Company WatchANALYSIS OF BREAKING NEWS
American International Group:
Down By Derivatives
February 12, 2008 - The latest casualty in the credit crisis is American International Group (AIG-NYSE). The stock lost almost 12% of value in one day when management disclosed losses of $4.88 billion, well above the original estimate of $1.15 billion given in December. Investors didn't like the news and dumped the stock.
Here's the essence of the problem for AIG and many other financial institutions: they don't know what value to put on some of their holdings, especially the more esoteric ones like CDO's (colllateralized debt obligations) and derivatives such as interest rate swaps, caps, floaters to fixed caps, credit default swaps, etc. There are more permutations on derivatives than any one can track. Many are one of a kind, derived for a specific transaction.
And that's the problem. These derivatives are not a simple thing to value. There's no symbol you can put on the screen and get a number. There is no market for these. They sit on the issuers' books, created at a specific time for a specific transaction. The attributes of each one makes it difficult to find a comparable security on which to base a price. So the institutions put a number on it, then try to justify that number to an accountant.
In the case of AIG, the accountants didn't like the numbers. They didn't agree with the valuation methodology and suggested other numbers, lower numbers. Or they wouldn't sign off on the financials. When an accounting firm puts that gun to any company's head, the company suddenly sees the numbers in a new way. Management doesn't have to agree with the numbers, but if they want a clean statement going to investors, they will sign off on the new numbers.
Now management is doing damage control, stating it doesn't believe the write-downs from the credit swaps could lead to greater losses for the company overall. Time will tell. For AIG and all the other financial institutions with CDO's, derivatives and other unusual, difficult to value issues may be a loaded gun or a spent one.
- Company Web site: www.aig.com- Ted Allrich |
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