AIG Drives GM Bankrupt

General Motors is going bankrupt.

Click edit above to add content to this empty capsule.

By now everybody knows that GM will not survive without a bankruptcy reorganization. President Obama has said that he will expect (require?) the bankruptcy soon.

Why?

GM makes plenty of money. It uses various accounting practices to avoid reporting a profit from its annual sales. And these practices are normal, ordinary, and legal. There is nothing wrong with reporting their income the way that GM reports theirs.

But it does make them look a lot less profitable than they really are.

It is worth noting, also, that GM make most of their sales during certain months of the year. In the autumn when new models are released, the make money. And they make money during the summer when people are out driving about and feeling good and prosperous. They don't make much money in the dead of winter. And they don't make much money in the last weeks just before the new models are released.

During the times when GM's sales are high they make enough money to keep them going for the entire year. But it is real hard to use this revenue to meet their day to day costs for the whole year. The available cash is just too bumpy and unpredictable.

That is why they use short term loans - to provide a constant availability of cash for the operational use of the company.

Corporate bonds are a great instrument. They are bought and sold through well regulated markets and their values are expressed in terms we all know how to understand and use.

A bond is issued at a specific value, say $100. This is its par value. It is sold at a price which is less than its par value, for example $70. This is its discount value. At the end of the bond's term it is bought back at full par value. Corporations can also buy them back early at markdown rates based upon market conditions.

Discount values for corporate bonds fluctuate as rapidly and as sharply as pork bellies or any other commodity. Banks don't like corporate bonds because of the fluctuation in their discount values.

During the last several years, banks have been combining corporate bonds under the CDO (Collateralized Debt Obligation) umbrella. CDOs are virtually illiquid. Mostly you can buy or sell them only with the entity that created them. Banks love CDOs because they are stable in value.

How does AIG come into this picture?

CDOs have another neat feature for banks. You can insure the value of a CDO by buying a CDS (Credit Debt Swap). A CDS is an insurance account for the par value of a CDO.

This is like an insurance policy on your home if it offers "full replacement coverage" against disaster.

It is a smart idea to buy a CDS for each CDO you own.

AIG wrote most if not all of the CDSs for the CDOs that were derived from GM bonds.

How is this driving GM into bankruptcy?

Last year the US government bailed out GM from a short term cash flow crisis and gave them instructions to reorganize their debts.

The thinking was that all of the holders of General Motors' corporate bonds would be forced to take a markdown in the discount value of their bonds.

Finances are supposed to work like that.

But the holders of CDOs derived from GM corporate bonds were insured for their full par value by AIG CDSs. And all AIG CDSs were guaranteed by the US government for their full par value. Therefore the holders of these CDOs said, "No, we're not going to take any markdowns. We are insured for the full value."

As a result, GM could not force the discount value of their bonds down and they could not buy them back at a low market value rate.

When you can't pay your creditors off, they come to collect. This is what has happened to GM.

So think about this:

If AIG did not insure the value of the CDOs derived from GM bonds, their value and the value of GM bonds would naturally decline. And GM could buy them back at a lower rate, and preserve enough cash to continue to operate. But the United States has guaranteed the value of the CDSs issued by AIG against those CDOs, so their value cannot decline. As a result, GM has no takers when they offer to buy back their corporate bonds at a discount value less than they were initially sold.

That's why General Motors is being forced into bankruptcy.

This is a case where the US government should get out of the market.

PPIP is a fraud - What Really should be done

The newest attempt by the U.S. Treasury department to bailout the mortgage crisis is just another failure.

In theory it encourages investments into worthless Collateralized Debt Obligations (CDO) by using a combination of public and private money to purchase them at auction.

In fact, the private money can be as little as 7% of the total purchase price and the "auction" has little to do with what you and I consider to be an auction.

What will happen in reality is the CDOs that still have value will be purchased at a deep discount by leveraged offerings of a little bit of private money and a lot of public money. The private investor will make a killing.

Meanwhile the worthless CDOs aill be purchased by a little bit of private money and a lot of public money and the originating mortgage owner will still default. The CDOs will become very worthless and will be sold on the secondary market to debt and bill collectors who will end up with the property. If the secondary market investor is the same as the auction purchaser, he will make a huge killing after he collects the defaulted property. Even if they are distinct entities, the auction purchaser will only lose 7% of his total investment and the seconday market investor will still make a killing on the property claim.

As you can see, nothing happens to reduce the evictions of home owners. Nothing happens to protect the taxpayer. And nothing happens to make credit actually flow again.

Here is what should be done.

Let's start by asking several questions:

1. How many CDOs have been issued?
2. What is the issuing value of each?
3. What mortgages were combined to costruct each CDO?
4. How much is each mortgage worth now?

Answering these questions is called unwinding the CDOs.

When you have unwound each CDO, you can compute it's remaining value. Some of them have the same remaining value as they had when they were issued. Some of them are worthless.

All CDOs should be rated accurately as to how much value they still have. If all of the mortgages which back the security have paid 100% on time, the CDO should be given a 100 rating. If all of the mortgages which back the security have defaulted, the CDO should be given a 0 rating. If half have defaulted but half have paid and are paying fully and on time, the CDO should be rated 50. And so on.

CDOs which are rated like this have a value and can be publicly and honestly traded. CDOs which have no rating have no value.

We must establish a public system of rating financial instruments.

How Many Toxic Assets Are There?

Has anyone counted this stuff?

I am dumbfounded daily at the reporting and journaling of the "financial crisis" that we are in.

We know that Collateralized Debt Obligations (CDOs) are the root of our current problems. We don't know 2 very important things:

1. What is the combined worth of the CDOs that have been issued?
2. How many CDOs were actually issued?

Have you heard either of these two issues discussed in any analysis of this stuff?

Exactly how much is the dollar value of all of the CDOs that were produced? It is always given as more than 3, 10, or 18 trillion dollars. Tweny trillion dollars is greater than each of those numbers, and so is 18 trillion and 1 dollar.

So, what is the actual dollar value of the CDOs that were written? (It is sufficient to report par value at this point.)

And how many CDOs were written? Was it one CDO or was it 18 trillion?

Finally, how many CDOs were bad, i.e. had at least one of its constituent mortgages defaulted upon?

Not every CDO is constructed from defaulted mortgages. Not every CDO is actually worthless.

When Western Union Bank unwound their CDOs and sold them at market value, they went for an average of 19% of their par value. That's not bad.

All notes are sold at discounted values from their par value. Even U.S. Treasury notes are sold at discounted values.

Let me ask again, just one last time, how many are there and what is their aggregate value?

"New Industries" Regulated

Thrashing their way out of the mess.

The federal government has announced intentions to regulate money market accounts, hedge funds, insurance agencies, and "industries too big to be allowed to fail".

Do you know what these things are?

A money market account is a mutual fund which keeps all of its assets in the "cash" market. They were created back in the 70's as a tool to avoid Jimmy Carter's inflation, which ran just about 20% per year. Money market accounts have become combined checking/savings accounts with banks that are not federally regulated or insured.

Once upon a time there were state regulated banks and savings and loans which were not federally regulated either. During the Reagan era they were all swept away. Some dissolved because of the savings and loan scandal and some became federally regulated banks.

The problem we have had is federally regulated banks pay such poor returns and charge such outrageous fees that people of common sense have avoided them. Instead they have put their cash into money market accounts. Last October, there was a run on the money market institutions as people tried to convert their accounts into real currency when the system tried to sieze up. The money market trust funds were not properly capitalized so some simply shut their doors.

That's what the governmnet wants to regulate about them. That is, money market accounts are about to be converted into federally regulated and insured bank accounts.

What about hedge funds?

Do you know what a hedge fund is? No one else does either.

At its ultimate analysis, a hedge fund is a brokerage account where you turn over all the investment decisions about the account to the broker. Except with hedge funds, the broker doesn't always have to be a licensed broker.

Bernie Madoff ran a hedge fund and used it to destroy $60 billion in investments.

Problem is, nobody is in charge of monitoring hedge funds. An ordinary broker directed account or a mutual fund is monitored by half a dozen agencies and organizations. Your money is pretty safe with them. (I admit there are abuses, but the SEC does a good job of finding the abuses and reversing their effects.)

But hedge funds represented a way to get around the regulators. All I can say is it's about time for them to be regulated by someone!

Insurance companies?

Three letters AIG.

You can also throw in hurricanes Katrina and Andrew. When those disasters struck, some insurance companies simply pulled up stakes from the affected areas and replied, "Sue me," to their policy holders.

Up till now, insurance companies have been regulated by state governments. Court decisions and electronic capital have made our old system worthless.

We need a national regulation of insurance corporations, and of "self insured" corporations and individuals. But we don't want to lose the best benefits we have now.

Federal regulation of the insurance industry should incorporate the best and most agressive state rule for insurance into whatever is proposed at the national level. We'll have to watch this.

Finally, "Too Big to Fail"

GM is too big to fail. Apparently so is Chrysler and so is Ford.

If a company is so big that it's failure will annihilate America, then that company must be regulated and changed.

I think any company that is so big its failure would devastate the USA should be broken up into smaller companies.

This is good for everyone. Do you remember the antitrust regulations of Teddy Roosevelt's era?

This is socialism!

No, it's not. Look back over the 20th century's ideologies and you will find this set of policies was not codified as socialism, but as fascism.

Yes, Mussolini was the first leader to practice these policies systematically.

To succeed, we must regulate carefully, fairly, and well so that all Americans benfit and are not threatened by our system of regulation.

Public Private Investment Program - PPIP is a taxpayer ripoff

The newest attempt by the U.S. Treasury department to bailout the mortgage crisis is just another failure.

In theory it encourages investments into worthless Collateralized Debt Obligations (CDO) by using a combination of public and private money to purchase them at auction.

In fact, the private money can be as little as 7% of the total purchase price and the "auction" has little to do with what you and I consider to be an auction.

What will happen in reality is the CDOs that still have value will be purchased at a deep discount by leveraged offerings of a little bit of private money and a lot of public money. The private investor will make a killing.

Meanwhile the worthless CDOs aill be purchased by a little bit of private money and a lot of public money and the originating mortgage owner will still default. The CDOs will become very worthless and will be sold on the secondary market to debt and bill collectors who will end up with the property. If the secondary market investor is the same as the auction purchaser, he will make a huge killing after he collects the defaulted property. Even if they are distinct entities, the auction purchaser will only lose 7% of his total investment and the seconday market investor will still make a killing on the property claim.

As you can see, nothing happens to reduce the evictions of home owners. Nothing happens to protect the taxpayer. And nothing happens to make credit actually flow again.

Here is what should be done.

Let's start by asking several questions:

1. How many CDOs have been issued?
2. What is the issuing value of each?
3. What mortgages were combined to construct each CDO?
4. How much is each mortgage worth now?

Answering these questions is called unwinding the CDOs.

When you have unwound each CDO, you can compute it's remaining value. Some of them have the same remaining value as they had when they were issued. Some of them are worthless.

All CDOs should be rated accurately as to how much value they still have. If all of the mortgages which back the security have paid 100% on time, the CDO should be given a 100 rating. If all of the mortgages which back the security have defaulted, the CDO should be given a 0 rating. If half have defaulted but half have paid and are paying fully and on time, the CDO should be rated 50. And so on.

CDOs which are rated like this have a value and can be publicly and honestly traded. CDOs which have no rating have no value.

We must establish a public system of rating financial instruments.

Abandon Stupid Policies

Yesterday, the U.S.Treasury announced that they were abandoning their approach to fixing the banking crisis. This is good. It was stupid to begin with.

Here is what they were previously planning to do:

• All of those bad mortgages that had been written with low teaser rates and enormous balloon rates had been split into investment notes and these investment notes were sold to investors from around the world. This is called monetizing the mortgages.
• Individual mortgages were split into multiple notes. So if a single home owner defaulted upon his mortgage, up to 20 notes could be damaged.
• This year everyone holding mortgage notes tried to divest themselves of them., only to discover no one else wanted these investment notes either.
• This caused a freeze up in the cash market.
• The U.S. Treasury was given $750 billion by Congress to buy these notes at retail prices so the investors would not lose everything and the cash market would unfreeze.

Retail Prices?!!

They couldn't buy the notes at their current market value because the value of a $40,000 note was almost zero. Nobody who held them wanted to sell them at zero dollars.

So what value could they pick?

Face value issue price.

The Treasury was planning to buy the mortgage investment notes at the same price they were when they were created, without any consideration for damage done to them by defaulting mortgages.

The investors were going to make a triple profit.

1. They were going to recover their initial principal without participating in any of the cost of the risk.
2. They were going to collect all of the payments made by all of the mortgage holders to date.
3. They were going to foreclose on the properties of the defaulting mortgage holders and resell these properties for at least a fraction of their value.

Who wouldn't want a deal like that?

Yesterday, the Treasury decided they didn't want to participate in this foolishness.

What should the U.S.Treasury do?

They should take their $750 billion and buy the difference between the present value of the homes on which mortgages are held and the value of those properties when those mortgages were issued.

This way a house which was worth $500,000 before the mortgage loan crisis but is now worth $300,000 today would have $200,000 of its mortgaged value purchased from the note holders by the U.S.Treasury.

This tactic will create a lien against that property so when it is sold for any value greater than its bought down value (in the example, $300,000) , the Treasury will collect its investment (in this case, $200,000).

What will this accomplish?

Immediately, the investment notes will provide return of part of their principal to their holders. But investors will still have to participate in the risk of the investment to recover their full value.

Home owners who are being buried by declining home values and rising monthly mortgage notes will find their monthly notes decreasing.

The U.S.Treasury will eventually recover their investments.

Finally, the panic will be stopped and cash will flow again.

The First Thing to be Done

What good will it do for us to win all of our wars, what good will it do for us to be given stable jobs, what good will it do for us to get health care if our money is no good?

The most important thing our government must do now is to guarantee the stability of our money.

And by "money" I don't mean merely our currency. Money in all of it's forms includes cash, credit cards, electronic transfers, and monetary notes of all kinds. The government only creates some of them. It guarantees the safety of only some of them.

What the government must do is to provide an insurance for all forms of cash.

Banks, money market funds, retirement funds, mortgage investment notes, and all other financial instruments must be protected against loss of principal.

Businesses will accept the potential loss of income from these tools if they do not also lose what they start with.

With this acceptance will come the availability of money which is presently hoarded in "safe" storage. This loosening of money will allow the formation of new money by entrepreneurs and savers.

How can the government do this?

The U.S. government can perform this very necessary task by providing an insurance program to every investment. This program will guarantee that no investor in any of these monetary forms will lose any of his principal.

The program will be paid for like all insurance programs - by a surcharge added on to the principal to establish the total initial buy-in for any of these investments.

Every cash investment must be insured. That means the insurance must be mandatory. Voluntary means no one pays for it. And the insurance must be funded by enough money to actually cover all of the at risk items. It is not sufficient to insure less than 100% of all cash investment items or less than 100% of all of the value of those investments.

What will happen as the result of this?

If cash is available, all other kinds of investment can be financed.

If cash is available, all government programs can be paid for.

If cash is available, jobs are inherently stable.

So we must conclude: Stabilize money now.