Monday, November 10, 2008

Money never sleeps

Part of the enhanced AIG bailout --

In one new facility, the New York Fed will lend up to $22.5 billion to a newly formed limited liability company (LLC) to fund the LLC’s purchase of residential mortgage-backed securities from AIG's U.S. securities lending collateral portfolio. AIG will make a $1 billion subordinated loan to the LLC and bear the risk for the first $1 billion of any losses on the portfolio. The loans will be secured by all of the assets of the LLC and will be repaid from the cash flows produced by these assets as well as proceeds from any sales of these assets. The New York Fed and AIG will share any residual cash flows after the loans are repaid.

Proceeds from this facility, together with other AIG internal resources, will be used to return all cash collateral posted for securities loans outstanding under AIG's U.S. securities lending program.

In closer to plain English, this move is addressing just one aspect of AIG's dizzying array of activities where it's hard to tell whether it was borrowing or lending. AIG had a side business lending securities to speculators (often short-sellers); it would get cash as collateral for these loans but then turn around and invest the cash in mortgage-backed securities. A great business as long as the wheels kept turning forward. But then markets turn down, the speculators need their cash back, but AIG has it invested in mortgage-backed securities and to pay them back has to sell into a down market.

Luckily there's a government willing to overpay for the securities and allow AIG to extricate itself from one of its predicaments. In another part of the bailout, the government is to buy the assets on which AIG made some bad bets so that it can unwind the bets themselves. There's no difference in principle between that operation and the government buying houses so that can unwind the bad bets on houses. It's nice that George Bush is making America safe for socialism.

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