February 15th, 2009

I asked Bob Moriarty of 321gold.com for some thoughts on my post from yesterday, luckily for me he took the time to answer me and his reply was that I should put more definition and background into it. So, I'll give you something that I think will clarifiy alot of what I wrote yesterday:
Why was AIG so important to bail out? I think this question is crucial, because it reveals a big hole in the derivatives conundrum. When bankers wanted to free up more credit so they could increase leverage or pass on bad paper, they had to (actually, still have to) have a good credit-worthiness of that particular paper/asset. And the only way to get a good credit-rating on bad assets is through insurance! So, companies like AIG insured, for example, the sub-prime loans and when these bad papers became worthless AIG couldn't pay up their insurance because they had not expected such a big loss - or they simply choose to not expect it for short-term profit.

To not confuse anyone, the insurance is not generally refered to as an insurance, they are called CDS's (credit default swap) and handled like bonds and not like traditional insurance (so really anyone can be an insurer in this business). And let me also add that CDS's are not only used to insure 'bad paper', but also stocks like Lehman Brothers.

And then AIG was bailed out because they were so important to sustain credit-ratings and therefore the value of these worthless assets ... now who knows how much money the US government will have to throw away into this monster? By the looks of it, this thing is far from over; in fact, the derivatives market has grown since the bail-out! Maybe the bankers are using the little credit-worthiness the US still has to milk the cow as much as they can before the fraud is no longer sustainable.