AIG SHOCKER: All That's Wrong With the Bailout

I am utterly amazed. First Fannie Mae and Freddie Mac. Then Lehman. Now AIG. AIG? Yes, AIG -- the government has taken control of one of the world's largest insurance companies. Someone help me -- my jaw is scraping the floor.

My amazement stretches from the government's action to AIG's seemingly utter inability to manage its CDS risks to AIG's seemingly boneheaded management to an absolute disgust right now with our nation's financial services system and its after-the-fact regulatory actions.

Let's start with the deal. Paulson and crew felt as though they absolutely had to rescue AIG or all financial services faced systemic systemic risk. That much is clear. The deal gives the feds nearly 80% of the company. The loan the Federal Reserve has given to AIG is payable at libor + 850 basis points. That puts AIG's cost of funds at 11.31% today. That's wicked high. Some online babblers are talking about how the government could make money on this deal. I certainly hope that making money was not even remotely part of the government's consideration in doing this deal.

How this happened points to AIG's inability to manage its risks in its financial products division, which sold credit-default swaps. The fact is that AIG's consumer insurance units are completely well-capitalized. Why are they well-capitalized? Because the law requires it. I don't think it would be right to credit AIG's risk management.

Greenberg, Sullivan, Willumstad -- they all deserve a piece of the blame. To varying degrees they allow their insurance company, which is supposed to be supremely able to evaluate risk, to allow itself to be swallowed by its risks. Of course, Paulson should have fired Willumstad as part of this rescue. The former CEOs also apparently instilled a corporate culture as honorable as a toothpick. You reap what you sow.

Over the last 20 years, there have been intimations that certain companies were "too big to fail." Well, now we see that Fannie, Freddie, and AIG were "too big to fail." In 1901, President Theodore Roosevelt took dead aim at the monopolistic trusts run by JP Morgan and others. Perhaps we need another kind of Sherman Antitrust Act? Perhaps we need a Sherman Anti "Systemic Risk" Act that protects our economy from companies that pose too much concentrated risk, much in the way that the Sherman Antitrust Act protects consumers from the abuses of monopolies? All I know is that I found myself a few minutes ago on INGDirect.com, trying to figure out if I can open a bank account before the markets open to spread my cash around between banks to keep the few pennies I own all covered by FDIC insurance. It has come to this.

As a nation, we need to prevent these types of failures, not react to them. This should be our regulatory mantra. Presumably, the volumes of banking regulation on the books are designed to prevent deep risks to our financial system. The regs didn't work this time. (I won't consider at the moment whether enforcement was more lax under Bush, and whether that helped create the problem we are in.)

According to the Chicago Tribune:

To fix the crisis, Paul Volcker, his words scrawled on a yellow legal pad, suggested the government establish a temporary entity with broader powers than what the Federal Reserve and Treasury Department enjoy.

Hey, if it works, great. If WaMu fails -- tomorrow is as good a day as any -- and on a drive for a carton of milk the average American suddenly drives past a brightly lit WaMu branch with a "seized" sign on its door, the fear of nationwide financial failure will chrystalize. Just behind widespread fear comes the next step in a financial calamity: widespread panic. That's when even Hank Paulson starts checking INGDirect.com. It might come to this.

Tags: aig, credit-crisis, federal-reserve, paulson, treasury

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Comment by Tim_Cleveland on September 18, 2008 at 7:01pm: I agree that the federal and state regulators were asleep at the wheel when it came to doing their job of examining these large firms. But what should we expect at this point? Do we think that suddenly these groups, whether headed by a Republican or Democratic appointee, will start doing a good job? Or should we expect that these positions will continue to be doled out to political allies who are totally unequipped to handle their job? Or worse, actually come from the ranks of the people they are now called on to regulate?

I totally disagree that the answer is more regulation and regulators. Here in the post-New Deal era we need to understand that when you hear soembody say "I am from the government and I am here to help you" we should take off running. There needs to come a point where we as Americans suck it up and say that as bad as it will hurt for a time, we need to let these organizations fail. We need to excise the cancer that is government with heir fingers in everything. If we don't, what will the result be? Willt he government one day be the only mortgage lender, insurer, retirement company etc. in the country?

As Blanche Devereaux said in A Streetcar Named [Government Regulation], "I know that streetcar, its the one that brought me here." Or she something like that.

Tim

Comment by Tom Burke on September 18, 2008 at 6:07pm: Further to Michael's comment, and echoing one of the talking heads on CNN - I think it was Ed Rollins - who said (paraphrasing here) "Where does Treasury get the authority to commit and spend this money? Congress appropriates money. Why wasn't Congress involved?"

Yeah, right. They'd do a wonderful job. But I must agree that the denizens of the Congress, who bear a large share of the blame for the long-term destruction of the system, should have been put on the spot here. Too bad Treasury-Fed-Bush didn't say that we need to take major steps but we don't have the authority - so over to you, Nancy and Harry.

I don't know enough about those crazy derivatives to have a truly informed opinion on the matter, but I have to say that I'm skeptical about the doomsday predictions about what would happen if the failures of Fan-Fred and AIG had been allowed to take place. Can anybody say for certain that the system would be irreparably harmed? If so, exactly how would that ultimate disaster play out?

Another thing about these credit default swaps and other giant obligations that AIG and probably a lot of other places blithely took on...The amounts look like hundreds or thousands of times the company's reserves, capital, net worth, market cap and every other measure of capability and value. Aren't there laws that prohibit putting the entire company at risk like that? Don't you need a stockholder vote at some point, or the transaction is either not enforceable or fraudulent? Rather reminds me of some fraudulent conveyance cases I studied in a previous life as a banker trying to learn how to do LBO lending.

Comment by JJ Hornblass on September 18, 2008 at 10:04am: Jeff, but there has been a big push to improve corporate boards and make them more accountable. That's what Sarbanes-Oxley did. I never sat on such a board, but my suspicion is that a board member can only do so much. AIG got into its pickle as a result of many, many decisions, some large, some small. A board could not have controlled every one of those decisions. At least that is my sense. I see more culpability in the federal government not exerting more control over these massive enterprises long before they got into trouble. That's what government has to do: protect the overall system. Obviously, the system has not been properly protected. We're back to a 1930s-like banking crisis.

Comment by Michael Gibb on September 18, 2008 at 8:18am: I think you've hit on one of the key problems to the spate of bailouts, Jeff. Nobody knows what the criteria is or when the money tree will go bare. Which institutions are "too big to fail?"

I'm also curious why the SEC has not played a greater role in these bailouts. Lehman, Fannie, Freddie, and AIG were all publicly traded companies. Why does the coverage only mention the Treasury Department and the Fed as being involved. Has the SEC become irrelevant?

Comment by Jeff on September 18, 2008 at 6:03am: Seems that there really was no choice on this one. Too big, too many people affected by the consequence of another Chap 11 here. The question is, where is the line drawn now? Who is next? Does GM get a bailout when they run out of cash next year? Or Ford or Chrysler or WAMU? With the global economy, it isnt just the US thats affected by these events. Clearly, AIG will have to come up with a payback and the change in management is a start. Greenberg, the former head of AIG came up with an interesting point: The ones who have to be under a microscope here are the AIG board of directors. Maybe its time that laws where written to make these people responsible for their actions and accountable for the greed that puts companies like AIG and Lehman at risk along with all of their employees.

Comment by JJ Hornblass on September 17, 2008 at 10:02am: The rumor going around the Street is that JPM had so many super-senior CDO swaps tied to AIG that it would have gone down with it -- and other financial institutions, too. Trades needed to roll and the rescue allowed for that, which is why Chapter 11 wasn't an option.

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