Sunday, September 21, 2008

My Sunday Feeling

I got the text message from a friend of mine who works in insurance defense. Actually, it's more complicated than that and it pisses him off when I refer to him as an insurance defense lawyer but he works for really large insurance companies helping them to avoid paying claims.

So I really paid attention to the text message that came in from North Carolina earlier in the week: "AIG going down."

This was indeed a breathtaking concept. AIG is huge. It has assets in the trillions. It manages an investment portfolio worth 750 billion in the United States alone.

So how could AIG be in trouble? Here's how as I understand it. Not being sufficiently content to make money by the wheelbarrowfull by doing what it was good at-namely the insurance business-,it evidently decided that it needed to become a player in the real estate boom in the US. AIG insured debt obligations that were tied to mortgages. And we know how good things have been in the mortgage backed securities world. AIG recorded losses of over 13 billion because of these obligations. AIG was a counterparty to an untold number of transactions involving banks and hedge funds. If it couldn't make good on its obligations the effect would have been disastrous.

It is indeed a sign of just how shaky AIG's cash flow was last week when they couldn't find any other lender who would give them a loan to bail themselves out of this short term fix. So they turned to Uncle.

Let's step back a minute and take a look at what caused this mess in the first place. There was a time when real estate loans were considered the safest loans a lending institution could make. The borrower applied for a loan. His finances were checked out. He had to have a pretty good down payment. The collateral he offered to secure was appraised. If everything checked out the loan was closed and the bank serviced the loan all was well with the world.

The problem was that it was really hard for lenders to get really rich doing plain vanilla lending. So they concentrated on getting deals done in order to get the fees knowing that they were going to sell the paper to some other downstream entity who would actually service the indebtedness. This downstream lender would then bundle these mortgages, the good the bad and the ugly into mortgage backed securities which would be sold on the market. Or they would be essentially "lent" for a fee to speculators who would basically trade them to themselves after getting guarantees from-guess who-outfits like AIG.

Everything was copacetic so long as real estate prices kept soaring. Loans that went bust were covered at foreclosure. And the money would keep coming from the "good" mortgages that were bundled in with the not-so-good or "not worth shit" mortgages out in the mortgage backed securities world.

But the cost of running two wars at once along with soaring gas prices caused real estate to tank. Which caused mortgage holders to be upside down. Which caused them to make claims on the guarantees.

Which put us in the current fix we are in right now.

But let us be clear about something. The financial system is not in a state of imminent collapse. AIG had a short-term liquidity problem. It was not insolvent. But if AIG could not have honored its guarantees, then an already frigid system of credit would have locked up considerably worse.

Let's be clear about something else. The government didn't just throw 85 billion at AIG. It is essentially a bridge loan, albeit at murderous rates, and with an 87% equity stake in AIG in addition to a secured position in AIG's hugely profitable insurance business. AIG may not even need the entire loan as it liquidates its considerable assets to raise capital.

Are your accounts at the bank safe? Yes, just so long as you don't exceed $125,000 per account ($250,000 in a joint account). Will you be able to get a loan? Probably, if you are creditworthy and have a down payment. For example, I redid my home equity line of credit to borrow an additional 10 grand. I did it over the phone with my banker. It was not a problem.

But will everybody be able to get a housing loan? I think the answer in the near term is clear: No. Which is certainly a sad thing in a certain sense.

But it is a good thing in the sane lending practices sense.


Melissa said...

Part of this guy's practice is to help insurance companies in insolvency. Here is what he had to say about the whole thing.

Polycarp said...

Your description of our clients and the highly specialized work we do for them is of course inaccurate and childishly oversimplified. Nevertheless, the collapse of AIG proves the case for federal regulation of the financial markets to a fare-thee-well. It also demonstrates that the insurance industry's exemption federal regulation is due to end. There is no way that any particular state, any combination of states, or all of them together, could have prevented this, and it should have been prevented.

tmfw said...

Your libeous observations notwithstanding, I agree w/your atypically prescient prediction that the McCarren Act will be someday repealed or modified.

Hell, my insurance man is all the time trying to get me to buy "products" like 401ks and car loans.