Full Tilt Justice



The Full Tilt Poker criminal prosecution really couldn't have come at a more opportune time for me since it perfectly illustrates the absolute insanity of the U.S. economic/justice system at this particular moment in time.  The actions of Full Tilt Poker, which were undoubtedly criminal and fraudulent in nature, parallel almost perfectly with the actions of the TBTF banks and other Wall Street financial titans, which also were undoubtedly criminal and fraudulent in nature.

For those of you who haven't been following the story, Federal prosecutors filed indictments against owners and board members of the online poker website Full Tilt Poker for defrauding investors.  As part of the several pronged attack, Full Tilt's online licenses were revoked and for all intents and purposes, their business was shut down.  After the indictments were unsealed and arrests were made of the major players in the Full Tilt business, prosecutors went so far as to accuse Full Tilt of being a "global ponzi scheme" which raided the funds of their customers in order to enrich their owners and board members to the tune of hundreds of millions of dollars.

A quick review of the indictments shows that Full Tilt indeed did lavish themselves with high dollar payouts and were undercapitalized to an alarming extent.  In March of this year, Full Tilt owed $390 Million to its customers in winnings but had on deposit just $60 Million dollars in assets.  In addition to this, Full Tilt had used customer accounts, which were promised to be off limits to the company itself and were held for the benefit of the customers, in order to pay owners and board members salaries and bonuses of approximately $440 Million.

This type of activity is not only bad business, but does appear to amount to criminally fraudulent activity which if proven will land those responsible for this looting of customer funds in federal penitentiaries for years if not decades.

Now, say instead of an online poker company you are instead the world's largest insurance company AIG.  What would happen if you acted in the same way as Full Tilt Poker?  You would think that if any major American company did anything like the absurdly illegal activity that is alleged against Full Tilt, that the hammer of American justice would come down hard and fast to protect the integrity of the American financial system, right?  Well, you'd be mistaken.

AIG presents a perfect example of why what went wrong leading to the crash of 2008 and the depression in which we still find ourselves was not only outrageous and criminal, but why the subsequent bailout by the Treasury and the Federal Reserve was possibly the worst single decision of the U.S. government in recent memory.

The only difference between the actions of AIG and the actions of Full Tilt appears to be that of scale.

The problems with AIG arose from their division AIG-FP (financial products) which issued insurance-like products known as credit-default swaps (CDS).  Although there are similarities between insurance and CDS, CDS are not insurance, they are financial derivative products which are not regulated like insurance and therefore have the same risks to the issuer of insurance policies, without any of the requirements of sufficient reserves or conservative investing of the premiums that are required of insurance products.  CDS are financial products which are purchased by customers (known as counterparties) who want to hedge their investments in the complex dervative investment products such as collateralized debt obligations (CDO).  A counterparty will purchase a CDS, paying a premium every required period (quarterly, annually, etc) with the promise that they will receive payout if the CDO in which they have invested suddenly fails and loses money. 

Another key difference between CDS and insurance is that CDS can also be purchased by any investor (usually hedge funds or other large investors) which are simply betting that a certain investment is going to fail, whether or not they actually are invested in that product itself.  In essence, it is simply a bet that a certain financial product or investment is going to fail, without the requirement that the purchaser have any stake in the investment against which he is betting.

AIG-FP was issuing CDS to an alarming extent during the 2000s.  Most of these were written on CDO products which were based on subprime mortgage loans.  Since the belief was that the real estate market would continue to rise in value over time for eternity, these were considered incredibly safe investments by AIG.  Their computer models showed that the chance of any of these CDO failing were so small, that the head of the AIG-FP branch actually stated in company e-mails that he could not foresee a situation in which AIG would lose a single dollar as a result of their obligations on CDS, even as the subprime mortgage market began to implode.

Because these financial instruments were unregulated, the profits on the sales of CDS and the fees generated by AIG were booked immediately as profit, which the liabilities created by the products were kept off-book, in essence showing no liability to investors.  Because of this AIG-FP became a profit generating machine for AIG and as long as the money was coming in, no attention was paid to what was happening beneath the surface -- a financial catastrophe of its own making which would bring down the largest insurance company in the world.

At the height of AIG's CDS binge, the company had a portfolio containing over $2.3 Trillion of CDS.  On this portfolio, AIG had $440 Billion in immediate obligations to counterparties.  However, despite this enormous amount of liability, there was little or no money set aside to cover these obligations.

Now, let's take a small step back and look at the comparison between what AIG did and what Full Tilt Poker's actions.  Remember, Full Tilt had obligations to its customers in an amount of $390 Million and had only $60 Million on deposit to cover these obligations.  AIG had obligations to its customers of $440 Billion (more than 1000 times the amount Full Tilt owed) and had essentially nothing on deposit to cover these obligations.

As we all know, the obligations to its counterparties came due and AIG was unable to cover the amounts owed.  So, after seeing what happened to Full Tilt, this would be the time that the Feds would swoop in, we'd see Wall Street execs in $3,000 suits being dragged handcuffed through the perp walk on the evening news, right?

Well, not exactly.  In fact, not at all.

It became known that AIG was unable to meet its obligations just after the Treasury and the Federal Reserve decided to impliment the Toxic Asset Relief Program and the larger bailout of the entire banking system.  AIG was negotiating with its counterparties, the largest of which was Goldman Sachs which had just received billions of dollars of government money to keep it afloat, in order to come to a settlement of the obligations.  This would have resulted in AIG paying out a settlement of 60% of its obligations to its counterparties to settle all of the claims against it. (An aside, in researching this post, I discovered that the CFO for the AIG division who was negotiating this settlement was a very good friend of mine from college -- odd).

While these negotiations were taking place between AIG and its counterparties, the Fed swooped in on September 16, 2008 and injected $85 Billion into AIG to help cover its obligations.  Furthermore, Tim Geithner, who was at the time the head of the NY Federal Reserve Bank took over the negotations from AIG.  The result of Geithner's takeover of the negotiations was that rather than the counterparties receiving a 40% haircut on their bad investment and receiving 60 cents for every dollar they were owed (a rather generous settlement under the circumstances), Geithner decreed that the obligations were to be paid at par value, meaning that the counterparties received 100% of everything that they were owed on their bad investments with AIG.  This resulted in Goldman Sachs alone receiving an additional $19 Billion in government money which was paid directly to it through the bailout of AIG.

The $85 Billion was only the beginning, though.  By the time that the Fed was done bailing out AIG, it had paid out $182.5 Billion to AIG's books either through direct injections of cash, or in exchange for purchasing the toxic assets which led to the implosion of the insurance giant in the first place.  This means that the taxpayer now holds the obligations on all of these bad financial instruments rather than AIG itself.

Now, let's remember also the emphasis that the Federal prosecutors in the Full Tilt case made about the money paid out to its owners and board members over the course of several years -- $444 Million dollars in total.  After the government bailed out AIG and paid its counterparties in full for the obligations that AIG owed them, in March 2009, AIG paid its traders in the very department AIG-FP that caused this entire mess, bonuses in the amount of $165 Million.  So, while Full Tilt may have misused their client money to enrich the owners and board members of the company, AIG took it a step further and after blowing all of their shareholder's money on ridiculously risky deals, they then used money given to them from the Treasury and Federal Reserve to pay bonuses to the very same idiots who caused the shareholders to lose all of their money in the first place!

Now, I would never excuse the type of fraud that seems to have been practiced by the owners of Full Tilt Poker and if it turns out that the allegations contained in the indictments issued by Federal Prosecutors are true, I hope that all of those indicted serve their time in prison.  But, it makes one question the very foundations of our justice system when you have companies like AIG who engage in what would appear to be conduct which is just as fraudulent and just as reckless not only escape any kind of criminal prosecution but actually receive government subsidies to save them from the financial consequences which would have been the natural and deserved result of their activities.

There are those who will say that these two examples are not comparable.  That allowing AIG to fail would have caused immeasurable damage to the entire financial system of not only the United States, but to the world as a whole, whereas Full Tilt was simply a money-making scam foisted by dishonest and unethical grifters looking to enrich themselves at the expense of the marks who spent money gambling on their website.  There may be some truth to that.  However, the grifters at AIG were no less dishonest or unethical or greedy than those at Full Tilt, and the worst part of this entire scenario is that not only did the government's actions following the financial crisis of 2008 not result in any substantial criminal penalties for those involved in the destruction of the American economy, but that nothing was done to prevent this very scenario from happening again -- and happen again it will.  The only question this time is, will we prosecute those responsible and demand change, or will we just drum up another bailout causing the entire economy to go full tilt?