The American Scene

An ongoing review of politics and culture


This Day Was Brought To You By The Word: Conservatorship

It’s completely unclear under what authority the Treasury might do this, but the rumor is that the current plan under consideration would put AIG under Federal conservatorship.

I think I understand the rationale for this idea. A loan would raise serious problems of moral hazard. Why would any bank provide liquidity in the interbank market if the Fed is ready to do instead for any institution deemed too big to fail? $50 billion would very quickly become $500 billion or more. And using the Fed would be especially bad, as the Fed has already been very busy trashing its balance sheet by accepting junk as collateral and lending to securities firms that it has not historically been allowed to regulate, and as the Fed is substantially insulated from political accountability. If there’s going to be a public bailout of AIG, Congress should do it, because they are accountable to the voters.

Moreover, AIG, like Lehman but unlike Bear Stearns, pretty much did everything wrong through this credit implosion. If the government is going to start choosing who’s worth bailing out, how a firm has behaved since the crisis began should be a consideration.

On the other hand, AIG may really be too big to fail. It would not only be the biggest bankruptcy in history by far; it would seriously worsen the position of dozens of major financial institutions that have purchased credit protection from AIG to cover large portions of their mortgage portfolios. I don’t have a list ready-to-hand of firms who would be put at risk of failure if AIG went under, but I’m sure there are some household names on it.

So conservatorship is appealing. It would let the government punish some stakeholders (common stockholders for certain, probably subordinated debtholders as well, maybe even senior debtholders) while protecting the most important stakeholders (policyholders) and avoiding a situation where the firm needs to liquidate in a fire sale, further depressing asset prices. It creates more moral hazard than letting it go bankrupt, but less than a bridge loan.

But as of this writing, I have no idea why the Treasury thinks they have the authority. I think they would need legislation. Right now, the only people I can think of who have the right to seize anything are the New York insurance regulators, who could seize control of the operating subsidiaries but would have no authority to do anything to the holding company. It would be a pretty huge reversal for the regulators to do that, though, given that earlier today they were ready to let AIG’s holding company borrow from its subsidiaries to the tune of $20 billion in the context of a larger liquidity solution. And I would think it would expose New York to potentially ruinous litigation by debtholders of the parent company who would see huge losses and would claim that there was no threat to policyholders specifically that would justify such an intervention.

At this point, I don’t think anybody knows where we’re going. But there is a hierarchy of ignorance. And one thing is clear: Senator McCain is way too close to the bottom of that hierarchy for comfort. His comments on the crisis have been almost pure in their incoherence, emptiness and self-contradiction. Obama has not distinguished himself as a key leader so far – most of the commentary I’ve seen from him is somewhat out of date, pointing to real problems that contributed to the crisis but not giving a good indication of how we get out of the mess we’re in now we’re in it. But at least he has some idea of what he’s talking about.

Back to the Past?

Matt Yglesias points out that our nation’s official foreign policy brain trust — the five former Secretaries of State — agree that we should talk to Iran as a matter of presidential policy. It’s enough to make us start hallucinating an early end to the Bush Era of international relations. But, among others, James Joyner has already splashed some cold water on our faces in this regard. Seeing Obama and McCain as continuations (or more charitably, refinements) of the Bush Era isn’t just a paleo pastime. Yet there’s no denying that Bush’s second term has operated according to a much different slate of objectives — or at least has coughed up different kinds of outcomes — than his first term.

So how can we turn the page if we can’t turn back the clock? Nick Gvosdev suggests that we thumb our rulebook back to George Washington. I’m ordering rubber bracelets now: With Whom Would George Negotiate? Too long? I’m ordering rubber garters.