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Why Does Aig Have To Post Collateral?

The Times' Gretchen Morgenson and former AIG CEO Hank Greenberg touched on this on "Charlie Rose" last night: One of the things that's so frustrating about the money AIG is paying to various banks around the world is that it's frequently not to compensate these institutions for losses it insured. It's just collateral AIG is forced to put up because its credit rating has been downgraded. In many cases, the losses haven't happened yet (though there have obviously been losses, too).

The Journal has a great example this morning:  

In 2005, Deutsche found a willing taker for a chunk of the mortgage risks held by START: AIG Financial Products. The derivatives arm of AIG agreed to pay out up to $1 billion under two of the START vehicles, if underlying assets deteriorated or the insurer's own credit rating fell below a certain threshold. AIG stood to earn a fraction of a penny each year for every dollar of protection it sold, according to securities filings, meaning it made less than $10 million annually on the $1 billion in insurance. ...

Last fall, after AIG's credit rating was cut, the insurer paid roughly $800 million to START, according to two people familiar with the matter. Much of the money is being held in escrow and will be used to pay off Deutsche's swap contracts if mortgage defaults in the portfolio rise above a certain level. [emphasis added.]

Which raises a question: Why is this necessary? With the government owning 80 percent of the company, you'd think people would feel comfortable that AIG would make good on its payments should the need arise (i.e., in the event of actual losses). If they didn't feel comfortable, the government could just state that it would make good on them--it would certainly be cheaper than posting billions and billions in collateral now. (Greenberg proposed something like this last night.) In effect, AIG's obligations have the backing of the U.S. government, which has the strongest credit rating in the world. And yet it still has to post collateral like a less-than-fully-credible operation. 

--Noam Scheiber