Aren’t we being a bit Harsh on AIG?
AIG is an insurance company. And how did they collapse? They were insuring risky investments by selling credit default swaps. Here’s how this all went down. But first, a few definitions of some terms in the way that I understand them:
Credit Default Swap: Basically Insurance on an investment. If the investment goes belly up, the company that sold the insurance pays money to whoever bought it.
Mortage Backed Securities: An Investment made up of a bunch of mortgages
Collateralized Debt Obligation: A section of a Mortgage Backed security. There are thousands of Mortgages in a Mortgage Backed Security. The CDO is a section of that security, and it’s all of the riskier mortgages. Like the Sub Prime ones, or… the guy who bought a $250,000 house who only makes $35,000 a year and is hoping to re-sell it before his adjustable rate mortgage adjusts and kills him financially. Put all those together and you’ve got the CDO in a Mortgage Backed Security.
Also, know this about credit agencies. There are big companies that get paid to rate investments. And they give these investments grades. The least risky investments are given AAA ratings. The MOST risky investments, or, investments that are more likely to fail, collapse, or default, (Like General Motors right now) are given CC ratings. Here’s what this looks like, and remember, AAA is the safest.
AAA BBB CCC
AA+ BB+ CC+
AA BB CC (Riskiest)
AA- BB-
A+ B+
A B
A- B-
Now that we have those things defined, watch this video:
PBS “NOW” – Credit and Credibility
Fast Forward to 3:39 if you have to. Watch at least until 8:22. Watch the entire piece if you can.
Through what this PBS special calls “dazzling financial engineering” basically, loose math… the credit rating on these CDO things, jumped from say a BBB (risky), to a AAA (not risky at all).
Here’s what they basically said: If we put ALL of the risky mortgages (BBBs) in one area (A CDO), since they’re all together, they’re no longer BBBs. When they stand together as a group, they’re much less risky and the CDO is now a AAA.
Make sense? Of course it doesn’t. But that’s what they were saying.
There’s the lie. This is where this all went wrong.
Wouldn’t it be accurate to say that if the credit agencies hadn’t fudged the math and relabeled boatloads of BBB investments into AAAs, we probably wouldn’t be in this entire mess?
Companies started buying up these new Mortgage Backed Securities and Collateralized Debt Obligations because they LOOKED secure. But they really weren’t. And AIG was insuring it all.
All of a sudden the truth came out when people started getting foreclosed on and the housing bubble burst. And when that happened, all of the companies who believed in something that was too good to be true, (a BBB investment with a AAA rating. A wolf in sheep’s clothing essentially) came calling to AIG for their insurance money they had coming to them through the credit default swaps.
And they all came at once. And like a run on a bank, AIG didn’t have the money to pay up.
Now let me ask you this. Say you were AIG. And a bunch of companies wanted to buy insurance from you, on investments that were rated AAA or around there. Sure these investments were a new fangled thing, but… the credit agencies were rating them super high.
Would you have stopped and said no? Would you have said: “I’m not going to sell you insurance on an investment that looks sound?”
If you were an insurance company, and saw a bunch of AAA investments asking to be insured, wouldn’t you probably take the AAA rating on face value and start insuring these new kinds of investments?
Should AIG have been a litte more skeptical? Of course. They share some blame here.
But if what I’m understanding is really true, if I’ve finally wrapped my brain around this entire issue… we should probably get off AIG’s back just a little. Right?
For more on Credit Default Swaps go here:
http://www.npr.org/templates/story/story.php?storyId=94748529
And again, watch the Video “Credit and Credibility” here:
http://www.pbs.org/now/shows/446/index.html
Dappered: Affordable Men's Style
Should we get off AIG’s Back?
AIG is an insurance company. And how did they collapse? They were insuring risky investments by selling credit default swaps. Here’s how this all went down. But first, a few definitions of some terms in the way that I understand them:
Credit Default Swap: Basically Insurance on an investment. If the investment goes belly up, the company that sold the insurance pays money to whoever bought it.
Mortage Backed Securities: An Investment made up of a bunch of mortgages
Collateralized Debt Obligation: A section of a Mortgage Backed security. There are thousands of Mortgages in a Mortgage Backed Security. The CDO is a section of that security, and it’s all of the riskier mortgages. Like the Sub Prime ones, or… the guy who bought a $250,000 house who only makes $35,000 a year and is hoping to re-sell it before his adjustable rate mortgage adjusts and kills him financially. Put all those together and you’ve got the CDO in a Mortgage Backed Security.
Also, know this about credit agencies. There are big companies that get paid to rate investments. And they give these investments grades. The least risky investments are given AAA ratings. The MOST risky investments, or, investments that are more likely to fail, collapse, or default, (Like General Motors right now) are given CC ratings. Here’s what this looks like, and remember, AAA is the safest.
AAA BBB CCC
AA+ BB+ CC+
AA BB CC (Riskiest)
AA- BB-
A+ B+
A B
A- B-
Now that we have those things defined, watch this video:
PBS “NOW” – Credit and Credibility
Fast Forward to 3:39 if you have to. Watch at least until 8:22. Watch the entire piece if you can.
Through what this PBS special calls “dazzling financial engineering” basically, loose math… the credit rating on these CDO things, jumped from say a BBB (risky), to a AAA (not risky at all).
Here’s what they basically said: If we put ALL of the risky mortgages (BBBs) in one area (A CDO), since they’re all together, they’re no longer BBBs. When they stand together as a group, they’re much less risky and the CDO is now a AAA.
Make sense? Of course it doesn’t. But that’s what they were saying.
There’s the lie. This is where this all went wrong.
Wouldn’t it be accurate to say that if the credit agencies hadn’t fudged the math and relabeled boatloads of BBB investments into AAAs, we probably wouldn’t be in this entire mess?
Companies started buying up these new Mortgage Backed Securities and Collateralized Debt Obligations because they LOOKED secure. But they really weren’t. And AIG was insuring it all.
All of a sudden the truth came out when people started getting foreclosed on and the housing bubble burst. And when that happened, all of the companies who believed in something that was too good to be true, (a BBB investment with a AAA rating. A wolf in sheep’s clothing essentially) came calling to AIG for their insurance money they had coming to them through the credit default swaps.
And they all came at once. And like a run on a bank, AIG didn’t have the money to pay up.
Now let me ask you this. Say you were AIG. And a bunch of companies wanted to buy insurance from you, on investments that were rated AAA or around there. Sure these investments were a new fangled thing, but… the credit agencies were rating them super high.
Would you have stopped and said no? Would you have said: “I’m not going to sell you insurance on an investment that looks sound?”
If you were an insurance company, and saw a bunch of AAA investments asking to be insured, wouldn’t you probably take the AAA rating on face value and start insuring these new kinds of investments?
Should AIG have been a litte more skeptical? Of course. They share some blame here.
But if what I’m understanding is really true, if I’ve finally wrapped my brain around this entire issue… we should probably get off AIG’s back just a little. Right?
For more on Credit Default Swaps go here:
http://www.npr.org/templates/story/story.php?storyId=94748529
And again, watch the Video “Credit and Credibility” here:
http://www.pbs.org/now/shows/446/index.html