Monday, November 10, 2008

The latest infusion for AIG is yet another transfer of wealth from the Federal Government to the financial system. It is increasingly clear that AIG did a terrible job modeling the risk on their credit default swaps, and if they had been Chicago Floor Traders rather than Harvard genius math Ph. Ds, they would have experienced the enormous demand for their product as evidence of an incorrect model, with a consequent adjustment to their model until demand slackened. However, moving our theoretical apparatus seven miles South in Chicago, to Hyde Park, we can still make sense of their ridiculously low prices for Credit Default Swaps: AIG default risk was built into the price, so at a CDS at two cents on the dollar for a fifty percent default risk had the embedded default risk of AIG itself.

We know that GS had 20B of AIG CDSes --but who were the other speculative counterparties? Now that the US stake in AIG has crossed 80%, this should be the requested in a FOIA filing. In the meantime, AIG should be put into a type of recievership where a federal judge can adjudicate which obligations will be made whole and which obligations will go out worthless. There is something outrageous about Federal money providing a 50x1 return on bets that were made at theoretical value and are going out at 5000 per cent.


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