Myths of the AIG Collapse

Barry Ritholtz

AIG FP remains somewhat somewhat unknown to most people. Numerous issues associated with the collapse seem to be — still — misunderstood by many professionals, analysts and pundits.

Consider:

• Hedge Fund: AIG FP was a derivative writing quasi-hedge fund within AIG. They were essentially a writer of highly leveraged, naked options. Indeed, their leverage was simply unconsionable.

• Exempt: Thanks to the CFMA, these derivatives were exempt from ALL regulation and supervision — no exchange oversight, no disclosures of risk, no transparency, no counter-party information, and most damaging of all, these derivatives required zero reserves in case of a claim. No other financial instrument receive this treatment;

• No Reserves Required: If AIG was forced to maintain reserves, would they have been able to write 3 trillion dollars in derivatives? (The fees on this $3T was $3 billion). Even a 5% reserve requirement would have meant having to put up $150 billion dollars;

• Lehman Did Not Kill AIG: Even if Lehman Brothers was saved, AIG would still have had enormous exposure — over $3 trillion dollars! — and carried tremendous risk. They had huge leveraged exposure to mortgages, especially credit default swaps written against sub-prime mortgages. The housing collapse was going to do in AIG regardless of whether Lehman was rescued or not.

• No Supervision: FP benefitted from being part of a highly regulated, triple AAA rated Insurance business. However, the derivative exemption prevented any of the state insurance supervisors from requiring normal reserves;

• Only a Few Employees Did In AIG: The firm had over 86,000 employees, but the FP division was a mere 400 people.

Chalk another win up for the Free Lunch crowd!

Posted via web from Jim Nichols