I wish I could tell you more about what this meant, but I really don’t understand fully why AIG is different from Lehman and why one is allowed to fail and the other is not and why it was a big deal to rescue Chrysler 1ith 1 billion dollars but nothing to rescue AIG with 85 billion and why they can do it without a peep from Congress.
I guess the real goal in business these days is to get big enough and do enough stupid things that everyone is relying on the bad loans you are holding, and then you are deemed to big to fail. I guess the main question I have is if we keep saying these things are too big to fail, why don’t we break them up?
Also, my gut tells me this is not over. I am betting the market will go up in the short term, and we will roll along blindly and in a few months something else will happen that will trigger a similar crisis, this time with someone else. Not sure when this will end, but it will probably have to start with the housing market bottoming out. At least that is what I think from listening to and reading all the financial folks the last couple of weeks.
This column seems to ask the right questions.
TheFountainHead
The biggest issue here isn’t the short term losses, though those hurt, it’s who is picking up the pieces. AIG wasn’t bailed out because it was too big. AIG was bailed out because if the US government didn’t bail it out, the carcass would be resurrected by the Chinese or the Koreans. Or both. AIG, as I understand it, is the backbone of American insurance companies. They quite literally underwrite our lives. Lehman brothers was allowed to crash, I believe, because of Barclay’s interest in it’s infrastructure. Paulson bit his lip and figured the British weren’t too awful as new owners, and let it fall. AIG, on the other hand, has literally trillions in assets around the world and the US that would be eaten up by companies based in countries who do not have our best interest in mind.
Some Guy
With all the crap happening right now in Pakistan and the financial meltdown, I have expect either or both candidates to come forward and say: “Uh, maybe not; he can have it.”
I have read some pundits saying Obama needs to be more specific about how he will deal with this and that regulation is a chimera. Maybe but I don’t see how not putting a new regulatory regime in is any kind of a solution. Also, this is amazingly complicated: I don’t see how anyone could really talk about this mess in some level of detail to please professional market observers and not completely lose the general public.
It is a big mess, it makes me very uneasy about the next 20 years in terms of retirements, education funding, everything. And rhetorically, in the heat of a presidential campaign we just are not going to get sober discussion of the details (not that most people would be able to follow it anyway).
David
The real monster in the water is a liquidity crisis. The banks have stopped lending to each other until they know who pooped in the pool (holds the bad mortgage CDOs). Lending Among Banks Freezes on the front of today’s WSJ tells the real story here, not the one focused on AIG.
sparky
there is one other point that i don’t think comes out clearly, though, like with Sarah Palin, it may upon closer inspection. i don’t mean swaps specifically, but rather the entire “shadow” financial system. over the last 20 years huge chunks of american finance have been moved out of the existing regulatory system and been built in essentially a free-for-all. the one thing hedge funds, IBs and AIG all have in common is that they were building financial structures with absolutely no oversight. it worked for a long time and a lot of people made too much money. but now it has come crashing down. and as the nyt piece says, there is no easy solution. what we are really seeing is the collapse of the US-universe that was built after WWII. it’s just taking a long time to die.
Napoleon
Because that is interfering with the market!
Wayne
A friend in the insurance business told me that AIG insured a lot of the sub-prime loans. That’s the reason for the bail-out.
cleek
i know little about this either, but i was wondering the same thing.
seems to me that if a private company is so critical to the market that it can’t be allowed to fail, then the market itself has failed.
Justin Morton
I think you’ve nailed it on the head. This isn’t over yet.
And ultimately the key is too prevent these institutions from becoming too big to fail. However, we’re past that poing. So currently, the Feds job is just to keep our economy functioning. And in that regard I think they’re doing the best they can.
Cap and Gown
John, what do you mean “break them up?” Don’t you see that this is all a secret plot on the part of the Republicans to create the Socialist States of America? While the Republicans tried to distract us reality by claiming it was the Democratic Party that favored socialism, they had a secret plot all along to nationalize the economy. Bush is the true Manchurian Candidate. Who knew?
Dreggas
let’s put it this way. AIG insures property (cars, homes, boats, commercial) as well as life insurance, the subprime mess, and pretty much everything requiring insurance. If insurance is the bedrock that helps guarantee that if your property etc. is lost somehow and that bedrock crumbles it basically yanks the rug out from under everyone.
Shygetz
From what I read on CNN, it looks like we didn’t bail out AIG…it looks like the Fed flat-out bought AIG, and now owns something like 80% of it with a veto power over pretty much all moves. The Fed claims that it’s going to probably liquidate most of AIG. My question is…why? If AIG ran at a good profit for so long, why liquidate it? Why not just have the government run it correctly with good practice regulations and let the private companies compete?
Brian
Next on the block – WaMu. Odds on the gov’t bailing them out?
I would say slim, but aren’t they pretty heavy in real estate? That may bump up their chances.
Teak111
AIG owned a ton of credit default swaps, basically insurance backing bundle mortgage instruments (simplified). Anyone who invested in these mortgage bundles also bought insurance from the likes of AIG. The insurance covers the company in case the mortgage bundles fail. Well, guess what? As I understand it, if AIG went under, there is no insurance on all the the shit pile. So the fed has basically stepped in and taken over insuring the shit pile.
Stuck in the Fun House
I don’t expect the worst has happened yet either, from the consequences of Bush and republicans all out efforts to make trickle down economics the foundation of America’s economy. Reagan talked about TDE, but showed restraint in his economic policies. Bush and his merry band of Robber Barons have waged an all out crusade to transfer this countries treasury into the corporate bottom line. They may have even set up a economic disaster none of us can really fathom right now. Mccain will fix it though, with more tax cuts for the rich. And Obama might not be Christian or American enough for some to vote for.
Napoleon
To be technically accurate they loaned them money and one of the loan terms allows the government to exercise a warrent to buy 80% of AIG (I do not know the terms, if it is for a nominal sum or a conversion of some or all of the debt to equity). As is typical in many loans the lender (the Fed) has forbidden certain activities without the permission of the lender.
mightygodking
Because AIG insured tons of people. Lehman was just an investment bank, when you get down to it; them going under hurts their investors, but not the system as a whole. In comparison, AIG’s insurance – particularly their corporate insurance wing – collapsing would wreak havoc on the entire financial system, as tons of major banks would suddenly find themselves uninsured. Uninsured operations would be considered less valuable, causing stock prices to fall, and a mass stock collapse… well. 1929.
Because it ran a profit based on shitty derivatives nobody wants now. Nobody, nobody, is going to buy subprime mortgage-based monetary instruments now. (The fact that AIG plans to pay off the line of credit the government is extending it by selling these subprime loans should make most observers go “uh HUH,” but that’s another kettle of fish.)
Teak111
Money quote from the NYTs:
“What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe.”
So now you and I are covering that risk. Welcome to the insurance game.
Dennis - SGMM
If this was the 1930’s, the administration would be reimbursing Al Capone for his bullets because the Capone Mob is “Too big to fail.” Willie Sutton and John Dillinger would be McCain campaign economic advisers.
Here in the present day, the administration is doing whatever it can to make certain that the final consequences of its catastrophic malgovernance play out in the next president’s term.
Va Highlander
How banks depend on AIG:
Rick Taylor
Democrats should be beating the hell out of the theme that if large corporations get a multi-billion dollar safety nets for when they fail, in turn it means the government has every right to police and regulate them; you can’t have one and not the other. Oh, and maybe we can afford to insure children, even ones who have nice counter-tops, if we’re ready to give billions to companies who’s leaders are millionaires.
On that note, I’m curious to what the reaction to this bailout is on the conservative blogs? I’d think they’d be against it, but then it’s the Bush administration that’s doing it.
Bob In Pacifica
I wonder where all the money goes. I mean, it goes somewhere. I suspect somewhere in Switzerland there are guys with top hats and monocles like in the Monopoly game smoking cigars and counting their winnings over this latest looting.
I was thinking last night, you know, right after George H. W. Bush oversaw Reagan’s S & L deregulation Neil Bush cleaned up with Silverado Savings. A couple years ago Jeb was pressuring Florida’s municipalities to buy Lehman Brothers junk and then he goes on their payroll after he steps down as Governor. No doubt someone in the Bush family circle is profiting from the AIG thingie. A few years ago Elliot Spitzer was investigating AIG but then the FBI nailed him for spending his own money on call girls. Hmmm.
Remember, Prescott Bush helped build the family fortune by managing Nazi investments for Brown Brothers Harriman before and during WWII (at least until they were seized under the Trading With The Enemy Act). His big payoff came when the Union Banking Corporation, a Fritz Thyssen financial front, was sold off after WWII. Much of the damage caused in Europe during WWII was by German banks seizing the central banks of the countries conquered. And lots of gold disappeared from lots of bank vaults. I guess Prescott and his spawn learned from the best.
I have this vision of Barbara Bush as Ma Barker at the breakfast table in Midland with Jeb, Neil and Dubya sitting around while her hubby is on the phone with his people over at Langley, yet another institution with multiple banking frauds in its portfolio (BCCI, Banco Ambrosiano, Palmer, Nugan Hand, etc., etc., etc.). And yet the damage caused by Ma Barker and her kids was piddling compared to the Bush family robberies.
When the real history is written, this will be a remarkable story about the depth of corruption in one family.
Rick Taylor
Via the moderate voice, a short french article explaining Freddie Mae and Fannie Mac.
Marshall
Because in our new quasi-monarchial system, Congress is almost as irrelevant as the Imperial Senate under Caligula.
CFisher
To summarize… we’re FUBAR.
Because in the good old days before our government was completely and literally in bed with corporations, there used to be a vague idea that in a free market system, companies that make bad decisions should bear the brunt of their own folly and tax dollars should only be used for stuff like roads, schools, and horribly overpriced and expensive defense contracts that didn’t always work.
That and the President at that time hadn’t added 5 trillion dollars in debt to the economy, the Fed was still realistic about interest rates, and we weren’t bleeding debt and lives in two wars.
Because Congress is no longer a co-equal branch of government, but a sad relic of an era when American citizens mistrusted government power enough to want it divided.
Because by the time you’re TBTF, you’ve already bought yourselves enough friends in Washington to get them to ignore you.
Scott de B.
There is an old quote: when you owe a little money, your creditors own you. When you owe a lot of money, you own your creditors.
It’s not even a new principle. Julius Caesar came to power at least partly because he owed so much money to so many people, the only way to pay them off was to become dictator. So they helped him do that.
alyosha
Someone else detailed this upthread, but AIG is strategic – if it failed, it would set off a whole lot of other dominoes falling. And so it had to be saved, the only issue was how.
jcricket
I’m sure the mob bitches and moans about all the regulations and laws that prevent them from running amuck – just like my kids bitch and moan about the rules I put on them to prevent tragedy from befalling them.
Another example – Republicans claim that Democrats lose, or get pilloried by conservatives, because they nominate “extreme liberals”. But the reality is that no matter who the Democrats nominate, the Republicans will attempt to smear them with outrageous lies, and paint them as baby-killing, communist-sympathizing, sex-education-for-toddler-worshipping nutballs. So there’s no use listening to Republicans – they are lying about how they will react and why they are acting – for their own self-interest (of course).
So too with corporations. They complain about each and every regulation. Any structure or requirements about what they can do and how they can do it is an unfair stranglehold on the free market economy designed and will surely ruin their chances of profiting. Any oversight put in place is an unconscionable burden, etc. They say this, because at least in the short and medium term, they benefit from doing whatever they want. The problem is, in the long run (as we’re seeing), we all lose when we don’t have the right anti-trust rules, general regulation and oversight in place.
As soon as we realize that the corporations and the Republicans are like the mob, or children, the better off we’ll be. If we’re feeling nice we can say, “I know it’s tough sweetie, but these rules are for your own good. You’ll hurt yourself and your friends if I let you juggle chainsaws.”
jcricket
It’s a little thick/dense, but I highly recommend Calculated Risk and Economist’s View for good summaries of all that’s going on.
Economist’s View, in particular, has had some great posts/links lately about the folly of “moral hazard” as something that actually works in real economies. Libertarians always go on about how people take more risks if they know they will be bailed out, which is true in theory (and sometimes in practice), but is wildly “over-diagnosed”. Countrywide, Lehman, AIG, WaMu, and all the hedge funds failing didn’t take on more risk because they knew they’d be bailed out. They did it because partially because they believed their own hype and mostly because it made them spectacularly rich over the last decade or two. They knew most of them would cash out far before the shit really hit the fan. The bailout (or not) is a complete afterthought.
Barbara
Because of the domino or ripple effect of what would happen to all of those counter parties to AIG transactions. My impression is that it would start an unstoppable waive of loss recognition as a result of unwinding bad transactions that would affect not just shareholders, but debtholders, which now include municipalities and pension funds. It’s insane that two or three parties were permitted to assume so much risk with so much leverage but that’s what is happening.
The Moar You Know
Yup. We, the taxpayers, have just bought yet another giant pile of worthless paper. Their current liabilities are around 960 billion dollars, against assets of just over a trillion. However, their potential liabilities are insane (potential loss exposure if we had an economic meltdown) – I think the figure I read recently was 62 trillion dollars (not a misprint).
That’s six times the GDP for the United States and more than a year’s GDP for the world (50 billion).
It’s the Credit Default Swap – a poorly understood financial tool – that may come back to bite us even worse. Supposedly, there are between 500 and 800 trillion dollars of these debt instruments issued, not under the control of any regulatory body.
Heckuva job, Wall Street.
Rex
I think this is the big shake out and most of the action is happening right now.
Washington Mutual is probably the next to go and with that the FDIC is going to be in really bad shape.
ThatLeftTurnInABQ
ding ding ding!
We have a winner!
If there is one phrase which everybody should learn from this story, it is: unregulated shadow banking system.
As in: most of the credit in circulation doesn’t come from what most people think of as “a bank” (in the sense of being boring and prudent and having lots of money in a vault somewhere). Depository institutions have been pushed to the side and largely replaced as a source of credit by a bunch of whiz kids whose risk taking behavior bears a closer resemblance to a car full of teenagers on a Friday night cruise than it does to ordinary Joe-6-pack’s idea of what a “banker” does. They can do this because unlike old fashioned banks, they aren’t being supervised by the US Government (via that old GOP bogeyman: regulation), so they can do whatever seems like a good idea at the time.
And these people have effectively been given the keys to the global economy and allowed to take it on a joy ride.
Ditto for insurance, as in this case.
The key to why the Fed rushed in to keep AIG from going bankrupt immediately (and this bridge loan deal looks to be just a slow motion bankruptcy in disguise) was to prevent their CDS (credit default swaps) positions from being liquidated all at once. Which might have brought the whole house of cards down.
AIG wasn’t saved because they were “too big” – it isn’t about just pure size. They were saved because they are one of the hands holding onto the pin which we need to stick back in the hand grenade that is the CDS market, or it goes boom and we all get hit with the shrapnel.
Lehman on the other hand wasn’t a big player in this market, so they got fed to the wolves.
When the death watch starts for other financial firms (several more are on deck as we speak), scan the news stories about them to see if there is any mention of what they are holding in the way of derivatives – that is the key to who gets saved and who doesn’t.
montysano
Looks like one of the new GOP talking points will be that this crisis was not due to lack of regulation, but instead to Bill Clinton, back in the 90’s, forcing banks to make risky loans to dusky-skinned types. Seriously. And it may be partly true; the GOP mostly owns this one, but they had some help from across the aisle.
Can anyone recommend a good read on this?
Ecks
Someone asked what the conservative blogs were thinking… So I checked red state, and found a pretty good technical description of what is happening. Leaving off some of the commentary around the edges, this helped me understand it better.
Who knew, Red State, good for something *other* than laughs and scaring children who won’t go to bed.
D-Chance.
I remember the cartoon from my youth of the Dutchboy who saw the leak in the dyke. He plugged his finger in it. Then, another leak appeared. He plugged it with a finger from his other hand. Then another leak appeared. He threw off his wooden shoe and stuck a toe in it. Then another leak and off with his other shoe and one more toe in the wall.
The dyke heaved, then steadied. The boy sighed in relief… then the whole thing blew, sending him flying.
I feel like I’m watching the live-action version of this ‘toon.
And, for the love of Matilda, can we get off the “Democrats are Socialists” now? The Republicans just nationalized both the mortgage and insurance industries in a matter of days. So much for their objections over a national health insurance plan.
rishathra
Size matters (no matter what the wimmens tells ya :-)
I’m not talking about market cap or moneys held, although the relative sizes hold, there, too. I’m talking about jobs that would have been lost and people cut loose, if the firms fell.
Lehman, though a huge bank, was essentially the smallest in its class, both in terms of market cap and in terms of jobs; 10,000-15,000 jobs (worldwide) IIRC.
AIG was the largest in its class, employing somewhere in the neighborhood of 100,000 people worldwide, plus all the money stuff that’s been discussed upthread.
So now we have an upper bound and a lower bound on the size of companies the Fed will permit to fail or will bail out.
I just wish I could guarantee that we won’t have to make finer distinctions through more examples. (That’s you, WaMu. :-( )
OriGuy
I encountered this quote in a book about Java (the programming language), of all things:
The significant problems we face cannot be solved at the same level of thinking we were at when we created them.
–Albert Einstein
The people who created these problems are incapable of thinking at another level, so they have to be solved by someone else.
Chuck Butcher
There is enough of AIG that is non-investment/insurance that is healthy to save the company if they can get a short term loan. Lehman was done for. The funny thing is that the govt ought to be able to profit from this deal. There simply wasn’t enough money in the private sector to do it.