Much has been written this week about the fall of the house of Lehman. Too big to fail became “someone has to” and the rest is history. The demise of Lehman has been one of the many sign posts that defined the GFC and now, ten years on, traditional and social media can’t seem to get enough of it as they look back on a time and a place that we hope to never see again in our capital markets. Stay tuned…
An equally interesting name caused a lot of blood-letting ten years ago too, but it has failed to get much anniversary ink this week. Near misses don’t sell as many newspapers as the actual train wreck itself and maybe that is why we have forgotten what AIG gave and took away. The former was the next gen use of the good old-fashioned Credit Default Swap (“CDS”), and the latter was the equity ownership of this entity that was taken by the US government (read: the taxpayer) for a cool $85 billion. Like most inventions, there was nothing inherently wrong with the concept of the CDS which had the original use case to provide insurance against defaults in the corporate and municipal bond space when this product was founded in the 1980’s. Financial engineering (code for capitalism on steroids) inevitably followed in the decades ahead, and this arcane part of the market drifted into default protection against diversified consumer loans and eventually subprime mortgages.
The packaging of choice for the underlying collateral was the eponymous CDO and the issuer was often the offshore, leverage-loving, SIV. The good times rolled, and AIG was the “insurance” leader here as their financial products group saw their revenues balloon from a pedestrian $700 million to over $3 billion in the less than five years leading up to the GFC. Afterall, how bad could it be when most of this paper carried the AAA rating of the big three credit rating agencies? Oops…
Happy anniversary AIG and thank you for a twisted gift that apparently keeps on giving. The thing about grabbing a hot skillet or wrapping your tongue around a metal pole in the dead of winter, is that you don’t often do it a second time. Surely the same would apply to the lessons learned when writing insurance against shadowy collateral beyond ones means to underwrite the loss, or not.
Apparently one way to mark this 10-year anniversary is to mimic it, and what better way to do that then to invite the base retail investor into the shark-invested waters. As reported last week by Bloomberg a certain London-based provider of passive products has just issued a new ETF that effectively sells protection against default on a menagerie of names from the investment grade corporation down to the high yield issuer. Put aside that this latter group has become synonymous with cov-lite, many of the so-called hedge funds are placing their portfolio bets by shorting some of these same names. D’oh indeed!
None of these points are either an indictment or an endorsement of this or any other product. As Mark Twain once said, “history doesn’t repeat itself, but it often rhymes.” AIG, SIV and GFC may not rhyme with ODD, IDD or D’oh, but they are close enough, even after ten years.
Seek diversification, education and know your risk tolerance. Investing is for the long term.
Bill Kelly is the President and CEO at CAIA Association. Follow Bill on Twitter and LinkedIn.