Thursday, April 02, 2009

The concrete life saver

We Brits are naive with money - we're so unused to having any - our Government has always looked after it for us. Perhaps this is why there are so few Brit blogs that help us understand finance.

Speaking of ruinous government help, Karl Denninger describes a trap that seems likely to bankrupt General Motors.

It seems that people who own GM's corporate bonds have an incentive to let the firm collapse: their losses will be made good by the equally-bankrupt former financial giant AIG, through Credit Default Swaps (CDS), which are insurances against default on loans. In its panicky attempt to keep the financial system functioning normally, the US Government has effectively become the guarantor for AIG's CDS contracts. So creditors of GM can expect 100% return of their capital.

Better still, once GM goes under, the bonds are unlikely to become entirely worthless. So GM bondholders will get 100% PLUS...

And this means that the Government's "help" is about to ruin a huge manufacturer and employer.

13 comments:

Elby the Beserk said...

We win - we win. We lose - we win. Regardless - you lose.

Neat eh?

hatfield girl said...

No wonder there is supposed to be a 'global' response. Then German taxpayers and UK taxpayers.... can be open to the same treatment.

How mean of Mrs Merkel. How generous of Gordon Brown.

James Higham said...

Better still, once GM goes under, the bonds are unlikely to become entirely worthless. So GM bondholders will get 100% PLUS...

And this means that the Government's "help" is about to ruin a huge manufacturer and employer.

I can't say I fully understand why though. I'm not disagreeing - I jsut can't see where it is leading.

Sackerson said...

Hi HG: world government - just what we need, now we've seen what national ones are like, eh?

Hi James: presumably GM will have some assets left even if they do go bankrupt. The shareholders will get nothing, but when it comes to divvying the spoils, don't bonds come next in the queue after bank loans? So if the US Gov't didn't underwrite AIG's CDS, then x cents in the dollar is all that the bondholders would get, so they would have a strong reason to agree a restructure that preserved more value in the company; whereas (according to KD) they can now let GM do down, claim the full value of their bonds on the insurance and still get some money back from the corpse of the company.

Sackerson said...

Hi, Elby: rogering the taxpayer again - just what big business loves.

Conrad said...

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.


Ruth

http://fendisite.com

Sackerson said...

Hi Conrad, and thanks for calling by - hope to hear from you again soon.

Conrad said...

I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.


Joannah

http://keyboardpiano.net

Anonymous said...

GM needs to go bust.

It is actually a huge welfare organisation with a middling finance arm and a small manufacturing business attached, which makes products nobody wants any more.

We need to get those assets doing something which actually adds value, instead of just reeling from one crisis to the next, constantly absorbing taxpayers' funds and then almost immediately asking for more.

Remember that if we'd had the benefits of humungous government in the 19th century, we'd still be subsiding the existence of tens of thousands of stage-coach drivers.

(Though come to think of it, if we'd had the benefits of humungous government in the 19th century, motor vehicles would never have been invented (due to Elf n'Safety), so we'd probably still need stagecoach drivers.)

Anonymous said...

The AIG thing was a massive mistake. Here's why:

Let's say I take out a loan for £100,000 to buy a house. I insure it with AIG, but not for £100,000 but for £1Million. AIG takes my money because as long as I pay the premimum I can insure whatever I want for whatever price I want. The house burns down. I claim my insurance. AIG claims it can't pay my insurance and goes bankrupt. What have I lost? £100,000. But say the government has bought AIG. My house burns down I claim the insurance. The government must pay. What have I lost? Nothing. But now the taxpayer has lost £1million.

So now what has happened is the US Gov has underwritten AIG and the trillions of CDS it has outstanding - far in excess of the actual amount of debt out there because the same debt has been insured multiple times. What happens when the economy goes sour? As you point out, the reckless creditors are only too happy to claim on their insurance. The government can no longer ignore them and just say they were misguided to put their faith in AIG. Instead they must pay off these bad debts. And because the insurance can be orders of magnitude greater than the actual debt, the problem for the US taxpayers is now magnified by orders of magnitude.

Foolish. Very foolish.

Anonymous said...

Second point. Why did the US Gov bail out AIG anyway? It was insuring loans presumably paid out by people and corporations that had big money. Individuals and corporations that had in fact made reckless investment decisions and relied to heavily on insurance to protect them from the consequences of their bad decisions. They deserved to get caught out. Since AIG has been bailed out the ordinary US taxpayer is now paying for the foolish investment decisions of rich people. Now we can see just how US politics works.

Not nice is it.

Sackerson said...

Thanks for your comments, Anons. Quite a mess.

Paddington said...

The AIG business is actually better than that. Suppose that we sell 'assets' with a face value of $1 million, with a 1% commission, knowing that the actual value (including the risk) is only $300,000. The commission should be $3,000, but we take our full $10,000. We have, in effect, reduced the value of the assets by a further $7,000. That is why there should be an even bigger stink over the bonuses.