AIG

There is a little for everyone in Marc Faber's latest appearance on CNBC. The infamous boomer (and doomer) believes (as we do) that today's downgrades are less significant for stocks (at least until the realization that banks and more importantly insurance companies are about to be cut as well - keep a close eye out on Allianz and Generali (of ASSGEN fame) - it is not incidental that they are abbreviated to A&G, just one letter away from our own AIG) as it is largely priced in but the equity market's rally of the last few weeks (with its lack of breadth and volume) is strongly suggestive of a bear-market rally (as opposed to the decoupling bull market that so many hope for). His view quite simply is that the ECB has undergone a backdoor monetization and without this the EUR would be significantly stronger especially given the huge short-interest (though he sees the trend for EUR is down).  Some highlights include: EUR weakness may help exports but the debt servicing costs of major European firms with huge US denominated debt wil suffer greatly, most European nations should be CCC-rated, nominally European stocks will outperform and holding quality dividend paying companies is preferred, valuation is practically impossible given ZIRP, and finally noting the irony, the worse the global economy gets (and the Chinese economy suffers), the more money printing will occur lifting nominal equity prices while real economies stumble and standards of living drop, so hold gold.

• China’s Forex Reserves Drop for First Quarter Since 1998 (Bloomberg) - explains the sell off in USTs in the Custody Account
• Greek Euro Exit Weighed By German Lawmakers, Seen as Manageable (Bloomberg)
• Greek bondholders say time running out (FT)
• Housing policy to continue (China Daily)
• Switzerland’s Central Bank Returns to Profit (Reuters)
• US sanctions Chinese oil trader (FT)
• Obama Starts Clock for Congress to Vote on Raising Federal Debt Ceiling (Bloomberg)
• Turkey defiant on Iran sanctions (FT)
• ECB’s Draghi Says Weapons Working in Debt Crisis (Bloomberg)
• Greece to pass law that could force creditors in bond swap (Reuters)

Almost six months ago we discussed the dramatic shifts that were about to occur (and indeed did occur) the last time the New York Fed tried to unwind the toxic AIG sludge that is more prosaically known as Maiden Lane II. At the time, the failure of a previous auction as dealers were unwilling to take up even modest sizes of the morose mortgage portfolio was the green light for a realization that even a small unwind of the Fed's bloated balance sheet would not be tolerated by a deleveraging and unwilling-to-bear-risk-at-anything-like-a-supposed-market-rate trading community. Today, we saw the first glimmerings of the same concerns as chatter of Goldman's (and others) interest in some of the lurid loans sent credit reeling. As the WSJ reports, this meant the Fed had to quietly seek confirming bids (BWICs) from other market participants to judge whether Goldman's bid offered value. The discreteness of the enquiries sent ABX and CMBX (the credit derivative indices used to hedge many of these mortgage-backed securities) tumbling with ABX having its first down day since before Christmas and its largest drop in almost two months. The knock-on effect of the potential off-market (or perhaps more reality-based) pricing that Goldman is bidding this time can have (just as it did last time when the Fed halted the auction process as the market could not stand the supply) dramatic impacts as dealers seek efficient (and critically liquid) hedges for their worrisome inventories of junk. The underperformance (and heavy volume) in HYG (the high-yield bond ETF we spend so much time discussing) since the new-year suggests one such hedging program (well timed and hidden by record start-of-year fund inflows from a clueless public which one would have thought would raise prices of the increasingly important bond ETF) as the market's ramp of late is very reminiscent of the pre-auction-fail-and-crash we saw in late June, early July last year as credit markets awoke to the reality of their own balance sheet holes once again.

Poor, poor Federal Reserve.

Now we all get to wince once again watching Greenberg trying to get his final Fat Cat licks in.

Steve Miller is the chairman of AIG. Between 2008 and 2009 AIG received $97.8 billion in loans from the Fed plus four bailouts totaling $69.8 billion in taxpayer money. This is what Steve had to say yesterday when asked by Bloomberg TV’s Betty Liu for his views on Occupy Wall Street.

We are still waiting to see the final form of the "Grand Plan" and what novel ways the EFSF guarantees will be applied to save the day. At the risk of sounding incredibly stupid, I have this feeling that Europe didn't actually work on any details until this past week, and Germany is suddenly realizing how bad the details are for them. Is it possible that some politicians got so caught in the moment of "saving Europe" and "fighting the speculators" that they kept promising more and more, without thinking whether they could or should deliver? You would like to think they didn't, but since none of the politicians are detail oriented, most of their contacts at investment banks are high level, former bankers, rather than traders, it is quite possible they didn't realize what they had agreed to. If some new EFSF is created, all of the future bargaining power in Europe will be shifted from France and Germany to PIIS. (it is a shame Ireland wasn't named Shamrock, it would make the acronym so much better).

Business as usual on Wall Street but it won't be enough to save pensions...

Three weeks ago, when discussing the failed (yes, failed) Maiden Lane 2 auction by the New York Fed, we said: 'Something quite disturbing happened during today's latest attempt by the Fed to sell $3.8 billion in face amount of Maiden Lane 2 assets: it had a busted dutch auction. In fact, the auction was so massively busted, the New York Fed managed to sell only half of the bonds for sale, or $1.898 billion in 36 Cusips of the total 73 Cusips offered for sale." Subsequently we noted the sudden radiosilence from the Fed on this issue on Twitter. To be sure, every MBS trader and the kitchen sink promptly complained that the Fed was saturating the market with toxic AIG garbage, which prompted us to declare that: "unless someone opens up a release valve, we are about to see a massive
regurgitation and even more massive repricing of credit risk, first in
IG, then in HY and ABX/CMBX, and lastly, and most massively, in
equities, which continue to exist in their own world and which are now
totally disconnected with HY, which they used to track so very closely." We just got the release valve: from Bloomberg: "The Federal Reserve Bank of New York is halting its sales of mortgage bonds acquired in the rescue of American International Group Inc. "Given prevailing market conditions” for residential mortgage-backed securities, “we do not anticipate any sales of bonds in the near term or until such time as the New York Fed deems it will achieve value for the public," Jack Gutt, a New York Fed spokesman said in an e-mail." Uh, what prevailing market conditions: a Nasdaq which has ripped over 100 points in one week (granted on no volume and on unprecedented market manipulation but so what). Regardless, this is a huge slap in the face for the Fed, which has just proven that even in a surging market it can not unwind an amount from its book that is less than 1% of its total asset holdings without actually crashing the market.

Just when one thought every imaginable taxpayer bailout scheme had been seen, experienced and in many cases, forgotten, here comes AIG once again. The specifics come from Deutsche Bank's Joshua Shanker initiation of coverage report on AIG (naturally with a Buy rating, $34.00 target price), where within the fine print he notes: "the company believes there may be bargains available from buying RMBS securities from European banks seeking better positioning under Basel III requirements. " Prudently, he adds: "We note that increased yield, in this regard, also carries with it increased risk." Translated this means that AIG is about to do for European banks what the ECB so far has been unwilling and/or unable: namely to transfer the risk associated with European banks' massive ongoing exposure to the continuously collapsing US housing market back to the US taxpayer, in the form of AIG, which was bailed out once, and which will certainly be bailed out again, when the time comes.

...You are down just 3% in a few hours. Also, as a reminder, flipping to bigger idiots only works when one has a profit. And congratulations to the US Treasury. The $5.8 billion in gross proceeds (and $5.4 billion net of the $385 million in fees paid to Bank of America, JP Morgan and other TBTFs) is almost, but not quite, in the same league as the $110 billion in new debt issued this week. Oh, and good luck with the remaining $41 bllion in AIG Treasury exposure (through the common) not at a loss (above $28.70)

According to Dow Jones and now CNBC's Kate Kelly, the AIG offering is due to price at $29 as underwriters supposedly have succeeded in the last minute scramble to get enough bid interest above the Treasury's breakeven price of $28.70. That's a $0.30 buffer. Surely this will inspire much confidence in the deep order book of institutions which despite having access to limitless zero cost cash, still barely chipped in enough to avoid major 11th hour embarrassment for Tim Geithner. In the meantime here is the math for determining just how taxpayers are winning on this deal: Treasury gets $5.8 billion in cash proceeds (200MMx $29), which is immediately offset by $35 billion in debt issued today, another $35 billion tomorrow, and $29 billion on Thursday. One step forward. Fifteen steps back.

So, as the government is about to unload some of its AIG shares on the market, we will hear about it all day long. It is impossible to listen to a report on AIG without someone mentioning how credit derivatives were directly responsible for the collapse of AIG which is proof that credit derivatives are bad. It also seems that everyone is convinced that it wasn’t the fault of the banks and that the bailout was justified. The reality is that AIG lost money on customized regulatory capital arbitrage pass through trades where they underestimated the risk but also gamed the system. The banks themselves were sloppy on the credit terms that they engaged AIG on, creating the margin call death spiral. Finally, it has never been made clear that AIG had to get dragged into the problem, and that AIG FP could have been ring fenced and not impacted the parent companies.

Remember the other most hyped up re-IPO ever, AIG (after that other Marxist-inspired, union-lubricating, channel-stuffing debacle GM)? The same company that nearly brought down the system, that insured more disaster prone garbage than even Berkshire Hathaway, which is  92% owned by the government because it wouldn't look cool if the government fully nationalized everyone after Lehman was left to die, and was subsequently eagerly attempting to buy back its toxic filth at half off prices from Goldman's Bill Dudley who just so happens works at 33 Liberty now? Well, you can kiss that goodbye: the FT reports that "AIG and the US Treasury are discussing whether to shelve or scale back plans for a large public offering this month because of the lacklustre performance of the insurer’s shares in recent weeks, people close to the situation said." You can also kiss the Treasury's boasts of a break even on its AIG "investment" - this despite 2 years of endless market levitation, forced short squeeze, margin hikes, several wars, $4 trillion in monetary and fiscal stimuli, and most certainly, the kitchen sink. "People involved said the most likely outcome of the deliberations would be for the offering to proceed at a smaller size and closer to the Treasury’s break-even point. This would allow the restructured company to provide a longer record to the market before a larger sale later this year. Shares in AIG have fallen more than 30 per cent since January 20, hitting $29.62 on Tuesday and jeopardising taxpayers’ profits on the share sale. Treasury’s break-even level is $28.73 a share and officials have been reluctant to approve an offering below that price." This likely also means that any follow on equity capital raises by AIG will be relegated to CDO issuance and other "silly paper" that will be bought only with other people's money.

The Fed, in bailing out the world (a meme that has only now received popular acceptance following the release of formerly classified Fed documents, despite our claims precisely to that end from back in October 2009) has become the world's largest hedge fund and with a DV01 of over $1.5 billion by now, has taken on virtually unlimited interest rate risk (a topic discussed back in April 2010). As such controlling inflation expectations, or more specifically, Long-Term rates (the part on the curve that Quantitative Easing is powerless to control) is the most critical aspect of the viability of the monetary system. Stunningly, today we learn that to keep long rates low, the Fed may have resorted to nothing short of the same suicidal trade that destroyed AIG FP and brought the entire system to its knees. Namely, Ben Bernanke is now quite possibly the second coming of Joe Cassano, since in order to keep rates low, Bernanke is forced to a last resort action of selling billions upon billions of Treasury puts to "pin" rates low contrary to natural supply-demand mechanics. If so, the Fed is now basically AIG Financial Products, although instead of being synthetically long mortgages (and thus betting on a rate decline) and selling hundreds of billions in CDS to amplify its bet, Bernanke has done the same thing, only this time with Treasurys. Of course, Ben has the printing press on his side apologists will claim. Alas, that will have no impact whatsoever, if indeed the Fed has been reduced to finding ever fewer counterparties to a synthetic bet to keep long-term rates low, as very soon, with inflation ticking up, all hell may break loose in an identical replay of what happened to AIG once the Fed's put is called against it. Only this time there will be nobody to bail out the ultimate backstopper, resulting in the long overdue end of the current failed monetary system experiment.