The financial services sector generally provides a stable place for investors, but after the banking crisis of 2007 and 2008 led to the near-failure of prominent, large-scale banks in the United States and around the world, investors are more wary of the category than in the past. Lehman Brothers failed in the U.S., while a number of other banks had to be bailed out by governments in order to remain liquid. A few that received billions in aid from the U.S. government in order to avoid bankruptcy were Merrill Lynch Wealth Management, a Subsidiary of Bank of America Corp (NYSE: BAC); American International Group, Inc. (NYSE: AIG); Federal National Mortgage Association (OTC: FNMA), known colloquially as Fannie Mae; and MBIA, Inc. (NYSE:MBI). However, the following three institutions continue to be embroiled in litigation long after the crisis, further proving they are not worth an investor's money.
AIG
AIG received the largest bailout from the U.S. Treasury as a public company, receiving over $67 billion in disbursements from the government. Only Fannie Mae and Freddie Mac, government-sponsored enterprises, received more in bailout money. AIG was a huge insurer of collateralized debt obligations (CDOs), the exact instrument that caused the crisis. AIG was forced to pay out $25 billion on policies covering these CDOs. AIG simply felt that it would never have to pay out on the CDO insurance policies, and a large simultaneous default situation was not possible. AIG, as the financial crisis of 2008 proved, was wrong.
Compounding the problem of its derivative risk in CDOs, AIG also became involved in lending securities from its life insurance policies for cash collateral. It then invested the cash in long-term illiquid investments, causing the insolvency problem that required a government bailout. Furthermore, a settlement has finally been reached between AIG’s Lavastone Capital LLC unit and Coventry First LLC over life settlements, generally called death bets, that were originally filed in 2014. The lawsuit accused Coventry of inflating prices, while Coventry responded that the suit was initiated simply to get AIG out of thousands of life settlements the company sold from the early 2000s until 2011, when AIG stopped selling them.
Litigation further embroils the company. In March 2016, the Securities and Exchange Commission (SEC) announced charges against three affiliates of AIG for advising clients to purchase more expensive share classes so the firms could collect higher fees. The three firms have agreed to pay more than $9 million to settle the dispute. Investing in heavily regulated markets such as insurance and finance should provide a measure of risk abatement, but AIG has not offered such low-risk aspects for almost a decade.
MBIA
Municipal Bond Insurance Association (MBIA) launched in 1973, and until 2008 was the nation’s largest company granting municipal bond insurance. MBIA is legally restricted from buying the infamous credit default swaps (CDS), but did so anyway through a second corporation that was a subsidiary of MBIA. The company’s exposure to the derivative during the 2008 crisis downgraded its credit rating to an A, preventing it from issuing bond insurance for five years after the crisis.
However, the Puerto Rican debt crisis of 2015, which MBIA was overweighted to the tune of $4 billion in bonds insurance, may have long-term effects for the still-recovering bond insurance company. MBIA had barely exited the derivative troubles of the 2008 financial crisis when it suffered this severe setback. If the Puerto Rico debt crisis does not get solved with a favorable outcome for MBIA, it may spell the end of the company.
Fannie Mae
Fannie Mae does not itself offer mortgage loans to consumers. Instead, it offers to buy mortgages from lenders, provided the lender meets the requirements, and then wraps the mortgages into guaranteed securities for investors to purchase. During the financial crisis in 2008, Fannie Mae was the largest receiver of bailout funds of any institution in the world, at $116.1 billion. Fannie Mae has since developed a path forward to mitigate its risk, and therefore taxpayer risk, from mortgage-backed securities (MBS). This path forward was the credit risk transfer (CRT) instrument, another derivative, yet one that transfers risk to the private investor.
Legal Challenges
The real risk to investors in Fannie Mae is not the derivative risk of the new CRT instruments, but the legal challenges that it faces from multiple lawsuits regarding the government’s conservatorship of the company. This conservatorship has taken over $108 billion from the company since 2008. The legal arguments against this conservatorship revolve around one simple aspect, which is that the agreement between the Treasury and the conservator – the government controller of Fannie Mae – is essentially an agreement between the government and itself. In either case, whether it's the derivative risk or the risk of the government siphoning all profits from Fannie Mae over the next 10 years, it would be wise to avoid investments in the company.
With hundreds of financial companies from which to choose, investors should avoid these three companies that are embroiled in litigation and still reeling from the effects of the 2008 financial crisis.
Blogger Comment
Facebook Comment