Another brewing storm is gathering off the coast of Wall Street. This time it is AIG.
The giant insurer? Wait a minute how did it get there? Turns out the sub-prime virus is a fighter... after having ravaged the balance shit of the FED, the subprime virus is taking on the big insurer boys.
See, by the mysterious ways of the CDS, the SP virus has found the balance sheet of the insurers. It turns out that buying credit swap is really buying insurance from someone. When you get it, the insurer pays your principal back.
You do that with an intermediary bank, the investments banks usually and they in turn need to cover their position, need to hedge, as their business model is non-directional on all the bets. All the intermediary cares about is getting a haircut off of the transaction wich, at the end of the day really is a transaction between you and the insurance.
But when a lot of debt goes bad, at the same time, that is a lot of claims coming all at the same and bad debt coming onto their balance sheet. It is a aggregator of debt and losses, making an fat juicy and easy target for bailout. Like shooting fish in a barrel.
Is insurance, specifically financial insurance, ultimately an economic function of the Treasury? After all haven't the CDS created the false illusion that your debt was safe and encouraged more debt in the first place? If the Treasury is going to control M4 then an AIG will help.
A number of analysts recommend counter cyclical measures applied to the too big too fail category, specifically of the accounting variety. As explained by Krugman, the debt death spiral is that when assets supposedly liquid become illiquid and impaired and you reflect that through accounting, by regulation you must adjust your lending accordingly.
The argument goes that by definition of L3 assets (long term), a few institutions should be allowed to sit tight and ride out storms instead of going through forced liquidation, which further aggravate the problem of asset depreciation. The way Krugman puts it is that debt levels are going down but not as fast as assets.
The regulation encourages the numbers runs as is reflected by the wild equity market movements.
Now an insurance body cannot experience a run, say like a bank with deposits can. This is a great advantage of the insurance business actually. There are no depositors, just contracts it is supposed to make good during hard times. Already the sorting out of the CDS triggered by conservationship on Framae, which is considered as a trigger event in many contracts, seems to be a problem. They are already blaming it on IT, since many contracts were done manually in the back-office. Have YOU seen the fax?
From what I gather, I think it is the debt of AIG which will end up being downgraded. But I could be completely off the mark on that one. Equity is taking a shot in the head, but I doubt that is how they raise their working capital anyway.
Even if it doesn't have it already then it will be given access to the various discount windows available to iBanks. This way they can pay out their claim and ride out the M4 storm keeping L3 or long term assets afloat somewhat. Some will argue that counter cyclical relief a la MTM relaxation will buy everyone time by preventing artificial death spirals. First do no harm! is the new motto of the accounting profession.
Buying time is good... I go long Time!