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AIG – A question for our readers


 

Last night’s shocking bail out of AIG hasn’t done much to calm the fears roiling through the markets this morning. It has, however, got me to thinking.

Clearly Paulson felt he was in a no-win situation, and made a decision based on the cold calculus of pragmatism. He ahd to decide which was the lesss terrible of two terrible options:

1) Let AIG fail, watch the shockwaves ricochet around the globe, and try to play defense – using small and quick interventions in the market to manage what would likely have been a huge crash in world markets. Essentialy this is the “let it blow up, then pick up the pieces” strategy

or

2) Bail out AIG, using the treasury to backstop souring credit and derivatives markets. this has the virtue of avoiding a crash, and possibly even turning a profit on AIG’s assets if the situation stabilizes over the next few months. The downside, as we’ve discussed, is the aspect of moral hazard. You are rewarding fools and crooks, forcing taxpayers to pay for their mistakes, and opening the government to a never-ending expectation of further bailouts every tie a major industry runs into trouble. It also, implicitly, encourages reckless bets in the financial markets, making future panics more likely and perhaps even more devastating. Essentially this is the  “save today and tomorrow is somebody else’s problem” strategy.

So, here’s my question:

Under what conditions would multi-billion-dollar bailouts of private businesses be acceptable?  What are the criteria you’d use, if you were Paulson for deciding when it is prudent to use public money to save private business?

I have my own thoughts on this, but I’d like to know what our readers and/or other contributors think.


 

AIG – A question for our readers

  1. Funny how nobody was there to bail out the homeowners who defaulted on their mortgages.

    It’s also funny how so many think socialism of any form creates a nation of lazy underacheivers, yet never complain about this sort of selective corporate welfare.

  2. First of all, I’d make it illegal to give CEO’s multi million dollar exit pay when they have been robbing the poor to give to the rich. Am timed of being labelled as being in the “Looney Left” when the greedy robbers have set about to enrich themselves while bankrubpting the country. Any non-economist could see what was happening yet no one did anything to stop the madness! Here in Canada, we are just as greedy as we watched McTeague litterally give the go-ahead to raising gas prices 13 Cents while even in the U.S. the increase was minimal. Why was a politician making such an announcement? Then, to add insult to injury, they lowered it only by 9 cents when nothing happened. We should use the Romanian method of getting the attention of our politicians and business people!!

  3. Honey, it’s Patrick!
    He’s been bailed out!

  4. That’s a tough call. Only because at some point all this hits the guy on the street. No, not that Street. The guy on the street doesn’t live there despite what the mutual fund flacks tell us.

    But there is something about bailing out derivatives Divas that makes my skin crawl.

  5. This hurts the capitalist in me to say, but maybe some kind of massive, mandatory paycut for all upper management as a condition for being bailed out.

    Yes, it would be largely symbolic, but that’s not always a bad thing.

  6. Well, in this case Steve (and in the case of Fannie and Freddie) the point of pay cuts is moot, because upper management are all getting fired. Nobody’ll shed a tear for them, I suspect.

  7. “Under what conditions would multi-billion-dollar bailouts of private businesses be acceptable?”

    There might be one or two cases where a bailout would be acceptable but I can’t think of any at the moment. Capitalism is messy but efficient and bailouts of bankrupt companies is just prolonging the hurt and wastefulness.

  8. “This American system of ours, call it Americanism, call it capitalism, call it what you will, gives each and every one of us a great opportunity if we only seize it with both hands and make the most of it”

    – Al Capone

    Funny how the weapons of the true criminal elite have changed.

  9. Having thought of this for all of a minute I would allow it in two circumstances:

    1) The company is responsible for managing the financial transactions representing X% of the economy. While I see no benefit to bailing out companies in general, there should be recognition of the importance that the financial sector plays (for better or for worse) in our economic infrastructure. So if their involvement exceeds a certain percentage, then they become eligible for aid.

    2) In order to receive that aid, I would take a chapter from the IMF. Institute a program of austerity measures (such as the elimination of bonuses which are often causes of risky behaviour), install a few government-appointed risk managers to lower the overall risk exposure (I’m thinking years, not weeks or months), and allow the government to require structural reforms as needed.

    This may only create a longer, more drawn out death, or maybe it will provide the necessary reform to keep the company solvent in the long run. In either case, the infrastructure will remain intact.

  10. Er, that shouldn’t say “in two circumstances” but “under two conditions.”

  11. I’m trying to think back to Lee Iaccoca’s autobiography. During the Chrysler loan guarantee debate, they pressed on 4 key issues in making the case for help:

    1) Impact of a Chrysler bankruptcy on the economy
    2) Veracity of their recovery plan
    3) Extent to which factors outside their control were to blame for their precarious situation
    4) Precedent (in their case, that there were plenty of precedents of US gov help for failing steel companies, airlines, etc.)

    You’ve already laid out what was the likely US Gov thinking with respect to the scope of impact of an AIG failure. That’s #1.

    As I understand it, AIG’s insurance businesess are sound, it’s their investment banking side that’s d.o.a., so assuming they have a credible plan to consolidate and recover by focussing on their core insurance business, that’s # 2 covered as well.

    #3 is tougher. But it seems to me that the US. Gov is implicitly acknowledging some of the responsibility for the credit crunch and its aftermath, and is acting at least in part out of guilt.

    And as for #4, well, they stepped in for Bear Stearns, they stepped in for the Asian crash, they stepped in for Mexico, for Argentina, they (and we) have been pouring hundreds of billions of liquidity into the markets over the past year…in the realm of global high finance, bailouts are a way of life.

  12. I would base it on two criteria
    1) the company is in a regulated sector
    2) the financial difficulties that the company faces are a direct consequence of regulatory impositions crashing up against an uncontrollable factor (i.e. sudden rise in cost of an input)

    In this case, we have companies that developped investments that were structured in such a manner so that they were not subject to much, if any regulation so that they could maximize their return. These same companies now seek help to cover their mistakes.

    d. andy jette refers to the Chrysler bailout. I’d ask the following question – Would the American auto sector be in better or worse shape now if the U.S. had not bailed out Chrysler? I fail to see how bail-outs encourage innovation and increases in productiviy. It seems to me that they encourage incompetence. How this is good for our overall economy is beyond me.

  13. The problem with corporate bailouts is that they essentially bail out the wrong people.

    Let the corporation die, but have damned good EI and welfare systems in place to help the individuals who find themselves in need through no fault of their own.

  14. Chrysler aficianados will likely reply that their 1981 bailout made at least one significant innovation possible: the car-platform-based minivan. Less happily from some points of view, one could point to the success of the 1980s-era Jeep Cherokee (by then a Chrysler product) as the opening stanza to the SUV era, predating the Ford Explorer and 4-door Chevrolet Blazer by at least 3 years.

    How is an AIG bailout good for our overall economy? No idea. If it all works out, 20 years from now we’ll look back and say yes. Otherwise….

  15. Steve, I vote number 1. Shocking, I know.

    Capitalism is SUPPOSED to kill off the weak and stupid and underperforming. If you don’t let that happen, and especially if you punish the successful through taxation to keep the weak and stupid and underperforming from getting killed off, you have KO’d capitalism, and I would say freedom, the two single (huh? two? single? whatever, bear with me here, I’m ranting, ok?) most important contributers to our phenomenal prosperity. And for what? To face the same moral hazard on a grander scale the next time.

  16. There’s no doubt this sets an awful precedent. But it really was the lesser of two evils. It’s one thing to let an investment bank fail, but the world’s largest insurer? I think a move like this is defensible when it’s made as a last ditch effort to avert a catastrophic breakdown of the financial system. Was there really an alternative in this case?

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