Thursday, October 30, 2008

Securities Lending? Are you serious?


Just when you thought your jaw couldn't drop to the floor, again, this year, you learn something new.

AIG lost $18 billion - billion - in its securities lending business. (h/t Felix Salmon)

Now, I'm out of it, but securities lending used to be one of those super-great, side businesses that turned an "extra" 2-5% a year, at almost no risk required.

So, to have lost $18 billion ... well, one just has to stagger back. 'Securities lending' must have been a euphemism for Casino Royal. Although this bit of information is in no way conclusive, it raises the prospect, not of some bets gone wrong, but of an almost abject loss of internal controls.

Of the two big Fed loans, the smaller one, the $38 billion supplementary lending facility, was extended solely to prevent further losses in the securities-lending business. So far, $18 billion has been drawn down for that purpose.

For securities lending, an institution with a long time horizon makes extra money by lending out securities to shorter-term borrowers. The borrowers are often hedge funds setting up short trades, betting a stock’s price will fall. They typically give A.I.G. cash or cashlike instruments in return. Then, while A.I.G. waits for the borrowers to bring back the securities, it invests the money.

In the last few months, borrowers came back for their money, and A.I.G. did not have enough to repay them because of market losses on its investments. Through the secondary lending facility, the insurer is now sending those investments to the Fed, and getting cash in turn to repay customers.

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