Posted on 03/30/2009 1:32:27 PM PDT by iThinkBig
Zero Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turn keeps on duping U.S. taxpayers into believing everything is good.
I present the insider perspective of trader Lou (who wishes to remain anonymous) in its entirety:
AIG-FP accumulated thousands of trades over the years, all essentially consisted of selling default protection. This was done via a number of structures with really only one criteria - rated at least AA- (if it fit these criteria all OK - as far as I could tell credit assessment was completely outsourced to the rating agencies).
Main products they took on were always levered credit risk, credit-linked notes (collateral and CDS both had to be at least AA-, no joint probability stuff) and AAA or super senior portfolio swaps. Portfolio swaps were either corporate synthetic CDO or asset backed, effectively sub-prime wraps (as per news stories regarding GS and DB).
Credit linked notes are done through single-name CDS desks and a cash desk (for the note collateral) and the portfolio swaps are done through the correlation desk. These trades were done is almost every jurisdiction - wherever AIG had an office they had IB salespeople covering them.
Correlation desks just back their risk out via the single names desks - the correlation desk manages the delta/gamma according to their correlation model. So correlation desks carry model risk but very little market risk.
I was mostly involved in the corporate synthetic CDO side.
During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever."
As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks - effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities - run a chart from say last September to current of say S&P 500 and Itraxx - credit has underperformed massively. This is largely due to AIG-FP unwinds.
I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period.
For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman's terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.
In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).
What this all means is that the statements by major banks, i.e. JP Morgan Chase (JPM), Citi (C), and BofA (BAC), regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.
For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this "one time profit", which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers' money flows into the market. If the administration is truly aware of all these events (and if Zero Hedge knows about it, it is safe to say Tim Geithner also got the memo), then the potential fallout would be staggering once this information makes the light of day.
And the conspiracy thickens.
Thanks to an intrepid reader who pointed this out, a month ago ISDA published an amended close out protocol. This protocol would allow non-market close outs, i.e. CDS trade crosses that were not alligned with market bid/offers
The purpose of the Protocol is to permit parties to agree upfront that in the event of a counterparty default, they will use Close-Out Amount valuation methodology to value trades. Close-Out Amount valuation, which was introduced in the 2002 ISDA Master Agreement, differs from the Market Quotation approach in that it allows participants more flexibility in valuation where market quotations may be difficult to obtain.
Of course ISDA made it seems that it was doing a favor to industry participants, very likely dictating under the gun:
Industry participants observed the significant benefits of the Close-Out Amount approach following the default of Lehman Brothers. In launching the Close-Out Amount Protocol, ISDA is facilitating amendment of existing 1992 ISDA Master Agreements by replacing Market Quotation and, if elected, Loss with the Close-Out Amount approach.
"This is yet another example of ISDA helping the industry to coalesce around more efficient and effective practices, while maintaining flexibility," said Robert Pickel, Executive Director and Chief Executive Officer, ISDA. "The Protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances."
And, lo and behold, on the list of adhering parties, AIG takes front and center stage (together with several other parties that probably deserve the microscope treatment). So - in simple terms, ISDA, which is the only effective supervisor of the Over The Counter CDS market, is giving its blessing for trades to occur (cross) below where there is a realistic market bid, or higher than the offer. In traditional equity markets this is a highly illegal practice. ISDA is allowing retrospective arbitrary trades to have occurred at whatever price any two parties agree on, so long as the very vague necessary and sufficient condition of "market quotations may be difficult to obtain" is met. As anyone who follows CDS trading knows, this can be extrapolated to virtually any specific single-name, index or structured product easily. In essence ISDA gave its blessing for below the radar fund transfers of questionable legality. The curious timing of this decision and the alleged abuse of CDS transaction marks by and among AIG and the big banks, is striking to say the least.
This wholesale manipulation of markets, investors and taxpayers has gone on long enough.
"The concept of fake asset pricing goes over the head of most people. That's why financial institutions love it so much. They can do what they like without looking like outright liars and crooks.
When Goldman said they didn't need AIG to pay them I couldn't stand but laugh. They claimed all their positions were hedged. Probably so, by a another slew of faltering insurers who can't hope to cover their derivatives obligations. And then, probably after the fact AIG was going bust."
The concept of fake asset pricing goes over the head of most people. That’s why financial institutions love it so much. They can do what they like without looking like outright liars and crooks.
Wholesale manipulation of markets, investors and taxpayers has gone on long enough.
I agree.............now what?
The terms are complex. The traders have no idea what they are trading either, I’d guess, much beyond the commission structure and some blurby idea of what the valuation model is.
Purchasers and the banks “agree” on a price, and the purchasers come up with 1/12th of the capital, with taxpayers on the hook for the rest.
Because these deals are so leveraged, any decline in the alleged value of the asset means taxpayers take huge losses, even while banks get paid off and private investors essentially walk away.
Lost by the third paragraph. Is there a financial wizard out there that speaks English?
Yes, I was telling friends some weeks ago that the Taxpaper money is being funneled to banks and Goldman Sachs thru AIG
“Some of the terms are a bit complex”
Complex indeed. You nearly have to be an Insider to know wth they’re talking about.
Keywords that make you think SCAM: AIG, GoldmanSachs, government, congress, Obama, Geithner,
AIG has a blank check from the government. Banks on the other hand are still a political football and the Goverment can’t give them any more money right now.
Rather then give money directly to banks they gave it to AIG who gave it to the Banks in the form of pay outs on contracts that they were the counterparty on.
I believe each state has an Attorney General and the ability to be heard by the U.S. Supreme Court for our protection. So if this is the case whats the hold up?
And just wait until AIG has to start paying off CDS made in the name of GM.
AIG knew they were about to take it in the shorts on the credit default swaps where banks were the counterparties, they also knew they were fixing to get taxpayer $$, so they passed that $$ to the banks. We the taxpayers paid into AIG. The banks recently posted VERY good numbers in the first third of this depression. Their stock prices went up ... now they are crashing.
All in all the taxpayers and the small investors in the country are getting RAPED.
The point is way over-hyped here, but basically the problem is that AIG is at the mercy of all of the other big trading desks out there.
AIGFP is locked into a huge number of trading positions. Everyone on the street knows that they are winding down their positions, meaning they are at a bargaining disadvantage.
They have been trying to hold onto their derivative traders in order to wind these down in an orderly manner (see AIG Bonus Fiasco), but I gather that it has dawned on AIG management that the prospect of doing that looks slim with politicians using them as a political football and with their derivative traders running for the door.
So, it’s a fire sale. And to move their merchandise, AIG is asking quotes on large chunks at a time of their trading portfolio, rather than just an individual trade. And no surprise, profits are to be had by the banks looking over the merchandise, knowing they have AIG over a barrel. AIG would do a lot better to outsource the portfolio to other firms to wind down, giving them an economic incentive to maximize value, but that isn’t politically feasible. The current employees probably are not very motivated to maximize value. Also there is the possibility of conflicts of interest if AIG traders are doing deals with banks whom they are hoping to get a job with.
In theory it is possible with patience over a long period of time to unwind the positions with minimal loss. You may remember the giant hedge fund Long-Term Capital Management, the bail-out consortium was actually successful in that case at doing just that.
Think of it like this ...
The government decides to rescue Microsoft because they’re in huge financial trouble and too big to fail. It costs Microsoft $50 to make each box of software that sits on a store shelf somewhere.
Microsoft knows they’re going to keep getting taxpayer money as long as they need it. So they sell all of the boxes they currently have in stock to the retailers: Best Buy, Circuit City, Walmart, Target, etc. for $10 each. The government sends Microsoft a check to cover the $40 per box that Microsoft is going to lose on that software.
The retailers then sell those boxes of software for $100 - $150 each. The retailers then report huge profits for the quarter during which this all happens.
But next quarter, they won’t be able to purchase boxes of software from Microsoft for $10 each. They’ll have to purchase it for $75 each. So they won’t be as profitable next quarter, but nobody cares about that right now.
Hey! Look! The retailers are profitable everybody. Things are looking up! Wall Street rallies. Investors sink money into the market. Retailers send dividend checks to their shareholders because they were profitable that quarter. (And by the way, Microsoft and those retailers donated tons of money last year to the political campaigns of the legislators who decided the government could write that check to Microsoft.)
The government said nothing. They didn’t suggest that Microsoft sell the software for more than $10 each. They simply handed Microsoft a check for whatever amount they lost.
Next quarter - uh-oh! The retailers aren’t profitable. Investors lose money because the markets are down. Shareholders own stock that’s worth way less than last quarter.
Microsoft gots its money. The retailers got their money. (The politicians already got their money and will probably get more next election cycle.)
And the money that everybody got came out of our pockets.
‘In theory it is possible with patience over a long period of time to unwind the positions with minimal loss. You may remember the giant hedge fund Long-Term Capital Management, the bail-out consortium was actually successful in that case at doing just that.’
Sure in theory it is, but how much return will be left for taxpayers after $2 T of counterparty fees are paid to wind down the $60 T in derivatives? Doesn’t leave too much for recovery just the $12 T - $15 T in debt. Yep, life will be wonderful in 2012 when U.S. loses it’s reserve currency peg and a loaf of bread is $10 as is a gallon of gas. I am civilized and not an advocate, but I do believe we will see a repeat of 1820 hanging scenerio for particular bankers. Unfortunately for those whom continue now to fleece the global taxpayer (at least the 2/3 of the that peg to dollar) there will be no safe place on earth.
Buckeye Texan, this was a perfect explanation to this audience, I thank you.
Well, perhaps I should have said: “And the money that everybody got is going to come out of our pockets, our children’s pockets, and our grandchildren’s pockets ...”
But thanks, I tried. :)
What is so frightening is that only a handful of people know what's going on so the con is a snap.Obama doesn't understand this stuff. Congress doesn't understand this stuff and the tax payer certainly doesn't understand this stuff. So, who's the sheriff? The con is so sophisticated that NOBODY knows whats going on! Yet the bill lands at the Treasury...
“Well, perhaps I should have said: “And the money that everybody got is going to come out of our pockets, our children’s pockets, and our grandchildren’s pockets ...”
But thanks, I tried. :)”
I see you have wisdom as well, for many in Washington and media say that this problem will our children and grandchildren’s problem. The cheque is already coming due in increments, notably in energy already.
For someone who claims to “think big” you sure do miss the big picture.
It’s not the inefficient unwinding of their trading portfolio nor the bonuses to traders that is the big picture in the AIG bailout.
AIG’s 2007 annual report: “Approximately $379 billion of the $527 billion in
notional exposure on AIGFP’s super senior credit default
swap portfolio as of December 31, 2007 were written to
facilitate regulatory capital relief for financial institutions primarily in Europe.”
A hole in the equity of the European banks to the tune of hundreds of billions of dollars. And that is just the CDS portfolio, that is not ALL of the trades of AIG with the European banks. If AIG had gone under who knows how big the hole in the European banks would have been. Massive bank runs and failure of the major European banks?
The AIG bailout was in essence a second Marshall plan for the banks of Europe. I hope Mr. and Mrs. U.S. Taxpayer aren’t holding their breaths waiting for the Europeans to thank them.
But go ahead, bleat on about inefficient unwinding of AIGFP trades or bonuses paid out to traders (which are not the major contributors to inflation), while Uncle Sam holds you upside down and shakes out your pockets to bail out, once again, Europe.
This article was in news, but is now in bloggers/personal with no categories. If the move wasn’t intentional, can we get this moved back to news? Just curious.
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