Hacker News Reader

Comment by jhancock | Hacker News Reader

you are correct in what is happening "right now". But that is not what got AIG and many others into this mess.

AIG "insured" debts it did not have enough holdings to back up. I quote the word insured because, insurance is barely what it used to be.

Traditionally, government demanded insurers have low-risk holdings to back up a sizable percent of their outstanding obligations. The regulations that handled this have been dismantled over the years. Additionally, the "insurance" has been broadened to include other type of investment vehicles instead of traditional insurance. AIG got greedy and was able to do so because they and others lobbied hard to allow them to be greedy. This was a multi-decade process.

View on HN

> Traditionally, government demanded insurers have low-risk holdings to back up a sizable percent of their outstanding obligations. The regulations that handled this have been dismantled over the years.

As I pointed out in another thread, AIG's assets have not had losses and the relevant regulations have not been dismantled over the years. (In fact, AIG had to register as a bank because of new regulations.)

What happened to AIG is that the mark-to-market for those assets, which are behaving exactly as predicted, went away. (AIG's portfolios are not taking a foreclosure hit because they cherry-picked.) That took AIG's credit rating down and then the covenants kicked in, requiring AIG to pay money that it didn't have.

FWIW, daily mark-to-market as a way of valuing long term assets was the rule before the great depression, was suspended under FDR, and reintroduced during the Bush admin (I think during the Enron reaction).

Mark-to-market is attractive, but does it necessarily make sense? Suppose that I have an apartment building that is throwing off enough cash to meet my obligations. Is it worth nothing on a day when no one offers to buy it? Is it worth nothing on a day when no one offers to buy "comparables"?

Mark-to-market applies only where the value of an asset is at issue. If, for instance, you want your insurance company to have a minimum value for its assets, to insure that they can pay out in case they need to, then you don't care what that asset is earning. All you care about is the value of that asset when sold, so that the insurance company can use that money to pay off its obligations to you.

Suppose I offered you $10,000 worth of stock in AIG as collateral for a $10,000 loan. When the value of that collateral goes down, it's fair for you to call the loan, even if AIG is still making money and distributing dividends.

These is the way that a bank treats its own customers who put up property as collateral, but when banks themselves are putting up collateral, they want to operate under different rules.

> Mark-to-market applies only where the value of an asset is at issue.

The value of bank and insurance company assets are always an issue.

> Suppose I offered you $10,000 worth of stock in AIG as collateral for a $10,000 loan.

That's a different situation because (as I understand it), the "collateral" was performing loan portfolios.

I agree that the market price for those porfolios is relevant but does it really make sense to immediately declare an institution insolvent and all that implies when buyers take a holiday?

There was some stock involved in many of these cases, but it was the stock of Fannie Mae and Freddie Mac. The US govt gave tax and other preferences to regulated institutions that held Fannie and Freddie stock as assets. This pretty much guaranteed that a lot of them would take a huge hit when Fannie and Freddie went down.

The danger of "Mark-to-market" is that one market decline can set off another which sets off another and pretty-soon you have a world-wide-financial collapse (oh, perhaps I'm exagerating...).

The individuals who create contracts which involve mark-to-market values might not care about these contract's potential to set off systemic collapse. The state or the regulators or "the people" jolly-well ought to care.

Right, my comments are about "right now", because they reference the article which deals with the situation right now -- specifically firing AIG's management because they are "sucking down" big bonuses.

I contend that the article focuses on one of the symptoms "right now" (bonuses to poor management still running a company); whereas the cause is government intervention. Without that intervention, the "right now" symptoms would not exist, i.e. AIG would not exist.

You bring up the long debacle that led to this situation. However, you fail to mention that our government and the Federal Reserve have been tightly tangled with AIG for a long time. Regarding "multi-decade process", there's plenty of government blame to go around. http://www.lewrockwell.com/rozeff/rozeff253.html

If you're contenting that AIG was insolvent and still issuing insurance, they should have been prosecuted under state fraud laws, not bailed out with billions of dollars.

insolvent is a tough word. I don't know if it applies as their books are so complex. The problem is that their investments should never have gotten this complex. AIG and others should never have been allowed to underwrite with such volatile investments. Running an investment bank as the back end to your underwriting is a fairly new thing. 20 years ago, Insurance companies were not allowed to do this. I know because I built IT systems for some of the largest insurers. One thing they all had on their radar was the ability to add investment banking and change the rules that enabled them to invest in other classes of assets. They kept chipping away at the rules until they got it.

The root of this problem is simply that insurance is supposed to be backed by securities that are significantly _less_ volatile than the security they are underwriting. If AIG doesn't have the assets to cover their bets, they clearly did not achieve this goal. The big question is why and which parties deserve blame. My money is on multiple parties.

Reply on news.ycombinator.com