Bets Against AIG BSC & LEH Are Not What Killed Them

And speaking of nuance:

Too many reporters still don’t seem to fully understand what killed Lehman, AIG, Bear, etc. Paragraphs like this in today’s NYTimes are simply wrong:

“Echoing the kind of trades that nearly toppled the American International Group, the increasingly popular insurance against the risk of a Greek default is making it harder for Athens to raise the money it needs to pay its bills, according to traders and money managers.

These contracts, known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire: a default by a company or, in the case of Greece, an entire country. If Greece reneges on its debts, traders who own these swaps stand to profit.”

No, those trades are not what “nearly toppled” AIG; rather, the company purposefully took on an inordinate amount of highly leveraged risk — 3 trillion dollars worth — with a massive concentration in housing and mortgage markets. Their models assumed that home prices were not going to falter, something demonstrably false had they done 15 minutes worth of research on it. Add to this the fact they failed to have any reserves on those ginormous trillion dollar bets. Further, the bulk of their most volative exposure was to rapacious counter-parties who out-maneuvered them at every turn.

These credit default swaps (CDS) were a bet on the deteriorating fundamentals of a company whose death was inevitable.

The CDS argument is a variation of the “Shorts are killing our company” nonsense that so many money-losing firms (Now, with accounting restatements!) hide behind.

Later in the piece, the Times captures the issue much better:

“A result, some traders say, is a vicious circle. As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety — and the whole thing starts over again.

On trading desks, there is fierce debate over what exactly is behind Greece’s recent troubles. Some traders say swaps have made the problem worse, while others say Greece’s deteriorating finances are to blame.”

That captures the subtlety better.

Lost in this argument is an understanding that ALL credit and banking is based upon a belief system: That the borrower is acting in good faith, that they remains credit worthy, and they have the means to service the debt.

The good faith and belief of their clients, trading partners and under-writers is a very fragile thing. That was something Dick Fuld of Lehman Brothers discovered way too late. It took a long time to fritter away 100 years of good will — it happened so slowly that he did not notice it. Perhaps if he saw that belief fading, he would not have rejected the firm saving billion dollar deal offered by Warren Buffett . . .

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Source:
Banks Bet Greece Defaults on Debt They Helped Hide
NELSON D. SCHWARTZ and ERIC DASH
NYT, February 24, 2010
http://www.nytimes.com/2010/02/25/business/global/25swaps.html

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