurance Corp. as the credit crisis continues to plague banks and the broader markets.

The Fed has taken on much of that total, including lending a cumulative $1.1 trillion in overnight or short-term loans since March to primary dealers through its emergency discount window and making a cumulative $1.9 trillion available through its term auction facility, a series of short-term transactions it began making available twice a month in January. A portion of the funds lent in these programs has been repaid; the totals represent what has been made available.

The Fed also took on tens of billions in debt, including $29 billion in debt of Bear Stearns, and made $60 billion of credit available to American International Group (AIG, news, msgs). It is committing $22.5 billion to set up a special-purpose vehicle to manage some of AIG’s residential mortgage-backed securities, and it is financing $30 billion of a second fund to hold $70 billion of multisector collaterized debt obligations on which AIG wrote credit default swaps.

And then there is the rescue of Citigroup (C, news, msgs), which involves an additional $20 billion injection of equity from the Treasury’s capital-purchase program, bringing the total since October to $45 billion. The government is guaranteeing up to $306 billion of loans, with Citi accepting the first $29 billion of any losses and paying $7 billion to the government as a fee. Citi will cut its dividend to 1 cent a share.

The government, through the Treasury, the Federal Deposit Insurance Corp. and the Fed, is backing 90% of the guaranteed loans, leaving the rest to Citi to back. The government’s exposure to loss is $240 billion, CreditSights says.

The FDIC, meanwhile, is guaranteeing $1.5 trillion of senior unsecured bank debt.

Not included in the total are the Fed’s long-existing discount window lending to commercial banks, the mortgage modification plan announced by regulators in November, support for the Federal Home Loan Banks and myriad other programs. On Nov. 25, the Fed announced that it will begin buying up to $100 billion in direct obligations of mortgage buyers Fannie Mae, Freddie Mac and the Federal Home Loan Banks. In addition, it will buy up to $500 billion worth of mortgage-backed securities backed by Fannie, Freddie and the Government National Mortgage Association.

More from MSN Money and Forbes.com

• We’re trillions down and still bailing
• In pictures: The worst, and best, cities to ride out the recession
• Have past crises taught us anything?
• In pictures: The 10 worst states for business
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• In pictures: Top 10 recession-proof jobs

Paulson and Bernanke have tried any number of ways to stop the free fall in housing prices and unfreeze the credit markets, with limited success. Rates that banks charge each other for three-month loans have dropped, but lending is contracting as banks brace for rising credit costs and corporate borrowers hunker down.

The Treasury has turned its focus from attempting to buy troubled assets from banks, which was the original intent of the Emergency Economic Stabilization Act in October, to injecting capital in the form of preferred equity stakes.

It started out with $125 billion worth of investments in eight major U.S. banks and has since expanded the program to an increasingly broad range of financial and nonfinancial companies. And with just $60 billion left of its initial $350 billion authorization under the emergency act, the Treasury faces a growing number of companies, including Detroit’s automakers, begging for assistance.

Financial Coaching For Boomers we can help

U.S. Explores Its Options With TARP

By MICHAEL R. CRITTENDEN and MAYA JACKSON-RANDALL

The Treasury Department said it is exploring additional ways to apply a $700 billion financial-industry rescue package approved by Congress in October.

“Treasury is committed to deploying the [Troubled Asset Relief Program] aggressively and is actively considering additional programs to strengthen financial institutions, restore the flow of lending, and address the many challenges to our financial markets posed by the ongoing housing correction,” the Treasury said in its report, delivered to Congress Tuesday.

The program, known as TARP, was passed by Congress last month in response to the crisis in financial markets this year. It gives the Treasury wide latitude to purchase illiquid assets and stakes in financial firms, among other measures.

The Treasury said it hasn’t made any decisions about new rescue programs and offered few details about what areas policy makers are exploring. The report addresses the issue of trying to slow the record levels of foreclosures. “In particular, Treasury will continue efforts to ensure loan modifications are sustainable,” said the report. A separate Treasury report detailing minutes of an Oct. 13 meeting of members of the Financial Stability Oversight Board suggested the Treasury is focusing on how to address ailing mortgages.

The reports could provide fodder for forthcoming congressional oversight hearings. Some lawmakers have questioned whether Treasury’s plan to inject $250 billion of capital into banks and other financial firms will spur lending to consumers and businesses.

There is growing pressure for Treasury to attach binding requirements to any capital injections, to prevent firms from hoarding the government funds or using them to pay for acquisitions.

Treasury is considering broadening the range of financial institutions in which it could purchase stakes to include bond insurance firms and specialty finance firms, said people familiar with the matter. And the Treasury, the Federal Deposit Insurance Corp. and other government agencies are said to be close to announcing a government program to address residential foreclosures at the root of the crisis.

Meanwhile, the Treasury has clarified life insurers are eligible to participate in its capital-infusion program, provided they are or apply to become a federally regulated bank or thrift. A significant number of insurance companies in the U.S. would qualify as they operate banks or thrifts.

Motivations to participate range from strengthening balance sheets to securing a source of money for acquisitions.

New York Life Insurance Co. said when it became clear the program was voluntary for insurers it decided it would not participate: “We are well capitalized with more capital than is required to maintain our triple-A ratings.”

—Leslie Scism contributed to this article.

Bloomberg Sues Fed to Force Disclosure of Collateral (Update1)

By Mark Pittman

Nov. 7 (Bloomberg) — Bloomberg News asked a U.S. court today to force the Federal Reserve to disclose securities the central bank is accepting on behalf of American taxpayers as collateral for $1.5 trillion of loans to banks.

The lawsuit is based on the U.S. Freedom of Information Act, which requires federal agencies to make government documents available to the press and the public, according to the complaint. The suit, filed in New York, doesn’t seek money damages.

“The American taxpayer is entitled to know the risks, costs and methodology associated with the unprecedented government bailout of the U.S. financial industry,” said Matthew Winkler, the editor-in-chief of Bloomberg News, a unit of New York-based Bloomberg LP, in an e-mail.

The Fed has lent $1.5 trillion to banks, including Citigroup Inc. and Goldman Sachs Group Inc., through programs such as its discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility. Collateral is an asset pledged to a lender in the event that a loan payment isn’t made.

The Fed made the loans under 11 programs in response to the biggest financial crisis since the Great Depression. The total doesn’t include an additional $700 billion approved by Congress in a bailout package.

Fed’s Position

Bloomberg News on May 21 asked the Fed to provide data on the collateral posted between April 4 and May 20. The central bank said on June 19 that it needed until July 3 to search out the documents and determine whether it would make them public. Bloomberg never received a formal response that would enable it to file an appeal. On Oct. 25, Bloomberg filed another request and has yet to receive a reply.

The Fed staff planned to recommend that Bloomberg’s request be denied under an exemption protecting “confidential commercial information,” according to Alison Thro, the Fed’s FOIA Service Center senior counsel. The Fed in Washington has about 30 pages pertaining to the request, Thro said today before the filing of the suit. The bulk of the documents Bloomberg sought are at the Federal Reserve Bank of New York, which she said isn’t subject to the freedom of information law.

“This type of information is considered highly sensitive, and it would remain so for some time in the future,” Thro said.

The Fed didn’t give Bloomberg a formal response because “it got caught in the vortex of the things going on here,” said Michael O’Rourke, another member of the Fed’s FOIA staff.

Thro declined to comment on the lawsuit.

The case is Bloomberg LP v. Federal Reserve, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net.