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Saturday, May 19, 2012

Is Greece perhaps similar to AIG?

I remember when the AIG problem hit the surface (over-exposed to sub-prime risks because of credit default swaps written). The US government had no choice but to bail-out AIG: maturities were coming up quickly and a bankruptcy of the world's largest insurer would have had unforeseeable consequences.

So the US government put up the first tens of billion dollars so that AIG could pay off CDS' to firms like Goldman, Deutsche, etc. And then there were more tens of billion dollars and more...

Those CDS' were written by a small London office of AIG. It took some time until they could calculate what the total potential risk for the US government would be. Fortunately, it was "only" in the 3-digit billion USD figures.

I remember thinking at the time "What if the potential risk is not 'only' in the 3-digit billion USD figures but, perhaps, 10 times as much?". That could have literally bankrupted the USofA!

EU institutions (particularly the ECB) have now entered open-ended risks with Greece (and the other deficit countries) without a ceiling in place. If they continue without a ceiling, the risk dimensions will sooner or later become unmanageable. If they put a ceiling in place now, a good portion of the annual GDP of the surplus countries evaporates.

Greece will be the first country where the EU will have to chose between one and the other.


Addendum
Imagine the US government, in an effort to raise new revenues for its budget, were to write MLDS' (Mars-landing-default-swaps) with the following structure: until year-end 2019, investors can buy for a fixed fee of 10 cents on the dollar assurance that the US will land a man on Mars before year-end 2020. If the US succeeds with that, investors lose their invested fees. If not, investors collect 100 cents from the US government.

How high do you think might be the total MLDS' outstanding at year-end 2019? What do you think might happen to the US government by year-end 2020 if they don't land a man on Mars?

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