Drinking at noon with AIG

In a rare moment of clarity (after roughly beer 23) last weekend it hit me how really down right criminal the behavior of some of the execs at AIG has been. Their massive exposure to Credit Default Swaps essentially bankrupted a company that had been built over hundred years of safe/responsible choices. In the 4th quarter of 2008AIG lost over 450k per minute!! It is really staggering when you think about.

On Saturday afternoon I was sitting at a table with some friends. I had given one of them a few bucks I had owed him from the last time we hung out. Roughly 1.7 seconds later a different friend then borrowed money from the person who I had just paid back. I jokingly said "I just should have given W the money".

My friend then laughed and said "I know right?".

In an instant the entire credit default swaps market became clear to me. There were 6 of us at this table, enjoying the NCAA tournament on a sunny Sad'day afternoon and I came up with the following scenario. Imagine if 4 of the 6 people, lets call them Holden, Granby, Palmer, and W had all needed to borrow money that day from my friend Matty Bayonne for whatever reason.


So Bayonne lends each person at the table 100k but he is a little worried about their ability to pay this money back b/c after all they are drinking at noon on Saturday and gambling on basketball. Bayonne wants protection in the event those 4 default (de fault the two sweetest words in the English language as Homer Simpson once said), so I offer him this protection for a fee of course, let's say 10%. So Bayonne has 400k out in loans and he pays me forty thousand and in the event any of them default I will then have to pay him the balance on their loan.


Bayonne now feels "insured", and feels it is guaranteed he is going to get the money he loaned out back no matter what happens. Problem is Bayonne is not too bright, and a little greedy, so he goes off and lends 100k to six more strangers in this bar, and again buys protection from me at 10%. So he has now lent 1 million dollars to people who have an affinity for the drink and he has no idea how they will pay it back, but he doesn't care. He feels safe b/c he has protection in the form of a credit default swap from me. After all he has now paid me 100k to guarantee this million dollars in loans. Ultimately a few of these people default, not a real surprise since Bayonne never even bothered to ask them if they had jobs. Holden and Granby are the only ones to pay him back so he comes looking to me for the other 800k. One major problem, I don't have 800k, never did. No one thought to ask me, or check to see if I could guarantee all these loans so I need a government bailout to pay him otherwise we both go bankrupt. And the best part of it all, I get to keep the 100k he paid me while the government writes the check to him for making loans he had no business making in the first place.



As ridiculous as this scenario sounds, this is exactly what AIG and many of the failed banks did, and it blows my mind. There is no way I would be allowed to write a million dollars in guarantees, after all I was there drinking at noon time too and don't have assets coming anywhere near that amount. Imagine this on a scale one million times the size, and one conclusion is maybe Joe Cassano ( one head of AIGFP) was also hitting the bottle early and often when he devised his credit default swaps. If you want to villanize someone/something, and lets face it we all do, villanize Cassano.

These banks wrote so many bad loans b/c they didn't "know" their borrowers any better than Matt "knew" the people in the bar. Many times they never verified their income, or if they even had a job. Sometimes they even went as far as to count unemployment as income, if they ever took the time to verify it at all. When the borrowers defaulted these banks went looking to AIG who had "insured" these loans and surprise surprise AIG didn't have the money or the assets to back their guarantees so they needed a bailout. The government allowed AIG to write credit default swaps without having the money or the assets to back them, and then left us(the taxpayers) holding the bag. And the real kick in the teeth, we raised taxes on Holden and Granby who were the only two people to pay back their loans in the first place!

AIG had no business doing what they did. I am as big a free market capitalist as there is, but what Cassano and AIG did was more akin to throwing dice at a craps table, hoping and praying he would never crap out, but with one significant difference. Cassano was playing with OPM (other peoples money) and we all know it's not gambling when its not your money. Cassano made hundreds of millions of dollars during the CDS run up days, and when he finally crapped out it cost him nothing. He kept all the money he made and was even kept on at AIG as a one million dollar per month consultant. AIG soon imploded, and had to receive billions and billions in bailout money. At its height one share of AIG stock was worth almost 73.00 dollars, as recently as this month it was worth less than 50 cents. I'm starting to think the AIGFP credit default swap group must also have been in the bar at noon most days.