When AIG first faltered, there were two companies jammed under one roof. One was a highly regulated, state supervised, life insurance company. In fact, the biggest such firm in the world.
The other firm was an unregulated structured finance firm, specializing in credit default swaps and other derivatives.
The first firm was Triple AAA rated. They had a long history of steady growth, profitability, excellent management. They made money (as the commercial goes) the old fashioned way: They earned it.
This half of the company held the most important insurance in many families’ financial lives: Their life insurance. When an AIG policy holder passed away, the company paid off the policy, providing monies that are used to pay off mortgages, kids colleges, and surviving spouses life time living expenses. Given the importance of this payment, one can see why it is crucial to make sure there are sufficient reserves to make good on the promise of the life insurance policies. The actuarial tables used were conservative, the accounting transparent. The policy payoffs rock solid, utterly reliable.
AIG, this insurance company, was well run. It made a steady income, provided a valuable service to its clients.
It was also very solvent.
The other part of the firm was none of the above. It was neither regulated nor transparent. It existed only in the shadow banking world, a nether region of speculation and big bets on derivatives. This part of the company engaged in the most speculative of trading with hedge funds, banks, speculators, gamblers from around the world. Huge derivative bets were placed, with billions of dollars riding on the outcome. It served a far more limited societal function than the Life insurance portion, other than a legal pursuit of profit.
This part of AIG was nothing more than a giant structured finance hedge fund. Despite the fact this hedge fund had no rating, no supervision or oversight, it managed to trade off of the Triple AAA rating of the regulated half of the firm. Somehow, it wastreated as if it was Triple AAA, regulated and guaranteed by the government.
This was nothing more than a giant scam, perpetrated by the people who were running the AIG hedge fund.
It was exempt from any form of regulation or supervision, thanks to the Commodities Futures Modernization Act. This ruinous piece of legislation was sponsored by former Senator Phil Gramm (R), supported by Alan Greenspan (R), former Treasury Secretary (and Citibank board member) Robert Rubin (D), and current presidential advisor Larry Summers (D). It was signed into law by President Clinton (D). It was the single most disastrous piece of bipartisan legislation ever signed into law.
As you might have guessed by now, this portion of AIG is the INSOLVENT half.
here is th question that every single taxpayer should be asking themselves: WHY AM I PAYING $1000 TO BAIL OUT THIS GIANT HEDGE FUND?
Of all the many horrific decisions that Hank Paulson made, this may be the worst. A very special description, given his track record of incompetence and cluelessness.
What should have been done?
Simple: When we nationalized AIG, we should have spun out immediately the good, solvent life insurance company. The hedge fund should have been wound down in an orderly fashion. Match up the offsetting trades, the rest go to zero. End of story.
You as a credit default swap gamblor have no reaosnable expectation that anyone is going to make good on your bets with another hedge fund. That is was under the roof of a legitimate insurance company is irrelevant.
Right now, we are into this clusterfuck for $166 billion, an every last penny of it is needless waste.
Taxpayers should not be bailing out hedge fund trades. This garbage must insanity immediately.
Originally published at The Big Picture blog and reproduced here with the author’s permission.