AIG's incompetent casino... Vegas is better regulated and better run

A.I.G. ran a massive gambling parlor, taking bets from anyone who wanted to bet the economy would turn down. But, unlike real gambling houses, A.I.G. was totally unregulated and had no “edge.” Unlike real casinos, it wasn’t guaranteed to win more from bettors than it lost. Instead, it basically asked everyone in the world to bet heavily on red. And then, when the economy turned red, A.I.G. had to pay off everyone at once, which it couldn’t do (without massive cash from taxpayers).

Insurance policies on financial assets should have been regulated as insurance or financial assets or gambling contracts. Instead, government insanely decided not to regulate them at all. Especially stupidly, government even allowed “naked” derivatives… “insurance” policies that are pure bets rather than insurance policies on some risk exposure of the insured party.

Here’s how stupid that decision was: A.I.G. gambled twice its value — without setting aside any collateral! — on these unregulated bets:

It is truly amazing how outsized A.I.G.’s insurance commitment was, at $440 billion. After all, in 2005, when A.I.G. put many of these swaps on its books, the market value of the entire company was around $200 billion.

That means the geniuses at A.I.G. who wrote the insurance were willing to bet more than double their company’s value that defaults would not become problematic.

Posted by James on Sunday, March 08, 2009