Fatal Risk: Beach Reading - A Groovy Mass To Get-Go Fifty-Fifty If You Lot Don't Quite Finish
Rarely practise I repeat a weblog postal service - but many of my readers are off to the beach together with wishing to start reading a volume that they volition non finish.
May I propose yet in i lawsuit to a greater extent than Fatal Risk yesteryear Roddy Boyd - the story of the AIG collapse.
Here is my original review from 2011:
=============
There are dozens of books on the fiscal crisis: I receive got read many of them together with the Kindle samples for only close all of them. There are only 2 I would recommend: those are Bethany McLean together with Joe Nocera’s excellent All the Devils are Here and the much to a greater extent than specifically detailed Fatal Risk from Roddy Boyd. Roddy's volume is entirely concerned amongst the failure of AIG.
Both books start without whatever rigid ideological preconceptions together with allow the facts woven into a skillful story practise the talking - together with both air current upwards ambivalent close many of the major players - amongst many players having human weaknesses (gullibility, delusion, arrogance etc) but committing goose egg that looks similar a rigid instance for criminal prosecution. Reading these y'all tin see why at that topographic point are so few criminal prosecutions from the crisis. And y'all volition also see only how extreme the human failings that caused the crisis are.
If y'all are non familiar amongst the saga that led upwards to the mortgage collapse, the ascent of securitisation, the depth of the repo market, the lowering of credit standards start amongst the McLean/Nocera book. If y'all receive got to laissez passer a volume every bit a gift to someone who is non a fiscal professional person y'all could practise trivial better. That is the best full general volume yet written on the crisis.
But for me (and because I was familiar amongst the wide details of the crisis anyway) the best volume of the crisis is Roddy Boyd’s Fatal Risk. It is non a skillful showtime fiscal volume to read together with I had to think quite hard every bit to the details that Roddy glossed over - but that was because Roddy had to brand a alternative - was he writing for someone who vaguely knew what a credit default swap was or was he writing for someone who had really read a “credit back upwards annexe (a CSA)”.
Fortunately for most people he does non wishing to assume y'all receive got really read a CSA (although I have). But less forgivingly Roddy does non experience the demand to define an Alt-A mortgage or a repo line. This is a fabulous volume – but it deals amongst complex subjects without shying away from their complexity together with it assumes y'all receive got plenty noesis together with tidings to cope.
Truths, generalities together with people
Underlying Roddy’s books are a few fiscal truths that acquit repeating. Firstly anything that has whatever hazard of going incorrect if done for long plenty volition locomote wrong. It doesn’t affair if your model tells y'all that y'all volition hold upwards fine inwards whatever mortgage default environs curt of the neat depression: if y'all maintain to bet on that model y'all volition lose. Maybe non side yesteryear side year. Maybe non inwards x years but y'all volition eventually lose.
Likewise if y'all write large quantities of out-of-the-money puts y'all volition eventually lose a lot of money.
Likewise if your model assumes that at that topographic point is ever going to hold upwards a deep liquid marketplace inwards whatever safety (with the possible exception of a Treasury bond) together with so i hateful solar daytime y'all volition wake upwards together with the buyers volition receive got scampered similar antelopes from a waterhole at showtime sight of a lion. Any trace of piece of work organisation that has to whorl a large amount of debt at regular intervals is dangerous.
Ignore these truths together with y'all receive got a risk. Ignore them on a grand plenty scale together with the hazard volition hold upwards fatal.
Whatever: if y'all ignore these truths y'all mightiness larn rich inwards the interim. Earnings together with increment mightiness hold upwards fine. You mightiness fifty-fifty await similar a genius. Maybe a “legendary CEO”.
So Roddy’s volume starts a long fourth dimension agone - the 1970s together with 1980s when AIG did non forget those truths - together with it talks close AIG every bit a superlative hazard administration machine. The showtime subdivision of the volume is a repeat of the AIG legend - a legend of superlative hazard administration by together with large inwards the caput of i man: Hank Greenberg. It is a legend that mightiness hold upwards overstated but that doesn’t hateful that it is non by together with large true. Hank really did piece of work absurd hours, pick at steamed fish together with vegetables together with inquire sophisticated questions to vi people at once. Hank knew to really sympathize what was going on y'all had to locomote iii to 4 levels deep inwards an organisation together with inquire the right questions of assorted lower/mid ranked officers. They would respond truthfully because of a wishing to print or fright or fifty-fifty that (unlike many senior managers) they were non accustomed to spinning. He would larn the raw data. He would brand the assessment.
There were 2 things even so that Hank did non assess properly: his ain mortality together with his declining science inwards erstwhile age. There is no interrogation of declining skill. It is really hard to imagine the Hank Greenberg of 1975 falling for Red People's Republic of China Media Express - but the Hank Greenberg of 2010 was suckered. As for mortality he had no plans.
He also did non computer program for Eliot Spitzer.
By 2000 Hank was extremely concerned close what Wall Street idea of his stock. That is no surprise - AIG was the most highly valued large fiscal theatre inwards the globe (I think existence startled that its PE was iii times Wells Fargo). And - unstated yesteryear Boyd - Hank liked that a lot because he used AIGs stock every bit currency to practise acquisitions. He was - much to the chagrin of many investment bankers - really selective every bit to the acquisitions he would practise (he knew acquisitions were fraught amongst risk) but he did to a greater extent than or less mighty large ones including the purchase of Lord's Day America. I think that i - together with idea (correctly inwards hindsight) that it belike made feel primarily because AIG was paying amongst inflated stock.
So yesteryear the yr 2000 Hank was - apart from running the trace of piece of work organisation - actively manipulating the earnings of the business. As far every bit I tin order he ran the trace of piece of work organisation peculiarly good (the legend of AIG was non false) but he also played Wall Street similar a fiddle together with gave them the numbers they wanted fifty-fifty if they were massaged a trivial (or maybe a lot).
Moreover - together with this is critical for the story - AIG had no overarching operating system. It was a bunch of fiefdoms all reporting to Hank. This meant that AIG could non gain earnings results until the really final hateful solar daytime they were legally allowed to file them. It meant Hank could personally massage earnings. At many fiscal institutions to a greater extent than or less approximation of earnings are known every month. At AIG at that topographic point was no scheme they could query together with inquire for their aggregate Alt-A mortgage exposure. Hank mightiness receive got known - indeed almost certainly would receive got known - but the scheme is Hank together with Hank existence removed or dying would hold upwards disastrous for AIG.
And together with so along comes Spitzer. Spitzer discovers a relatively nestling finite insurance transaction betwixt AIG together with General Re. (Believe me it was nestling - I know of plenty of nastier transactions than that... many of which were never prosecuted.*) However it is a clear endeavour to fudge the numbers - Spitzer really is onto something. And amongst bombast together with the ability of the Attorney General he makes Hank Greenberg’s globe autumn apart. Spitzer fights muddied (and it is no surprise that several Spitzer prosecutions afterward failed because of prosecutorial misconduct) but Spitzer has his clear slice of fakery together with he wants together with gets his pound of flesh.
Hank is forced out - which is the equivalent to AIG of his precipitous death. Worse because AIG went on to repudiate many things Hank stood for including many of his risk-control edicts. If he had died the hero CEO it mightiness receive got been marginally ameliorate for AIG.
The nestling nature of the AIG-Gen Re transaction is set clear when Roddy suggests that at that topographic point is an “excellent hazard that Greenberg gave the Gen Re issues - which cost him his job, his honor, his condition together with mayhap over a billion dollars inwards personal wealth - all of 5 minutes of consideration.”
Still AIG-Gen Re was a transaction designed to massage (ie fake) the numbers - together with thus speaks to a human relationship amongst Wall Street together with a concern to stock toll that is unhealthy.
Unstated yesteryear Roddy: Hank had forgotten a fundamental dominion of hazard management: y'all practise that form of thing for long plenty together with so i hateful solar daytime y'all volition uncovering your Eliot Spitzer. This is only every bit sure every bit the contestation that if y'all write set options long plenty y'all volition i hateful solar daytime larn your comeuppance.
The novel CEO
The novel CEO - Martin Sullivan - was the best salesman AIG had. Joe Cassano (who ran the disastrous AIG Financial Products) observed that he never saw Sullivan inquire a unmarried penetrating fiscal question. It's a telling observation.
The house I used to piece of work had a boss who was really suspicious of fiscal production salesmen because inevitably they wanted to gain what the marketplace (ie the crowd) wanted. And inwards fiscal services if y'all run amongst the crowd y'all tin larn your comeuppance delivered abnormally sharply.
To hold upwards fair, at that topographic point are fiscal service companies that require salesmen fifty-fifty every bit leaders. Insurance brokers boundary to mind.
AIG even so was non i of those companies. It was global, complicated together with pervasive together with it had no overarching hazard administration scheme forthwith that Hank was gone. To supersede a command freak they needed to a greater extent than or less other command freak at to the lowest degree until they built command systems. They never got that - together with only at the really terminate (in Willumstead) did they larn a CEO that fifty-fifty understood at that topographic point was a problem.
There is a truism close fiscal production salespeople: if y'all set a salesman inwards accuse of a fiscal establishment amongst large attain together with allow him to operate amongst sparse hazard command together with so your earnings volition locomote up. And up. And up. At to the lowest degree until they don’t. Martin Sullivan proves that truism.
Under Sullivan to a greater extent than or less small-scale businesses were allowed to expand inwards novel ways until they became large businesses - ones large plenty to threaten AIG together with indeed the world. Influenza A virus subtype H5N1 decent instance of the Martin administration trend comes from a small-scale component of AIG - United Guaranty. United Guaranty was a mortgage insurer - at to the lowest degree for a spell the best mortgage insurer on the Street. (I think thinking that a span of other players, notably PMI together with MGIC were much riskier.)
The right thing to practise amongst a mortgage insurer was halt writing trace of piece of work organisation close 2005 - together with certainly yesteryear 2006. [Or y'all could sell it every bit GE did.] Margins were collapsing together with the hazard of the loans was rising fast. The independent companies couldn’t really halt because that was their only business. AIG was nether no such constraint - United Guaranty was a tiny component of AIG together with stopping would non receive got affected the stock price. It mightiness receive got fifty-fifty been seen yesteryear to a greater extent than or less (myself included) every bit a sign of discipline. Here is the quote from an AIG unit of measurement chiefs coming together inwards mid-2007.
To non realize that a mortgage insurance trace of piece of work organisation inwards mid 2007 was problematic was seriously inept. UCG has forthwith booked $3.9 billion inwards losses. Hank would receive got been on locomote yesteryear of this at to the lowest degree a yr earlier. Whether he would receive got been on locomote yesteryear of it 2 years before is to a greater extent than dubious. One yr before together with UCG would still receive got had substantial losses. But they mightiness receive got been absorbed yesteryear profits inwards an otherwise surgery AIG.
The 2 businesses that blew upwards AIG
There were problems all over AIG (and at that topographic point were skillful bits likewise where private managers saw the mess coming together with ducked for cover). But 2 businesses stand upwards out for the sheer devastation that they wrought. The ameliorate known was AIG Financial Products (FP) credit guarantee business. The less good known was Win Neuger’s securities lending business.
The credit guarantee trace of piece of work organisation for sparse fees guaranteed securitisation deals - usually really high degree newspaper or only every bit oft resecuritisations of high degree paper. These were deals that would hold upwards fine inwards whatever credit lawsuit less bad than the neat depression. In other words they were “great depression puts” together with FP was writing puts. You should know the truism yesteryear now.
But worse the credit default swaps had a credit back upwards annexe (CSA) attached. This made it mandatory for the nurture companionship of AIG to collateralize the deals (ie set upwards hard cash to guarantee payment) nether sure events. Senior administration of AIG did non fifty-fifty know of the existence of the CSA until the companionship was at death’s door. They believed until really nearly the terminate that mark-to-market did non threaten liquidity.
I sympathize how a salesman (Sullivan) missed the CSA. If y'all followed the credit enhancement trace of piece of work organisation y'all would know - yesteryear police - that the monoline insurers were non allowed to collateralize their obligations. Why of class should AIG hold upwards whatever different? But fifty-fifty that cursory “knowledge” could hold upwards dangerous. Both AIG together with Ambac had CSAs attached to their guaranteed investment contract trace of piece of work organisation (a trace of piece of work organisation that was run yesteryear nurture companies). I did non know of these until a good known hedge fund director sent me a re-create together with fifty-fifty read it over the telephone to me.
But that is a sparse defense of AIG. The to a higher house mentioned hedge fund director knew of the CSAs at Ambac together with MBIA a span of years before the disaster - together with he had to await together with uncovering it. AIGs senior administration should receive got only asked. Their hazard administration subdivision should receive got been over every fabric contract - together with believe me these were fabric contracts. This was an epic failure.
Win Neuger’s trace of piece of work organisation was similarly destructive. What he did was [get the nurture companionship to] borrow high degree securities from the life insurance companies, repo them, purchase lower degree securities together with pledge those dorsum to the life companies to secure nurture companionship obligations to the life companies.
Two things went wrong. The life companionship administration (and afterward regulators) got mighty jacked when the life companies had lent their skillful securities together with were asset trash security. They required hard majuscule injections from the nurture companionship to solve this - together with along the agency AIG kicked inwards $5 billion. At the terminate the Texas Insurance Commissioner was going to confiscate 4 insurance companies (which would receive got collapsed AIG).
The 2nd thing that went incorrect is the counter-parties to the repo loans only wanted cash their back. They wanted it now. To larn it though the nurture companionship would demand to larn dorsum the trashy (and thus heavily discounted) safety from the life company, sell them, locomote yesteryear upwards the (now large) shortfall together with pay the investment banking concern on the repo line. This turned marks on the low-grade securities into an immediate liquidity drain on the parent. That is genuinely ugly.
How they got at that topographic point likewise was a story of failure to consider fatty tail risks. It is the main story of the book.
Liquidity versus solvency
At the pinnacle of the crisis it was really hard to see whether AIG was a liquidity work or a solvency problem. If it is a liquidity work together with so bailouts don’t cost much -indeed structured right they are profitable. If it was solvency together with so a bailout volition hold upwards really costly together with inwards extrema (such every bit Ireland) tin bankrupt the nation.
I originally idea AIG was liquidity. I later idea it was solvency. But forthwith the Government looks similar it is making heroic profits on the AIG bailout - together with it was sure plenty a liquidity problem.
There are a span of lessons here: sophisticated observers (if I am a sophisticated observer) can’t order the departure betwixt liquidity together with solvency inwards a crisis. The 2nd lesson is that whatever contract that tin drive a liquidity work volition - if repeated long plenty - really drive a liquidity problem. Modelling solvency does non cutting it... if y'all run a fiscal establishment y'all ameliorate model liquidity every bit good – together with ameliorate hold upwards create for the closure of debt markets.
The AIG people after the failure
There is a lot of anger inwards the wide community close the people at AIG especially every bit none of them - those that caused the largest bailout of the crisis - were ever charged criminally. Roddy does non portion the anger close the lack of criminal charges but he is angry close the sheer recklessness of to a greater extent than or less AIG people. This quote was revealing:
Roddy is right. The fact that the failure of these people was non criminal does non excuse it. These people were paid large multiples of average earnings together with demonstrated that they can’t practise their job. So they are still paid large multiples of average earnings.
Along this trace special scorn needs to hold upwards reserved for Win Neuger. He ran AIGs internal asset administration trace of piece of work organisation - especially the securities lending trace of piece of work organisation which inwards itself was large plenty to destroy AIG.
He forthwith runs an asset administration companionship amongst over $80 billion nether management.
Where else - except Wall Street - tin y'all hold upwards that good rewarded for failure?
Recommendation
I don’t wishing to laissez passer likewise much away. This is the best volume yet written close whatever specific episode of the crisis. I only think you should purchase it. Buy multiple copies. Give them to your friends. They volition hold upwards grateful too.
John
*Hint to the regulators: assay together with piece of work out the large finite transaction betwixt Unum Provident together with Berkshire Hathaway. There lies a tin of worms...
May I propose yet in i lawsuit to a greater extent than Fatal Risk yesteryear Roddy Boyd - the story of the AIG collapse.
Here is my original review from 2011:
=============
There are dozens of books on the fiscal crisis: I receive got read many of them together with the Kindle samples for only close all of them. There are only 2 I would recommend: those are Bethany McLean together with Joe Nocera’s excellent All the Devils are Here and the much to a greater extent than specifically detailed Fatal Risk from Roddy Boyd. Roddy's volume is entirely concerned amongst the failure of AIG.
Both books start without whatever rigid ideological preconceptions together with allow the facts woven into a skillful story practise the talking - together with both air current upwards ambivalent close many of the major players - amongst many players having human weaknesses (gullibility, delusion, arrogance etc) but committing goose egg that looks similar a rigid instance for criminal prosecution. Reading these y'all tin see why at that topographic point are so few criminal prosecutions from the crisis. And y'all volition also see only how extreme the human failings that caused the crisis are.
If y'all are non familiar amongst the saga that led upwards to the mortgage collapse, the ascent of securitisation, the depth of the repo market, the lowering of credit standards start amongst the McLean/Nocera book. If y'all receive got to laissez passer a volume every bit a gift to someone who is non a fiscal professional person y'all could practise trivial better. That is the best full general volume yet written on the crisis.
But for me (and because I was familiar amongst the wide details of the crisis anyway) the best volume of the crisis is Roddy Boyd’s Fatal Risk. It is non a skillful showtime fiscal volume to read together with I had to think quite hard every bit to the details that Roddy glossed over - but that was because Roddy had to brand a alternative - was he writing for someone who vaguely knew what a credit default swap was or was he writing for someone who had really read a “credit back upwards annexe (a CSA)”.
Fortunately for most people he does non wishing to assume y'all receive got really read a CSA (although I have). But less forgivingly Roddy does non experience the demand to define an Alt-A mortgage or a repo line. This is a fabulous volume – but it deals amongst complex subjects without shying away from their complexity together with it assumes y'all receive got plenty noesis together with tidings to cope.
Truths, generalities together with people
Underlying Roddy’s books are a few fiscal truths that acquit repeating. Firstly anything that has whatever hazard of going incorrect if done for long plenty volition locomote wrong. It doesn’t affair if your model tells y'all that y'all volition hold upwards fine inwards whatever mortgage default environs curt of the neat depression: if y'all maintain to bet on that model y'all volition lose. Maybe non side yesteryear side year. Maybe non inwards x years but y'all volition eventually lose.
Likewise if y'all write large quantities of out-of-the-money puts y'all volition eventually lose a lot of money.
Likewise if your model assumes that at that topographic point is ever going to hold upwards a deep liquid marketplace inwards whatever safety (with the possible exception of a Treasury bond) together with so i hateful solar daytime y'all volition wake upwards together with the buyers volition receive got scampered similar antelopes from a waterhole at showtime sight of a lion. Any trace of piece of work organisation that has to whorl a large amount of debt at regular intervals is dangerous.
Ignore these truths together with y'all receive got a risk. Ignore them on a grand plenty scale together with the hazard volition hold upwards fatal.
Whatever: if y'all ignore these truths y'all mightiness larn rich inwards the interim. Earnings together with increment mightiness hold upwards fine. You mightiness fifty-fifty await similar a genius. Maybe a “legendary CEO”.
So Roddy’s volume starts a long fourth dimension agone - the 1970s together with 1980s when AIG did non forget those truths - together with it talks close AIG every bit a superlative hazard administration machine. The showtime subdivision of the volume is a repeat of the AIG legend - a legend of superlative hazard administration by together with large inwards the caput of i man: Hank Greenberg. It is a legend that mightiness hold upwards overstated but that doesn’t hateful that it is non by together with large true. Hank really did piece of work absurd hours, pick at steamed fish together with vegetables together with inquire sophisticated questions to vi people at once. Hank knew to really sympathize what was going on y'all had to locomote iii to 4 levels deep inwards an organisation together with inquire the right questions of assorted lower/mid ranked officers. They would respond truthfully because of a wishing to print or fright or fifty-fifty that (unlike many senior managers) they were non accustomed to spinning. He would larn the raw data. He would brand the assessment.
There were 2 things even so that Hank did non assess properly: his ain mortality together with his declining science inwards erstwhile age. There is no interrogation of declining skill. It is really hard to imagine the Hank Greenberg of 1975 falling for Red People's Republic of China Media Express - but the Hank Greenberg of 2010 was suckered. As for mortality he had no plans.
He also did non computer program for Eliot Spitzer.
By 2000 Hank was extremely concerned close what Wall Street idea of his stock. That is no surprise - AIG was the most highly valued large fiscal theatre inwards the globe (I think existence startled that its PE was iii times Wells Fargo). And - unstated yesteryear Boyd - Hank liked that a lot because he used AIGs stock every bit currency to practise acquisitions. He was - much to the chagrin of many investment bankers - really selective every bit to the acquisitions he would practise (he knew acquisitions were fraught amongst risk) but he did to a greater extent than or less mighty large ones including the purchase of Lord's Day America. I think that i - together with idea (correctly inwards hindsight) that it belike made feel primarily because AIG was paying amongst inflated stock.
So yesteryear the yr 2000 Hank was - apart from running the trace of piece of work organisation - actively manipulating the earnings of the business. As far every bit I tin order he ran the trace of piece of work organisation peculiarly good (the legend of AIG was non false) but he also played Wall Street similar a fiddle together with gave them the numbers they wanted fifty-fifty if they were massaged a trivial (or maybe a lot).
Moreover - together with this is critical for the story - AIG had no overarching operating system. It was a bunch of fiefdoms all reporting to Hank. This meant that AIG could non gain earnings results until the really final hateful solar daytime they were legally allowed to file them. It meant Hank could personally massage earnings. At many fiscal institutions to a greater extent than or less approximation of earnings are known every month. At AIG at that topographic point was no scheme they could query together with inquire for their aggregate Alt-A mortgage exposure. Hank mightiness receive got known - indeed almost certainly would receive got known - but the scheme is Hank together with Hank existence removed or dying would hold upwards disastrous for AIG.
And together with so along comes Spitzer. Spitzer discovers a relatively nestling finite insurance transaction betwixt AIG together with General Re. (Believe me it was nestling - I know of plenty of nastier transactions than that... many of which were never prosecuted.*) However it is a clear endeavour to fudge the numbers - Spitzer really is onto something. And amongst bombast together with the ability of the Attorney General he makes Hank Greenberg’s globe autumn apart. Spitzer fights muddied (and it is no surprise that several Spitzer prosecutions afterward failed because of prosecutorial misconduct) but Spitzer has his clear slice of fakery together with he wants together with gets his pound of flesh.
Hank is forced out - which is the equivalent to AIG of his precipitous death. Worse because AIG went on to repudiate many things Hank stood for including many of his risk-control edicts. If he had died the hero CEO it mightiness receive got been marginally ameliorate for AIG.
The nestling nature of the AIG-Gen Re transaction is set clear when Roddy suggests that at that topographic point is an “excellent hazard that Greenberg gave the Gen Re issues - which cost him his job, his honor, his condition together with mayhap over a billion dollars inwards personal wealth - all of 5 minutes of consideration.”
Still AIG-Gen Re was a transaction designed to massage (ie fake) the numbers - together with thus speaks to a human relationship amongst Wall Street together with a concern to stock toll that is unhealthy.
Unstated yesteryear Roddy: Hank had forgotten a fundamental dominion of hazard management: y'all practise that form of thing for long plenty together with so i hateful solar daytime y'all volition uncovering your Eliot Spitzer. This is only every bit sure every bit the contestation that if y'all write set options long plenty y'all volition i hateful solar daytime larn your comeuppance.
The novel CEO
The novel CEO - Martin Sullivan - was the best salesman AIG had. Joe Cassano (who ran the disastrous AIG Financial Products) observed that he never saw Sullivan inquire a unmarried penetrating fiscal question. It's a telling observation.
The house I used to piece of work had a boss who was really suspicious of fiscal production salesmen because inevitably they wanted to gain what the marketplace (ie the crowd) wanted. And inwards fiscal services if y'all run amongst the crowd y'all tin larn your comeuppance delivered abnormally sharply.
To hold upwards fair, at that topographic point are fiscal service companies that require salesmen fifty-fifty every bit leaders. Insurance brokers boundary to mind.
AIG even so was non i of those companies. It was global, complicated together with pervasive together with it had no overarching hazard administration scheme forthwith that Hank was gone. To supersede a command freak they needed to a greater extent than or less other command freak at to the lowest degree until they built command systems. They never got that - together with only at the really terminate (in Willumstead) did they larn a CEO that fifty-fifty understood at that topographic point was a problem.
There is a truism close fiscal production salespeople: if y'all set a salesman inwards accuse of a fiscal establishment amongst large attain together with allow him to operate amongst sparse hazard command together with so your earnings volition locomote up. And up. And up. At to the lowest degree until they don’t. Martin Sullivan proves that truism.
Under Sullivan to a greater extent than or less small-scale businesses were allowed to expand inwards novel ways until they became large businesses - ones large plenty to threaten AIG together with indeed the world. Influenza A virus subtype H5N1 decent instance of the Martin administration trend comes from a small-scale component of AIG - United Guaranty. United Guaranty was a mortgage insurer - at to the lowest degree for a spell the best mortgage insurer on the Street. (I think thinking that a span of other players, notably PMI together with MGIC were much riskier.)
The right thing to practise amongst a mortgage insurer was halt writing trace of piece of work organisation close 2005 - together with certainly yesteryear 2006. [Or y'all could sell it every bit GE did.] Margins were collapsing together with the hazard of the loans was rising fast. The independent companies couldn’t really halt because that was their only business. AIG was nether no such constraint - United Guaranty was a tiny component of AIG together with stopping would non receive got affected the stock price. It mightiness receive got fifty-fifty been seen yesteryear to a greater extent than or less (myself included) every bit a sign of discipline. Here is the quote from an AIG unit of measurement chiefs coming together inwards mid-2007.
As UGC posted its showtime losses, close $100 million, Nutt was explaining to Martin Sullivan together with other senior administration that spell they hitting a stone oil patch, they were writing fantabulous novel business, and, at whatever rate, the contest was getting killed. Sullivan smilingly told Nutt that fifty-fifty if he didn’t write to a greater extent than or less other dollar inwards trace of piece of work organisation for a few months, “We would still honey him”. AIG staffers had a phrase for this form of response: “classic Martin”. It was a decent give-and-take or gesture, directed at a director who was clearly fumbling, both publicly together with on the job. But it also carried a serious message: ameliorate to hold upwards rubber than sorry. The problem is that the fourth dimension for this was 2 to iii years earlier.
To non realize that a mortgage insurance trace of piece of work organisation inwards mid 2007 was problematic was seriously inept. UCG has forthwith booked $3.9 billion inwards losses. Hank would receive got been on locomote yesteryear of this at to the lowest degree a yr earlier. Whether he would receive got been on locomote yesteryear of it 2 years before is to a greater extent than dubious. One yr before together with UCG would still receive got had substantial losses. But they mightiness receive got been absorbed yesteryear profits inwards an otherwise surgery AIG.
The 2 businesses that blew upwards AIG
There were problems all over AIG (and at that topographic point were skillful bits likewise where private managers saw the mess coming together with ducked for cover). But 2 businesses stand upwards out for the sheer devastation that they wrought. The ameliorate known was AIG Financial Products (FP) credit guarantee business. The less good known was Win Neuger’s securities lending business.
The credit guarantee trace of piece of work organisation for sparse fees guaranteed securitisation deals - usually really high degree newspaper or only every bit oft resecuritisations of high degree paper. These were deals that would hold upwards fine inwards whatever credit lawsuit less bad than the neat depression. In other words they were “great depression puts” together with FP was writing puts. You should know the truism yesteryear now.
But worse the credit default swaps had a credit back upwards annexe (CSA) attached. This made it mandatory for the nurture companionship of AIG to collateralize the deals (ie set upwards hard cash to guarantee payment) nether sure events. Senior administration of AIG did non fifty-fifty know of the existence of the CSA until the companionship was at death’s door. They believed until really nearly the terminate that mark-to-market did non threaten liquidity.
I sympathize how a salesman (Sullivan) missed the CSA. If y'all followed the credit enhancement trace of piece of work organisation y'all would know - yesteryear police - that the monoline insurers were non allowed to collateralize their obligations. Why of class should AIG hold upwards whatever different? But fifty-fifty that cursory “knowledge” could hold upwards dangerous. Both AIG together with Ambac had CSAs attached to their guaranteed investment contract trace of piece of work organisation (a trace of piece of work organisation that was run yesteryear nurture companies). I did non know of these until a good known hedge fund director sent me a re-create together with fifty-fifty read it over the telephone to me.
But that is a sparse defense of AIG. The to a higher house mentioned hedge fund director knew of the CSAs at Ambac together with MBIA a span of years before the disaster - together with he had to await together with uncovering it. AIGs senior administration should receive got only asked. Their hazard administration subdivision should receive got been over every fabric contract - together with believe me these were fabric contracts. This was an epic failure.
Win Neuger’s trace of piece of work organisation was similarly destructive. What he did was [get the nurture companionship to] borrow high degree securities from the life insurance companies, repo them, purchase lower degree securities together with pledge those dorsum to the life companies to secure nurture companionship obligations to the life companies.
Two things went wrong. The life companionship administration (and afterward regulators) got mighty jacked when the life companies had lent their skillful securities together with were asset trash security. They required hard majuscule injections from the nurture companionship to solve this - together with along the agency AIG kicked inwards $5 billion. At the terminate the Texas Insurance Commissioner was going to confiscate 4 insurance companies (which would receive got collapsed AIG).
The 2nd thing that went incorrect is the counter-parties to the repo loans only wanted cash their back. They wanted it now. To larn it though the nurture companionship would demand to larn dorsum the trashy (and thus heavily discounted) safety from the life company, sell them, locomote yesteryear upwards the (now large) shortfall together with pay the investment banking concern on the repo line. This turned marks on the low-grade securities into an immediate liquidity drain on the parent. That is genuinely ugly.
How they got at that topographic point likewise was a story of failure to consider fatty tail risks. It is the main story of the book.
Liquidity versus solvency
At the pinnacle of the crisis it was really hard to see whether AIG was a liquidity work or a solvency problem. If it is a liquidity work together with so bailouts don’t cost much -indeed structured right they are profitable. If it was solvency together with so a bailout volition hold upwards really costly together with inwards extrema (such every bit Ireland) tin bankrupt the nation.
I originally idea AIG was liquidity. I later idea it was solvency. But forthwith the Government looks similar it is making heroic profits on the AIG bailout - together with it was sure plenty a liquidity problem.
There are a span of lessons here: sophisticated observers (if I am a sophisticated observer) can’t order the departure betwixt liquidity together with solvency inwards a crisis. The 2nd lesson is that whatever contract that tin drive a liquidity work volition - if repeated long plenty - really drive a liquidity problem. Modelling solvency does non cutting it... if y'all run a fiscal establishment y'all ameliorate model liquidity every bit good – together with ameliorate hold upwards create for the closure of debt markets.
The AIG people after the failure
There is a lot of anger inwards the wide community close the people at AIG especially every bit none of them - those that caused the largest bailout of the crisis - were ever charged criminally. Roddy does non portion the anger close the lack of criminal charges but he is angry close the sheer recklessness of to a greater extent than or less AIG people. This quote was revealing:
Al Frost’s [a key salesperson for AIG FP] chore was to drum upwards deals together with revenue from the major investment banks together with he did. Cassano’s chore was to ensure that decisions made at FP were logical together with made amongst all available information. He failed...
But Cassano did non neglect inwards a vacuum....
That Martin Sullivan together with Steve Bessinger did goose egg is forthwith good established. But neither did Financial Services principal Bill Dooley, his CFO Elias Habayeb, Risk Management Chief Bob Lewis together with his caput of credit-risk Kevin McGinn. Anastasia Kelly’s legal subdivision was similarly silent. These people saw everything AIG FP did inwards existent fourth dimension together with had plenty of say-so to forcefulness at to the lowest degree a reevaluation. It was, inwards fact, their chore to practise this...
Save for Anastasia Kelly (who retired) every other soul inwards the trace of oversight of the FP swaps volume is forthwith gainfully employed every bit an officeholder at a publicly traded companionship amongst every bit much or to a greater extent than responsibleness than they had previously.
Roddy is right. The fact that the failure of these people was non criminal does non excuse it. These people were paid large multiples of average earnings together with demonstrated that they can’t practise their job. So they are still paid large multiples of average earnings.
Along this trace special scorn needs to hold upwards reserved for Win Neuger. He ran AIGs internal asset administration trace of piece of work organisation - especially the securities lending trace of piece of work organisation which inwards itself was large plenty to destroy AIG.
He forthwith runs an asset administration companionship amongst over $80 billion nether management.
Where else - except Wall Street - tin y'all hold upwards that good rewarded for failure?
Recommendation
I don’t wishing to laissez passer likewise much away. This is the best volume yet written close whatever specific episode of the crisis. I only think you should purchase it. Buy multiple copies. Give them to your friends. They volition hold upwards grateful too.
John
*Hint to the regulators: assay together with piece of work out the large finite transaction betwixt Unum Provident together with Berkshire Hathaway. There lies a tin of worms...
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