Arnold Kling  

Notes From the Bailout

What If I Were Dr. Doom?... Lectures on Macroeconomics, No...

Below are various links, including some that pertain to AIG.

The government is eventually planning to sell the normal insurance lines of AIG. The proceeds from those sales then can be used to fund losses on the credit default swaps and pay off government loans.

1. The Washington Post reports,

Yesterday, Fannie Mae went public with its concerns about this federal assistance. It warned that it "may prove insufficient" to allow the company to routinely pay off its loans or "continue to fulfill our mission of providing liquidity to the mortgage market at appropriate levels."

One of the conditions of the bailout was that Fannie Mae should stop lobbying. But that's like asking the sun not to shine.

2. Felix Salmon writes

the job [Treasury Secretary] is bigger, now, and includes persuading both Congress and the public that the government is doing the right thing... And [Larry] Summers, like Paulson, is really bad when he has to talk to people he doesn't respect.

If one of the criteria of Treasury Secretary is "plays well with others," then I agree that Larry may not be the ideal choice. But, gosh, playing well with others in today's environment means going along with the trend toward turning more of the financial sector into quasi-private, quasi-public entities like Freddie and Fannie in their glory days. Larry at least recognizes the problems with that model. I hope Larry gets the job, although I doubt he will.

3. I owe Yves Smith an apology. When I brought up Mussolini in the context of the bailout, it was over two weeks after she had done so. I somehow missed that.

4. I saw it when I read her take on AIG.

Remember, AIG does NOT [have] any God-given right to existence. If every significant operation AIG has must be sold to repay the taxpayer, and AIG ceases to exist, that would be a perfectly fine outcome. A systemic collapse would have been avoided, taxpayers would have gotten as much as possible out of a bad situation, and AIG would be liquidated in an orderly fashion. What is wrong with that picture?

The question is not whether AIG ceases to exist, but when. My sense is that government decision-makers are taking the view that "now" is not a good time, for two reasons. First, they think that hurriedly selling off the insurance lines in the current environment would fetch a low price. Second, they think that AIG's counterparties in their credit default swaps are making excessive demands for collateral relative to likely losses. As time passes and the losses come in lower than feared, the liquidity problems in the credit default swap business will ease. I'm not saying that I agree with this reasoning, but I'm guessing that's the thinking.

Steven Randy Waldman piles on.

What kind of society is compatible with an economy managed by a cadre of large, politically connected firms whose operations and those of the state are intimately connected, and which cannot be permitted to fail since that would bring "chaos"?

...It is likely that taxpayers will turn a paper profit on their paper claims against financial institutions. But that's not because they are good "investments". It's making these investments good is now a constraint on government action. The Fed cannot behave in ways that would compromise the value of the trash on its balance sheet. Once AIG was too big to fail, it cannot fail, no matter how big the black hole grows. Once GM enters the penumbra, very soon now, it also must not fail. Of course, we will not count this terrible loss of policy freedom as a cost.

I wish that those of us who are frightened about Washington's bear hug of what used to be the private sector could do more than just carp on the sidelines. One of the reasons that I would prefer Larry Summers for Treasury is that I think he is less likely to be awed by corporate executives insisting that the survival of their firms is of great social import.

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COMMENTS (7 to date)
Joseph writes:

Arnold, I enjoyed this post. What can we do to end this madness? Keep pumping out content.


Gary Rogers writes:

There are two themes that come up frequently in discussing the bailouts. The first is how much of a mistake it was to allow Lehman Brothers to fail and the devastation it caused to the commercial paper market. The second is that the original bailout cost estimates seem to be too low for AIG, Fannie, Freddie. The thing to watch is how soon the market is cleared of the ripples from Lehman Brothers and how long the bailouts of the other institutions continues to be a drain while not solving the underlying problem.

Yes, the failure of Lehman Brothers was severe, but it is over. The others are not and will not be over for quite some time.

Dave writes:

I've got to say that I don't agree with your logic on AIG.

Think of the track of value that AIG will retain over the next few months (years?). Over time, other insurance companies are going to poach AIG's key staff or just convince its clients that they would rather not risk getting in line with all the other policyholders for their cash if circumstances somehow change. Won't be a tough sell. Don't forget, its market share was in large part held because of the AAA rating.

The only enduring assts that insurance companies have are their employees. You can't tell me that there are many employees that want to stay at AIG and work for taxpayers who have strong opinions on salaries etc.

If the goal is to get repaid, the government needs to move fast or it's going to wind up holding an empty shell with no revenue but lots of legacy claims to pay off.

If they choose to wait and see, AIG will either shed its business or 'buy it' by cutting rates. With less cash to pay those future claims (AIG is the biggest writer of Directors and Officers and Errors and Ommissions insurance which is all giong to get creamed following the credit crisis) the business becomes less appealing to future buyers and generates less premium to offset the taxman's burden once the government figures out nobody wants to buy what's left.

floccina writes:

If GM is too big to fail and so we bail it out, shouldn't we then break it up into smaller companies?

Nathan Smith writes:

What are good extant models of the type of state we are transitioning to?

Obviously you have to expect that all these bailouts will lead to a big upswing in rent-seeking behavior by businesses. How do we get back to a level playing field from where we're at?

Jeff writes:

There is no chance whatsoever that AIG will repay all the money the Fed has loaned it. Their June 2008 quarterly statement shows them with a(n overstated) book value of $78 billion. Since then, they have borrowed over $120 billion from the Fed, and according to press reports, nearly all of that has been used to post collateral against their CDS obligations. Unless there is a miraculous turnaround in the CDS markets, that money is gone. The only way they can be staying out of bankruptcy court is by pretending that the funds they've posted as collateral are still their assets, which is utter nonsense.

I will make a prediction here that the taxpayers will end up losing at least $100 billion on AIG by the time it does go bankrupt, which will happen before the middle of next year. And the most outrageous thing about this is that the prime beneficiaries of the Fed loans have been the parties on the other side of those CDS, mostly European banks. Think of it. The U.S. taxpayer is gifting European banks to the tune of $100 billion without any elected official having to vote for or approve of it. Where is the outrage? Why does Bernanke still have his job? This is by far the biggest Fed screw-up of all time.

Jason writes:

"Yves" is a common male French name.

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