AND THE UGLINESS CONTINUES ...

It looks like problems in the market simply won't go away. After saying it wouldn't bailout any more private players, it looks like the federal government is going to jump into the AIG mess.

Here's what's happening, hopefully in easy to understand analogy form ...

The best way to think of the AIG mess is to imagine taking out a home equity loan to help out a deadbeat relative. Then, imagine you're sitting around with one of your cynical cousins and they say, "You know, you're never going to get the money back." You respond, "I bet you I do." You make the bet. The silliness continues, and other cousins take you up on your bet.

As they expected, Deadbeat Relative #1 doesn't pay you. You not only lose the money you lent to your relative, you lose your house. Because you have such a dysfunctional family, you're now faced with the prospect of having to pay off your cynical relatives. You don't have the money. They could care less. They panic because they had already planned what they were going to do with the money you were going to pay them. They're now camping out at the doorstep of your new apartment.

You pray for a miracle. Since you're not a giant coroporation, the federal government ignores your plight. You declare bankruptcy, and go on an alcoholic binge.

End of analogy.

AIG's problem is they thought they could cover the complex and murky world of collateralized debt obligations (CDOs, represented by Deadbeat Relative #1) like they covered lives, homes and cars (here's a pretty good article that explains what's happening). As the provider of insurance for poorly constructed CDO products, AIG is on the hook to pay the insurance policies of the first wave of CDO defaults (Deadbeat Relative #1) and other market players whose CDO contracts are going to tank in the future (your Cynical Relatives).

How big is this insurance mess? Consider this. The size of insurance portfolios (called Credit Default Swaps) grew from a “modest” $1 trillion in 2001 to an astounding $45 trillion by 2007 – which is more than double the value of the U.S. stock market, and far exceeds the $7.1 trillion mortgage and $4.4 trillion U.S. treasuries market.

My friends, with additional mortgage problems around the corner (adjustable rate mortgages haven't begun to kick in) we are looking at a financial mess that really is just beginning.

Don't believe me? Take a look at the growing size of total U.S. credit market debt, which I posted on a few months back. As a reminder, it's far bigger today than it was in 1929. If I get a chance, I'll post on this later in the day.

I'll definitely be talking about this on the program this Saturday.

- Mark

P.S. For those of you who want some graphics on the CDO/CDS mess, this is from the NY Times.