"Weapons Of Financial Mass Destruction"

AP – Former CEO of AIG Martin Sullivan, center, waits to testify later today before the House Oversight and …

The hearing also revealed that AIG executives hid the full range of its risky financial products from auditors as losses mounted, according to documents released Tuesday by a congressional panel examining the chain of events that forced the government to bail out the conglomerate.

The panel sharply criticized AIG's former top executives, who cast blame on each other for the company's financial woes.

"You have cost my constituents and the taxpayers of this country $85 billion and run into the ground one of the most respected insurance companies in the history of our country," said Rep. Carolyn Maloney, D-N.Y. "You were just gambling billions, possibly trillions of dollars."

AIG, crippled by huge losses linked to mortgage defaults, was forced last month to accept the $85 billion government loan that gives the U.S. the right to an 80 percent stake in the company.

Waxman unveiled documents showing AIG executives hid the full extent of the firm's risky financial products from auditors, both outside and inside the firm, as losses mounted.

Three former AIG executives were summoned to appear before the hearing. One of them, Maurice "Hank" Greenberg — who ran AIG for 38 years until 2005 — canceled his appearance citing illness but submitted prepared testimony. In it, he blamed the company's financial woes on his successors, former CEOs Martin Sullivan and Robert Willumstad.

"When I left AIG, the company operated in 130 countries and employed approximately 92,000 people," Greenberg said. "Today, the company we built up over almost four decades has been virtually destroyed."

Sullivan and Willumstad, in turn, cast much of the blame on accounting rules that forced AIG to take tens of billions of dollars in losses stemming from exposure to toxic mortgage-related securities.

AIG's problems did not come from its traditional insurance subsidiaries, which remain healthy, but instead from its financial services operations, primarily its insurance of mortgage-backed securities and other risky debt against default. Government officials feared a panic might occur if AIG couldn't make good on its promise to cover losses on the securities; investors feared the consequences would pose a threat to the U.S. financial system, which led to the government bailout.

AIG suffered huge losses when its credit rating was cut, thanks largely to complex financial transactions known as "credit default swaps." AIG was a major seller of the swaps, which are a form of insurance, though they are not regulated that way.

The swap contracts promise payment to investors in mortgage bonds in the event of a default. AIG has been forced to raise billions of dollars in collateral to back up those guarantees.

Sullivan said many of the firm's problems stemmed from "mark to market" accounting rules mandating that its positions guaranteeing troubled mortgage securities be carried as tens of billions of dollars in losses on its balance sheet.

This in turn, said former AIG chief executive Willumstad, who ran the company for just three months after Sullivan left, forced the firm to raise billions of dollars in capital. The federal rescue came after AIG suffered disastrous liquidity problems after its credit rating was lowered, forcing the company to come up with even more capital.

"AIG was caught in a vicious cycle," Willumstad said in the testimony.

Greenberg said that AIG "wrote as many credit default swaps ... in the nine months following my departure as it had written in the entire previous seven years combined. Moreover, "unlike what had been true during my tenure, the majority of the credit default swaps that AIGFP wrote in the nine months after I retired were reportedly exposed to subprime mortgages."

But Sullivan said the complex swaps had underlying value, even as the market for them froze, sending their book value plummeting and forcing AIG to scramble for collateral.

"When the credit markets seized up, like many other financial institutions, we were forced to mark our swap positions at fire-sale prices as if we owned the underlying bonds, even though we believed that our swap positions had value if held to maturity," Sullivan said.

Until recently, most people had never even heard of derivatives; but in terms of money traded, these investments represent the biggest financial market in the world.  Derivatives are financial instruments that have no intrinsic value but derive their value from something else.  Basically, they are just bets.  You can “hedge your bet” that something you own will go up by placing a side bet that it will go down.  “Hedge funds” hedge bets in the derivatives market.  Bets can be placed on anything, from the price of tea in China to the movements of specific markets. 

“The point everyone misses,” wrote economist Robert Chapman a decade ago, “is that buying derivatives is not investing.  It is gambling, insurance and high stakes bookmaking.  Derivatives create nothing.”1  They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services.  In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling.  But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve “risk management.”  Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked.  But the cost was an increase in risk to the financial system as a whole.

Credit default swaps (CDS) are the most widely traded form of credit derivative.  CDS are bets between two parties on whether or not a company will default on its bonds.  In a typical default swap, the “protection buyer” gets a large payoff from the “protection seller” if the company defaults within a certain period of time, while the “protection seller” collects periodic payments from the “protection buyer” for assuming the risk of default.  CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes.  In one blogger’s example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money – free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims. 

And there’s the catch: what if the hedge fund doesn’t have the $100 million?  The fund’s corporate shell or limited partnership is put into bankruptcy; but both parties are claiming the derivative as an asset on their books, which they now have to write down.  Players who have “hedged their bets” by betting both ways cannot collect on their winning bets; and that means they cannot afford to pay their losing bets, causing other players to also default on their bets. 

The dominos go down in a cascade of cross-defaults that infects the whole banking industry and jeopardizes the global pyramid scheme.  The potential for this sort of nuclear reaction was what prompted billionaire investor Warren Buffett to call derivatives “weapons of financial mass destruction.”  It is also why the banking system cannot let a major derivatives player go down, and it is the banking system that calls the shots.  The Federal Reserve is literally owned by a conglomerate of banks; and Hank Paulson, who heads the U.S. Treasury, entered that position through the revolving door of investment bank Goldman Sachs, where he was formerly CEO.

    Most American taxpayers and consumers know nothing of complicated Wall Street investments and speculations but it behooves us all to understand what credit swaps or derivatives are, because this unregulated Wall Street financial product has become what billionaire investor Warren Buffet calls, "weapons of financial mass destruction". Very large banks like Lehman Bros. and very large insurance companies, like AIG were heavily involved in sub-prime mortgage credit swaps, which essentially are side bets on businesses to fail or loans to default. In other words, Lehman Bros and AIG covered bets by US and global speculators that securities and bonds involving sup-prime mortgages would default within a certain time period and when these financial products did indeed default, Lehman Bros. and AIG didn't have the collateral to cover the bets or the "insurance premiums" paid to them by the derivatives buyers or the speculating gamblers. As I see it, today's Wall Street investment banks are nothing more than bookies and gamblers with American citizens businesses, mortgages, car payments, insurance, 401k and retirement plans, with the blessing of the US Treasury Dept., the Federal Reserve Banks and a Wall Street bought US Congress. As I see it, no more damn bailouts of Wall Street "bankstas", no more damn "credit swaps" and "derivatives trading", and no more damn unregulated Federal Reserve Banks. Let the US and global economy "bottom out", let the housing and derivatives bubbles burst, let the damn recession play out, so that American ingenuity and spirit can get our economy going again. What do you think?

tags: credit swaps  derivatives  politics  takebackamerica  business  capitalism  congress  wall street bailout  the fed  aig  lehman bros  

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