Posts Tagged ‘depression’

Why we can not allow AIG to fail

Sunday, March 8th, 2009

Many Americans are tired of giving money to AIG. It does not seem to be making things better. However, if the government were to allow AIG to collapse, the rest of the economy would go with it.

AIG is a different kind of animal when compared to the Bear Sterns and Lehman Brothers. Those companies were allowed to collapse because they were more or less self contained. As an insurer, AIG has its hands in way too many cookie jars. Many large and somewhat stable companies have assets that are backed by AIG, if you remove AIG from the equation, these stable companies are now are a huge risk to default themselves. There credit ratings will suffer and you would see another Bear and Lehman like spiral.

The government will keep pumping in capital until the nasty spiderweb that AIG has created can be untangled and bankruptcy can occur gracefully. Until then, get used to the abyss of soul sucking sorrow that is AIG.

It seems that AIG has been a major underwriter of Mortgage Insurance. Of course, in keeping with the times, they were fraudulent about the underwriting of these policys.

AIG categorized its instruments as Credit Swap Defaults, rather than the Mortage Insurance that it really was, because they did not have the liquid assets to qualify these instruments as Insurance.

Say bye to AIG and there would be a domino effect throughout the international banking industry, as many institutions far and wide hold what they think, and are counting on as positive assets, would be in fact worthless.

Here’s the problem: if you insure against loss in a case where a catastrophe can hit almost all your insurance customers are once, you’re screwed.

Was AIG dumb? Yes. Did they understand the risks they were taking? No.

But now look at who bought the insurance. Banks that were trying to hedge their exposures. Did they understand the counterparty risk they were taking by using AIG? No… but AIG was rated AAA so they thought there was no risk.

How much money has the Government handed over to AIG? And how many installments have already been made? I lost count, but one cannot help but notice this repetitive propping up of AIG at any cost. I think I understand why.

Expect the recession to get much worse

Saturday, February 28th, 2009

Check out the unsold inventory numbers – Reductions in demand were so steep in December that producers were not able to stop in time. That Inventory will be standing there for quite some time, When the quarter gets re stated in 180 days (like they always do) the decline will have been sharper.

Better (as in more current) indicators of actual economic activity would be found looking at Commercial Rail traffic trends or miles driven. Total traffic is down over 16% y-o-y. That suggests that second quarter GDP will be much worse than 4Q08.

The impact of global declines has not yet fully hit our economy. Only one of several reasons why the “this is good, we will now rebound faster” idea is not sound this time around. Many were surprised when at the end of last year, economic data was not as bad as they projected. Part of the reasons was that the excess inventory problem had not fully hit the market. Expect it to hit soon, and hit hard.

It’s a pretty vicious spiral. Consumers don’t buy goods from stores. Stores have inventory sitting on shelves and warehouses, so they don’t buy from manufacturers. Manufacturers don’t get the capital to produce goods (since no one is purchasing). To make end meets, they lay off workers. These workers (consumers) are unable to purchase goods from stores. Hence the spiral.

Add another dimension – the warehouse concept for retail is built on turns per square foot. If people aren’t buying, each marginal purchase picks up cost per square foot. Lower margins can only last for awhile, especially when leverage has been used to fund the stores. Then, take it a step further in regards to the cost function of the supply chains that are no longer at optimal levels. When you have a system that depends on stability, there is no way to forecast the impact of our present instability.

Sophisticated and large supply chains are narrowly optimized (ODE/PDE) and all the hubs, spokes, trucks, rail cars, depots, warehouses and racks and the people within are built to a forecast demand point which squeezews all excess out of the system within a narrow range of the demand forecast….but change the demand forecast downward in a somewhat significant way and the fixed and semi fixed costs escalate all out of proportion to straight line revenue declines.