Let” s say that I ‘ m a pension fund, and I have money to provide to other individuals. And I want to provide it to other people, because this way I can obtain rate of interest on it rather of it simply sort of resting and doing nothing. And if I’lend it to someone apart from the federal government, I ‘ ll obtain better interest. let ‘ s say that there ‘ s– so let me attract me, I ‘ m. the pension plan fund. Maybe I ‘ ll attracted. me in magenta.
That ‘ s me, pension plan fund. And allow ‘ s state that there” s. some firm, let ‘ s claim it ‘ s GM. I think you ‘ ve listened to of them.
They require to borrow cash, perhaps. And I ‘ d like to provide. There ‘ s an issue below.
I take care of the retirement fund. for the teachers of The golden state, or for the.
car employees of Michigan, or whatever. And component of my charter claims. that I can only spend
in really’, really, really secure. instruments.So I ‘ m not enabled to go wager. individuals ‘ s money, because this is people ‘ s retired life.
I can ‘ t do extremely expensive. I ‘ m just kind of making. AAA would certainly be like.
The greatest ranked protections? These are points that have a. very low chance of default.
Firm A is just rated,. I wear ‘ t recognize, allow ‘ s say it ‘ s ranked BB.And actually, this is a good.
would certainly be objective enough offer all of these companies.
Unfortunately, it” s not. They ‘ re private entities,.
And I think I touched on it in. the video on collateralized debt obligations.
Their incentives are. Allow ‘ s state I have Moody ‘ s.
Moody ‘ s is one of the ratings.
So they ‘ ve stated, these guys,. they ‘ re respectable, yet they ‘ re not the united state federal government. or something. There ‘ s a chance that they
can. go under, for whatever factors, or they ‘ re sensitive. to the economy as a whole.And I say, man, I would love. to lend these people money. I would love to lend.
these guys the $1 billion that they need. And these guys are prepared to.
pay me 8% passion. But I can” t do it, me
as. a pension fund, I can not lend them money. Because I” m just permitted.
to provide cash to A or above types of bonds. Or I can only buy A or above.
This person needs money. I have money to give him.
his company debt rating, that was given by Moody” s, simply. isn ‘ t high sufficient for me to lend him the money.
And this is where credit rating. default swaps can be found in.
In a suitable globe, I would offer. Company A, I would give them $1 billion. And then perhaps they would.
I can” t do it, because they are BB rated. And my charter states I can just.
I go to an additional entity. And let” s call this.
And these entities are. basically insurer on financial obligation. And I ‘ m calling this.
Due to the fact that AIG really did do this, one AIG. It could be anything. A great deal of financial institutions did this,.
a whole lot of insurer did this. There are some firms that.
just concentrate on writing collateralized– sorry, in.
What does AIG do for me? Well initially of all, it” s. essential to note that Moody” s has offered AIG, I don” t know,. I wear ‘ t know what their.
They stated, you recognize what,’they. are nearly risk-free.
They ‘ re virtually like the. U.S. government. Moody ‘ s has considered their.
books, or supposedly, or hopefully has actually considered their. books, and states, oh you know, if you loan them cash,. they ‘ re great for it.
So they have a really,. really high rating.Although, as soon as again, you have. to fret about the motivation.
Due to the fact that that paid Moody ‘ s to. provide that rating? And whenever you
‘ re getting. paid to give a rating, you have to wonder concerning what your
. rewards are, in terms of how you price points. However anyway that” s a conversation. for another video clip. What AIG states is, you. know what pension fund? I know you intend to offer.
Firm A money, and Firm An intends to obtain.
cash from you, however you have this problem because.
they” re BB ranked. So what’we ‘ re mosting likely to. do is we ‘ re mosting likely to insure this bond.We ‘ re mosting likely to insure this funding.
that you” re providing to Company B. What we desire in return for that.
is an insurance premium. We want you to pay us.
a little of this interest each year. , if you pay us a little bit of.
.
this rate of interest every year, we will certainly insure this settlement. So you obtain 10% a year, and.
you give us 1% a year. So you provide us 1% a year. And this is likewise 1%– simply.
to find out a little bit of economic lingo– this is also.
somebody would certainly say 100 basis points.One basis point is.
1/100th of 1%. So 1% of the same point.
as 100 basis points. 2% is the same point as.
200 basis points. So you pay me 100 basis factors.
of the 10% per year, and in exchange, I will certainly give you.
insurance on A” s financial obligation. And as a matter of fact, it could have not.
even been structured in this manner. It might have been structured.
That Company A right below, before also issuing the.
bonds, they include this insurance policy with the bond.So as opposed to
giving 10%, they.
removed 1% to insure it. And then these essentially.
Well, they” re BB,
but yet ‘ re. All of the unexpected, these.
bonds, since they” re being insured by this entity that.
is AA, which Moody” s has actually identified is AA, these bonds. are currently sufficient for my pension fund to hold. You know what since I claimed.
even if firm A goes under, I have this AA.
man guaranteeing it. And so I” m penalty. This is the equivalent.
of holding AA bonds. And what” s my reliable.
passion price? I” m obtaining 9% per. year, right?’I ‘ m getting 10 %per year from. Firm B, and after that I have to pay 1% to AIG. And if Company B goes under.
tomorrow, AIG is mosting likely to offer me my $1 billion back. And you might state, Sal,.
this seems like a rather great scenario. And this is where it starts.
to obtain a bit dubious. Since AIG, they” re not simply.
insuring my debt or my funding that I gave to corporation A. And consider it, AIG didn” t. need to do anything.AIG didn ‘ t need to place. up any security.
AIG didn ‘ t claim, you recognize what,.
You would certainly assume that if you.
you, this AIG corporation would need to establish.
aside the money. Yet they didn” t have. to do that.
They just have to state, hey,. Moody ‘ s has actually claimed we ‘ re AA, we ‘ re excellent for financial obligation. We ‘ re great for insurance policy.
You just pay us 1 %a year.
and trust us, or trust Irritable ‘ s, that we really are.
helpful for the cash. They never needed to establish. apart the cash.
You ‘ re just taking place a jump. of faith that, if and when Company A defaults,. AIG is going to be excellent for the money.Now this is
where it.
Let me remove Moody” s from the. AIG didn” t simply insure. Allow ‘ s state that there is.
Allow ‘ s claim that they ‘ re B– I. don ‘ t recognize, all these scores have various terminology. They ‘ re B + rated. ? And allow ‘ s claim there ‘ s$ 10. billion of financial obligation that they borrow from a few other party. And in return, they provide 11%. And this is Pension Plan Fund B. And this pension fund had.
the very same problem. They can only get A-rated.
or over bonds. AIG additionally guarantees their.
financial obligation that they offered to Company C.Maybe they ‘ ll pay them–‘.
Company C is maybe a little bit riskier, so out of.
the 11% I have to pay maybe 150 basis factors. Or 1 and 1/2%, that” s the. very same thing as 1%.
And in exchange, they. guarantee C ‘ s financial obligation.
Now something really interesting. can happen here.
AIG all of the unexpected. Has an excellent company design? Because they had the ability to get.
this AA rating from Moody” s, they can simply maintain insuring. other individuals ‘ s financial debt, and they don ‘ t have to put any kind of.
money aside, right? They wear” t need to provide their.
possessions to any individual else. And they just get these.
revenue streams, right? From my pension fund.
they” re obtaining 1 %each year
of$ 1 billion.From this pension fund, they” re. getting 1 and 1/2%, 150 basis factors, each year. And they can do this, truthfully,.
as long as they desire. They could do this.
a thousand times. And as long as Moody” s doesn ‘ t. get questionable. As long as Moody ‘ s doesn ‘ t. start saying, hi there, wait a second, AIG, you
only have$ 100. billion in properties, yet you have actually insured $1 trillion.
Something questionable going on, I” m. going to reduce your ranking. As long as that doesn” t happen,.
increasingly more debt. And truthfully, as long as none.
of that debt goes negative, they simply obtain this outstanding earnings.
stream, and their chief executive officer will obtain excellent bonuses. I assume you begin to see where.
you” re having a solitary point of failure and a house of cards,.
and I” ll proceed that in the following video.
And let ‘ s state that there” s. some corporation, allow ‘ s state it ‘ s GM. I put on ‘ t understand, let ‘ s say it ‘ s ranked BB.And really, this is a great. Allow ‘ s say I have Moody ‘ s.
Moody ‘ s is one of the ratings. Moody ‘ s has actually stated we ‘ re AA, we ‘ re excellent for financial debt. Let ‘ s claim that they ‘ re B– I. put on ‘ t understand, all these scores have different terminology.