Hedge funds could reap billions from AIG John Byrne

Published: Wednesday March 18, 2009





Print This Email This $160 million in bonuses to AIG executives? Try billions in dollars slated to be paid by AIG to hedge funds.



The massive now mostly-government owned insurer American International Group is slated to shell out billions of dollars to hedge funds that bet against the US housing market, according to documents reviewed by the Wall Street Journal.



In other words, vulture investors that bet the US housing market would crumble are scheduled to receive billions of dollars in premiums on their bets, even though many of them never had a material investment in the housing market. And the cash paid out to these investors is coming from US taxpayers, who bailed out AIG.



To use a metaphor, AIG was the casino that couldn't do math and the hedge funds are successful, well-schooled gamblers.



Hedge funds are typically only open to superrich investors, in part because of their high risk, and hold much of the market for betting against the stocks of certain industries or companies.



"The documents show how Wall Street banks were middlemen in trades with hedge funds and AIG that left the giant insurer holding the bag on billions of dollars of assets tied to souring mortgages," the Journal's Serena Ng reported . "AIG has put in escrow some money for at least one major bank, Deutsche Bank AG, whose hedge-fund clients made bets against the housing market, according to a person familiar with the matter. The money will be released to the bank if mortgage defaults rise above a certain level."



"In essence, while the U.S. government is busy trying to prop up the housing market -- by trying to limit foreclosures, among other things -- it is simultaneously putting up cash that could be used to pay off investors who bet housing prices would tumble and many mortgage holders would default," Ng added.



Just how much AIG is on the hook for is unclear. Congress has committed $173 billion to bailing out AIG thus far, but its unknown how much of this could be enjoyed by hedge fund investors. AIG's housing market bets have cost taxpayers $52 billion to date.



"The transactions worked like this: Investment banks such as Goldman Sachs Group Inc. and Deutsche Bank sold financial instruments to hedge funds letting them bet that mortgage defaults would rise," Ng wrote. "These instruments were credit default swaps, a form of insurance that pays out in the event of a debt default.



"Many of the assets AIG insured were tied to subprime mortgages. The deterioration of those high-risk mortgages, along with AIG's own financial woes, forced the insurer to put up billions of dollars in collateral, mostly to the banks that were its trading partners," Ng added. "AIG sold protection on securities backed by physical assets, as well as on positions almost entirely backed by other financial bets."





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