Comments on: AIG: First Credit Default Swaps, Now Insurance Companies

By: Nathan Aschbacher

Nathan Aschbacher — Sun, 09 Aug 2009 05:44:57 +0000

In 2010 and 2012 I’m voting straight against the incumbent, regardless of the party of their opponent.

By: iceman15

iceman15 — Sun, 09 Aug 2009 01:04:52 +0000

I agree that using BET’s is problematic in that the underlying ‘risk’ analysis (implicitly) assumes that a worse case scanario (e.g. unparallelled failures in mortgage payments as a result of a collapse in housing prices) could NOT be factored in as there was no (recent) historic parallel. This is the typical failure of the ‘random-walk’ paradigm that all future ourcomes are discounted by current prices. Keynes showed in his General Theory (1936) that market ‘perfection’ required that optimal market clearance (=> no ‘unemployed’ resources) could not be achieved as correct discounting across all markets, at all times, was impossible. Thus government intervention to prevent sub-optimal clearing (=> unemployed resources) is necessary.

IMHO, an easier explanation of this current turn might be to look at what the insurance subsidiaries actually comprise. Value (discounted net revenue streams => stock price) is the sum of both premium income and market returns. Inurance companies will typically try to match expected cash flows, e.g. by purchasing a bond against an annuity (price of bond annuity receipt, bond interest annuity payouts) & making the spread. Whilst Treasury bond prices have gone through the roof, the widening Treasury/Corporate spreads (& indeed the general impossibility/volatility of valuing corporates) have substantially increased insurance co. risks. In addition, burgeoning cash flows have become MUCH more difficult for the insurance companies to invest given the above-mentioned valuation issues and historically low interest rates. It is not surprising that under such uncertainties, especially given more suspicious regulators post Sept ‘08, that ‘conservative’ pricing has become the ‘norm’.

By: masaccio

masaccio — Sun, 09 Aug 2009 00:49:24 +0000

Synoia, thanks for that explanation. Your comments and links are really helpful to me as I try to work with what I used to know about statistics for these posts.

The only things this method has going for it are that all of the financial elites use it, so all the players are probably using similar estimates in their planning; and it provides some consistency across time, so the estimates at different dates at least use the same methodology.

AIG says it has tweaked the assumptions, see page 29 of the 10-Q, link above. If you have time, I’d appreciate your thoughts on their discussion of this calculation for the multi-sector CDO portfolio, particularly whether their assumptions make sense.

By: Synoia

Synoia — Sat, 08 Aug 2009 22:38:59 +0000

These people are ridiculously easy to pull apart (demonstrate their methods is invalid and its use negligent), here’s a BET explanation:

http://pointlessly.blogspot.co…..nsion.html
“
- First, the collateral pool is mapped to a hypothetical portfolio of N uncorrelated assets (the diversity score).
- The default probability of assets in the hypothetical portfolio is then calculated with WARF (Weighted Average Rating Factor).
- Since the default event of each asset is uncorrelated, the probability of J defaults in the portfolio simply follows binomial distribution:”

The first statement is an assumption “portfolio of N uncorrelated assets.” In the economic system, there are no uncorrelated assets, as we are bitterly discovering.

Two recently provide factors that provide correlation among assets are:

- House Prices
- Unemployment

We’re done with this BET risk management technique.

As was recognized in the BIS (bank of international settlement) paper:

http://www.bis.org/publ/work163.pdf

“However, if the actual intra-sector correlation is greater than 20%,
Moody’s old approach runs the risk of underestimating expected losses and over-rating notes by applying a DS that is too high.”

and

“On the other hand, it would appear that the BET underestimates EL when the collateral assets are correlated, with the degree of underestimation rising in the subordination level.”

No shit: “degree of underestimation rising in the subordination level” and what did our wonderful mashers of the universe do? Sold a huge number of 80%+20% (The 20% was a second loan subordinated to the 80% loan), and these loans were directly correlated by being paid by the same homeowner.

By: Bluetoe2

Bluetoe2 — Sat, 08 Aug 2009 21:20:52 +0000

The revelation today that the Obama administration has worked out a sweetheart deal with big pharma should be the straw that tips the scales. It’s obvious whose side he’s on. We should have known the day after the election when he appointed Rham Emanuel COS. It’s time for progressives to let him know he has lost trust and support. The U.S. doesn’t need 8 years of Bush Lite. Time to start thinking about making him a one termer and finding a challenger in the primaries. Here’s an interesting essay.

http://www.infowars.com/progre.....rat-party/

By: dakine01

dakine01 — Sat, 08 Aug 2009 21:03:49 +0000

Book Salon a couple of flights upstairs with Chris Mooney’s Unscientific American hosted by JD Stemwedel

By: Phoenix Woman

Phoenix Woman — Sat, 08 Aug 2009 20:45:10 +0000

Imagine if that money had gone to Detroit instead. The recession really would be over by now, and GM would be rolling the first Chevy Volts into the showrooms.

By: bobschacht

bobschacht — Sat, 08 Aug 2009 20:11:34 +0000

Thanks for this summary. I still have a bad feeling about this.
I’d prefer to hear that there are some serious fraud investigations that will result in something more serious than the dainty wrist slaps that have been meted out thus far.

Bob in HI

By: ShotoJamf

ShotoJamf — Sat, 08 Aug 2009 19:38:52 +0000

“Remember that time we gave AIG, say, $150bn. Boy that was fun, wasn’t it?”

Especially that “no Vaseline” part. That enhancement would undoubtedly have been another $100bn, give or take a few bucks.

By: PJEvans

PJEvans — Sat, 08 Aug 2009 19:32:13 +0000

I was wondering if their profits were real or just paper - or possibly only because we were bailing them out.

Thanks!