Sunday, September 23, 2012

Why I Own AIG (Again)

In a future blog I will list my worst purchases. One of them is AIG. I bought AIG back in 2007 at about $65 and saw it go to $2. It is one of four stocks I bought that suffered an unrecoverable catastrophic loss. The other two are Alcatel, Citigroup and a startup where I worked.

So why on earth would I dive back in AIG? The answers I give are surprisingly psychological and subjective.

Firstly, AIG is not the same company that almost drove itself to insolvency in the summer of 2008. Back in the summer of 2008, the mortgage defaults from lax lending standards was driving down the price of various mortgage-backed securities (MBSs). This hit AIG doubly hard because it provided "insurance" on the MBSs, called credit default swaps (CDSs). The insurance AIG sold in theory hedged the possible loss for exposure to MBSs. And as with any insurance, the insurer collects a small premium in exchange for a small chance of a big loss. But AIG miscalculated on the small chance and the correlated MBSs were collectively a toxic mess that made CDSs a huge liability. And with the increase of these liabilities, the collateral payment requirements of the CDSs drove AIG to the point where it almost could not make the payments. This was when Federal Reserve called AIG too-big-to fail and stepped in — at a steep price. The Federal Reserve took over 80% of the company in exchange for funding an entity to hold all of AIG's toxic CDSs and MBSs. This entity is called Maiden Lane.

Now four years on, I am quite convinced the US financial system will not collapse. And I am beginning to believe in my gut that AIG is viable. Now, it certainly helped that the US government recently announced that all of Maiden Lane has been sold — and at a profit to the Federal Reserve! This is one psychological catalyst for me to feel good about AIG again.

AIG also really got my attention in the last six months when I found that Bruce Berkowitz has has invested 36% of his $7.7Bil Fairholme Fund in AIG. I always knew he was bullish on the financials, but I have never heard of a 36% investment in a single stock by a fund.  Berkowitz is one of my most respected investors with a tremendous track record. I wrote about Berkowitz in an earlier post here.

The Fed action of 2008 effectively wiped out my AIG holding. And although it stung, it didn't sting as much as my losses in the dot-com bubble. Following the dot-com bubble I vowed never to invest in tech stocks again. But over the subsequent years I have seen the cheap valuations tech and have come back to it in a big way. And I have realized my statement "I will never buy tech again" is in itself a contrarian indicator. I said that because I was reacting to the sting of my losses in my tech investments, but so are million of other investors and they too are saying "I will never buy tech again". This kind of knee-jerk thinking has caused the market to unfairly discount tech. So this time I purposely try to embrace AIG precisely because I was burned.

And so, in June of this year, I took a look at AIG (one source I used is Berkowitz's presentation on AIG).  I learned that AIG is now a plain vanilla life insurance, property and casualty insurance and a financial services company.  And I opened a position in AIG, again.

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