AIG’s CEO, Edward Libby, admitted today that credit default swaps brought down the company:
Mistakes were made at AIG, and on a scale that few could have imagined possible. The most egregious of those began in 1987, when the company strayed from its core insurance competencies to launch a credit-default-swaps portfolio, which eventually became subject to massive collateral calls that created a liquidity crisis for AIG.
But instead of letting AIG go quietly into the dark night, Liddy is trying to blackmail America and the world by using a threat. As Salon notes:
[He was] specifically referring to the the buildup of a $2.7 trillion portfolio of credit default swaps and other derivative products. About $1 trillion worth of that portfolio has been “wound down,” said Liddy, but AIG is still on the hook for an unthinkable $1.6 trillion worth of liabilities.
“There is still risk that that could blow up,” said Liddy, and it was clear from his expression that the prospect was not a rhetorical exercise.
Liddy didn’t need to further connect the dots. If AIG F.P.’s outstanding portfolio of derivative products “blows up” — the cascade could likely bring down AIG’s counterparties. Which would inevitably require the expenditure of further government trillions to prevent a systemic crash.
When will people start demanding that the government rescind AIG’s credit default swaps? The government has that power. Indeed, the same arguments which have been made for the government’s authority to cancel AIG’s bonus contracts can be used to cancel AIG’s CDS contracts. In order to receive any more bailout money (or to keep the money they already received), AIG’s counterparties need to cancel their CDS contracts. And for foreign CDS counterparties, the government could simply say “we will not loan your central banks any more money unless you cancel the CDS contracts”.
This is a national emergency. Instead of doing something dumb like seizing gold, the government can do something productive and force a rescission of all of AIG’s outstanding CDS contracts or – at the very least – give the counterparties a haircut and cram the CDS contracts’ dollar values down to a very small amount.