AIG — There are Many Criminals Here

It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress.
– Pudd’nhead Wilson’s New Calendar
(from twainquotes.com)

There are many upset over the bonuses paid to AIG employees, most notably politicians seeking to curry favor with voters.  That these bonuses were known to the Fed, and the Treasury Department does not matter to many.  They see their tax dollars being taken by people who destroyed their own company, and they are angry at those getting the bonuses.  Better they should be angry at those who bailed them out, and who oversee the Fed — Congress.  That was the biggest crime.  By keeping AIG alive, they faciltated the crime they now decry, because bonuses would have disappeared in bankruptcy.

There was a better way, as I have written about before.  If there were systematic risk issues, guarantee the derivatives counterparty, and send the rest of AIG into Chapter 11.  The operating insurers and other financial companies would survive; those invested in the holding company (common and preferred) would lose their investments, and bondholders would have to compromise and receive equity in the new firm.

Is that what we did?  No, we invested in, and lent money to the holding company.  Money going to a holding company can go anywhere inside the network of companies (pay bonsuses, for example), whereas money to a subsidiary stays there until  conditions are good enough that dividends can be paid to the holding company.

In order to convince the Government that the recent  bailout of AIG was crucial to the financial system, they submitted this paper to the Fed and Treasury.  I’ll comment on it, page by page.

Page 2) They talk of a failure of AIG being a systemic risk when it is only the derivatives counterparty that is such.

Page 3) Same error, though the need to post capital is a reason why the holding company is insolvent.  That AIG would lose some of its foreign subsidiaries is no concern of the US Government.  Also, there would be no need to sell pieces of AIG if it were in Chapter 11.

Page 4) They overstate the life insurance systemic risk.  Yes, there is risk, but typically policyholders have to give up a great deal in order to surrender.  Their operation life insurance companies are likely healthy, but if not, the State Guaranty funds are around to protect things.  AIG is big in life domestically, and a failure would hurt, but not kill the life insurance industry.  The real risk is in the financial guaranty business, through AIG Financial Products, which is not regulated.

Pages 5, 6 ) Totally overstated.  Not likely at all.  AIG’s life subsidiaries are not that critical to the US economy.

Page 7) AIG is big, so what?  The regulated subsidiaries should survive.  Unregulated subsidiaries, aside from AIGFP, pose no systemic risk.

Pages 8-10) Overstated, and false.  The operating insurers are safe.  Let the parent company fail.

Page 11) Who cares if a consumer lender goes down — there is no systemic risk there.

Pages 12-16) Not relevant — those subsidiaries are solvent.

Pages 17-18) Relevant and true — AIGFP poses systemic risk.  But no concern for the Muni market — that will survive even without AIG.  Besides, why would they sell, even in insolvency?

Page 19) So ILFC is big — that does not mean it poses systemic risk.  The airlines will own the planes directly, if they can’t lease them.

Page 20) Sorry, the assets of the US Government and the Fed are already lost — they should not have bailed out AIG.

Page 21) Don’t overrate the importance of the insurance industry, and especially not AIG.

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AIG bamboozled the US Government (Fed/Treasury) into bailing them out.  Aside from their derivatives counterparty, there was no systemic risk associated with AIG.  The foreign subsidiaries are foreign, and should not be a concern of the US Government.  The domestic insurance subsidiaries are regulated by the states, and should be solvent.  If not, the guaranty funds will pick up the slack.

There was no reason to bail out AIG as a whole, and there remains no reason to continue to do so.  Congress has no one to blame but itself in the current brouhaha over bonuses at AIG.  They could have done it differently.