Wednesday, May 27, 2009

It's Not That Hard

A while back, I pointed out why it was ridiculous for Goldman Sachs and other banks to say that because AIG was a triple-A rated company, the banks should not be blamed for taking on all these risks with AIG as a counterparty. So I was glad to see Dow Jones columnist Donna Child earlier this week provide even more proof for how outrageous the banks' claims are.

NEW YORK (Dow Jones)--Described as a "black hole," American International Group Inc. (AIG) is largely inscrutable - but not to everyone. Like the proverbial canary in the coal mine, key reinsurance markets delved deep into the operations of AIG and concluded that they could not sustain life.

Had investment banks had the benefit of the same insight, they might have averted the counterparty risks that required a substantial bailout orchestrated by the U.S. Treasury.

Why did reinsurance markets possess the insight that had eluded investment banks?

Investment bankers understand single transactions and fees for insurance company clients, such as bond offerings, sidecars or equity issuance.

Reinsurance, which is contingent financing for underwriting risks, contains all of these features with an element of continuity that becomes an intangible asset between the insurer and reinsurer. Reinsurance companies, therefore, have a much longer time horizon than investment banks.

With a potential long-term exposure to AIG, reinsurance markets carefully scrutinized AIG's business as part of their underwriting due diligence. Because of the longevity of AIG's business commitments, the long-tail nature of certain of its liabilities and its pricing practices, including those at AIG's London-based Financial Products unit, leading reinsurance markets concluded, in the phrase of one provider, that "making a return on reinsuring AIG was an accomplishment if not a rarity."

Having reached this conclusion years ago, leading reinsurance markets declined to participate in certain of AIG's transactions and thus averted the costly lessons learned by investment banks with credit counterparty exposure to AIG and ultimately, because of the systemic risk involved, to the U.S. Treasury.

Is it too much to ask bankers and traders making millions of dollars a year to actually, you know, do research into the risks they are taking?

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