Why AIG Gave Your Money To Other Banks

There’s been a big stink about how AIG has given a bunch of taxpayer money to other banks. Why why why, demand the American people. Well, it’s not like they enjoy shoveling money out the door, wait, scratch that, but anyway, the real reason is because of something called “collateral calls.” Marketplace’s Paddy Hirsch explains the situation with the help of his friends Mr. Magic Marker and Mrs. White Board in this video.

Collateral calls [Marketplace]


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  1. Redwraithvienna says:

    So if i get that right : The money isnt lost for AIG, IF AIG survives, and it will get the money back as soon as the insurance on the Bonds will run out, or they get a better Credit Rating, or the Company they insured gets a better Credit Rating.

    But : what happens if Goldman Sachs (for example) goes belly up ? Will AIG get the collateral back ? since as long as the insurance is good, the money doesnt really belong to GS but to whoever owns the Bonds ? or am i getting something wrong there.

    • Anonymous says:

      I was wondering the same thing. It sounds like AIG could eventually end up with a MASSIVE payday. And if it was a GM bond and you have the govt helping them out too…we are just paying for GM twice in that case. It sounds like the money is just circling and AIG is living off the spoils.

    • nybiker says:

      @Redwraithvienna: I think you have it correct. To use the examples in the video, as long as the bond issuer (GM) continues to pay the interest, all is good. The collateral calls are due to either AIG or GM’s credit ratings going down and the bondholder (Sam/GS) wanting to insure against not getting his $5M back. And Sam/GS doesn’t get the collateral if GS goes under, but rather the bondholder, whoever that might be if Goldman goes under, gets the collateral.

    • seishino says:

      @Redwraithvienna: 1. If AIG’s rating goes down, they have a massive liquidity freeze, which doesn’t help their short-term collateral position, but is actually a long-term neutral. That may very well be enough to bankrupt them again in the short-term, though. 2. If their insured property goes down, they have to pay out on the insurance. This is a legitimate expense which they don’t get back, and may be paying out on risk ratios taken on in the mid 2000’s. I.E. the risk of default now is much higher than it was. 3. If the company who bought the insurance defaults on the arrangement, AIG legitimately is owed the money that formed the collateral on the arrangement. However, they will likely have to fight bankruptcy courts for it. In a bankruptcy court, they will probably get pennies on the dollar.

      So AIG’s exposure here seems pretty large. It is nice that this money isn’t entirely disappearing into the void, and that even in a bad scenario the money is going to pay off potential future debts.

      But in the grand scheme of things STOP INSURING EACH AND EVERY RISK IN LIFE. If you do, be sure you are saving enough money from it that your institution can survive in bad times. Also if you do, be sure that doesn’t facilitate your customer companies taking greater and stupider risks with your money, without a consummate increase in premiums.

      • wardawg says:

        @seishino: “Yes, I would like the additional insurance. ‘Cause you’ve got a Ford Fiesta that’s about to see more airtime than a skateboard at the X-Games.” ~Jeff Foxworthy

        I agree entirely, I wish people would stop using insurance as a license to be an idiot.

    • Canoehead says:

      @Redwraithvienna: Here’s the thing – in most cases where AIG is required to post collateral, they have to post US Treasuries or something similar. So AIG is taking gov’t money, buying gov’t debt and then pledging it to secure its obligations. In a way this is good (well, less bad) because AIG is actually helping to stimulate the market for gov’t debt, which the gov’t needs so it can pay for all the bailouts plus all the other socialist utopia stuff from Pelosi and Obama.

      When AIG posts the collateral, it generally isn’t put in the hands of the counterparty – rather it would be held by some sort of custodian (i.e. a neutral party) – If the underlying company which the CDS insures does not default and the term of the CDS ends, AIG gets the collateral back. If the CDS is triggered, then AIG has to purchase the insured debt – if it does this, it gets its collateral back after it pays out. If Goldman goes bust, Goldman does not get the collateral, UNLESS AIG has “forfeited” it by defaulting on its own obligations -though those obligations would likely not end at Goldman’s bankruptcy, rather they would continue in the hands of the receiver until the term of the CDS ends. The sort of god news is that, as reckless as AIG was in writing a ton of CDS without any hedging (Soros had a great piece in the WSJ last week explaining AIG’s mispricing of CDS), not all – not even most – of the companies they insured are going to default. A lot are – far more than they anticipated – but not a majority, so most of that collateral will be coming back.

      In the next episode, I will explain their problems with GICs and PUAs.

    • sirellyn says:

      @Redwraithvienna: You guys are all assuming that a dollar now buys the exact same as a dollar in even 5 years from now. Even a dollar from 2004 buys a little more than 140% than it does now.

      There is WAY more money printing thats going on now. By a factor of 5 to 10 it seems. I wouldn’t count on any sort of payday. This is going to continue to be a disaster.

  2. MikeHerbst says:

    Can I just say that I love this whole Whiteboard series?

    Very informative for those of us who never paid much attention to anything beyond our own 401k until now!

  3. ReverendBrown says:

    Nice to see Paddy back. I missed him greatly. It left me badly in need of…

  4. Russell McLean says:

    @Redwraithvienna yes, I think you are right. However, in this example, with today’s announcement about GM and the fact the President has given them 60 days to avoid bankruptcy those bonds are on a very shaky footing. I think the bigger risk is not of Goldman Sachs going belly up but of GM going under. In that case the AIG bailout money is going to go to the bond holders who insured the GM bonds.

    It seems to be an ever descending spiral. The less money AIG has the more it has to pay in collateral which in turn causes it to have even less money.

    Now, if the government guarantees the GM bonds through bankruptcy then AIG will never have to payout and instead the insurance obligation moves to the taxpayer.

    • mac-phisto says:

      @Russell McLean: to expand though, AIG isn’t just out the money if GM goes belly up. they would retain the bonds in exchange for the payout. in a complete liquidation, bondholders & other secured creditors get first pickings at the leftovers. more likely, GM would be restructured. as part of the restructuring, interest payments are typically reduced & stretched over a longer time frame. in that case, AIG could still receive full face value of the bond, but will have to wait longer for the money.

      • Russell McLean says:

        @mac-phisto: Part of the restructuring I read about these days typically requires the bond holders to accept stock instead of the bond at a rate less than the cost of the bond. I think either way AIG is hurting.

      • Brawndo_The_Thirst_Mutliator says:

        @mac-phisto: So best case scenario, AIG gets the money, just over a long period with a lowered interest rate. How does this get offset with inflation or does that even come into play in this scenario? I mean, and I’m just trying to play devils advocate here, when the US govt took over AIG, we canceled all outstanding contracts, and re-wrote them, but only for agencies that were going to be AA rated at a minimum? That to me seems as if it would guarantee the return on the tax payers investment in a much quicker period, and allow AIG to get back on its feet and function on its own.

        On another note, I will be tracking my car insurance company’s credit rating, and when they fall I will call them up, demanding a collateral payment now.

        • mac-phisto says:

          @Brawndo_The_Thirst_Mutliator: the big issue, as i see it, with your idea is that essentially the gov’t would be saying that everything under AA is junk. this could cause the bond market to fall apart & have widespread effects throughout the nation (bear in mind that municipalities fund a large number of their major projects with bonds & i’d imagine AIG is insuring some of those as well).

  5. Skellbasher says:

    Since it’s bond insurance, it’s slightly less risky.

    Bonds are debt in the issuing company, and are higher up on the food chain for repayment in the event of a bankruptcy.

    In this GM example, should GM file for bankruptcy, AIG would be responsible for paying the balance on the insurance contract. However, AIG would then take ownership of the bonds. Bondholders are next in line after secured creditors, so bonds might end up getting paid out at 20-30% face value. AIG recoups some of it’s losses here, and depending on how long the premiums were paid on the insurance contracts, could possibly break even.

    Longer term, I think that a good portion of this money will end up coming back to AIG as the contracts come up.

  6. wwahammy says:

    Here’s what I don’t get. If the bond that AIG is insuring for Sam is riskier, why does AIG have to put up more money? If anything, Sam should have to pay more because for insurance because he’s insuring riskier assets.

    Did anyone else wonder about this?

    • shan6 says:

      @wwahammy: Because that’s the way the contracts were written. Once again it seems AIG was not a fan of forsight, or thinking that all good things come to an end.

      • ARP says:

        @shan6: Yes, it’s idiotic. An INSURANCE COMPANY seems to be assuming that nothing will go wrong and all large companies will thrive forever. I thought the whole point of an insurance company is to be conservative and assume a certain percentage of failure/payouts. They seems to overleverage themselve to the point that even a small dip in the market would cause them to pay huge amounts of money for Collateral Calls. I don’t get it.

        • mac-phisto says:

          @ARP: it seemed idiotic to me as well, but am i the only one that chuckled at the irony of it? c’mon, for once the insurance company is getting the squeeze instead of the other way around.


          • Brawndo_The_Thirst_Mutliator says:

            @mac-phisto: I would completely enjoy relishing in this moment with you, if it wasn’t actually the US tax payer who’s ending up paying for the squeezing. So, in other words, you’re still getting farked by an insurance company.

          • Canoehead says:

            @mac-phisto: Per Soros’ WSJ article [online.wsj.com] AIG thought that they were selling insurance, and that not everything could or would go wrong at once. They did not understand they were really selling bear warrants – a cheap way to short a company – which could be a volatile commodity in and of themselves. Politically I am 180deg from Soros, but he accurately diagnoses the problem, though I disagree with his cure.

    • Anonymous says:

      I think its due to the fact the bond is insured and part of that insurance is protection against downgrading of the bond. I agree though that while Sam is now wanting to insure a riskier asset he should pay more. When our car gets in a wreck, we get a collateral payment (to repair the vehicle),but our premium increase – why doesn’t the premium for a bond as well? Is bond insurance a bigger scam than the car insurance industry???

      • Canoehead says:

        @BrockCinyras: The premium would increase at the end of the current term – assuming anyone would ever issue a CDS on GM again – but for the length of the term, the price is fixed – and the collateral requirements are derived from the the insurer’s perceived ability to pay. You can crash your car multiple times – but you can only default on payment once (well, essentially).

    • David Schwartz says:

      @wwahammy: Because that’s exactly what Sam insured against. If you have fire insurance, and your house catches on fire, then the insurance company has to pay up during the life of the policy. Sure, when you go to renew your policy, you’ll pay more. But that’s a longer-term issue than the AIG problem.

      When Sam bought his insurance, both GM and AIG were very solid companies. Sam could have avoided paying AIG a penny, and felt pretty safe anyway. AIG never considered (!) the possibility that they would be downgraded, their risk analysis only looked at the possibility that the issuers would default.

      This should show why AIG was so profitable doing this. In the vast majority of cases, AIG doesn’t have to pay a penny. And people are willing to pay quite a bit for this insurance, because it gives them such an upside against both types of risk.

  7. monolithic says:

    Wow, this site is amazing. It has so much information. I’ve watched a bunch already.

  8. ARP says:

    The problem is that someone has to back those policies. If AIG fails to pay out on those policies, then numerous banks, pension funds, etc. will have even less money because they can’t collect collateral or get the actual payout. Banks with less money= less lending= economy slowing down.

    So why not let AIG fail and have the US government directly back those crap investments so they don’t get downgraded? It seems like we’re paying all these morans a ton of money just to send collateral call money to policy holders. We’re paying this enormous middle-man fee. The US government can step in an prevent Collateral Calls by backing these policies. If we can get some value back, get collateral, back, keep policy payments, etc. its ours to keep. I wouldn’t allow this long term, but its a short term solution to this mess.

  9. kaceetheconsumer says:

    I love Marketplace. I’m not an investor at all but I’ve learned so much about economical issues from that show over the years.

    Every time people these days claim they had no idea any of these problems were coming, I am annoyed, because I have been hearing commentators on Marketplace warn of these consequences for years. In particular, Robert Reich has gone on several rants over the years about bad mortgages being given out to those who cannot pay them (and sometimes can barely benefit from them, such as the interest-only mortgages), too much consumer credit, etc., always ending with a warning that the chickens will come home to roost.

    Then they did, and everyone acted surprised.

    How is it that I, a stay at home mom listening to Marketplace, had more of a clue of this crash coming than all the supposed experts on financial channels?

    Maybe Marketplace should be required listening for anyone with any kind of stake in the markets…

    • Canoehead says:

      @kaceetheconsumer: “In particular, Robert Reich has gone on several rants over the years about bad mortgages being given out to those who cannot pay them (and sometimes can barely benefit from them, such as the interest-only mortgages), too much consumer credit, etc., always ending with a warning that the chickens will come home to roost.”

      That is frakking hilarious give that the Clinton Admin’s tinkering with the CRA and its regs was one of the prime causes of the mortgage meltdown -and his buddy Robert Rubin was a huge force at Citi leading up to this disaster.

  10. litbruin says:

    How do I make this work on my car insurance. The thought of AAA paying me to keep insuring my car is mighty tantalizing.

  11. quizmasterchris says:

    None of these parties deserves one penny of taxpayer money. Isn’t risk supposed to be the capitalist mantra?

    AIG rolled the dice and lost. So did Goldman-Sachs, etc. So did the people who invested in Goldman-Sachs, and in GM. GM, the only party here making, useful, tangible goods, doesn’t deserve to survive in the marketplace if it isn’t profitable.

    People with under $100,000 in the bank are insured by the FDIC. People making massive speculative investment based in the labor of others should have to live with their gambling results.

    All of these “free market” idiots are proving what a tremendous fraud their capitalist “ideology” has been all of these years. The first whiff of trouble and they turn to the taxpayer (i.e. a perverted form of socialism) to bail them out, this on top of every conceivable corporate welfare hand-out they could take/bribe for, two decades of deregulation and the weakest taxes and union opposition in the industrialized world.

    Then these same people will argue with a straight face that low wages and no guarantees of health care or housing are the ways to make the poor work for a living! Apparently capitalist “risk” is only for people with no capital, people who create real wealth by working productively for a living.

    • Brawndo_The_Thirst_Mutliator says:

      @quizmasterchris: Actually us true free market thinkers are getting quite sick and tired being bunched together with these damn thieving commies. I would love nothing more, and Im sure you would as well, to take them out back, and put them to force labor camps to pay off what they have taken that wasn’t theirs.

  12. quizmasterchris says:

    Oh yeah, and I liked the whiteboard thing on the whole, but you’d think that if you were explaining something slightly complex with only three actors, you wouldn’t name two of the three “Sam!”

  13. Lucky225 says:


    That is all, kthx.

  14. ZukeZuke says:

    Liked the video. Very educational for us laypersons!

  15. JohnDeere says:

    you mean it has nothing to do with the fact that they are an insurance company and thats what insurance companies do?

  16. Anonymous says:

    I think it’s abhorrent that out of 182 billion in bailout money, more than half of it went to foreign banks. Collateral calls or not, 100 billion of American taxpayer money went to pad rich European bank accounts. If we had simply let AIG fail, 182 billion dollars would have been back in the economy. Yet people still whine about 100 million in bonuses. Big whoop.

  17. squablow says:

    So if these companies with bonds can be kept afloat long enough to become profitable again, or at least, long enough for their bonds to mature, then the collateral will be repaid to AIG who could then repay it to the government.

    Of course, if a large enough number of bond-issuing companies do go bankrupt/default on their bonds, then the collateral is lost to the original bondholders and AIG can’t repay the money to the government.

    Geez, I watched a 7 min video and suddenly I have a new understanding of what the “bailout” was for and how it could possibly work and could possibly fail.

  18. chrisjames says:

    Well, it still is a “backdoor bailout.” The government money-monkeys don’t give a crap about AIG. They know that all the banks holding on to crummy bonds like this are trying to stay solvent with those collateral payments. AIG’s purpose is to funnel money, and if AIG collapses, the banks will be left holding all the risk. The O-Team needs to get to work on threatening AIG to restructure, too.

    Jesus Christ! what a messed up idea. Dig in with risk, then insure it, then fiddle with the insurance so that it immediately pays out as the risk increases. In the end, there is no risk whatsoever… except on the part of AIG, who gladly took in all these contracts. Morons.

    • Canoehead says:

      @chrisjames: To be clear, I am pretty sure that accounting rules do not allow you to book money that is pledged to you to secure a contingent obligation. I am sure that Goldman feels better with AIG’s collateral pledges, but it does not actually improve their capital position (though it would help their risk analysis).