Credit Market Datapoint of the Day, AIG Edition

What was that about the credit markets improving? Not so fast:

American International Group Inc. has used $90.3 billion of a U.S. government credit line since it was bailed out last month...
AIG's latest balance was revealed yesterday by the New York Federal Reserve, and is up from $82.9 billion a week ago...
The firm needed cash after credit downgrades forced it to post more than $10 billion in collateral to clients who purchased guarantees on bonds that lost value.

What this means is that over the course of the past week, the value of the default protection written by AIG has gone up so much that the insurer has had to put up an extra $10 billion in collateral. Collateral requirements are a function of secondary-market CDS prices: they go up when CDS spreads go up. And so the spike in collateral means that CDS spreads, at least on the stuff that AIG was insuring, have gone up substantially over the past week.

This doesn't exactly come as a surprise, of course: all risk assets have been decimated during the latest bout of market carnage. But the sheer magnitude of AIG's collateral requirements is stunning. Consider this:

AIG sold protection on $441 billion of fixed-income investments, including $57.8 billion in securities tied to subprime mortgages. The swaps plunged in value as the assets they guaranteed declined, forcing $25 billion in writedowns over nine months and leading to three quarterly losses.

Remember that the writedowns took place before AIG was nationalized. And let's say that the subprime securities have all at this point been marked to zero. Then that would require AIG to put up $33 billion of collateral. And let's say that AIG has manged to lose $7 billion on its securities-lending business. Then it has still had to put up $50 billion in collateral against $383 billion of non-subprime guarantees. That's equivalent to non-subprime bonds trading at an average of 87 cents on the dollar. Which might not sound too distressed, until you remember that AIG only guaranteed securities it considered extremely safe.

I don't know exactly what kind of non-subprime securities AIG was writing protection on. But given the amount of collateral it's had to put up, one can only conclude that the market is pricing in a wave of defaults the like of which America hasn't seen in a very long time. And which would easily justify the kind of stock valuations we're seeing at the moment.