The FT was out with this article today on the Fed’s “killing” it has made on AIG.
The same AIG that still needs Fed assistance? Over 1 year later?
Yes, I’ll admit there’s a good deal less exposure to the AIG now than there was at the height of credit crunch in the fall/winter of ’08. But this chart is only part of the support AIG is receiving. To get an all-in number, you need to account for other vehicles. In addition to the credit extension you see in the chart above, there’s the two SPVs Maiden Lane II and Maiden Lane III:
Now what, you may be wondering, are in Maiden Lane II & III? Well, the NY Fed tells us. First, the note to Maiden Lane II (emphasis mine):
Note: On December 12, 2008, the Federal Reserve Bank of New York (FRBNY) began extending credit to Maiden
Lane II LLC under the authority of section 13(3) of the Federal Reserve Act. This limited liability company was formed to purchase residential mortgage-backed securities from the U.S. securities lending reinvestment portfolio of subsidiaries of American International Group, Inc. (AIG subsidiaries). Payments by Maiden Lane II LLC from the proceeds of the net portfolio holdings will be made in the following order: operating expenses of Maiden Lane II LLC, principal due to the FRBNY, interest due to the FRBNY, and deferred payment and interest due to AIG subsidiaries. Any remaining funds will be shared by the FRBNY and AIG subsidiaries.
So Maiden Lane II is managing the RMBS book that AIG ran aground with.
Nice. The credit risk in that portfolio is miniscule *sarcasm off*. I guess it would make too much sense to have a loan loss reserve or some capital cushion against future losses with this portfolio. Oh, I’m sorry, what was I thinking? That would require transparency on the NY Fed’s part to see if they had such a reserve.
Maybe an audit is in order?
But now let’s turn our attention to Maiden Lane III and the Fed’s explanation of it (again, emphasis mine):
Note: On November 25, 2008, the Federal Reserve Bank of New York (FRBNY) began extending credit to Maiden Lane III LLC under the authority of section 13(3) of the Federal Reserve Act. This limited liability company was formed to purchase multi-sector collateralized debt obligations (CDOs) on which the Financial Products group of American International Group, Inc. (AIG) has written credit default swap (CDS) contracts. In connection with the purchase of CDOs, the CDS counterparties will concurrently unwind the related CDS transactions. Payments by Maiden Lane III LLC from the proceeds of the net portfolio holdings will be made in the following order: operating expenses of Maiden Lane III LLC, principal due to the FRBNY, interest due to the FRBNY, principal due to AIG, and interest due to AIG. Any remaining funds will be shared by the FRBNY and AIG.
So if you thought there was risk in Maiden Lane II, Maiden Lane III really takes the cake. Multi-sector CDOs that were all probably bespoke transactions. Because as the FT article pointed out, “selling the CDOs in the Maiden Lane III portfolio would be tricky because they are complex and illiquid.” And as the Fed has effectively become the market by being the one true buyer in the market, there’s no way they can realize the marks they believe these CDOs trade at now. Because as soon as they signal they’re selling, those marks would come crashing down all around the Fed.
I’m including this attachment (Crouhy-IXIS) that I dug up from a conference I attended almost 3 years ago, because it highlights exactly what some of those instruments look like. It’s dense in math, but try to look past that. Because as Dr. Crouhy pointed out to all of us attendees, the market – at that time – had an “abundance of liquidity” which made things like bespoke CDOs possible.
It took every ounce of self-control I had to restrain myself from laughing aloud.
The abundance of liquidty allowed for an overabundance of bespoke transactions like these, but as I pointed out to a fellow conference attendee:
“If I have 20,000 people who want an Orange County Chopper motorcycle, what do I have? A market with 20,000 buyers? No. I have 20,000 markets with 1 buyer each. That does not represent an improvement in liquidity, that represents (in a way) an excess of risk-taking. Because who else would buy my Orange County Chopper? I had it made for me, there’s no homogeneity. So who would buy it from me if I had to sell it? And what price would they pay?”
And therein lies the problem. The market for these things has changed. There are fewer – way fewer – buyers of CDOs now than when this presentation was given.
I said about the Fed’s “profit” on MBS, I’ll say it about these holdings from AIG. If they think they made a “killing” on them, let them go cash in the chips and see how many they get back.
Good luck with that…