Saturday, 7 March 2009

AIG - saviour of European banks

Whatever you might say about Americans, you have to acknowledge their generousity. Since autumn, they have collectively poured in $150 billion into the insurance company - AIG. Who are the main beneficiaries of this huge fiscal transfer? Banks, particular ones in Europe.

Before the Lehman crisis exploded, AIG were up to their necks in a dubious business called regulatory arbitrage. In principle, banks are supposed to keep minimum levels of capital - which is, crudely speaking, the difference between bank assets (loans) and liabilites (deposits and other funding sources).

A reasonable capital adequacy ratio should limit risky lending and provide a cushion if things go bad and the bank makes losses. However, capital adequacy ratios are 'risk-weighted". Riskier investments, say mortgages, have a higher weight and require more capital. Less risky assets, like government bonds, have a lower weight ans use less capital.

However, banks, especially the European ones, circumvented these regulatary capital requirements by buying insurance for their riskier assets. This allowed banks to reduce the risk weighting on dubious investments, such as subprime related assets, and extend more loans with less capital. These insurance contracts went under the fancy title of credit default swaps.

Of course, the risk didn't go away. It was merely transferred from the banks to the insurance company. Guess who was the insurance company writing those contracts? Yes, it was AIG. In effect, European banks had collectively passsed off all their risk to a solitary insurance company in another country.

When default rates on risky investments, like subprime loans, began to increase, Banks started to invoke their credit default swaps. They wanted their insurance payouts. Unfortunately, AIG didn't have the financial reserves to payoff the losses from the largest housing bubble in history. It was basically bust.

Here is where the US government generously stepped into the breach. On behalf of the American people, it has pumped in the cash to keep AIG from going bankrupt, and keeping the European banking system from also crashing.

I love America. I despise this anti-American pose that has infected Europe. After hearing about the AIG bailout, I love America even more. What I can not understand is why haven't the rest of Europe fallen to their knees, facing westwards, and begged forgiveness for all the mean things recently said about the US. We should be pleading for them to keep AIG alive, because if the US government pulls the plug, then Europe can kiss good-bye to its banking system.

13 comments:

Mitch said...

I wonder if Obama mentioned that to Brown? just before he asked for more troops.

Anonymous said...

If Obama had any sense, he would have written in down as part of a trade....

Anonymous said...

Well if the europeans couldn't be grateful after WW2, Marshall aid and providing the bulk of NATO for the entirety of the Cold War, why should they suddenly become grateful just because the US taxpayer is underwriting the EU banking system?

Anonymous said...

You are suggesting that EU banks should be grateful for getting something they paid for.
AIG -sold- insurance.
Should we feel grateful to car insurance companies?

fajensen said...

After hearing about the AIG bailout, "blah.blah.blah. I Love You"!!

Gawd Damn: You should get your silly head checked for alien implants or maybe an aneurysm!

*Anything* from AIG, the FED, and Wall Street so far has been deceptive, fraudulent or straight lies and suddenly you are convinced about the do-good'iness of the lying pond-scum??

I.M.O. they are just lying a bit more to get foreign people to lend them some more money they can lend to people who cannot pay it back!

Americas time has passed.

Anonymous said...

AC: "I love America. I despise this anti-American pose that has infected Europe."

I like and admire America too, The US economy has directly provided me with four of six employments, the fifth was probably subsidised indirectly by America. The sixth was in a declining industry in the UK - mining.

I am sorry to see the US & the UK adopting the bailout as the supposed solution to the problem.

If they save every bank in the US, UK & Europe - which they wont, after 'the dust has settled' there will be massive over capacity and a much smaller world economy which will need many fewer banks. The banks will fail anyway, the finance sector is set to shrink.

Anonymous said...

Yes, yes, we Brits owe a great deal to the US, indeed.

Seriously, we would have goners without the US in World War II - not just for the resources they made available, but also for the way they did it - such massive energy, sacrifice and commitment.

We also owe rather a lot to the Russians, by the way, who took the bulk of the fight against the Nazis, with great human sacrifice and colossal industrial effort. Without them Hitler would have enjoyed many a cup of tea in the Mall.

B. in C.

Anonymous said...

Anon @10:42, AIG is bankrupt without US **GOVERNMENT** spending those contracts would have gone up in smoke as would a large portion of EU Tier one capital.

B in C, Battle of Britain 1940, Invasion of Russia 1941 so maybe again you are confusing them with the americans who supplied the parts and oil for the British to keep their planes in the air when they were actually fighting the Germans as opposed to a year later. Also without logistical and financial support of the americans the Russians would probably have collapsed in 1942.

Anonymous said...

B in C: "We also owe rather a lot to the Russians, by the way, who took the bulk of the fight against the Nazis, .. "

Don't forget the Russians were quite happy to coexist with the Nazis, and had signed up to the Molotov-Ribbentrop pact. I have no doubt the Russians were quite happy to allow the Germans free range in the West.

It was good fortune for us that the Germans attacked the Russians. That the Russians had to fight for their lives and we helped them too. The gratitude on that score should at least be equal, moderated too by the great waste of time and resources they put the West through in the latter half of the 20th century.

Ready Steady Go said...

I suspect the recent article in the WSJ has started to highlight where the money is going...and may be trying to sway mass opinion to the -ve?

dearieme said...

"Don't forget the Russians were quite happy to coexist with the Nazis,..": oh, far too feeble. The USSR was the Nazis' ally in attacking Poland, was its major supplier of many resources, having earlier allowed the Germans to evade anti-armament agreements by training the Luftwaffe in the USSR. Eventually the thieves fell out. Lucky us.

Anonymous said...

dearimem: "oh, far too feeble. "

Yea, Anonymous one was feeling mellow today.

Anonymous said...

“Dubious business?” Doesn’t to me to be the case. It looks to me that people have been looking for someone to blame for the financial crisis. First the media blamed AIG, and now they have turned their guns on Goldman Sachs (http://nymag.com/news/business/58094/). This is leaving me confused here. Who is responsible for what here?