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Just Shoot Me

Bala, 28, Gordon Gekko in the making, pseudo-intellectual, cynic, bibliophile, obsessive compulsive ranter...

AIG's cows

February 10, 2009

There a thousand WTF tales in the financial clusterfuck that became the depression we are facing now. But i am most fascinated by the sordid tale of AIG . Maybe it has something to do with the 3 years i spent as a software consultant (aka cyber coolie) for them, but even in the confederacy of dunces they stand out for their stupidity. Apart from the losses their Credit Default Swaps division (CDS) piled up (which i have described as playing russian roulette with 5 bullets in the chamber), their investment unit did far worse by aggressively lending mortgage backed securities. John Carney explains how it happened by using the cow story here:


You have two cows.

John Paulson borrows one cow so he can sell it for $100. He gives you $10 as collateral.
You buy your neighbors cow for $100, which you finance by taking out a $90 loan from the bank and use John's $10 to make up the rest.
You brag to everyone about your financial health. You have assets--two cows you own, plus one Paulson owes you--worth $300, and liabilities of just $100.
A third of the country goes vegetarian.
You thought your two cows were worth $200 and now they are worth $140.
You express confidence in your financial health. Your assets are now worth only $200--your two cows plus the one John owes you--but your liabilities are still only $100. If necessary, you could sell the assets at this distressed price and pay off all your loans.
You hold onto your cows because you are sure the market is "dislocated." Some day someone will want to eat beef again.
The rest of the country goes vegetarian. Your two cows are now worth $2 each to guys who want to make dog food.
John Paulson buys a cow in the market for $2 and he gives it to you as repayment of the loan. You now have three cows worth six bucks.

John wants his $10 back.
The bank calls. It wants its $90 back.
You call the Federal Reserve and ask for a bailout.

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posted by Bala, 9:27 PM

1 Comments:

Awesome. Very simple put. How have u been? Still waiting that announcement!
commented by Blogger Shilpa, 11:36 PM  

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