How do you lose money in Securities Lending?

T

texrex2002

By borrowing the security from the owner, lending it it to a "shorter" in exchange for a fee and collateral, and then mis-investing the cash generated from that???

So how did AIG's Securities lending division lose money on mortgage backed CDO's???? not like they've been appreciating lately...

They must have been lending their own CDO's, but then why would they have to pay a counterparty? If they were borrowed CDO's they would be liable only for the borrowing fee, not any MTM loss...

I think I must be mis-understanding something fundamentally...
 
My guess is that they didn't lend and borrow the actual CDOs, but rather the individual bonds etc that were probably used to hedge the various exposures of the portfolio.

One possible scenario could be that, once the whole street knew what they had, they had to pay up A LOT to do anything in repo. Moreover, my guess would be that the haircuts they had to pay would have been something out of a 50s horror flick.
 
Quote from texrex2002:

By borrowing the security from the owner, lending it it to a "shorter" in exchange for a fee and collateral, and then mis-investing the cash generated from that???

So how did AIG's Securities lending division lose money on mortgage backed CDO's???? not like they've been appreciating lately...

They must have been lending their own CDO's, but then why would they have to pay a counterparty? If they were borrowed CDO's they would be liable only for the borrowing fee, not any MTM loss...

I think I must be mis-understanding something fundamentally...
More...

Please reread the news stories. AIG lent securities and then invested the proceeds in subprime mortgages rather than treasuries to get extra yield. The subprime mortgages sank in value, hence the losses.

IF AIG had run their securities lending business like everyone else they would have made extra profits when treasury prices went up. Since AIG was greedy for extra yield they instead had large losses on their subprime mortgage investments.
 
Quote from jeb9999:

AIG lent securities and then invested the proceeds in subprime mortgages rather than treasuries to get extra yield. The subprime mortgages sank in value, hence the losses.
More...

Thanks. That's the piece I was missing...
 
Quote from jeb9999:

Please reread the news stories. AIG lent securities and then invested the proceeds in subprime mortgages rather than treasuries to get extra yield. The subprime mortgages sank in value, hence the losses.
More...

As Moodys and S&P rated subprime mortagages "AAA" it was a "risk free trade" for AIG ! :D
 
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