Monday, 10 November 2008

Why AIG must be kept afloat

It has written an awful lot of CDS protection. If it goes down, the contracts accelerate and the banks who bought protection get recovery on the current MTM. Recovery is unlikely to be more than 50 cents on the dollar, and so the protection buyers would suffer large losses. At least a hundred billion, I would estimate, probably more. So you have the choice between letting AIG fail and putting 100B or more into the protection buyers, or giving it another 50B and trying to keep it afloat. That's a no brainer.

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2 Comments:

Blogger peterxyz said...

and when $50b isn't enough, you invoke the sunk cost fallicy and sink another $50b in to protect the $100b.
There seems to be altogether too much of this - arrange DIP for the rest of the business and ring-fence the toxic stuff - then worry about supporting those affected. They should have some collateral and should have provisions against AIG default. These days $100billion is what 2-3weeks worth of write-offs at the recent run rate?

As for turning AIG into a frankenstein repurchasing CDOs .... that's hardly going to clear the waters

11:41 pm  
Blogger David Murphy said...

I don't _approve_ of it. I just think that it is inevitable. AIG without AIG FP would, it seems, be a solvent and reasonably liquid company, but AIG FP without the cross subsidy of the insurance business would need somewhere around $200B of capital. (It wrote over $500B, and I can't believe they are not 40% underwater on average. Maybe it's better but likely it isn't.)

This means that AIG is Frankenstein today. The question is where the lightening bolt to reanimate it will come from.

One way out (again, not a recommendation) would be a government entity to bid for these CDS. Given the counterparty risk, the government could bid less than the mark from the protection buyers.

8:07 am  

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