Tuesday, March 17, 2009

AIG Bankrupting Cities Across America?

Although the news about AIG bonuses yesterday was disturbing, it was not nearly as disturbing as some of the other news that came out at the same time.

Up until a few days ago, the names of the institutions that AIG had paid with bailout money were kept secret, but when we found out who they were, there was one category that stood out starkly: municipalities in California.

I decided to do some research on how much money belonging to cities and municipalities AIG is holding. What I found out was frightening.

Municipalities all over the country have evidently handed over money to AIG from their municipal bonds. This means that cities across America are at risk of losing billions of dollars, and risk going bankrupt if AIG does!

AIG states on its website that it directly manages $72 Billion of these assets that belong to cities across America.

At the end of the day, these assets are actually made up of schools, hospitals and libraries in towns everywhere. It is almost for certain that we’re talking about much more than $72 Billion being at risk, which is a staggering number to begin with.

In addition to handing over immense amounts of cash to AIG, cities have been making extremely risky financial bets through Credit Default Swaps, which is evidenced by the payments to municipalities in California, as I mentioned in the beginning.

AIG owes a lot of people money for these swaps and is like a bookmaker who can’t pay the people who all bet money on the winning horse that nobody thought was going to win. The difference here is that all those people who are supposed to be paid money by AIG have decided to keep quiet about it, presumably so as to not create a panic.

With respect to all the cash that was handed over, everyone may not know what the so-called “municipal bond market” is, or how that relates to AIG, but it works something like this:

- individuals or corporations give money to, for instance, the city of Los Angeles for the construction of a school

- Los Angeles promises to pay a 5% return on the money 10 years in the future. That is “the municipal bond”

- Los Angeles hands over the money to AIG, in order for AIG to make that 5% for the bond holders. The section of AIG that does this is called the “Fixed Income” unit

You may realize where I’m going with this: AIG hasn’t exactly been the best or wisest investor over the last few years. AIG is now a black hole of losses, and it almost doesn’t matter how much taxpayer money you put into the company, most people who are owed money by AIG will not be paid.

For now, AIG is on life support with taxpayer money and with the temporary illusion peddled by Washington and Wall Street that everything is going to be just fine. It won’t.

There is a strong possibility that problems with municipal bonds will add a whole new dimension to the crisis, and that cities across America will have to choose between closing schools or paying bond holders when AIG eventually files for bankruptcy.

I have argued before that the main difference between the United States and other industrialized countries is that the U.S. does not safeguard a standard of living for its citizens, and that basic services are, like everything else in this country, a gamble for everyone. If the gambles at 70 Pine Street in New York (the AIG building) don’t work out, kids in California may not go to school.

Moreover, I advise that the winner-takes-all voting system should be destroyed


Anonymous said...

So, why are the papers all saying that things seem to be looking better as a result of geitners plans.

Housing numbers are supposedly looking better.

The dow is rising..

What's going on?

Jacob said...

One thing is for sure, this historic crisis did not just go away in a matter of days.

The construction increase is a little puzzling, but it was an increase from extremely low levels. It may have to do with previously planned projects or consolidation in the industry.

The Dow has, as usual, a very weak connection to long-term reality, and this looks like an ordinary bear market rally which will end as abruptly as it came about.

I'm actually seeing more disturbing signs than ever. In addition to the bond story in the posting today, the Chinese are seemingly cooling to the idea of buying more U.S. Treasuries, which would present a problem on an entirely different scale.

If they stopped buying treasuries, we all know what's coming: catastrophic inflation.

There are many possible scenarios for the U.S. and the Dollar, and I don't yet know which one I believe will happen. A global crisis can either weaken or strengthen the U.S. in general, depending on how the rest of the world sees the U.S. as a global economic leader.

This presents several interesting issues, one of which is regulation. The world consensus (whether one believes that or not) is that too little regulation caused this crisis. Huge amounts of capital came to the U.S. as a result of the lack of regulation, and if the U.S. economy is now regulated, that capital will probably go away, deepening the crisis.

Anonymous said...

I think you need to do a post that explains the 30 billion dollars that AIG gave to firms like Goldman Sachs, which prior to this payment, had claimed that they were fully hedged against any losses on their credit default swaps.

This is perhaps the most under reported story of this AIG mess.

And Geitner hiring citibanks former economist to help him out!!

an average patriot said...

They are the largest and insure everything. Every city and State would be in trouble. I can not believe we put all our eggs in one basket.
What really peeves me and no one mentions is I refuse to believe that our taxpayer money was taken by AIG and given to European Banks.
WTF is wrong with us? They took on bad debt it is up to their countries to help them out not us!

SocGen was the biggest recipient at $11.9 billion, Deutsche Bank AG received $11.8 billion and the UK's Barclays Plc was paid $8.5 billion. What the hell is wrong with us!