While much of the focus of attention among Kossites (myself included) has been on whether or not to bail out GM, we have been diverted from the true Moby Dick of all bailouts, that of AIG. According to Chris Whalen, managing director of Institutional Risk Analytics, the hundreds billions of additional dollars being poured into AIG right now are just peanuts compared to the true ultimate cost of the remaining credit default swaps outstanding, which at the very minimum, will cost $15 trillion.
You read that right, $15 trillion. And it could be much more. Whalen argues that the nomination of Timothy Geithner to Treasury Secretary, who is fully on board for the AIG bailout, makes a decade long recession likely as the government futilely tries to pay back the trillions that will come due on this bad paper.
More below.
Whalen's analysis focuses on the $50 trillion or so outstanding credit swap obligations, and assumes what he deems an extremely conservative amount of defaults, leading to about $15 trillion of this amount having to be paid out. It's worth noting that he estimates that if things go very bad, the figure could be more like $40 trillion.
In the face of these staggering figures, he states that attempting to pay off holders of this bad paper is completely futile, and that attempts to do so are a prescription for a decade of economic misery. He concludes that the the only solution for giants like AIG that hold all this bad paper is bankruptcy, which would finally burst the last bubble of the financial speculation madness, that of these gambling house derivatives:
President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation.
And, yes, we can put AIG and the other providers of protection through a bankruptcy and force the CDS market into a quick and final extinction. Remember, when AIG goes bankrupt the insurance units are taken over by NY, WI and put into statutory receiverships. Only the rancid CDS positions and financial engineering unit of AIG end up in bankruptcy. And fortunately we have a fine example of just how to do it in the bankruptcy of Lehman Brothers.
More ominously, Whalen claims that Obama's pick of Timothy Geithner, hailed by some as an experienced veteran without a lot of baggage, is actually a sign that the government will pursue an AIG bailout to the bitter end.
Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full.
It's important to remember Whalen's point about AIG, which is that the insurance units can be put into receivership and remain untouched, thus countering a crucial argument for AIG's bailout, that its insurance business was too important to the economy to fail. It won't have to.
And here is the other key point that he makes: AIG and other big institutions must fail first. The credit default swap bubble has to be lanced now. Other bankruptcies are going to follow in this economy. And every time they do, they will cause more CDS's to come due. If we don't say could buy to them now, the other bankruptcies will cause trillions of dollars of payouts that we can't afford. And then the government will be forced to try to prevent everyone and everything from going into bankruptcy, which will be ultimately unaffordable.
Don't take my word for it. Get educated. Read up on derivatives yourself and who holds them. And then let's hold our elected officials feet to the fire to rid the world of these ruinous financial instruments once and for all by refusing to pay out on them.