So AIG is applying to the Federal Reserve for bridge financing to allow it to enter a restructuring deal with KKR. AIG got itself into big trouble writing credit default swaps for the mortgage market, and is now facing massive losses on Hurricane Ike. That the Fed is even considering the move shows just how much the lines between different types of financial firms have blurred in this brave new world of novel financial instruments and megamergers.
Ben Bernanke is in a tough place. Opening the loan facilities to the insurance business will further strain a loan portfolio already crammed full of risk--just as the Fed has announced that it will start accepting equity as collateral. But if AIG doesn't restructure, it may have to start dumping its massive asset portfolio. This, of course, will further erode the value of the securities held by solvent banks, meaning that more of them will likely show up at the Fed's discount window with their beggar's bowls out.
This is where I'm supposed to end with a snappy, sure summation of what the Fed should do. But all I know right now is that I'm sure glad I don't have Ben Bernanke's job.
Copyright © 2010 by The Atlantic Monthly Group. All rights reserved.
When does it stop? It has to stop somewhere. Where does "B-52" Ben draw the line?
Just think about all the pensions/annuities out there that will disappear as the insurers begin to go under. Can you imagine the political ramifications?
I will commit ideological heresy here and comment that maybe the people who thought it was a bad idea for insurance companies to get into securities and derivatives were not completely stupid after all. To put it in concrete terms, you have a people out there who dutifully paid their insurance premiums and now face their insurance company going belly up not because there has been a disaster and the company is over exposed but instead because a bunch of knuckleheads who should have known better thought the housing market would go up forever.
The fact is that no amount of education, intelligence or regulation can prevent people from being greedy and stupid. But what things like Glass Steagall did do is build firewalls to prevent the stupidity in one sector from damaging all sectors.
"That the Fed is even considering the move shows just how much the lines between different types of financial firms have blurred in this brave new world of novel financial instruments and megamergers."
That AIG has the temerity to go begging to the fed shows just how badly the Fed screwed up by bailing out Bear Stearns.
What would be the market premium for a $40 billion one month line of credit to AIG? Or to put it another way, on what terms would Berhshire Hathaway organise that line?
Is there any reason why the Fed or the US Treasury should do it for less? If not, why should not a consortium of private equity houses with sovreign wealth funds, or indeed Berkshire Hathaway with whoever, produce the bridge? If AIG can post collateral to match a downgrade, is there not time for the market to work it out?
Once you say something is "too big to fail", can you really be surprised when it becomes the goal of financial institutions to be "too big to fail"?
The mood here at AIG is somber, to say the least. Everyone is sort of hanging around and shooting the bull about what this all means, and what Willumstad's reorg is gonna look like. I'll be OK because I'm 24 and don't have a problem with tending bar, working moving and going back to law school but I just feel so damn bad for all the old guys who are scared right now. What the fuck do you do if you're 60 and a big chunk of your change is in your options and sinking 401K? The worst part is we're one of the high-performing AIG divisions--all we do is write good business and make money that the financial services assholes can piss away
I'm going to go with no they should not be bailed out by the Federal Reserve. If anyone needs to be bailed out, it should take an act of Congress.
If you want to see an example of how even really, really smart Democrats often have no idea what they are talking about when there's a financial crisis....
http://yglesias.thinkprogress.org/archives/2008/09/safety_nets.php#comments
For the poor: snappy, sure summations of what to do. For the rich: respect for the complexity of the question.
Echoing John's posts, if a company is too big to fail, then it should properly be thought of as being too big to exist.
It is completely necessary for Congress to take a long look at their friends in the banking and financial industries and tell them that they have to be responsible for themselves. It is hardly unfair for Congress and finance industry execs to be expected to imagine what would happen if things went very wrong, and if said scenario would best result in a 'necessary' bailout, then current arrangements need to be changed. End of story.
Since when has Yglesias ever been smart?
Yes lampwick - when someone going through liquidation can destroy the entire country's (if not the world's) economy, then things are a little more complicated. You'll not that libertarians and free market ideologues oppose small government bailouts and government involvement in markets because it creates just this kind of problem. If Bear had gone to the wall like so many wanted, Lehman would likely have sold itself and avoided bankruptcy. Lehman's bankruptcy catalyzed Merril's decision.
Despite the left's idea of finance, free market ideologues really do know what they're talking about. This entire crisis is caused by letting anyone on the left anywhere near a position of authority on finance.
AIG having problems is truly scary - $1 Trillion balance sheet. The people who are going to get truly screwed are the annuity holders. A normal person with coverage will just move insurers, while those with outstanding claims will be mostly fine. States usually have a $100k limit on compensation, which is fine for most people. Those hit the worst will be very well off people with total loss claims - no mortgage to encourage a bank to hep out, but they should have sufficient resources to manage. The real problem is in annuities - $100k present value isn't that much and is VERY had to live off of. Just remember this when someone tries to sell you an annuity!
I await your libertarian friends saying "well we don't like it, natch, but the government should bail out and nationalize XYZ because otherwise it will be too painful - and I've got a polo match to attend this weekend".
Silly, silly conservatives are now waking up and realizing that Dumbya's reign has put the economy in the fucking toilet - but they still want to elect McCain so Dumbya's policies will continue.
Meatheads. Morons. Goobers. To be a member of the conservative movement now is to be insanely stupid. No movement in American history has ever been so completely discredited. Dumbya is the worst president in our history. He makes Herbert Hoover look like a giant by comparison. The Bush Error will be a byword for incompetence, corruption and just plain evil for centuries to come.
If AIG took on so much risk that a bad bet could destroy the world's economy, then their risk taking becomes a matter of public concern, and it is in the public's interest to cap that risk.
But, thanks to free market ideologues, we didn't.
And the lesson from this is that... "TOO MUCH REGULATION!"
Right...
There's been a couple of comments referencing policyholders so I believe some clarification is necessary.
Companies like AIG are set up as holding companies, with their insurance operations as subsidiaries. Those subsidiaries are regulated as to the amount of capital they need and the type of assets they can hold on their balance sheet. The holding companies are unregulated and can hold pretty much whatever assets they want.
In summary, the troubles at the holding company level that AIG is experiencing should not have any effect on the ability of its insurance subsidiaries to honor its obligations.
Of course, the above only holds true up until the point that the state of New York stupidly allows them to use capital at the insurance company level to bail out the holding company. Grrr.
S&P 500 is down only 2% after one of the biggest players collapses......and we clearly need to overhaul our entire financial system in response?
Perhaps Naomi Klein can write a book about how some political element use small crises to impose extreme regulation and enlarge government.
From the WSJ:
"During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world."
Link
Despite the left's idea of finance, free market ideologues really do know what they're talking about. This entire crisis is caused by letting anyone on the left anywhere near a position of authority on finance.
I love it when somebody on the libertarian loony fringe argues from the first principle that "we're always right." Very convincing.
SS,
Those assets backing the obligations are also someone else's debt, and it isn't just US Government debt either. The coming asset/debt deflation will take them down just as surely as it did Lehman this weekend.
What everyone will be looking for is the counterparty that cannot fail.
Real libertarians have seen this coming for a long time. They have been warning you for decades that debt-backed currencies fail in exactly the manner you are seeing today, and that the failures are catastrophic if that currency is systemically used. You are seeing the fallacy of "too big to fail". The certain moral hazard created by the "too big to fail" philosophy guarantees that the final failure will be as big as possible.
The natural governor of risk- having to suffer the consequences of risking your own money without recourse to being bailed out- was removed from the system a long time ago. We created a system where the potential rewards greatly outweighed the actual, personal risk in far too many financial transactions, even those right down to the level of the individual. No doubt that we will continue our folly even after this, since nearly everyone thinks the real issue is better government regulators and different laws, but such regulators have always sufferred from the same defect- they don't have money in the game, and far less incentive to limit risk to what is actually appropriate. And practically no one but libertarians are pushing for the actual change that will solve the problem- get the government out of the currency business.
Yancey:
Interesting comment. Assuming gov'ts are not in the currency business, who would be?
I see a big problem with tying currency to any commodity price (gold for example), since a growing economy needs a growing money supply. If the supply of that commodity diminishes, deflation results.
So is there another solution? Is there a way to let the market print currency, and if there is would it be a good idea?
ken,
Yes, end legal tender laws and end capital gains taxes on all currency conversions. Freely acting people will settle upon a currency, or currencies for use in transactions. Banks could set up their own currencies backed by whatever they wished, and people could choose to use it or not based on their collective judgement of it's inherent worthiness. I don't doubt that fraud would occur, but that fraud would not be systemic as it is now, and fraudulent banks would be sniffed out pretty rapidly by it's currency's value.
I am no advocate for government tying currency to a commodity backing, however, I have to ask- why do you think deflation is always bad? A deflation that is the result of growing productivity relative to the money stock should be no cause for worry.
Banks could set up their own currencies backed by whatever they wished
Did this happen in the years before the Civil War?
Rob Lyman,
This long online book is probably more than you asked for, but it is a wonderful history of banking in the United States. Part 1 is the history before the 20th century, but if you have the time and interest in monetary matters, the entire book is highly recommended.
Stupid regulations do cause problems like this - the regulations that encouraged if not demanded more lending to people who couldn't afford it. The regulations that gave Senators and Representatives power over financial firms so that their whims (like lending to ACORN approved people) could be enforced.
Then there's the government involvement in the markets (Freddie, Fannie) and government bailouts (Bear) that just create further problems. There are also regulations that prevent bailouts (rules on the ownership of broker dealers) by private firms, and very substantial interference in investments by foreign entities.
We have been complaining about these problems for years, highlighting these risks. But Liberals knew better. We've discussed how the regulations that other countries imposed created problems, encouraged crony capitalism, and kept emerging markets emerging. Japan Inc.'s lost decades? Analyzed, discussed, and mirrors to America's system pointed out. Asian contagion? Russia's 90's problems? Same for both.
Liberals, by definition, don't know what the flip they're talking about. You just want more regulation and "oversight". There are no testable hypotheses, hell there's a complete rejection of empiricism. Market fundamentalists have complained with specific, testable predictions. We've discussed the increased risk that certain market structures create, how that risk is created, how it can be mitigated, and why our proposals are superior in crises. And we've done this in non-academic settings. Liberal prescriptions, especially in the popular press, contain none of this. Academically, liberal economists tend to different problem sets, as otherwise it's like creationists doing evolutionary biology or running a genetics start-up - the cognitive dissonance reaches super nova levels.
There' a very solid reason why regulations are a bad idea - they never work. It's like writing software or user test-cases: a single, (relatively) small group of people can not envision all of the possibilities that the user population will come up with. Regulations and software are inherently textual - you can only constrain behavior with what is explicitly written.
No matter how good a group you have, there will always be bugs. Coders can never win against virus writers, but they have the advantage of operating on a 24/7 time cycle. Regulations get updated MUCH more slowly, especially since so much is written into statutes. So the opposition is working 24/7 while the bug fixes come out in years or decades. Then there's the problem that the opposition is not only larger and faster, they are much smarter, more experienced, and much more motivated (they are VERY well rewarded for finding exploits and get substantial individual rewards - no one at the SEC gets a huge bonus for winning, thanks to all of the agency issues and due process concerns).
The libertarian critique doesn't require that you accept the morality of markets. You just need to accept objective reality. It's like Thermodynamics - engineering would be much simpler if the rules weren't as stringent, the air would be cleaner, nearly everything would be cheaper, but the laws of Thermodynamics are LAWS and must be obeyed. Regulations are always fighting the last crisis (just like Generals fighting the last war) and the next problem created by intersecting regulations can't be foreseen or prevented by those that create regulations. What regulations can do is to create single points of failure and introduce false confidence (or moral hazard) to the players.
The lower the regulatory burden, the higher the perceived risk and the lower likelihood of systemic problems. The Dutch road model (fewer signs, fewer accidents) works just as well for financial regulation as it does for road safety. Most of the Liberal program would be actually kind of nice, but it isn't possible due to the facts of human psychology. Too bad that one of the other facts of human psychology is a preference for solutions that feel good instead of ones that are demonstrably effective.
Hey,
With the greatest respect, your non-regulated system is as open to human folly and abuse as any other system. You can not remove the human element from the equation. Where humans are involved failure is always an option, even in a pure free market environment. There is no perfect system. Don't make the same error is logic the communists made. (ie that an economic system can negate human nature)
As for empiricism, I say bring it on. I bet your models can't hold up. Repealing the Glass Steagall act was not a "Liberal" idea. It was a Cato libertarian idea, and looking back now it looks like an epic mistake. Please step into the witness box and defend it.
Re: . Freely acting people will settle upon a currency, or currencies for use in transactions.
This is nuts. Governments have been issuing currency since King Kroisos of Lydia minted the first drachma. The only idea that would be nuttier would be to suggest getting rid of money altogether and returning to pure barter. Perhaps we can also go back to exorcizing demons out of sick people, enslaving laborers and worshipping the thunder. I've heard some folks who wanted to return to the 19th century, but never the 19th century BC.
Governments have been issuing currency since King Kroisos of Lydia minted the first drachma
The purpose of minting coins was to obviate the need to weigh out precious metals for every transaction. I'm pretty sure Yancy is concerned with paper currencies and banknotes rather than coins which contain a specified amount of a commodity.
Megan
I am also glad you don't have Ben Bernanke's job.
Yancey,
What you have there is an idea I've never thought about.
First things first
"I am no advocate for government tying currency to a commodity backing, however, I have to ask- why do you think deflation is always bad? A deflation that is the result of growing productivity relative to the money stock should be no cause for worry."
I think deflation will be bad for the following reasons
1. If money gains value when it is not spent, it makes no sense to trade. Everyone that can hang on to their money, will. That will take a great deal of wind out of our sales
2. Wages will have to drop over time. The better the economy is doing, the more wages will drop. Just imagine the mess that will come from that, even before someone mentions unions
3. When money starts gaining in value, debts become harder to pay off. Thus it becomes incredibly difficult to start a business.
Of course, there is a slight possibility of all these factors acting as a negative feedback loop. As the economy surges forward, the increased debt burden slows it down. When the economy starts to slip, everyone finds themselves with more buying power, at least for a short time, until the wages adjust. Best time to either start, or expand a business would be when the economy begins to drop. Best time so save would be when economy starts to gain... Might not be so bad after all...
Re: I'm pretty sure Yancy is concerned with paper currencies and banknotes rather than coins which contain a specified amount of a commodity.
Coinage is very easy to manipulate too. Anyone who reads any history knows that. Neither inflation nor deflation were invented with paper.
"As for empiricism, I say bring it on. I bet your models can't hold up. Repealing the Glass Steagall act was not a "Liberal" idea. It was a Cato libertarian idea, and looking back now it looks like an epic mistake. Please step into the witness box and defend it."
Simple. I have yet to see a cogent explanation of how Glass-Steagall would have averted this mess. Rather, virtually all of the explanations that I have seen rely on what could just be a coincidence.
JonF,
And every government issued/validated currency has failed in history, usually taking their countries down with them, and all for the same reason- the temptation to inflate is nearly irresistable, and doubly so for governments that have monopolies on violence and can enforce legal tender laws.
The US dollar will fail, if not in this crisis, then a future one- it is not a question of if, only when. We see each financial crisis in sequence growing larger and more difficult to contain. We have put all our eggs in a single basket and that basket is going to fail and take the country down with it.
The solution is simple- a complete decentralization of currency issue. I really don't expect this to happen- governments always refuse to give up currency control since it is so profitable for politicians and their fellow parasitical enablers and supporters in the private sector.
People will not resort to barter in the absence of government issued currency. If you really believe this, then you are ignorant of monetary history. Barter only takes hold in countries that have worthless government currency, but that strictly enforce their legal tender laws.
Ken,
If people come to expect slow deflation over time, they will adjust their time preferences accordingly. How do I know this? I know this because we have seen this adjustment in times of increasing inflation, and decreasing inflation. There is nothing special about people adjusting to actual deflation. Expected purchasing power of money in the future is a key ingredient in the determination of interest rates. In a time of anticipated deflation, there is nothing logically inconsistent in the existence of actual nominal negative interest rates (but, of course, real interest rates will be positive, as they must be).
I know people have a problem getting their minds around this, but this is because governments have conditioned you to expect inflation and to behave accordingly. The US had a slow general deflation over the course of the 19th century in which there was mostly free banking in most parts of the US, and yet we went from an agrarian society through the beginning beginning of the industrial revolution, and people didn't hoard money irrationally- they still consumed, invested, and grew the economy.
Libertarianism is, in practice, a political hypochondria. It predicts doom for every divergence from libertarianism (which is to say, for everything), and then pats itself on the back when problems arise.
Very convincing.
I'm also convinced,
If they had only predicted doom, then you would have a point, but they not only predict doom, but also lay out exactly why and how it will occur, and that description is spot on perfect for what we are seeing today in the financial meltdown.