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AIG – Holy Moly


 

I am stunned, STUNNED at the news that the U.S. Federal Reserve and U.S. Treasury have kicked in US$85 billion to bail out AIG.

Just 48 hours after insisting that a bail out of Lehman Bros. was an absolute non-starter, Henry Paulson pulls a COMPLETE 180, and coughs up the cash to save AIG. The reason, apparentlly is pure pragmatism. Lehgman was allowed to fail because it could be allowed to fail. they made a calculated decision that Lehman was not big enough, or important enough to actually spark a market crash, and sure enough, this week’s modest sell off on the Dow proved them right. but they decided that AI with its $1 trillion in assets, and almost $30 billion in counterparty risk, would have brought worldwide trade in derivatives to a standstill and triggered a real, live old-fashioned freak out. And so, Uncle Sam bails the kids out of the drunk tank again.

Amazing. Absolutely amazing.  I never thought I’d see the day when the U.S. government essentially nationalized a major private company for the sake of minimizing fallout int he capital markets. I guess the Republicans just really really didn’t want a Black Monday in the middle of an election campaign.

That said – I can understand the dilemma Paulson is in. to fail to save AIG may well have triggered a huge market sell off, possibly global in nature, and it may well have brought lending to a halt and driven rates through the roof. Bad mojo all around.  But the precedent is just incredibly, staggeringly bad for the separation of government finances from private enterprise.

Mr. Paulson, GM and Ford are on the line, they have an urgent favour to ask.


 

AIG – Holy Moly

  1. Yup thats big.

    Going concern and financial infrastructure are the key words.

    Somehow this is going to put financial regulation back on the table, and I dont think bonuses and salary that are driven by these instruments will safe from that inquiry.

    Ford and GM, well their implosions will be more contained. There risk is better understood, and they have real assets worth buying….what is Ford in Chinese or General Motors in Hindi?

  2. Conclusion: no matter how irresponsible you are, get big. Really, really big. Make it impossible for you to be allowed to fail, and the taxpayer bails you out for any stupidity.

    This way lies insanity. A good solid painful whupping of the stupid corporation is an ESSENTIAL part of successful capitalism. Skimming taxes from the successful to prop up the stupid? How long will an economy put up with that?

  3. “How long will an economy put up with that”

    Probably as long as Republicans keep “getting out of the way of the private sector”.

    What really surprises me is that they actually seem to have taken an equity position. I assume they think/hope it’s temporary and that somebody somewhere sometime is prepared to take it off their hands. Probably at an ” incentivized” price.

  4. I don’t think the Fed has a choice because the ramifications if they had not intervened, the impact would have been felt around the world. When the financial markets have settled down, there needs to be a period of reflection and if necessary, more regulation and oversight in the this sector.

  5. It’s a bailout in the sense that the shareholders are getting $0.20 on the dollar (i.e. the government has nationalized 80% of the firm) and the directors have voted to lose their jobs. Woot!

    Who wins? The taxpayer. The assets of AIG will eventually come back, and the Fed will be able to sell them at a tidy profit (and still owning the company).

    The losers? AIG’s customers & shareholders. But it beats defaulting on all that credit insurance and having the rest of the economy shut down. It sucks when banks fail. Consumers lose their savings, but the average Joe has government-insured deposits (well for $60K or so, after that, well you enjoyed being rich and you probably have other assets somewhere).

    But when the rest of the companies in the real economy lose their savings, they have to shut down. That’s what the government is really afraid of.

    When the financial guys say this is Armageddon, the idiots on CNN don’t get it. Terence Cocoran’s article in the Globe today was typical: it’s not another Depression. Not yet.

    It’s like main street is standing on the beach front looking at the water receding, wondering how the ocean could just disappear so quietly. The tsunami is on its way.

  6. I think their nationalizing the wrong industries. They encouraged overbuild of housing and then bailed out. Over speculation of financial “services” and then bailed out. Meanwhile for profit doctors offices overprescribe diagnostic services.
    The Republican tax-cut mantra has failed. It sounds disturbingly like S.Harper’s rhetoric: we now have the lowest corporate taxes in the western world. Where tax cuts have stimulated employment (Finland), it was because the burden was too high (us a decade ago). Where they haven’t worked (Dubya USA), taxes were already low. Liberal environment platform is incredibly employment intensive and Layton just announce a massive retraining programme. Financial sector doesn’t look to be hiring so I guess the oil patch is the basis of Harper’s economic platform? Does an industry earning $30B in profit hire more when it earns $35B?!

  7. Steve, most economists will say that there is the “real” economy and the “financial” economy.

    Events in one impact the other but not necessarily on a 1:1 basis and not necessarily in the here and now. No doubt there will be a price to be paid in the “real” economy but I don’t think we’ve really seen it yet.

  8. This video never seems to get old.

    Best part (from the end, but the whole thing is hilarious in a macabre kind of way):

    Host: Now people are saying the crisis is likely to turn into a, ah, financial meltdown. Can that be avoided?

    Banker: It can be avoided provided governments and central banks give us, the financial speculators, back the money that was lost.

    Host: Isn’t that rewarding greed and stupidity?

    Banker: No, no. It’s rewarding what the Prime Minister Gordon Brown called the “ingenuity of the markets.” We don’t want this money to spend on ourselves. We want it first for ourselves so we can continue borrowing and lending money without thinking too much about it.

    Host: Yes, but if the worst came to worst and you didn’t get this money, what then?

    Banker: Then there would be another market crash. And then I’d say to you what people like me always say: it’s not us that would suffer, it’s your pension fund.

  9. Sisyphus it comes down to the fact that the economy is built on debt. Little debts in the “real” economy get bundled up into bigger debts. It’s the biggest debts at the top of the chain that are now at serious risk of default.

    Some of the biggest commercial banks in the US (Washington Mutual, Citicorp) are at risk of default, i.e. bankruptcy. If that happens they can’t make payroll and they can’t redeem deposits. Sounds pretty real to me.

    The problem with credit insurance is that there is $62T of credit that needs to be insured. The Iraq war was “merely” $3T and all the retail deposits in the US are only $1T. Big numbers confuse me but I think that assuming the financial sector can take this sort of hit without it affecting anyone else is pretty naive.

  10. Sorry,Steve. I guess I wasn’t very clear. Oh well.

  11. Does anyone know who’s starring in the next act, after Merrill Lynch, Lehman, and AIG?

  12. “It sounds disturbingly like S.Harper’s rhetoric: we now have the lowest corporate taxes in the western world. Where tax cuts have stimulated employment (Finland), it was because the burden was too high (us a decade ago). Where they haven’t worked (Dubya USA), taxes were already low.”

    You’re mixing up your taxes. The US hasn’t cut the federal corporate tax rate since 1986 and has the 2nd highest corporate tax rate in the OECD. You can’t use Bush’s tax cuts to attack Harper’s cut to corporate taxes because Bush never cut the corporate tax rate.

  13. Right sbt. My bad (and lowest in western world is projected over next few years). Wow, I just assumed Bush cut corporate taxes. Wonder why some of those high-end income tax cuts didn’t go to US multinationals. I think the point is the same though. Steady as she goes is nice, but we need a backup plan, going into deficit if necessary I guess. I’d feel a lot better about the Conservative economic policies if they weren’t so laissez faire. They have nibbles of inspiration in their budget 2008. A $5M capital cost depreciation allowance for railroads. Would they be willing to increase that rail subsidy 1000x if we need to grow trade to Asia or Russia? Palin might be their next Prez.

  14. Phillip, methinks they’ve been able to keep corporate taxes so high because the US is the one place corporations can’t leave. (Well, some have, but not the way they would if we or, say, Ireland had corporate taxes that high.) But nowadays one starts to wonder how long American economic exceptionalism will last, eh? Not that one is exactly eager for the aftermath…

  15. This is perfect example of ‘moral hazard’. From what I have read, AIG turned down private equity because they were going to have to give up too much control and mgmt knew the Fed would have to do something because of the chaos if AIG failed.

    And giving $25/50 billion to automakers to build more fuel efficient cars is crazy. Automakers are huge bureaucratic messes and no real innovation is going to happen in GM or Ford labs.

    If U.S. government wants to develop new types of engines to reduce oil/gas consumption, it should set up something like the Ansari X Prize and offer $500 million to the first person/company that can develop a non-gas engine that performs just as well.

  16. I think I would have been more surprised if the government stood by and watched AIG get flushed down the toilet. They need to control this wildfire and there weren’t many other options left open to them. Desperate times…

  17. On the off-chance that the current crisis is not the result of 7 years of artificially low interest rates and the mortgage bubble they produced, but rather the result of Divine Wrath, perhaps Alan Greenspan should be thrown into an active volcano.

  18. Hmmm . . . I’m agreeing with JWL on economic issues. (Has Ottawa frozen over?) This is a perfect example of moral hazard. Also of asymmetric information–since nobody really knows how large the credit swap market is (10’s of trillions?? 100’s of trillions??) or how much of it is controlled by AIG, only AIG has any idea of how much damage it could do if it goes down. Nobody really cares about the insurance parts of the world’s largest insurance company. Lost of companies are willing to swoop those up. Credit swaps are pretty much deregulated, by the way.

    Although the insurance industry is by its very nature the standard example of moral hazard & asymmetric information. It’s just in the other direction this time.

    Some people are talking about comparisons about the ’29 banking & market crash. I think the late 90’s Asian currency collapse is a closer parallel. The ’29 crash was in a mostly unregulated & uninsured environment. The Asian crisis started when financial institutions (Hi CitiBank!!) made too many risky loans, & the financial loss was nationalized to protect the private financial markets.

    I’m all for the volcano part. Can I add my own list of people?

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