September 15, 2008 is the day that Lehman died and the moment that the world’s central banks led by the Fed went all-in. As it has turned out, that was an epochal leap into the most dangerous monetary deformation that the world has ever known.
It needn’t have been. What was really happening at this pregnant moment was that the remnants of honest capital markets were begging for a purge and liquidation of the speculative rot that had built up during the Greenspan era. But the phony depression scholar running the Fed, Ben Bernanke, would have none of it. So he falsely whooped-up a warning that Great Depression 2.0 was at hand—-sending Washington, Wall Street and the rest of the world into an all-out panic.
The next day’s AIG crisis quickly became ground zero—the place where the entire fraudulent narrative of systemic “contagion†was confected. Yet that needn’t have been, either. In truth, AIG was not the bearer of a mysterious financial contagion that had purportedly arrived on a comet from deep space.
As subsequent history has now proven, AIG’s $800 billion globe spanning balance sheet at the time was perfectly solvent at the subsidiary level. Not a single life insurance contract, P&C cover or retirement annuity anywhere in the world was in jeopardy on the morning of September 16th.
The only thing gone awry was that the London-based CDS (credit default swap) operation of AIG’s holding company was monumentally illiquid. Joseph Cassano and the other latter-day geniuses who were running it had spent two decades picking up nickels (CDS premium) in front of a steamroller, while booking nearly the entirety of these winnings as profits—all to the greater good of their fabulous bonuses.
But now, as the underlying securitized mortgage market imploded, they needed to meet huge margin calls on insurance contracts they had written against mainly AAA tranches of mortgage CDOs. In truth, however, the whole mountain of CDS was bogus insurance because AIG’s holding company did not have a legal call on the hundreds of billions of cash and liquid assets ensconced in dozens of its major subsidiaries.
From a legal and cash flow point of view, Hank Greenberg’s mighty insurance empire was essentially a mutual fund. Cassano and his posse had been implicitly pledging assets (via AIG’s corporate or consolidated AAA rating) that belonged to someone else—-namely, the insurance subsidiaries and the state insurance commissioners who effectively controlled them.
Yet this scandalous fact was not a world crisis, nor really any crisis at all. Yes, the several hundred billions of CDS contracts sold be the Cassano London operation were bogus and could not be paid off—–since the holding company had no available liquid capital. Nevertheless, they had been purchased almost entirely by a dozen or so of the largest banks in the world, including Deutsche Bank, Barclays, Societe Generale, Bank of America/Merrill Lynch and Goldman Sachs, to name a few of the usual suspects. And as I documented in The Great Deformation these banks could have readily afforded the hit on the underlying CDOs and deserved it.
As to the former point, the combined balance sheet of the impacted big banks was about $20 trillion at the time, and the  potential loss on the CDS contracts that AIG’s holding company could not fund was perhaps $80 billion at the outside. After all, most of the CDO paper which these mega-banks had magically transformed into AAA credits (and thereby could hold without posting a dime of capital) consisted of the so-called “super-senior†tranches. The real nasty crud at the bottom of the CDO capital structures had been pawned off to institutional investors and trust funds for Norwegian fishing villages and the like.
So the day of reckoning for AIG’s CDS fraud presented no danger to the world’s banking system. The loss might have amounted to 0.5% of their combined footings—–a one-time hit that Wall Street brokers would have counseled to ignore and which might have zapped banker bonuses for the next year or even less.
