Hedge Funds That Bet Against Housing Market May Get AIG Cash
{{#rendered}} {{/rendered}}Some of the billions of dollars that the U.S. government paid to bail out American International Group Inc. stand to benefit hedge funds that bet on a falling housing market, according to people familiar with the matter and documents reviewed by The Wall Street Journal.
The documents show how Wall Street banks were middlemen in trades with hedge funds and AIG that left the giant insurer holding the bag on billions of dollars of assets tied to souring mortgages. AIG has put in escrow some money for at least one major bank, Deutsche Bank AG, whose hedge-fund clients made bets against the housing market, according to a person familiar with the matter. The money will be released to the bank if mortgage defaults rise above a certain level.
In essence, while the U.S. government is busy trying to prop up the housing market -- by trying to limit foreclosures, among other things -- it is simultaneously putting up cash that could be used to pay off investors who bet housing prices would tumble and many mortgage holders would default.
{{#rendered}} {{/rendered}}It's unclear how much government money might eventually flow to hedge-fund investors. Overall, the government has committed up to $173.3 billion to bail out AIG. Of that amount, AIG's housing-related bets have cost U.S. taxpayers some $52 billion.
The investment strategies involved are perfectly legal maneuvers. Still, the losses show how AIG strayed from its core business: selling standard insurance policies to businesses and individuals to protect against everything from fires to lawsuits. "AIG's financial-products division went heavily into the business of speculation, and its gambling debts are what taxpayers are paying off right now," said Martin Weiss of Weiss Research, an investment consultant in Jupiter, Fla.
An AIG spokeswoman declined to comment, as did a spokesman for the Federal Reserve Bank of New York.
{{#rendered}} {{/rendered}}The transactions worked like this: Investment banks such as Goldman Sachs Group Inc. and Deutsche Bank sold financial instruments to hedge funds letting them bet that mortgage defaults would rise. These instruments were credit default swaps, a form of insurance that pays out in the event of a debt default.