Off Balance Sheet Antics Hit the Insurance Giant AIG

The Cat: By-the-bye, what became of the baby? I'd nearly forgotten to ask.
Alice: It turned into a pig.
The Cat: I thought it would.

This is provided as background to help you understand why the Net Asset Value of your uninsured money market funds takes a healthy single digit hit in the near future.

By the way, AIG used to speculate in the silver markets and was one of the short seller cartel. Wait until that anti-bubble blows up.

AIG Poised to Absorb $5 Billion Losses From Securities-Lending
By Miles Weiss

June 27 (Bloomberg) -- American International Group Inc. plans to absorb losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse during the past year.

The world's largest insurer will assume as much as $5 billion of any losses on sales of the investments, up from a previous commitment of $500 million, said Christopher Swift, vice president for life and retirement services, in an interview. AIG also will inject an undisclosed amount of capital into some of the subsidiaries, he said.

Moody's Investors Service and A.M. Best Co. both cited the writedowns in May when they downgraded New York-based AIG's credit ratings. State regulators in Texas said they didn't know AIG was investing cash collateral from the securities-lending business in subprime-linked assets and were concerned the insurance units hadn't put aside enough capital to cover potential losses.

``We were aware of this portfolio, but we didn't have transparency on what was in it because it was off-balance sheet,'' said Doug Slape, chief analyst at the Texas Department of Insurance in Austin, which oversees three AIG insurers that have suffered about 60 percent of the writedowns. (You are a regulator you great prune. You go ask for it and get it from them - Jesse)

The reduction of asset values in the securities-lending portfolio was part of the $38 billion in pretax writedowns that AIG reported during the past three quarters. That total included reductions of $20 billion on guarantees known as credit-default swaps and $18 billion on mortgage- and asset-backed securities, including some tied to subprime home loans. Most of the mortgage-related holdings are in the securities-lending pool.

Recovery Expected

The securities-lending business caters to banks and brokerages that borrow for themselves and clients to hedge trades, cover bets that a stock will fall and avoid trade- settlement failures. AIG's life-insurance subsidiaries invest their premiums in stocks and bonds. To make extra money, they lend out those securities through a central pool that invests cash collateral.

AIG said in regulatory filings that about $9 billion of the markdowns on mortgage-backed securities resulted from temporary market-value declines that it expects to be reversed. Those unrealized losses don't affect earnings.

In the meantime, its support for the insurance subsidiaries relieves pressure to sell the holdings at a loss should the banks and brokerages close out their loans, said Laura Bazer, a senior credit officer at Moody's in New York.

``At that point the AIG life insurance companies would have to make a decision to find cash elsewhere or sell the securities at a loss, which nobody wants to do,'' Bazer said. ``If you think those securities are money good, you want to hold them until maturity.''

`Adequate Liquidity'

AIG's securities-lending program hadn't experienced a ``significant'' decrease in loan balances as of March 31, according to a May 8 filing with the U.S. Securities and Exchange Commission. Swift said in an interview last week that AIG has ``adequate liquidity'' to fund any required returns of collateral.

Securities lending has traditionally been perceived by the Federal Reserve and other bank regulators as a business with few risks. Other companies with securities-lending operations include MetLife Inc., State Street Corp. and Northern Trust Corp. While some invest their collateral only in Treasuries, others buy bonds backed by mortgages and credit-card receivables to get additional yield, said Josh Galper, a principal at Vodia Group LLC, a Concord, Massachusetts, financial-services research firm.

``The range of investments go from very conservative to very risky,'' Galper said.

$78 Billion

State regulatory filings show that AIG's securities-lending unit used almost two thirds of its $78 billion in cash collateral to buy mortgage-backed securities that plunged in value starting last July as subprime defaults climbed. Most of the securities were rated AAA or AA. The market value of the collateral pool, including cash and securities, fell to $64.3 billion as of March 31.

In addition to the $9 billion in unrealized losses, AIG and its 12 insurance and annuity units that participated in the securities-lending pool incurred $3.9 billion of realized losses, or declines the company no longer classifies as temporary. These losses reduced AIG's earnings, primarily in the fourth quarter of 2007 and the first quarter of 2008.

AIG has a third category of investment loss: those booked when an asset is sold below original cost. The insurance units are required to reimburse the securities-lending pool for their share of these losses. Though none of these losses have been recorded, AIG has agreed to cover up to $5 billion of them.

Maturity Mismatch

Subprime holdings in the securities-lending pool weren't the only issue cited by regulators. Some state officials said AIG invested more than half the collateral in debt securities that on average would pay off in three to 10 years. Because AIG loaned bonds for periods ranging from overnight to 60 days, the insurance units could be exposed to a cash crunch if borrowers suddenly returned securities and demanded their collateral back.

``We were surprised at the length of the paper,'' said Joseph Fritsch, director of insurance-accounting policy at the New York State Insurance Department in Manhattan. Still, Fritsch and Erin Klug, a spokeswoman for Arizona's insurance department in Phoenix, both said AIG had notified them about the losses in the securities-lending portfolio and voluntarily decided to backstop the insurance units involved.

``AIG did the right thing,'' Fritsch said. ``They have put the guarantees in, and they have put money into the companies.''

To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net

The Bear Market of 1929 - 1933 and the Decline of June 1930

It was the first wave down in October 1929 that took out the speculators.

It was the third wave decline that decimated the nation and the professional traders such as Jesse Livermore and Arthur W. Cutten.

There were temporary bottoms and substantial rallies of hope off steep short term declines, all the way down to the bottom in 1933. The Republicans were swept out of office and a reform Democrat was elected, Franklin Delano Roosevelt.

The decline we have seen so far this June in the Dow Jones Industrial Average is the largest June drop since that short term market bottom in 1930.

A historical reminder for those who have a certain mindset about what happens when debt is wiped out, a serious deflation occurs, and a currency is devalued in response to it.

Dow Jones Industrial Average Nears its Worst June Decline Since 1930

Union Bank of Switzerland Formally Charged with Fraud by State of Massachusetts

AP
Mass. regulators file fraud charges against UBS
Thursday June 26, 1:50 pm ET
By Jay Lindsay, Associated Press Writer
Mass. regulators accuse UBS of fraud in sales of risky auction-rate securities

BOSTON (AP) -- Massachusetts regulators filed civil fraud charges Thursday against UBS Financial Services for allegedly selling investments it knew were extremely risky, but portrayed as safe.

The complaint by the Massachusetts Securities Division alleges that the financial services arm of the Swiss bank UBS AG knowingly let brokers present its auction-rate securities as virtually risk-free so it could reduce its own stake in the failing program.

The investments have their interest rates set at periodic auctions, depending on the submitted bids.

When the program ultimately failed, investors -- many of them retirees or small business owners -- were left with securities they can't sell, the complaint said.

"These customers have now discovered ... that they have been blindsided by the very people who were supposed to have their best interests at heart," the complaint said.

UBS spokeswoman Karina Byrne said the company was disappointed state regulators filed the complaint while the company was working to solve the problems caused by the auction rate market failure.

In a statement, she said the company supported the market longer than any other firm, and have offered loans at favorable rates to clients with holdings in it. "Contrary to the allegations, UBS is committed to serving the best interests of our clients," she said.

Auction rate securities were once considered safe, and were purchased by investors who wanted a place to park their money where it could be easily accessed.

But starting in February, weekly and monthly auctions at which investors normally purchase such the securities failed to yield buyers, as investors sought to avoid risk amid turmoil in credit markets.

The complaint alleges that even though executives were calling the program an "albatross" and knew it was near collapse early this year, it continued to sell the securities to individual investors. It presented them as a good value, in order to reduce its own inventory, the complaint says.

The complaint also alleges investors were never told the auctions weren't true auctions, and that UBS stepped in when buyers abandoned the program to underwrite the products and set the interest rate so the program wouldn't fail.

The state wants to force UBS to return all investor funds and pay a fine. The amount of money being sought was not disclosed in the complaint.

Last month, UBS agreed to buy back $37 million worth of these securities sold to 17 Massachusetts towns and cities and to the Massachusetts Turnpike Authority, under an agreement with Attorney General Martha Coakley.