AIG is saying here that it has insured $307bn of corporate loans and prime residential mortgages that are on the balance sheets of banks, mostly European banks.

The banks have bought this insurance to protect themselves against the risk that these loans would go bad, that borrowers would default.

Their motive for doing so was to reassure their respective regulators – such as the FSA for UK banks – that these loans are of minimal risk.

And the benefit of doing that was that they could lend considerably more relative to their capital resources.

But if AIG is in trouble, then doubts arise about whether it would be able to honour the financial commitments it has made through these insurance contracts (which, for those of you who like to learn the lingo, are called super senior credit default swaps).

In fact, in a wholly mechanistic way, the downgrades of AIG’s credit rating that we saw last night automatically increased the perceived riskiness of loans made by banks that have insured credit with AIG.

The trouble came largely from AIG’s foray into financial services. I don’t know enough about that operation, but that was clearly mismanaged. But a lot of insurers have gotten their heads handed to them with similar initiatives (Swiss Re, for instance).

The big problem at AIG was that Greenberg ran it like the French court. He made tons of detailed decisions personally. I have been told by people who know Greenberg personally that he thinks he is immortal. No succession planning, in fact Greenberg may have subconsciously set things up so they were so dependent on him that they would go awry when he was no longer on the scene.

I have a friend who is a very senior executive who joined right before Greenberg got the heave-ho. He said no one knew how to make an important decision, all roads lead to Greenberg.

So AIG apparently functions very well on an operational/tactical level, but has been left in a mess strategically and in its top level organization. And the financial services guys appear to have taken ground in a power vacuum.

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My point is that this smells very much like a senior preferred equity investment. And this shows how saying the Fed can “only” make collateralized loans is really meaningless. The Fed can make any investment it wants and just slap a “loan” label on it.
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Not really. The loan is required to be debt in substance and form. If the Fed makes advances for an instrument that is equity in substance, someone might have standing to sue the Fed for damages or injunctive relief. Maybe a hedge fund who would benefit by scuttling the Fed’s plans. Maybe a citizen with Ron Paul’s politics.

if hank greenberg gets a better deal than the average joes invested in the mutual funds that owned FNM/FRE common & preferred because he happens to be a card carrying member of AEI (and hence is close to the neocons who are running our government) then it will be a sad, sad day for america. it will be another data point which supports the notion that non-elected bureaucrats are deciding which institutions survive and which institutions fail (or are confiscated, in the case of FNM/FRE) based on ideological views and personal relationships.

disgusting.

That said, anyone who is clever should have realized (or is probably starting to realize) that a limitation to making “only” collateralized loans is not much of a limitation at all.

For example, a good lawyer can write what is basically an “equity” investment with loan documents (like a participating subordinated loan or a thinly collateralized loan with warrants like what the Fed is doing). In much the same way, a lawyer can also write what is basically a “debt” investment with equity documents (a joint venture agreement where the money provider gets all its “equity” back plus a preferred return prior to any other distributions (and you could also include a guarantee)).

My point is that this smells very much like a senior preferred equity investment. And this shows how saying the Fed can “only” make collateralized loans is really meaningless. The Fed can make any investment it wants and just slap a “loan” label on it.

Oh well, Vive le France! I guess.

Signed,

Taxpayer

“keep good people?” give me a break! the good people that ran the business into the ground in the first place? cause it’s pretty close to six feet down in the ground right now. greedy, extremely short-sighted people who were ideologically pre-disposed to overlook the most massive housing bubble in history, which appears to be most of wall street, are not good people to have running a business.