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Amherst is just doing what AIG should have been doing all along.

AIG sold insurance on bonds. If the bonds defaulted, AIG pays up. Except, this is special insurance...called a derivative...also known as a credit default swap.

And because it’s special, people in addition to the original lender can buy it.

With normal insurance, only say...a homeowner can purchase fire insurance on her house.

...but with credit default swap insurance, your neighbors and friends can each purchase fire insurance on *your* house.

So multiple credit default swap insurance policies can be sold for the same house. If your one house burns down, then AIG has to pay each of your friends full face value for your house; multiple payoffs.

Amherst did the math and saw that was silly. There were 5 brokerages on Wall Street betting that these circa 2005 Lehman sub-prime mortgages would default, so Amherst sold 5 insurance policies.

Wall Street was so certain that these loans would default that they were paying 90% of the home mortgage value as their insurance premium to buy the credit default swaps.

5 * 90% = 450% of face value.

Amherst then bought the mortgages and paid them off with their own money. Thus, the deadbeat homeowners couldn’t default...they got their houses for free.

And Amherst got 450% of the face value of those toxic sub-prime loans by selling so many credit default swap insurance derivative contracts to the brainiacs on Wall Street.

Easy money. Amherst *knew* that those loans couldn’t default because Amherst was buying them.

Well, that’s how AIG’s derivatives should have been handled.

Instead, the Fed paid off all of AIG’s contracts. That’s like paying out Amherst’s 450% above due to being too stupid to know to just buy the discounted loans.

Ron Perelman played a criminally brilliant variation of this game some years back with Revlon bonds, only he actually *did* own the underlying asset. Made himself a tidy half billion or so. Bought a controlling (actually consolidating) interest in Revlon’s stock, artificially ran up the price of the stock with a lot of fraudulent sales figures (er, I mean “innovative accounting methods”), sold about $1 billion in bonds backed by the Revlon stock he owned while the stock was flying high, then let the truth about the sales figures come out. Stock tanked, bonds tanked, and he bought back all the bonds at about 50 cents on the dollar — but of course he still had the original billion from the bond issue to buy them back with, so the difference was his profit.

I classify Perelman as a criminal (notwithstanding the fact that he’s never actually been convicted of anything), but the people who bought these bonds were so stupid they shouldn’t be allowed to have money, and Perelman made it so.

Thanks for that explanation, it makes sense now.

This reminds me of the Insurable Interest clause in life insurance. Simply: “If you want to buy a life insurance policy on someone else’s life, you must have an interest in that person remaining alive, or expect emotional or financial loss from that person’s death. This is called an insurable interest. Without this requirement, it would be very easy to make a living by purchasing life insurance policies on elderly strangers, and then collecting the proceeds when they died. The insurable interest requirement also prevents people from buying a life insurance policy on someone and then causing or hastening that person’s death.”

There’s a reason the insurance industry is heavily regulated — it’s to keep crap like this from happening. When selling what amounts to insurance, the financial industry should be regulated as well.

"So multiple credit default swap insurance policies can be sold for the same house. If your one house burns down, then AIG has to pay each of your friends full face value for your house; multiple payoffs."

I think the whole deal with the financial meltdown, at the top, was that the insurance contract (swap) was for "market value of a derivative of mortgage bonds" not face value.

When the crunch came, the insurers stood to say "the value is 10% because no one is buying". The entire meltdown transpired because Uncle Sam or whoever changed to mark to market and there was no market.

Nothing could be settled short of court which never transpired, no one could value their assets, credit and lending collapsed, financial markets came to a standstill, .

yitbos