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AIG. Was the Bailout From Hell a Mistake?

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The word du jour right now is “rathole”, a rather ugly expletive that equates to plughole, drain, succubus, and other such unpleasantries. It may however be too polite a phrase for what is going on right now with the bailout of AIG, the government’s new pet project that looks like it’s going to hand the downpayment on fixing the nation’s health care shambles to Goldman Sachs and their ilk.

Just like everyone else in this country, I’m spitting with fury at the idea that the government is handing over money to keep these clowns out of the poorhouse. The bonuses should have been blocked way before they went public, and the fact that the President is being exposed to ye olde “What did you know and when did you know it?” game only eight weeks into his administration does not bode well.

Then there’s the irksome question of whether the meeting where it was decided to keep AIG alive in September of last year was actually a little joke played on us by Goldman Sachs. (After all the key people around that table were Paulson, ex-boss of GS, Blankenfein, current boss of GS, and Tim “someone put me out of my misery now” Geithner). We’ve known for years that Goldmans was a class above every other investment bank, but their ability to game the system seems utterly unparalleled now.

Finally, there’s this little nugget. We were told that if we’d let AIG die the global banking system would have collapsed. That the $1.6 trillion in Credit Default Swaps (CDSs) that they sold to the world’s top financial institutions who’d sunk their dough into those toxic assets would suddenly go away, leaving them totally exposed, and toppling like dominoes. Makes sense, right? I mean, if the insurance company backing those toxic assets goes belly up then the world’s banks are left holding the bag. Stands to reason.

Or does it?  With the caveat that I really don’t know what I’m talking about, I’m not so sure. And here’s why.

Let’s start with what everyone knows. We know that the slice and dice mortgage derivatives that the best and the brightest of the world’s financial institutions got suckered into buying because of their AAA ratings (purchased AAA ratings it should be noted) went really, really bad. We know that this stuff has been written down all over the world, but there’s an awfully long way to go.

We know that financial institutions and hedge funds bought AIG’s Credit Default Swaps to the tune of $1.6 trillion (AIG’s own numbers) as a way to insure themselves just in case these investments went bad. We know that AIG didn’t have to back the CDSs with assets like they have to with regular insurance. And if we know that, I’m guessing the guys who are holding these CDSs knew it way before we did. They also knew that there was no way AIG would be able to find more than a fraction of the $1.6 trillion in the “very unlikely” event the assets went bad. In short, as soon as the rats started leaving the sinking ship when Bear Stearns went down everyone knew most of the Credit Default Swaps were worthless.

Wait. Rewind that. “Everyone already knew most of the Credit Default Swaps were worthless.” Far from being the keystone holding the system together, AIG might in fact have been utterly irrelevant to the future of the world’s financial system, except to elite banks like Goldman Sachs. Goldmans, it turns out, were one of the first counterparties out and got paid back in full for their bad bets – by the US taxpayer. Which goes a long way to explaining the scare story that Paulson and Blankenfein (let’s call them the Goldman boys) worked on poor, put-upon Tim Geithner. Paulson signed the check over to AIG, the rathole was dug, and the payouts were readied. Goldman Sachs didn’t want to take the PR hit of taking TARP funds direct, but by instigating “Operation Chump”, ie filtering the TARP funds through AIG first, was a fine and dandy idea. Ka-ching for Blankenfein and Paulson. Ka-ching for the top banks on the planet who didn’t want to face the music. Ka-pow right in the keester for the rest of us.

One could be pardoned for suggesting all this doesn’t pass the smell test. That perhaps AIG could have been left to wither on the vine, and bypassed entirely in favor of the bad bank plan that’s on the cards now, which would have saved us that health care down payment. Or that perhaps the AIG bailout (or “Operation Chump”) might well have been a ruse to salvage the reputation of the top banks.

There are three very painful ironies at the heart of all this. Here’s number one. What made AIG critical to the world economy was the act of saving it.  If AIG had failed, its mainly worthless CDS contracts would have continued to be, well, worthless. But once we made the decision to prop up the company, the world’s banking system knew it had found a sucker to back those contracts again and again. That sucker would be….us.

The second irony is this, If we’d let AIG fail, we would have been forced to price the toxic assets at the heart of the credit crisis, which is the only true way that recovery from the crisis can be quantified. But backing AIG’s CDS’s undermines that vital requirement. Now all we have to do is bilk the US taxpayer for billions upon billions more to honor Credit Default Swaps of banks all over the world at the asking price.

Finally, irony number three. The public is readying a lynch mob. Congress wants blood. Even President Obama is mildly indignant, but it’s all for naught. Because bailing out AIG is the biggest example of moral hazard imaginable. When it comes to punishment, actions speak louder than words. All the feiry rhetoric about AIG execs falling on their swords means nothing if Uncle Sam’s still signing the checks to bail these clowns out. Big banks made really bad bets, then bought snake-oil insurance to back them. Two awful decisions for which they should pay the price. Except that we’re paying it for them.

Someone, please tell me I’m wrong about all this.

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One Response

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  1. No, you pretty much got it right.

    I was railing back in September that the people screaming that we're just “hours from collapse” were full of it. They were creating a panic designed to push through something onerous.

    Go back and watch “The Phantom Menace” again. This time instead of whining about how annoying Jar-Jar Binks is, look for parallels to the ways TARP and bailout and stimulus have been crammed as crisis control.

    Me? I just know this economy is tanking, and we need to give unlimited power to Senator Palpatine. He'll steer us right!

    Ike

    March 23, 2009 at 2:44 pm


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