formerexpat
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Post by formerexpat on May 28, 2012 9:12:26 GMT -5
mmhmm, decoy only posted the full article because he saw his link didn't work. His link didn't work because he didn't post the full and correct link, which I posted in reply #119.
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djAdvocate
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Post by djAdvocate on May 28, 2012 11:11:19 GMT -5
"i was referring specifically to this crisis, which i believe is in mortgage backed securities. what is the commodity in those cases?" I don't think the JPM issue is really a crisis whatever. i was being more general. you don't think the derivatives mess is a crisis?, but a MBS is an asset, not a derivative. The deal with an MBS is that every mortgage is different. But by splitting them up and making an MBS that is a combination of bits of many different mortgages, they tried to make them into something more akin to something that can be traded like a commodity. right. so, what is the commodity? it is not mortgages, right?
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formerexpat
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Post by formerexpat on May 28, 2012 20:31:01 GMT -5
What mess? Define it and then we'll answer whether it's a crisis. $600T of derivatives is not a crisis. As I've pointed out (here is the link again: www.bis.org/statistics/derstats.htm), over 78% of them are interest rate swaps; a common derivative used to hedge against interest rate risk in the insurance and banks. Another 10% are for foreign exchange hedges, which are very common. The piece of the mortgage loan is the underlying asset to the buyer with the interest payment being the means to extract income...or extract value through buying it on the cheap if you can. There are still some of them that are undervalued after you look through to the monoline wrap and what they'd pay in the event of default. I wouldn't necessarily call it a commodity. The underlying premise of spreading risk is a good one for companies that buy a lot of mortgages [like insurance industry, for example].
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djAdvocate
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Post by djAdvocate on May 28, 2012 20:40:33 GMT -5
The piece of the mortgage loan is the underlying asset to the buyer with the interest payment being the means to extract income...or extract value through buying it on the cheap if you can. There are still some of them that are undervalued after you look through to the monoline wrap and what they'd pay in the event of default. I wouldn't necessarily call it a commodity. The underlying premise of spreading risk is a good one for companies that buy a lot of mortgages [like insurance industry, for example]. i am sorry, so what is the commodity (or underlying asset, as i put it earlier) again?
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decoy409
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Post by decoy409 on May 29, 2012 8:25:50 GMT -5
$1.4 Quadrillion is roughly: -40 TIMES THE WORLD’S STOCK MARKET. -10 TIMES the value of EVERY STOCK & EVERY BOND ON THE PLANET. -23 TIMES WORLD GDP. That's what Derivatives are,when you pull back the covers. Now call it and percentages whatever you so desire,bottom line,there is NOTHING in our time capable of keeping the payments Magicly covering it. Home ownership,please,how about "we've decided to support the WORLDS GREATEST SHOW!" "Why with the years and years and years of interest payments we give them instead of paying directly the balance and a small fee,why PONZI can last until there is nothing left to milk to support it."
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Post by Deleted on May 29, 2012 18:57:58 GMT -5
I don't think underlying asset is correct. The MBS is an asset with a claim against actual mortgages. It's no different than trading an actual mortgage except you're buying bits and pieces. I'm no expert on MBSs, but I suspect that by making an MBS out of bits and pieces of individual mortgages, you can essentially create an "average" mortgage, such that all shares carry the same risk, allowing for a more liquid market where shares can be bought and sold without evaluating each individual mortgage.
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formerexpat
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Post by formerexpat on May 29, 2012 21:10:33 GMT -5
Technically, you are correct; practically, it's extremely difficult to designate the underlying mortgages to the appropriate bond holder with all the tranches and properties involved. You'd also have to get the bank where the mortgage is held involved so one could split up the fractional ownership of each of the underlying mortgages.
Before MBS's, insurance companies would hold an entire mortgage loan (mostly commercial and some still do, but with less frequency). It's much easier to determine the asset backing that loan since it's a one for one relationship.
When it's cut up 100's or even 1000's of ways, it gets much more difficult.
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djAdvocate
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Post by djAdvocate on May 30, 2012 0:09:48 GMT -5
I don't think underlying asset is correct. The MBS is an asset with a claim against actual mortgages. It's no different than trading an actual mortgage except you're buying bits and pieces. I'm no expert on MBSs, but I suspect that by making an MBS out of bits and pieces of individual mortgages, you can essentially create an "average" mortgage, such that all shares carry the same risk, allowing for a more liquid market where shares can be bought and sold without evaluating each individual mortgage. if so, how can the value of the derivatives market be greater than the value of the mortgage market? are the same securities being rebundled in different MBS's?
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Post by Deleted on May 30, 2012 18:25:36 GMT -5
I don't think one has anything to do with the other. I don't know if there are MBS derivatives, but even if there are, the derivatives market covers just about any commodity you can think of. And like I said, it's not an accurate statement to say the derivatives market is valued at $600T. I'm not really even sure how one would calculate the value.
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formerexpat
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Post by formerexpat on May 30, 2012 20:18:41 GMT -5
They're unrelated. Derivatives can be and are used for non-MBS related hedges [interest & fx being the most widely used].
You'd use the market value of the derivative itself. See the link I've posted for the fair value of the derivatives that have a notional value of $600T.
There are derivatives hedging in both directions. It's kind of like a bookie saying that he's got $1,000 in placed bets but $500 for team A and $500 for team B. At the end of the day, assuming no change in spread, the bookie pays out $900 and keeps $100 for himself.
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Post by Deleted on May 30, 2012 21:04:56 GMT -5
"You'd use the market value of the derivative itself."
But for every short there is a long. Don't they offset?
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formerexpat
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Post by formerexpat on May 30, 2012 21:24:16 GMT -5
Not necessarily...but, even assuming there is an equal number of trades for each side, there will still be a residual fair value as the price for those instruments change to find the equilibrium. Think of it in sports betting terms (because I think that's what most people can relate). The point spread opens up at 8.5 points and everyone takes the underdog in the beginning of the week until the point spread trims down to 6 points (pretty big margin there for effect). If the favored team wins by 7 points, there will be a number of people that are paid, including those who chose the favorite when the spread decreased to 6 points and those that took the underdog when the spread was at 7 points. There is a calculable fair value to that situation, just like you'd see for derivatives. This link: www.bis.org/statistics/derstats.htmSays fair value at 12/31/2011 was $27 trillion, with $22.6 trillion of it in interest rate & FX contracts (a common and simplistic derivative instrument used by almost every major institution, including multinationals). Here is a really good summary, kind of duplicating some of what we discussed but potentially put it in better words than I could: www.slate.com/articles/news_and_politics/explainer/2008/10/596_trillion.html
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djAdvocate
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Post by djAdvocate on May 30, 2012 23:44:35 GMT -5
I don't think one has anything to do with the other. I don't know if there are MBS derivatives, but even if there are, the derivatives market covers just about any commodity you can think of. And like I said, it's not an accurate statement to say the derivatives market is valued at $600T. I'm not really even sure how one would calculate the value. well, i am no closer to understanding how that $0.6Q was arrived at, but thanks for all of the confusing details. ;D
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Post by djAdvocate on May 30, 2012 23:50:41 GMT -5
Not necessarily...but, even assuming there is an equal number of trades for each side, there will still be a residual fair value as the price for those instruments change to find the equilibrium. Think of it in sports betting terms (because I think that's what most people can relate). The point spread opens up at 8.5 points and everyone takes the underdog in the beginning of the week until the point spread trims down to 6 points (pretty big margin there for effect). If the favored team wins by 7 points, there will be a number of people that are paid, including those who chose the favorite when the spread decreased to 6 points and those that took the underdog when the spread was at 7 points. There is a calculable fair value to that situation, just like you'd see for derivatives. This link: www.bis.org/statistics/derstats.htmSays fair value at 12/31/2011 was $27 trillion, with $22.6 trillion of it in interest rate & FX contracts (a common and simplistic derivative instrument used by almost every major institution, including multinationals). Here is a really good summary, kind of duplicating some of what we discussed but potentially put it in better words than I could: www.slate.com/articles/news_and_politics/explainer/2008/10/596_trillion.htmlok, so this works like options? there are bets positive and negative on the same underlying issues? so, if we have an asset Q valued at $7.5 million, you can have trader "A" who is betting that the value of asset Q will fall to $5 million on 12/21/12, and trader "B" who is betting that the value of Q will be $10 million on 12/21/12. as the underlying asset approaches $5 million, the derivative traded by "A" will gain in value, and the value of the derivative traded by "B" will fall to zero as the date approaches. if the value ends up between $5M and $10M, both end up with nothing, even if the face value of their investment is, say $100k. is that right, or am i steering my boat into a reef?
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Driftr
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Post by Driftr on May 31, 2012 9:37:08 GMT -5
They're unrelated. Derivatives can be and are used for non-MBS related hedges [interest & fx being the most widely used]. You'd use the market value of the derivative itself. See the link I've posted for the fair value of the derivatives that have a notional value of $600T. There are derivatives hedging in both directions. It's kind of like a bookie saying that he's got $1,000 in placed bets but $500 for team A and $500 for team B. At the end of the day, assuming no change in spread, the bookie pays out $900 and keeps $100 for himself. Actually, the bookie takes in $550 and pays out $500. But I like the example. What happens when there's $900 bet on team A and only $100 on team B? Bookie lays off the bet right? What happens when that second guy can't pay? If there are derivitives being traded and the counterparties aren't being forced to show they have the equity to pay, I think we have a problem.
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Post by djAdvocate on May 31, 2012 9:58:16 GMT -5
me too. it will be interesting to see how those who are on the losing end of these bets will deal with it.
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Post by Driftr on May 31, 2012 13:57:56 GMT -5
me too. it will be interesting to see how those who are on the losing end of these bets will deal with it. Well we already know how AIG deals with it. They don't even bother to lay off the bets when they're unbalanced. See, if they do that, then they have to split some of the vig they charge when folks place their bets. That's not good for the bottom line ya know. Better to just keep all the bets in house and then if the wrong 'team' or 'commodity' does the wrong thing badly enough, you can just run to .gov and threaten the whole system will come a tumblin down if they don't pay off for you. Lovely racket.
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Post by Deleted on May 31, 2012 20:20:50 GMT -5
"is that right, or am i steering my boat into a reef?"
You're closer than you think, because options are derivatives. The only part you're missing is that not everyone is betting on what the price will be in the future. Those who actually buy and/or sell the commodity in question are making trades simply to get rid of their price risk. Also, traders "A" and "B" might be counterparties to the same trade (i.e. one sells the option and the other buys it). ------------------------------------------------------------------------------ "Not necessarily...but, even assuming there is an equal number of trades for each side,..."
There MUST be an equal number of trades for each side. The only way for one person to take a short position is for someone else (or multiple someone else's) to take an equal long position.
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Post by Deleted on May 31, 2012 20:21:54 GMT -5
"If there are derivitives being traded and the counterparties aren't being forced to show they have the equity to pay, I think we have a problem."
Derivatives are heavily regulated, and a party that can't post margin will have their position automatically closed out.
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Driftr
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Post by Driftr on Jun 1, 2012 7:27:05 GMT -5
"If there are derivitives being traded and the counterparties aren't being forced to show they have the equity to pay, I think we have a problem." Derivatives are heavily regulated, and a party that can't post margin will have their position automatically closed out. Then please explain why AIG required a bailout in order to pay off Goldman.
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Post by The Virginian on Jun 1, 2012 8:41:10 GMT -5
Derivatives are heavily regulated, By Whom
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Post by Savoir Faire-Demogague in NJ on Jun 1, 2012 8:44:34 GMT -5
"If there are derivitives being traded and the counterparties aren't being forced to show they have the equity to pay, I think we have a problem." Derivatives are heavily regulated, and a party that can't post margin will have their position automatically closed out. Then please explain why AIG required a bailout in order to pay off Goldman. AIG provided insurance on the sub-prime mortgages that were flooding the market and being bought up by FNMA, packaged and sold to banks, investors, mutual funds, 401Ks, pensions and endowments.
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Post by Deleted on Jun 1, 2012 16:25:43 GMT -5
"Then please explain why AIG required a bailout in order to pay off Goldman."
You tell me. I suspect most of what you're saying is made up. There are probably a lot of reasons why.
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Post by jarhead1976 on Jun 1, 2012 17:28:21 GMT -5
One thing for sure ,as you read the last paragraph , the price of eggs just went up , just like the unemployment rate. Funny thing these derivatives. You can bet on eggs and lose the farm. JPMorgan's Troubles And The Price Of Eggs by MARILYN GEEWAX EnlargeJoern Pollex/Getty Images Do complex Wall Street transactions ever do anything to help average people? To answer that question, we consider the case of an imaginary company, Chickens LLC, that's looking to grow. text size A A A May 18, 2012 Journalists have spent many days and millions of words hashing over the news that banking giant JPMorgan Chase lost billions of dollars trading "synthetic" derivatives. I am one of those journalists who, more or less, can understand what the bank says it was trying to do, i.e., hedge against loan losses. But here's what I have a hard time explaining: What does this kind of complex trading have to do with the price of eggs? In the past, you could ask what big bankers on Wall Street did for a living and get an answer that made sense in terms of the "real" economy. Their job was to help investors buy and sell stocks, and those transactions could spur companies to grow. Consider the investors who — back in the 1970s — purchased shares of Bob Evans Farms Inc. Wall Street firms helped trade shares of the breakfast-oriented restaurant chain, which grew into a huge employer with more than 700 locations. I can see how Wall Street helped connect me with my breakfast eggs at Bob Evans. Wall Street still does straightforward stock deals like that — for instance, Facebook's initial public offering. But in addition to helping buyers and sellers exchange stocks and bonds, today's traders also do transactions that are far, far more complex. Some involve "synthetic" derivatives. As JPMorgan has demonstrated, such transactions can break bad and end up costing a bank a fortune. But what about when they go right? Do these transactions ever do anything to help average people? For an answer, I went to Matthew Jensen, an economic researcher at the American Enterprise Institute. I asked him: "What does synthetic-derivative trading have to do with the price of eggs?" He made up a company, Chickens LLC, and we headed off together to see how this works: Step One: Understand what a derivative is. This term refers to a financial product that derives its value from an underlying asset. For example, corn is an asset. A derivative could be a contract to buy or sell corn in the future at a set price. So a contract that allows you to, say, buy corn at a low, fixed price could become very valuable if a drought were to drive up the price of corn. A derivative like that could help a cereal maker sleep better at night, knowing he's not going to have to pay a fortune for corn if the weather turns dry. Step Two: Understand what a "synthetic" derivative is. This type of derivative attempts to replicate what some other — more annoying — financial product might do. The goal is to accomplish the same financial mission, but with fewer hassles. So, say you don't want to actually enter into a contract on the future price of corn, and you certainly don't want to take possession of corn. Instead, as Jensen put it, you could "cobble together some other assets to mirror the performance" of a contract to purchase corn. It's like assembling a Fantasy Corn League, where people can place side bets on how the real corn prices are going to move — up or down. To create these purely financial products, a Wall Street firm could package up just-invented options that mimic the payout schedule and characteristics of real futures contracts, and the investors would never have to worry about the complexities that come with entering into an actual contract to buy real corn. Step Three: Understand why anyone would play this game. Jensen says these transactions "can provide flexibility to investors because any aspect (payoff schedule, yield, exposure to interest-rate risk, etc.) can be modified, without having to find the perfect asset in the existing market." In other words, if you are worried about only one thing, such as the direction of interest rates, these kinds of synthetic investments can help you offset that specific risk — just as buying traditional options can help protect farmers and cereal makers worried about corn prices. Step Four: Think about our imaginary company. Say Chickens LLC wanted to expand, so it borrowed money using a floating-interest-rate bond. By borrowing money, our imaginary company could acquire more hens and more corn for feed to produce more eggs, Jensen explains. But the owners of Chickens LLC are worried about interest rates rising because they haven't yet entered into a contract to sell their eggs. They don't want to pay more for the borrowed money — especially not until they know for sure what price they'll get for their eggs. They could just sit there and take their chances — hoping the eggs will sell high and interest rates stay low. But sitting around being nervous doesn't exactly encourage hiring. Instead of the do-nothing approach, the owners could construct a synthetic derivative out of their existing bond and an additional derivative product. As Jensen says, Chickens LLC "can find one other party with opposite risks, and enter into an interest-rate swap for the exact amount of time needed to match the time to maturity" of its existing bond. Now, of course, as with any transaction, things can go wrong — very wrong. Earlier this week, JPMorgan Chief Executive Officer Jamie Dimon said his company's derivative-trading strategies were "flawed, complex, poorly conceived, poorly vetted and poorly executed." Ouch. That's how banks and their investors can lose billions of dollars in a very short time. But when the sophisticated financial products and trades go well, the profits can be enormous. Step Five: Again, what does any of this have to do with the price of eggs? Let's go back to Chickens LLC and assume that it did not use flawed, poorly conceived synthetic derivatives. Let's assume it properly hedged against interest-rate risks, and now the owners can feel more confident. Knowing they have well-constructed synthetic derivatives on their side, they don't have to hoard cash and fear the worst. Instead, they can be more confident about hiring workers, and they can go ahead and "lower prices on eggs," Jensen says. www.npr.org/2012/05/18/152934962/jpmorgans-troubles-and-the-price-of-eggs*Link added by mmhmm. Jarhead, if you copy/paste an article here, please provide a link to the source of said article, per our CoC. Thanks.*
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Driftr
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Post by Driftr on Jun 1, 2012 19:45:13 GMT -5
"Then please explain why AIG required a bailout in order to pay off Goldman." You tell me. I suspect most of what you're saying is made up. There are probably a lot of reasons why. What exactly do you think I've made up? I suspect you realize you mis-spoke when you said derivitives are heavily regulated and rather than admit that, you're choosing to start with the insults. Please though, prove me wrong.
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Post by mmhmm on Jun 1, 2012 20:28:02 GMT -5
mmhmm, decoy only posted the full article because he saw his link didn't work. His link didn't work because he didn't post the full and correct link, which I posted in reply #119. Super, formerexpat. Thanks for posting a working link. Now, folks can read the article, if they wish to do so, by accessing it through your post #119.
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formerexpat
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Post by formerexpat on Jun 1, 2012 20:53:51 GMT -5
Geez...you people kill me.
1) AIG (specifically the Financial Products Division) were the sellers of CDS's, or credit derivative swap. This is not an insurance product; it is not regulated by the insurance commissioner and like every swap, is a derivative. CDS's have been regulated under the Securities Act of 1933 and Securities Exchange Act of 1934; though fairly lightly.
2) AIG didn't get bailed out; they got an emergency loan at 11%. The reason - because very few companies can come up with the that many billions in cash that was required as part of the ISDA agreement for a collateral call when the counterparties that were being hedged against [like Lehman] got downgraded.
The amount of collateral posted is contingent on the counterparty rating. The lower the rating, the higher the collateral that the seller needs to post. As Lehman went under nearly over night, it had a ripple effect and per the ISDA agreement forced AIG to post billions in collateral.
BUT
AIG did have the cash available. However, it was located in their insurance subsidiaries and the Financial Products Division (who sold the CDS) is not an insurance company and couldn't get the cash from the insurance subsidiary. Insurance regulations (because they are for the benefit of the policyholder) are extremely restrictive when it comes to a company removing money from an insurance company. When all of this occurred, there was an emergency meeting with the national insurance commissioner, the NY insurance commissioner and the Fed to see whether a special exemption would be made to allow AIG to bring the cash needed out of the insurance subsidiary. At that meeting, it was determined that was not going to be the way it was going to be handled and instead an emergency loan would be made.
I'll also point it out to people that the Commodity Futures Modernization Act of 2000 [signed in Dec] excluded CDS's from being regulated as futures or securities. The Insurance department had already concluded earlier that year that a CDS was not an insurance contract.
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Post by Deleted on Jun 2, 2012 9:15:48 GMT -5
"I suspect you realize you mis-spoke when you said derivitives are heavily regulated and rather than admit that, you're choosing to start with the insults. Please though, prove me wrong."
I've studied derivatives for years, both as part of getting my MBA and also as part of my employment. I buy about $100 million/yr in energy which includes hedging with derivatives. The company I work for hedges to the tune of hundreds of billions. What are your qualifications?
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Driftr
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Post by Driftr on Jun 2, 2012 10:05:15 GMT -5
"I suspect you realize you mis-spoke when you said derivitives are heavily regulated and rather than admit that, you're choosing to start with the insults. Please though, prove me wrong." I've studied derivatives for years, both as part of getting my MBA and also as part of my employment. I buy about $100 million/yr in energy which includes hedging with derivatives. The company I work for hedges to the tune of hundreds of billions. What are your qualifications? I'd be happy to answer your question after you've answered mine.
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Driftr
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Post by Driftr on Jun 2, 2012 10:05:46 GMT -5
Geez...you people kill me. 1) AIG (specifically the Financial Products Division) were the sellers of CDS's, or credit derivative swap. This is not an insurance product; it is not regulated by the insurance commissioner and like every swap, is a derivative. CDS's have been regulated under the Securities Act of 1933 and Securities Exchange Act of 1934; though fairly lightly. 2) AIG didn't get bailed out; they got an emergency loan at 11%. The reason - because very few companies can come up with the that many billions in cash that was required as part of the ISDA agreement for a collateral call when the counterparties that were being hedged against [like Lehman] got downgraded. The amount of collateral posted is contingent on the counterparty rating. The lower the rating, the higher the collateral that the seller needs to post. As Lehman went under nearly over night, it had a ripple effect and per the ISDA agreement forced AIG to post billions in collateral. BUTAIG did have the cash available. However, it was located in their insurance subsidiaries and the Financial Products Division (who sold the CDS) is not an insurance company and couldn't get the cash from the insurance subsidiary. Insurance regulations (because they are for the benefit of the policyholder) are extremely restrictive when it comes to a company removing money from an insurance company. When all of this occurred, there was an emergency meeting with the national insurance commissioner, the NY insurance commissioner and the Fed to see whether a special exemption would be made to allow AIG to bring the cash needed out of the insurance subsidiary. At that meeting, it was determined that was not going to be the way it was going to be handled and instead an emergency loan would be made. I'll also point it out to people that the Commodity Futures Modernization Act of 2000 [signed in Dec] excluded CDS's from being regulated as futures or securities. The Insurance department had already concluded earlier that year that a CDS was not an insurance contract. Nice write up. Thank you.
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