Government Soaks Up AIG's Toxic Credit Default Swaps On Our Dime

We know that credit default swaps (CDS) were largely responsible for AIG's downfall.

Now, in Stage II of the government's bailout of AIG, the feds are going to soak up some of AIG's toxic CDS.

According to Bloomberg:

The U.S. will provide as much as $30 billion to help buy the underlying assets of credit-default swaps that AIG sold to investors, including banks. AIG will contribute $5 billion and bear the risk of the first $5 billion in losses, the Fed said.

The insurer guaranteed about $372 billion of fixed-income investments as of Sept. 30, compared with $441 billion three months earlier. AIG booked more than $7 billion in writedowns during the quarter on the value of the swaps.

The Financial Times writes:

Under the new plan, the Fed will put $30bn in a new vehicle that will purchase some $70bn of AIG's CDSs from its counterparties. AIG will contribute $5bn to the vehicle.

If, over the next few years, the value of the CDSs increases from the current depressed price, the Fed will keep two thirds of the profits, with AIG getting the rest.

As the Wall Street Journal explains, AIG holds more than $400 billion dollars in CDS and $80 billion of collateralized debt obligations. AIG has been forced to post about $50 billion in collateral to its trading partners, largely to offset sharp drops in the value of securities it insured with the credit-default swaps. These liabilities continue to balloon even after the first Fed bail-out.

And the BBC points out that many of AIG's CDS were purchased by European banks - not for the purpose of minimizing risks - but solely to fool regulators into thinking that they had less exposure than they really did.

So the purchasers of many of AIG's CDS are not without fault.

We need to abolish CDS or value every CDS contract at $1, so we the taxpayers don't have to buy up all the toxic CDS out there on our own dime.