Your Money at Work, Fixing Others’ Mistakes
By GRETCHEN MORGENSON
Published: September 20, 2008
http://www.nytimes.com/2008/09/21/business/21gret.html?_r=1&oref=sloginCredit default swaps, which operate like insurance policies against the possibility that an issuer of debt will not pay on its obligations, were the single biggest motivator behind the A.I.G. deal.
A.I.G. had written $441 billion in credit insurance on mortgage-related securities whose values have declined; if A.I.G. were to fail, all the institutions that bought the insurance would have been subject to enormous losses. The ripple effect could have turned into a tsunami.
So, the $85 billion loan to A.I.G. was really a bailout of the company’s counterparties or trading partners.
Now, inquiring minds want to know, whom did we rescue? Which large, wealthy financial institutions — counterparties to A.I.G.’s derivatives contracts — benefited from the taxpayers’ $85 billion loan? Were their representatives involved in the talks that resulted in the last-minute loan?And did Lehman Brothers not get bailed out because those favored institutions were not on the hook if it failed?
We’ll probably never know the answers to these troubling questions. But by keeping taxpayers in the dark, regulators continue to earn our mistrust. As long as we are not told whom we have bailed out, we will be justified in suspecting that a favored few are making gains on our dimes.
A.I.G.’s financial statements provided a clue to the identities of some of its credit default swap counterparties.
The company said that almost three-quarters of the $441 billion it had written on soured mortgage securities was bought by European banks. The banks bought the insurance to reduce the amounts of capital they were required by regulators to set aside to cover future losses.
Enjoy the absurdity: Billions in unregulated derivatives that were about to take down the insurance company that sold them were bought by banks to get around their regulatory capital requirements intended to rein in risk.
Got that?
Which brings us to Item 2 for policy makers. Stop pretending that the $62 trillion market for credit default swaps does not need regulatory oversight. Warren E. Buffett was not engaging in hyperbole when he called these things financial weapons of mass destruction.
“The last eight years have been about permitting derivatives to explode, knowing they were unregulated,” said Eric R. Dinallo, New York’s superintendent of insurance. “It’s about what the government chose not to regulate, measured in dollars. And that is what shook the world.”
And it will continue.
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