AIG and DZ Bank: Dumb and Dumber

by Stubborn Mule on 16 March 2009 · 8 comments

To date, in their efforts to make the Global Financial Crisis (GFC) even more disastrous than it already is, the US Government has pumped an extraordinary $170 billion into the American International Group (AIG), the humbled and humiliated insurance giant. AIG’s biggest problems arose from entering into enormous credit default swap (CDS) transactions. The reason this creates systemic risk is that CDS are bilateral transactions between two counterparties and so if AIG is in trouble, so are the counterparties on the other side of the transaction. CDS are a little like insurance contracts (albeit with far less regulation), which is perhaps why AIG was attracted to the business, and with AIG selling protection, the buyers of protection are nervous.

Dumb and DumberGiven the amount of money that the US Government has provided to AIG, it is reasonable for US taxpayers to expect some transparency from the recipient of their hard earned dollars. Today AIG has begun taking steps in that direction with the release of a number of documents under the heading “AIG Moving Forward”. Among these documents was a list of collateral postings made to AIG’s CDS counterparties. While this does not give the full picture of the vast CDS transactions volumes AIG built up over recent years, it gives an interesting glimpse of some of the larger participants in this dangerous game. The collateral postings are similar to margin payments made on margin loans when share prices fall: as AIG loses money on its CDS, it makes collateral payments to the counterparty to mitigate the risk that AIG may not be able to pay up in the future.

The counterparty list includes many of the usual suspects: Deutsche Bank, Goldman Sachs, UBS, etc. There are, however, a few interesting names. The one that struck me was DZ Bank,. Never having heard of DZ Bank, I had to look them up. It turns out, that Deutsche Zentral-Genossenschaftsbank is the fifth-largest bank in Germany and operates as a central bank for small German co-operative banks.  It is not a listed company as it is collectively owned by the 1,000 or so cooperative banks it serves. It seems that providing services to these banks was not enough for DZ and so they branched out into the exotic world of CDS. Based on AIG’s disclosure, DZ have received a total of $1.7 billion in collateral (split between direct payments from AIG up to December 2008, and payments from the Maiden Lane III vehicle established as part of the Government bail-out) and so they ventured into CDS in scale. I can’t help thinking that in doing so, they didn’t know much more about what they were taking on than Waverly Council. It also helps to explain how they managed to lose €1 billion in 2008.

One last point on the subject of AIG. Despite managing to destroy such large amounts of value, it seems that they still want to pay bonuses of $165 million to senior executives. Timothy Geithner, Obama’s new Treasury Secretary, described this as  “unacceptable”. I think he was politely trying to say “wake up and see what’s going on around you!”.

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{ 7 comments… read them below or add one }

1 AJ March 16, 2009 at 3:32 pm

Who’s got who over a barrel? Did you see the AIG propaganda about what would happen if they were let go? The greedy so-and-so’s are taunting the government, knowing full well they’ll continue to be supported.

2 stubbornmule March 16, 2009 at 3:37 pm

Yes, that “AIG: Is the Risk Systemic” piece reads more like a ransom note than anything else. “OK, we’ve got your economy, but if everyone just does as we ask, no-one will get hurt”!

3 James March 17, 2009 at 7:57 am

Why did DZW buy protection from AIG and on what assets?

4 stubbornmule March 17, 2009 at 8:28 am

@James: the report is silent on that question, but I’d guess either intermediation trades of the type that caught ANZ out or some very large negative basis deals.

Following some private correspondence from a some-time commenter on this blog, I should also acknowledge that the ransom line was inspired in part by a Planet Money podcast from a month ago that described a piece by a Deutsche Bank analyst about the need for bank bailouts as a ransome note. So, a hat tip to Planet Money and their very excellent podcast!

5 James March 17, 2009 at 8:52 am

Beware of banks with a “Z” in their name. Too late now for that bit of advice. Something to think of in the future.

6 Michael Michael March 17, 2009 at 7:29 pm

Planet Money is particularly excellent in my view – especially when contrasted with the relatively poor offering from ABC’s ‘Background Briefing’ from a few weeks back.

@James, I hearya. Just compare the fundamentals of the famed “Bowie Bank” (Bowie’s hillariously un-ironic grab for yet more money from his fans, and which ended up in some CDSs, say Planet Money) with the next generation “Zowie Bowie Bank” – sadly only ficticious.

7 Ian Bailey March 22, 2009 at 10:09 pm

This is tackled head on by Matt Taibbi in Rolling Stone a few days ago. http://www.rollingstone.com/politics/story/26793903/the_big_takeover/

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