The only thing that I never understood about the great CDS debacle is why it ever happened. Alex is a very old hand when it comes to structuring deals, and one of the great principles is that you can never reduce aggregate credit risk by structuring. Physicists might liken it to entropy.
Sure you can enhance the position of an individual counterparty by giving him a guarantee or CDS, but that just means the credit risk is transferred to a party willing to take the risk of loss. The aggregate risk that a party outside the financial system fails to pay does not change. Which is why I never understood why CDS’s should be treated as any different from assignable guarantees or standby letters of credit. The only difference was that they were passed around swaps desks by traders each having the attention span of a gadfly.
So it seems appropriate that the AIG bonus scandal should involve an equally baffling comment from the Treasury Secretary Timothy Geithner, who told congressmen that Uncle Sam will recover the bonuses paid by AIG from operations and deducting the amount from the next $30 billion in fresh equity.
Hang on a minute there Mr Geithner. Either AIG needs the extra $30 billion or it doesn’t. What if they need the money? Taking it back will kill the company.
OK, here’s a solution. Why not increase the amount of equity to be injected by the amount of the bonuses to be recovered, then you can recover the bonuses without damaging the company.
Then everybody will be happy ..... except for the sane and the intelligent, but you will never please everyone.