Monday, September 29, 2008

Small AIG London unit brought down entire house of cards: a warning about "asymmetry"?

The New York Times, on Sunday Sept. 28, featured a front page cover story that shows how a small group of people (in this case, a London unit of the American International Group [with fewer than 400 employees, all highly compensated] brought down the entire holding company.

I relate the story because it is a glaring example of the perils of “asymmetry” – in business, at least, but the concept could apply to other areas (like Internet publishing).

The story is by Gretchen Morgenson and is titled “Behind Insurer’s Crisis: A Blind Eye to a Web of Risk: How a small, freewheeling unit brought A.I.G. to its knees”, link here.

The article indicates that executives barely understood how the product that they offered – credit derivatives – would play out in a real world. They thought they were spreading and “insuring” prosperity. But what they did was amplify the effect of bad mortgages on the financial system with what behaved like a runaway virus transmitted within a circumscribed community, that in turn could “amplify” it to affect others.

And this happened overseas, somewhat beyond US securities law, but in a stable, democratic ally, the United Kingdom, which should presumably have similar concepts of regulating securities.

Now, the press is reporting that Europe is in a similar turmoil. As Congress prepares to vote on the The Bailout, markets are down not only because of uncertainty over the vote, but because regulators overseas are beginning to see that nobody understood this, that no end is in sight, and that the bailout might not work after all.

The Wall Street Journal Monday morning has a somewhat related story (with a different interpretation) focusing on Lehman Brothers, “Lehman’s Demise Triggered Cash Crunch Around Globe: Decision to let firm fail marked a turning point in crisis,” by Carrick Mollenkamp, Mark Whitehouse, John Hilsenrath and Ianthe Jeanne Dugan, link here. It’s interesting. Apparently AIG was in bed with Goldman but not so much with Lehman, so the Fed played God and let Lehman be euthanized rather than be assumed by an “angelic” identity (to paraphrase some science fiction – companies become like “souls”). ING, a company that I still have a relationship with as a retiree, has some stake in Lehman. (ING has been tanking early Monday and it’s not clear how this is related to Fortis, which is also having to be rescued, apparently because of bad mortgages overseas as well as in the US.)

I’ve compiled and provided all the relevant links to the House of Representatives site on the new legislation (“The Emergency Economic Stabilization Act of 2008” along with its “Troubled Assets Relief Program” [TARP]) here.

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