I like to think of myself as a reasonably cynical person, at least in matters of finance.
When I started reporting on Mexico's markets in 1998, Russia had just defaulted in billions of debt. Russia and Mexico had virtually no direct financial or trade relationship, yet large investors punished Mexico anyway. (To be fair, Mexico still hadn't recovered from its own financial meltdown of a few years before.) The peso plunged against the dollar, sparking something close to hyper inflation. I watched in awe as working people's real wages -- my own included, since I was paid in pesos -- dropped by about 5 percent per month.
I moved to New York City in 1999, as the dot-com bubble entered what turned out to be its final puff-up. As a senior editor at a Wall Street trade magazine, my desk commanded a magisterial view of New York Harbor from 15 gleaming stories in the air. Within two years, the Nasdaq had surrendered something like 80 percent of its value. My next office was in the windowless bowels of a seedy Lower Manhattan building.
I haven't seen it all, but I've seen plenty. Nothing has prepared me for the federal government's $85 billion takeover of what's left of the world's biggest insurance company. Let's look at the details of this unprecedented deal.
When the stock market closed Tuesday, investors were valuing AIG at $10 billion -- and threatening to take it lower. The Federal Reserve swooped in with $85 billion in public cash -- in return for 80 percent of AIG shares.
Let's see: 80 percent of $10 billion is $8 billion. So for our $85 billion layout, we -- i.e, the taxpayers -- got $8 billion in value. We overpaid for AIG by a factor of more than ten.
And what do we get for our investment? AIG isn't just an insurance company -- it's a sprawling financial giant, and a poster child for the deregulatory fever that has governed U.S. financial markets since the 1990s.
For decades, the Depression-era Glass-Steagall Act kept insurance underwriters, stock underwriters, and traditional lenders separate. Then in the 1990s, as this excellent Frontline report shows, Congressional Republicans worked with the Clinton Treasury to undermine Glass-Steagall. The venerable act finally toppled in 1999.
Depressing presidential campaign note: two of the chief instigators of Glass-Steagall's demise -- Robert Rubin and Phil Gramm -- are now top economic advisers to Obama and McCain, respectively.
With annoying Glass-Steagall taken care of, former AIG chief Hank Greenberg -- not so long ago the most formidable player on Wall Street -- began taking cash generated by the ever-profitable but boring insurance business and building out a financial-services empire.
Soon enough, AIG began making billions insuring newfangled Wall Street products like those now-infamous mortgage bundles and "collatoralized debt obligations."
Everything was more or less rosy (though Hank Greenberg did resign in disgrace over an accounting scandal) until 2007, when Wall Street's mortgage-back house of cards collapsed.
So, again, what are we getting 80 percent of today, for our $85 billion? Check out this New York Times graphic. We get a moderately profitable (but declining) traditional insurance company, alongside a financial services firm that has hemorrhaged $27 billion in the last three quarters alone.
And who's on the line for the company's massive expected future losses? We are.
Some will argue that we're getting much more than a wrecked company for our investment. In this view, the Fed had to step in to bail out AIG, because if the insurance giant had failed, financial chaos would have gained steam. That's no doubt true.
But guess what? Financial chaos is gaining steam anyway. As I write this, shares in the two remaining Wall Street investment banks -- Goldman Sachs and Morgan Stanley -- are cratering. Within days, failing some miracle, they're likely either be bailed out at our expense, or folded into large traditional banks, where federally insured deposits can be raided to offset their losses. In other words, either way, untold billions more out of the Treasury.
And get this: In the wake of the AIG buyout, Standard & Poor's is now considering slashing the U.S. government's credit rating. That move would significantly jack up the federal government's cost of borrowing money -- which it will be doing plenty of, given this ongoing mess and the other ones in Iraq and Afghanistan.
As I wrote two days ago, we're entering the era of climate change with a severely overextended Treasury -- a dwindling financial position from which to invest in public-transportation infrastructure, low-carbon energy sources, etc. And that statement is even more painfully true today.
What's gotten us here is a now-discredited, quasi-religious fantasy that unregulated markets dominated by a few big players lead to ever-increasing prosperity. What we really get is a system that privatizes profit -- any chance that execs from Bear Stearns, Lehman, Fannie Mae, Freddie Mac, or AIG will pony up any savings from their kingly recent salaries? -- and socializes risk.
What we really get is a federal government that can't get it together to tackle urgent social or ecological problems -- but that can mobilize billions in a flash to bail out banks.
As the eminent economist Joseph Stiglitz recently wrote:
We had become accustomed to ... hypocrisy. The banks reject any suggestion they should face regulation, rebuff any move towards anti-trust measures -- yet when trouble strikes, all of a sudden they demand state intervention: they must be bailed out; they are too big, too important to be allowed to fail ...
The present financial crisis springs from a catastrophic collapse in confidence. The banks were laying huge bets with each other over loans and assets. Complex transactions were designed to move risk and disguise the sliding value of assets. In this game there are winners and losers. And it's not a zero-sum game, it's a negative-sum game: as people wake up to the smoke and mirrors in the financial system, as people grow averse to risk, losses occur; the market as a whole plummets and everyone loses.
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Comments
View as Flat
tidal Posted 6:24 am
17 Sep 2008
And it's obviously a lot more complicated than that, but your example overstates things...
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Jon Rynn Posted 6:38 am
17 Sep 2008
can the Federal government keep AIG and fannie and freddie? I suppose what's being cooked up is to let the Feds bring them back to health, then sell them back off for some ridiculously small sum (disaster capitalism at its finest), but another avenue would be to simply nationalize them. This seems rather obvious to me -- if you bail them out, you "get" to own them. It might also give pause to the cowboy capitalists who think they'll get away if they mess things up.
When will the dollar "crater"? As I tried to explain here, the trade deficit is already moving the dollar down, but won't all of these shenanigans make things worse?
and 3) I thought Goldman Sachs pulled out of the mortgage related problems before they blew up, but maybe not.
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Tom Philpott Posted 6:40 am
17 Sep 2008
Now the firm's market cap is $5.5 billion. By your logic, investors would have been wise to bid its market cap up to $95 billion today. Seems like they're buying more into my analysis than yours.
The only way this deal makes sense is if prevents other bailout obligations down the road. Maybe. But today, things were looking pretty hairy for Goldman Sachs, Morgan Stanly, and WaMu.
Victual Reality
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Sean Casten Posted 6:45 am
17 Sep 2008
This isn't to apologize for AIG, and I agree with you on Glass-Steagall. But as loans go, this is hardly a gift to AIG.
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Tom Philpott Posted 6:50 am
17 Sep 2008
Victual Reality
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Sean Casten Posted 6:56 am
17 Sep 2008
Note also that if the gov't does end up with 80% of the equity, the value could well exceed the share price on liquidation.
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Tom Philpott Posted 7:04 am
17 Sep 2008
The $85 billion bailout of AIG on Tuesday by the U.S. Federal Reserve "has weakened the fiscal profile of the United States," S&P's [chairman] John Chambers told Reuters in an interview.
WTF. And as a result ...
The cost of insuring 10-year U.S. Treasury debt against default rose on Wednesday to a record high, a day after the government rescued insurer AIG with an $85 billion loan.
Right now, the dollar is holding up -- propped up perhaps by the fall in oil prices? But, as Jon asks above, how long before foreign investors start to dump it?
Victual Reality
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Tom Philpott Posted 7:07 am
17 Sep 2008
Victual Reality
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PurpleOzone Posted 8:20 am
17 Sep 2008
Credit card debt has gone up significantly, with too many people maxed out. (I don't have the figure in my mind.) People were financing purchases by home equity loans.
How many people will not be able to keep up payments on their credit cards? Is this the next shoe to drop? Who puts up the money for consumer debt?
Foreigners have been subsidizing U.S. government and personal debts. Now they are stiffed with bad loans from us. Will they continue to trust us? (By the way, in most countries a mortgage-holder can't mail the key to the lender and walk away -- the debt follows them all their life. Europeans didn't know about the U.S. practice when they bought our mortgages.)
3 of our 5 big investments banks just vanished -- and Morgan Stanley and Goldman Sachs are the subject of rumors. These have provided loans to corporations for expansion.
Too many people in the U.S. have believed the laws of economics and physics don't apply to us, because "we're Americans". Our morning hangover is not going to be pretty.
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infp Posted 9:12 am
17 Sep 2008
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Tom Philpott Posted 10:33 am
17 Sep 2008
With little notice, regulators at four agencies that oversee the nation's banks and savings associations on Monday and Tuesday proposed a significant change in accounting rules to bolster banks and encourage widespread industry consolidation by making them more attractive to prospective purchasers. The regulators and the Bush administration have decided to resort to further loosening of the accounting rules to try to get the industry through problems that some experts have attributed in large part to years of deregulation.
And how would looser accounting help? Isn't that like sending tequila shots out to a bunch of drunk guys fiddling with their car keys?
Here's one way:
And on Sunday, the Federal Reserve announced that it had eased restrictions that had prevented regulated companies from transferring money to less regulated and more risky affiliates. That action would, for instance, enable one arm of a giant financial company, like the commercial banks of Bank of America or Citigroup, to move money to another arm, like their investment units.
Cool. Now big banks can raid their federally insured deposit accounts -- ie, your granny's savings account -- to prop up cash-bleeding businesses!
And there's this:
[One] action by the four banking agencies provides more favorable accounting treatment of so-called goodwill, an intangible asset that reflects the difference between the market value and selling price of a bank. The move is similar to a step taken in the midst of the savings-and-loan crisis that helped many institutions in the short run. Over the longer term, that decision increased the overall costs of the bailout after the government took away the goodwill benefits.
Awesome! It cost taxpayers more money during the last meltdown, so let's do it again!!!! But this is what really got me:
Already this year, 11 banks have failed. The proposed accounting change could help other faltering banks by making them more attractive to potential buyers.
Wait a minute. We're talking about funny money here -- merely twisting things around explicitly to make severely damaged companies look healthier. But is such trickery really going to fool execs at a potential buyer company? Really? Accounting tricks that everyone knows are accounting tricks?
Victual Reality
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Sean Casten Posted 11:12 am
17 Sep 2008
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Sean Casten Posted 11:20 am
17 Sep 2008
To be sure, I'm not saying that the AIG deal is a great investment opportunity for the US. Lord knows I'm not smart enough to figure that out. But I am smart enough to know that in the current market, there is only one entity with the ability to quickly deploy an $85 billion, 24 month loan with warrants. (Hint: It's not Lehman Brothers!) So to the extent that AIG is a really good investment idea, one could certainly argue that the reason no one else has done it is because no one else exists who can put that kind of financing together on such short notice. And lest we forget, Hank Paulson is One Smart Dude, who didn't do so bad for himself running smaller lending agencies in years past.
But all of that is beside the point - I'm certainly not suggesting that this was done as part of a US investment strategy. Simply that if AIG defaults on the loan causing the feds to exercise the warrants, there is a lot more value there than today's market cap implies, so the simple math of 80% x $10BN doesn't apply.
Frankly, I think the federal approach on this one is pretty masterful. Too big to fail, so we prop you up, but we own your soul if you screw up again. It's precisely what commercial banks do, and precisely what Washington is usually reluctant to do. The view in the rear view mirror is nothing to praise, but this particular move looks to me like an awfully creative approach to a crummy situation. My two cents, anyway.
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Tom Philpott Posted 12:16 am
09 Oct 2008
Remember AIG?
From today's Wall Street Journal:
http://online.wsj.com/article/SB122348485787515823.html?m ...
The federal government said Wednesday it would lend American International Group Inc. as much as another $37.8 billion, a sign that its initial $85 billion effort to shore up the company is coming up short.
The move, which comes less than a month after the Federal Reserve agreed to bail out the giant insurer, raises questions about whether the government will need to keep injecting money into the troubled company. So far, the Fed has agreed to make nearly $123 billion available to AIG.
The government's original plan was that the initial loan would allow AIG to meet its obligations as they came due, buying it time to sell assets. The proceeds of those sales would be used to pay back the loan. As of Oct. 1, AIG had drawn down $61 billion. The Federal Reserve is expected to indicate Thursday the latest borrowing figure. AIG hasn't yet announced any significant asset sales.
The government's deepening involvement underscores its view that a failure of AIG could have devastating consequences for the global financial system. The government has a major interest in the fate of the company, because it took an 80% ownership stake in exchange for extending the original loan. Now, it is effectively loaning money to itself to keep its own insurance company afloat.
"How could this company have gotten itself into a position where it is reliant on the government for almost $125 billion of liquidity funding?" asks David Havens, a credit analyst at UBS. "Eighty-five billion was breath-taking."
By the way, liquidity funding is like taking out loans to pay your bills. Taking out a loan to buy a car that's going to get you to work is one thing; going into debt to pay the electricity bill is a pretty dire situation. Then an AIG flack says something even more breathtaking:
An AIG spokesman said that "it's just an extraordinary situation in the markets." He added that the new plan "is part of our effort to arrive at an overall solution." He said it is designed to help the company avoid needing to borrow the full $85 billion, and that it was not a sign that the initial plan was faltering.
So .... you're borrowing this $37 billion so you don't have to draw down the rest of that $85 billion? I'm afraid Sean and Adam are going to have to step up and explain the wisdom of all of this to us dunderheads.
Victual Reality
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Sean Casten Posted 12:19 am
09 Oct 2008
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Tom Philpott Posted 12:25 am
09 Oct 2008
Victual Reality
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Jon Rynn Posted 12:42 am
09 Oct 2008
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Tom Philpott Posted 3:46 am
09 Oct 2008
Victual Reality
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Jon Rynn Posted 4:12 am
09 Oct 2008
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Jon Rynn Posted 4:19 am
09 Oct 2008
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Tom Philpott Posted 4:27 am
09 Oct 2008
Victual Reality
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Jon Rynn Posted 5:11 am
09 Oct 2008
Daly basically says that the problem is that too much debt and financial assets have been created, much more than the wealth those instruments reflect.
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Sean Casten Posted 5:29 am
09 Oct 2008
I will leave to smarter minds than mine to take out of that historical view what is the best thing to do next, but it does seem to be a fairly insightful observation on how we got here.
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