Transfer of Wealth - Taxpayer TO Banks via AIG

A: Tyler Durden is not just the founder of Fight Club, he is also the founder of ZeroHedge.com and quickly becoming the must read blog out there in the financial world. Bookmark it. The latest post gets into a correlation desk trader email, and if proven accurate, spills the details of the largest transfer of wealth this country has seen to date from you, the taxpayer, to the banking system. And it was only 5 days ago that I remarked, "...for what its worth, I am hearing that the banks are having a great quarter", when trying to put the recent rally into perspective. Could AIG be the vehicle to transfer taxpayer funds to the banks as part of a larger re-capitalization plan?

I am begging for some reader participation here to help verify if this claim is fully accurate, partially accurate, or just a rumor? It is NOT news that the AIG counterparties got bailed out in this mess, but this takes it one step further.

From ZeroHedge.com's, "AIG Was Responsible For The Banks' Januray & February Profitability":

"During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever".

As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks - effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities - run a chart from say last September to current of say S&P 500 and Itraxx - credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period."

Tyler offers his layman translation of this:

"In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were:

a) one-time in nature due to wholesale unwinds of AIG portfolios,
b) entirely at the expense of AIG, and thus taxpayers,
c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent,
d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this "one time profit", which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity, also funded by taxpayers' money flows into the market."

All I know is, the banks were big time under capitalized, marks were way off, AIG was on the wrong side of huge CDS trades and had to be bailed out by the government, AIG counterparties were made whole, and during this period of chaos it's hard to imagine no scams taking place as firms fight for survival. When the government takes taxpayer money to bail out the banks, this kind of behavior happens. The average Joe usually doesn't learn about the scam until much later, but in this new virtual world with so many attentive and capable bloggers feeding off of inside tips, scams are harder to get away with in regards to the unknowing public. I am still digesting this and must admit that this is something I know very little about (I assume AIG is unwinding whole portfolios of issued CDS positions at vast discounts funded by taxpayer rescue funds, but the article gets into corporate synthetic and asset backed CDO positions too), but I am not shocked at all to learn that there in fact was a transfer of wealth from the taxpayer to the banks. Does anyone really believe they will make out well with these investments; if you can call them that anymore?

I would have liked to believe that the banks claim on recent profitability was a result of a pickup in traditional banking operations; mainly due to the fed's actions and ZIRP policy in place during this period of bank repair. I did NOT want to hear that the bulk of banks' profits to start the year came from taxpayer rescue funds that allowed AIG to unwind trades to the benefit of the counterparty; AIG received $182.5Bln in rescue funds to date.

Oh what a tangled web we weave! I knew the plan was to recapitalize the banks, but if this is the preferred path to achieve that, well, we may see chaos yet again. If we see a new round of share dilution to raise capital from the major banks left standing, well then we know there is some truth to this.

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