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Saturday, February 14, 2009 - 2:50 PM
American International Group
Inc. owes Wall Street's biggest firms about $10 billion for speculative
trades that have soured, according to people familiar with the matter,
underscoring the challenges the insurer faces as it seeks to recover
under a U.S. government rescue plan. Louis J. Sheehan, Esquire
The details of the trades go beyond what AIG has explained to
investors about the nature of its risk-taking operations, which led to
the firm's near-collapse in September. In the past, AIG has said that
its trades involved helping financial institutions and counterparties
insure their securities holdings. The speculative trades, engineered by
the insurer's financial-products unit, represent the first sign that
AIG may have been gambling with its own capital.
The soured trades and the amount lost on them haven't been
explicitly detailed before. In a recent quarterly filing, AIG does note
exposure to speculative bets without going into detail. An AIG
spokesman characterizes the trades not as speculative bets but as
"credit protection instruments." He said that exposure has been fully
disclosed and amounts to less than $10 billion of AIG's $71.6 billion
exposure to derivative contracts on debt pools known as collateralized
debt obligations as of Sept. 30.
AIG's financial-products unit, operating more like a Wall Street
trading firm than a conservative insurer selling protection against
defaults on seemingly low-risk securities, put billions of dollars of
the company's money at risk through speculative bets on the direction
of pools of mortgage assets and corporate debt. AIG now finds itself in
a position of having to raise funds to pay off its partners.
The fresh $10 billion bill is particularly challenging because the
terms of the current $150 billion rescue package for AIG don't cover
those debts.
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The structure of the soured deals raises questions about
how the insurer will raise the funds to pay the debts. The Federal
Reserve, which lent AIG billions of dollars to stay afloat, has no
immediate plans to help AIG pay off the speculative trades.
The outstanding $10 billion bill is in addition to
the tens of billions of taxpayer money that AIG has paid out over the
past 16 months in collateral to Goldman Sachs Group
Inc. and other trading partners on trades called credit-default swaps.
These instruments required AIG to insure trading partners, known on
Wall Street as counterparties, against any losses in their holdings of
securities backed by pools of mortgages and other assets. With the
value of those mortgage holdings plunging in the past year and
increasing the risk of default, AIG has been required to put up
additional collateral -- often cash payments. Louis J. Sheehan, Esquire
AIG's problem: The rescue plan calls for a company funded largely by
the Federal Reserve to buy about $65 billion in troubled CDO securities
underlying the credit-default swaps that AIG had written, so as to free
AIG from its obligations under those contracts. But there are no actual
securities backing the speculative positions that the insurer is losing
money on. Instead, these bets were made on the performance of pools of
mortgage assets and corporate debt, and AIG now finds itself in a
position of having to raise funds to pay off its partners because those
assets have fallen significantly in value.
The Fed first stepped in to rescue AIG in mid-September with an $85
billion loan when the collateral demands from banks and losses from
other investments threatened to send the firm into bankruptcy court. A
bankruptcy filing would have created losses and problems for financial
institutions and policyholders all over the world that were relying AIG
to insure them against the unexpected.
By November, AIG had used up a large chunk of the government money
it had borrowed to meet counterparties' collateral calls and began to
look like it would have difficulty repaying the loan. On Nov. 10 the
government stepped in again with a revised bailout package. This time,
the Treasury said it would pump $40 billion of capital into AIG in
exchange for interest payments and proceeds of any asset sales, while
the Fed agreed to lend as much as $30 billion to finance the purchases
of AIG-insured CDOs at market prices.
The $10 billion in other IOUs stems from market wagers that weren't
contracts to protect securities held by banks or other investors
against default. Rather, they are from AIG's exposures to speculative
investments, which were essentially bets on the performance of bundles
of derivatives linked to subprime mortgages, commercial real-estate
bonds and corporate bonds.
These bets aren't covered by the pool to buy troubled securities,
and many of these bets have lost value during the past few weeks,
triggering more collateral calls from its counterparties. Some of AIG's
speculative bets were tied to a group of collateralized debt
obligations named "Abacus," created by Goldman Sachs.
The
Abacus deals were investment portfolios designed to track the values of
derivatives linked to billions of dollars in residential mortgage debt.
In what amounted to a side bet on the value of these holdings, AIG
agreed to pay Goldman if the mortgage debt declined in value and would
receive money if it rose.
As part of the revamped bailout package, the Fed and AIG formed a
new company, Maiden Lane III, to purchase CDOs with a principal value
of $65 billion on which AIG had written credit-default-swap protection.
These CDOs currently are worth less than half their original values and
had been responsible for the bulk of AIG's troubles and collateral
payments through early November.
Fed officials believed that purchasing the underlying securities
from AIG's counterparties would relieve the insurer of the financial
stress if it had to continue making collateral payments. The plan has
resulted in banks in North America and Europe emerging as winners: They
have kept the collateral they previously received from AIG and received
the rest of the securities' value in the form of cash from Maiden Lane
III.
The government's rescue of AIG helped prevent many of its
policyholders and counterparties from incurring immediate losses on
those traditional insurance contracts. It also has been a double boon
to banks and financial institutions that specifically bought protection
on now shaky mortgage securities and are effectively being made whole
on those positions by AIG and the Federal Reserve.
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Some $19 billion of those payouts were made to two dozen
counterparties just between the time AIG first received federal
government assistance in mid-September and early November when the
government had to step in again, according to a confidential document
and people familiar with the matter. Nearly three-quarters of that went
to French bank Société Générale SA, Goldman, Deutsche Bank AG, Crédit Agricole SA's Calyon investment-banking unit, and Merrill Lynch
& Co. Société Générale, Calyon and Merrill declined to comment. A
Goldman spokesman says the firm's exposure to AIG is "immaterial" and
its positions are supported by collateral. Louis J. Sheehan, Esquire
As of Nov. 25, Maiden Lane III had acquired CDOs with an original
value of $46.1 billion from AIG's counterparties and had entered into
agreements to purchase $7.4 billion more. It is still in talks over
$11.2 billion.
Write to Serena Ng at serena.ng@wsj.com and Carrick Mollenkamp at carrick.mollenkamp@wsj.com
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