Goodbye Yellow Brick Road

Well, here we are, with the "purchase" of AIG by US taxpayers, the Fed, Treasury and everyone on Wall Street are praying the bond market does not collapse. 

What has happened is AIG, the largest insurer in the world, was about to eat hundreds of billions of dollars in Credit Default Swaps they wrote. These CDS are insurance policies written to protect against losses by exotic financial instruments called derivatives. So, the US taxpayer is now the proud owner of AIG, insurer to the world. The $85 Billion the Fed "loaned" to AIG gives the Treasury 79.9% ownership. Imagine that, the US Government now owns a publicly traded insurance company.

Not good news.

The problem is somewhat complicated, yet resides in the fact that most of the derivatives AIG wrote CDS on are now worth almost nothing. AIG has written CDS for $441 Billion, $307 Billion to European banks. The $85 Billion was the amount needed today to meet reserve requirements as the derivatives lose their AAA ratings and go to AA, A, BBB and lower. With each downgrade of a derivative class, the reserve requirements increase. Expect a lot more taxpayer money to go to AIG. Eventually, the reserve requirements will match the insured amount. So, AIG (now the American taxpayers) will cover the losses on derivatives for the European banks. 

Simply put, $85 Billion is a drop in the bucket. 

To add to this, AIG, and other insurers, are important cogs in the wheels of the financial world. AIG and other insurers MUST keep up their business lines, or no one will put new money in the system.

AIG is only one of dozens of companies to write CDS. What happens to other large insurers and reinsurers when they have to pay on derivative losses? To get the original AAA rating, issuers of derivatives had to buy the CDS. The reason US Treasury Notes are rated AAA is they have the full faith and backing of the US Government. They rated these risky financial vehicles the same as US Treasury Notes!

There are a lot of derivatives that have, are, and will go bad. Over $700 Trillion of them have been sold since 2002. 

Did you get that?

More than $700 Trillion in real value at the time of purchase has lost somewhere between 50% to 95% of its original price.

That's the real reason the Fed bailed out Fannie Mae and Freddie Mac. China had bought over $1 Trillion of these derivatives from Fannie and Freddie. Japan and Korea together had bought around $500 Billion. So, in one fell swoop, Mr. Paulson and Mr. Bernanke and the current administration thought it was better that the US taxpayer eat those losses than our trading partners. Even though these countries bought them hoping to make a profit, it is now going to the average American to cover the losses. Mr. Paulson knows that the federal deficit instantaneously increased by $1.5 Trillion, and he is being disingenuous when he states it might be $300 Billion.

Any action taken by congress to save the housing and mortgage market through Fannie and Freddie can only increase the burden of the federal deficit. Smarter people than I believe the recent actions involving the mortgage giants will eventually add somewhere around $5 Trillion to the national debt.

I can only guess what is next. All arrows though, point to disaster. Foreign investment in US Treasury notes is declining - very bad news, since we need purchases of at least $2 Billion per day just to manage the interest owed, never mind retiring some of the deficit. The amount we must sell each day increases with each bailout. Soon, we will not find enough buyers for Treasuries. That will be the day the US loses its AAA rating. 

There ain't no going back from that point.

It is hard to blame the media for not keeping up. Without advertising revenue, no media outlet is there to print or broadcast a story. 80+% of advertising comes from multi-national corporations. The majority of media outlets are now owned by a few corporations, whose sole interest is profit. If the advertisers don't like the stories, they take their money elsewhere. This is why FOX has been so successful - from the beginning, they made no bones about what they were. They told the big corporations "go ahead, write the story. As long as you spend your money with us, we will allow you news input." To remain in the game, most other media companies have had to accede a little, sometimes a lot,  just to survive. 

Problem is, deflection from the real story has become central. Why do I write about finances so much? Numbers never lie, they are immutable truths. In other words, in the financial world it is easy to find inaccuracies. Really, it is low hanging fruit, and I am lazy.