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.

7 thoughts on “AIG — There are Many Criminals Here

  1. lets be serious here. AIG didn’t bamboozle anyone. Paulson bailed out AIG in order to save Goldman. Period. THE END.

  2. David,

    In the context of financial/insurance companies such as AIG can you explain the distinction/interrelationship between the holding company and operating company (subsidiaries). I’m not sure I fully understand this. Thanks for your time.

  3. There’s something I don’t understand. You say:

    If there were systematic risk issues, guarantee the derivatives counterparty, and send the rest of AIG into Chapter 11.

    My view is most of the counter parties were “insuring” mortgage bonds, correct? AFAIC, these things were as fraudulent as AIG’s “insurance.”

    Why would you advocate pumping fed $$ into CDS counterparties w/out opening their books first? Why has AIG incurred all the wrath, when (at least as I understand) much large culprits are investment houses?

    1. jdmckay — I’ve said this before, but I work on two levels. Level one is unacceptable to our society, which is what I think would be best. No bailouts; just let the crisis burn out.

      Level two is: how would you bailout at the least cost to society? 1) Only bail out entities that are regulated, according to previously described rules. The FDIC is an example here. 2) Exception to rule 1 — if a non-regulated entity’s failure would cause much of the regulated system to fail, bail out only the element that threatens the solvency of the regulated system. Let the rest fail.

      We might look at AIGFP and allege stupidity. Why do we bail out stupidity? Because intelligent parties looked at AIG as a whole and said, “No way that could go down,” and accepted them as a hedge counterparty, in the process getting the better side of the trade. Seemed like a good idea at the time. My guess is that a failure of AIGFP would have led to the failure of most of the big banks of our world, and that would bee too big of a risk to take.

      We live in a fiat money system. Fiat money systems rely on controlling credit. We did it badly on the way up, we’re doing it badly now, but protecting AIGFP while letting AIG fail would have been the right move, together with taking losses on AIGFP at least partially out of the hides of AIG bondholders.

  4. Great post. With such eye-watering levels of money being committed, I wonder why Congress wouldn’t request a “rebuttal” piece such as yours and let the most persuasive argument guide them. Though “AIG hooey” may not be the best working title….

  5. Thanks for taking time to explain. I figured your statement I asked explanation for was something like that: eg. making assumptions based on “that’s the way it is”.

    I’m not a financier, econ guy or anything else like that (just econ 101 in college in ’70s), rather a ME, musician and last 18 yrs a programmer.

    However, I got wind of this thing coming last March (’08) as contractor working on data center by a group of banks attempting to trace mortgage paper downstream. Quickly became clear what was ahead, w/ARM rates due to kick in etc etc.

    I’ve spent literally a few thousand hours since becoming a money guy, and have managed to stay ahead of the curve… no losses on my life savings except for home devaluation.

    With that said, in my view given enormous reach of this whole thing, as a metric for evaluating what the feds should (not) do I don’t accept wholesale bailouts of any 1 sector, whether investment banks, AIG or whatever. Whether “unfreezing the credit” system or preventing “global financial failure”, seems to me that’s pretty much happened anyway.

    Beyond that, however, at least for me… the notion that these guys who did all the damage are being recapitalized on taxpayer dime w/debt borrowed from future taxes is surreal. Particularly given how far US has fallen behind in generation of real economic value… where’s this income going to come from?

    There’s just way too much wrong throughout financial system to explain TARP/”stimulus” and all the rest as an attempt to “fix the financial system.” I say this based on my experience navigating around this system to save my little pot of gold, and the ignorance of financial “professionals” I dealt with along the way.

    I had a lot of fights (shouting, not bad feeling) w/wife, my grown kids, and 87/88 yr. old parents advising they get out of market when DOW was still about 1k. Reasons were obvious:

    a) paper value replaced the real kind
    b) depractation of real US econ activity’s homegrown value masked by cheap imports… eg. who the hell’s gon’a pay for these 10/30/60/100% higher ARM mortgages, and who’s gon’a catch guts of the thing when bottom starts dropping through the floor?
    c) In my home town (Albuquerque), every single money manager… every single one: Schwab, Wells, Owner of largest most prestigious Accounting firm in ABQ (and bunch of others) kept telling fore-mentioned family members the same thing: don’t pull your investments, this is just an adjustment. I argued it was an impending cascading collapse. Point being, not a single one of them… not one, had done their homework sufficient to be armed w/underlying facts which indeed have played out. In one form or another, they relied on “advise” handed to them by their employer’s investment arm, WSJ (always behind the curve), rating agencies, etc etc.

    How can a financial system be solid when most of it’s participants do not understand it’s functioning? When the “professionals” a public relies upon are, with all due respect, pass through bots w/little or no authentic POV based on evaluation & knowledge of underlying realities?

    And that’s just a cursory introduction to way I see things.

    And please don’t misunderstand me… I’ve been reading this blog (and few others, along w/Roubini subscription) since early last year. Aleph has been among top tier source of good understanding and reliable education for a neophyte like myself. I’m grateful… thanks.

    I’m just expressing my POV, and it’s pretty well hardwired now: my “finger to the wind” has served me well, and I’m not likely to usurp my finger’s judgment in financial matters any time soon.

    Based on Bush’s team’s (non) corrective actions, and even worse Obama’s (I walked streets to get him elected, managed precincts etc.), personally I see no meaningful recovery based on implemented programs, and very real possibility of US falling into 3rd world status economically.

    With Obama’s very scatter shot spending (really hits no target squarely), dependence on entirely broken finance for “recovery”, and utter lack of making distinctions which identify culprits and sinkholes in system that got us here… this one’s just too big. I don’t think it’s going to work, and AFAIC it’s fool hearty.

    Ok, well just my $.02 worth (now about $.0123 and dropping fast), and thanks again for your excellent musings on this blog.

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