How AIG Facilitated European Banks Circumventing Minimum Capital Requirements

One of my hugely plugged in buddies has been warning that European banks are even more wobbly than US ones, and the ECB will wind up, like the Fed, cutting rates to as close to zero as it dares.

Some of his grim view is based on the fact that EU banks on average are much more highly geared than their US peers, and they were buyers of the dreckiest, end of credit cycle CDOs and structured credits.

But I wonder if he knew about this item too….(hat tip reader Richard)

The more information comes out, the more the financial industry looks like a house of cards. Is this the reason that the authorities have been reluctant to go in the direction of more transparency, despite the frequent calls for it? Particularly when more disclosure might reveal that they were asleep at the switch in the credit bubble?

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  1. slowy

    Yves, for the past 24-48 hours or so, your website is way slow. Did you add something? I see the little amazon thing, and the google thing in the corner… please check it out.

  2. doc holiday

    Yah, yah, OT, but check this out, in regard to The Bailout Proposal, i.e, Chrysler had a clock ticking on the government bailout and to the best of my metal capacity, I don’t think Paulson has a clock involved in his recent proposal; no clock implies an open-ended theft of Treasury cash!

    From an insane person at CR:

    If anyone is interested the details of this bailout are here:….s/ j0105_06.sgml

    Obviously, the bottom line with the chrysler bailout, was that the people borrowing the cash had to agree to terms and negotiate a deal..


Sec. 8. // 15 USC 1867. // (a) The authority of the Board to extend
loan guarantees under this Act shall not at any time exceed
$1,500,000,000 in the aggregate principal amount outstanding.


Sec. 9. // 15 USC 1868. // (a) Loans guaranteed under this Act shall
be payable in full not later than December 31, 1990, and the terms and
conditions of such loans shall provide that they cannot be amended, or
any provision waived, without the Board’s consent.

    There was a friggn clock ticking on that deal, just as any deal, as with any mortgage, any CD^2, any cash flow related deal:

Sec. 9. // 15 USC 1868. // (a) Loans guaranteed under this Act shall
be payable in full not later than December 31, 1990, and the terms and
conditions of such loans shall provide that they cannot be amended, or
any provision waived, without the Board’s consent.

The Proposal Paulson is pushing has no friggn Clock!

  3. Anonymous

    I also have been having trouble with the web site the past couple of days. Sometimes it locks up my browser completely.

  4. Chris

    Thanks for posting this information> Is there any difference between what is identified here as "regulatory arbitrage" and the practices used to evade taxes? Though I suppose someone in one jurisdiction selling a product to a customer in another jurisdiction could easily make a convincing case about the level of their ignorance or whatever they call it.

    Again I think this just highlights the lack of application of law as well as regulation in this kind of financial practice. Ad victorem spolias! And such spoils, you've never seen spoils like these, let me tell you…

  5. francois-guillaume

    question to Yves or anybody…
    looking at the Leverage ratios figure from the table
    (for example barclays 60)

    are those numbers before taking into account AIG reinsurance or after (in that case, leverage would be even larger…)

    for example, if a bank has structured some CDO insured by AIG as a AAA asset to some investor, in its current balance sheet, it shows no asset, but if suddenly AIG fails, they should support that guarantee to the CDO investor at a loss… that of course would transform in a big loss, thats the main source of problem for all banks doing structured credit.

    do you have more info on who might be more affected among European names???

  6. Anonymous

    also i would like to make the following point, which is not stressed enough…
    there are 2 sides of the coin:
    we keep talking about bad debts, assets to be written down , of leverage which needs to be unwound, balance sheet reduction, hedge funds closures…
    the assets on their balance sheet is someone else debt. SIVs, CDOs, LBOs,ARSs were among the first debt mkt closed but for the system as a whole, if there is less buyer for debt, who will buy all the debt which needs to be rolled over, by banks, but also corporates, and even states…
    So far, auctions still happen.. paper is placed at ever higher spreads, but there we could go nearer to the stage that the old buyers are so impaired or not even there anymore, when the debt, even of the best issuers, wont be rolled over.
    So the hard-liners, laissez-faire, let them all fail, might prompt a real disaster.

  7. Been there

    AIG apparently sold a large volume of phony CDS insurance policies that underpriced the cost of the risk they were taking on –and- with the benefit of 20/20 hind sight, overestimated their ability to follow through on these commitments. I assume that these banks are now sitting on a huge pile of mbs assets that are no longer insurable, and therefore non-saleable. Naturally, this has caused a tremendous amount of uncertainty with regards to some of the European banks. IMHO, uncertainty is the major reason for the escalation of the current crisis. Uncertainty, caused by non-insurable collateral is what is now causing transaction velocity for certain asset classes to slow down to a crawl in financial markets. Financial firms that thrive on high velocity transaction volumes which are the power generators of their service and investment fees, find themselves now stuck with large inventories of high risk illiquid assets. Their continued ability to generate fees has been greatly constricted. They’re slowly choking to death.
    If these institutions are able to unload the problem assets onto the backs of the taxpayers at an inflated cost, they will be free to reinvest the bailout proceeds in more liquid assets, possibly treasuries or some other government insured securities. The bailout may turn out to be nothing more than a large number of one off transactions, where financial firms are rescued at the transaction level. However, there’s a good chance it does nothing to eliminate the uncertainty at the economy level, because whatever number of assets actually get purchased – there will still be a large number of uninsurable assets still stagnating out there.
    Where’s the guarantee that taxpayers won’t wind up paying interest expense on the bailout proceeds to the very people that caused the problem in the first place? Where’s the guarantee that the bailout proceeds will increase transaction velocity beyond a simple one and done scenario? Where’s the guarantee that the proposed bailout package will make a dent in market uncertainty beyond the actual assets that get purchased?

  8. realty-based lawyer

    AIG: yes, I figured the bank balance sheets were the reason for the AIG bail-out; putting all those assets back on would make it clear they were insolvent. These were the “negative basis” trades in which the bank bought a CDO/CLO tranche (normally AAA, but there were rumors AIG went further down the credit spectrum) and then hedged it with a CDS from a highly-rated counterparty, often a bond insurer or AIG, which was a huge player in that game. (Not from a hedge fund; their ratings weren’t high enough). Encouraged by the BIS and banking regulators in general, I might add, who explicitly permitted assets to be removed from banking books on this bases (see also FAS 133).

    Switching gears to the super-duper-so-called-$700-billion-bailout. Yves, do you know why no one (and I do mean no one, not even those hostile to the bailout) even mentions that this is a *revolving* facility, like a credit card? How much can you charge on a $700 billion credit card over two years? A huge amount, as long as you pay off your charges. Buy $700B today, sell them tomorrow for a 30% loss, buy another $700B on day 3, etc. At the end of a month you’ve lost $3.15 trillion. There’s nothing I know of to prevent that except the rather loose oversight provisions and, I suppose, the national debt limit; feel-good talk about holding the assets until their value recovers are just that, talk. I’m not saying, of course, that the losses would be $3.15 trillion/month; the system breaks down before then, and I don’t think that’s the intention. But there’s nothing to prevent it.

    This is designed to facilitate a massive bailout of Wall Street through fees, commissions and so on. Churning can be very profitable. It will bail out the chosen banks’ balance sheets too, of course. Banks that don’t sell will mark to the new Treasury bids (which should qualify under the new SEC/FASB clarification of fair value accounting),

    It won’t encourage the development of a private market. Who would buy at the prices the Treasury will pay? The Treasury will be the entire market. So there won’t actually be liquidity for the assets.

    I also agree with you and many others who don’t think it will actually solve the underlying problem. There isn’t the money (mostly, wages) to pay back the debt or support lending.

    But it will probably be adopted. That’s what happens when you only hear testimony from the Treasury and the Fed.

  9. Edwardo

    European banks are More wobbly than U.S. ones?

    This statement demands clarification since it would impossible to be more wobbly than the now dead
    Wamu and Wachovia for example?

  10. Steve

    AIG was in the same business as the monolines. As AIG is shrunk, it is unclear to me anyway how their CDS wraps can still be considered money good. AIG can meet its funding needs thanks to the Fed, but its balance sheet remains a sinkhole. Its derivatives book is unsaleable, and I think there’s been some pretty myopic optimism here. Of course, if assets AIG has wrapped wind up with the government, then the horrendous losses will come but in the next administration.

  11. Anonymous


    I’ve been having page-loading problems too. It takes much longer than it used to take for your blog to load. From what I can tell, it’s related to the Amazon ads.

  12. Yves Smith

    Sorry for the site performance. Have asked Ed Wright to look into it. The culprit is probably the Amazon ads, hopefully he will undo them soon.

    Again, apologies.

  13. Hamlet, Act 3, scene 2, line 230

    The lady doth protest too much, methinks.

    Why the keen interest in page loading? Perhaps Yves need to update security?

  14. Vaudt Varken

    Could it be that the high number for the ING Group is due to it being an insurance company as well? It is public knowledge here in Holland though that ING has kind of a lot of assets it still needs to write down.
    And Yves: great site, have been reading it daily for seven months or so.

  15. Richard Kline

    *aaaiiiiiEEEEEE* Eurobanks using CDSs as regulatory capital. . . . Why does it occur to me only now that human beings aren’t smart enough to manage their own finances?

    And reality based lawyer, the revolving nature of the Pigout Proposal _was_ actually noted by Yves and other commentators immediately upon presentation of the proposal. But with so many flaws and so little time this issue has fallen by the wayside. The nominal tranching of the funding authorization in the present Bill in Congress may impair this revolving nature, I forget, but I do not believe that this ‘feature’ {sic} was removed. It’s something like, if Paulson says he needs it, he can go there.

    —And still we have liberal commentators saying, well, we have to do something, so let’s pass this to kick the can down the road to ‘a better Administration’ (i.e. one the commentator has connections in). *ickkk* No, let’s not, and say we did: that will have exactly as much positive effect on the _insolvency_ crisis as passing the Pigout Proposal, i.e. none whatsoever.

  16. Anonymous

    I have a question for Yves or anybody, related to the upcoming Lehman ISDA auction on October 10th (ft article:
    From my understanding, Lehman had about 150 Billion $ of bonds oustanding when it defaulted and it is estimatd that there is (sandy Chen from panmure) 350 Bn $ of CDS contract written on Lehman. It was estimated in this FT article that recovery rate on the bond is between 15 to 19 cents on the dollar and so investors who wrote protection will pay 81 to 85 cents on the dollar. Meaning those investors will have to pay, let’s take 80cents on the dollar for 350 bn $, roughly 280 Bn $. So an additional 280 Bn $ losses for these unknown lehman CDS underwriters which are mostly banks, insurance companies and hedge funds. What sort of impact do you believe this losses could have? (keeping in mind that in absolute terms there is 0 loss to the market since the insured will get the CDS underwriters’s 280 bn $.)

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