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.
Aren’t insurance companies supposed to be, like, “prudential” and “solid as a rock?”
— Steve Sailer · Sep 16, 10:29 PM · #
As far as the authority is concerned, I’m no American lawyer but it seems to me that under the Depression era legislation that is still in effect, if the circumstances are urgent enough, the Fed and the Treasury can pretty much do anything they feel like doing.
— PEG · Sep 16, 10:56 PM · #
More to the point, according to this excellent Deal Journal post: http://blogs.wsj.com/deals/2008/09/16/the-aig-crisis-by-the-numbers/ AIG must pony up about $15 billion to its creditors yesterday because of a credit downgrade, and has no extra cash. So if it doesn’t pay up, they’re going to visit it with a crowbar and break its kneecaps. It also probably needs to write down around $25 billion in toxic securities.
However, AIG also has around $40 billion worth of assets it could sell to meet those payments, and it is being circled by private equity vultures. It would have to sell them at fire-sale rates. Painful, sure. But hey. What Paulson should do — knows he should do — is slap some sense in whoever is running AIG these days, get him on the phone with Kravis or Schwartzman and get him to sell some family jewels. These guys are just screaming to buy distressed assets.
The reason why AIG is asking for help is not because they’re victims of a run and are neck-deep in the financial system like Bear, it’s because they’re stubborn and don’t want to give up the empire.
— PEG · Sep 16, 11:05 PM · #
Granted he would have never won, but it would have been nice if Romney was somewhere on the ticket, just so that there would be someone with a clue on one of the major party tickets.
— kab · Sep 16, 11:48 PM · #
Noah: What does this mean for the markets and for your thesis about Lehman signaling a huge unwinding of leverage? Should we buy the S&P? Put cash under the mattress?
— steven k · Sep 17, 12:27 AM · #
I don’t give investment advice, steven k. But if you keep a sufficient amount of your assets in liquid form, preferably 80 proof, you will be able to trade it for food and ammo if things really get bad, and you’ll be able to celebrate by drinking it if they don’t.
— Noah Millman · Sep 17, 12:39 AM · #
I can has job, world?
What a decade to enter adulthood in. Sheesh.
— Freddie · Sep 17, 02:23 AM · #
Aw, come on, you know what I mean. What are the big storylines going to be in the American economy? After tech and real estate, what next? Is it pharmaceuticals, which have developed almost nothing for a decade, despite all the talk about revolutionary new therapies? Is it a return to bread-and-butter, real-economy manufacturing? Health-care services? Cars? And will we see multifront recession from all the money being flushed out of the system? Can banks still make money?
— steven k · Sep 17, 02:45 AM · #
Alternative energy will be the next boom.
— Steve Sailer · Sep 17, 06:31 AM · #
When you accuse someone of bottom-of-the-barrel ignorance, at least a few specifics would help. Especially as McCain seems to have started worrying about the housing market, and the Mae/Mac-problem before it was hip, I.e:
http://www.govtrack.us/congress/record.xpd?id=109-s20060525-16&bill=s109-190
McCain in may 2006:
“For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac—known as Government-sponsored entities or GSEs—and the sheer magnitude of these companies and the role they play in the housing market. OFHEO’s report this week does nothing to ease these concerns.
In fact, the report does quite the contrary. OFHEO’s report solidifies my view that the GSEs need to be reformed without delay.”
Doesn’t seem terribly “bottom of the barrel” to me. Might even qualify as prescient.
— st · Sep 17, 10:38 AM · #
My, how I hate this term “too big to fail.” If this is really true, in the future such firms need to be dismantled until they are in failable bite sized pieces.
— ERM · Sep 17, 11:49 AM · #
Freddie, you’re entering adulthood in a decade when a hell of a lot of other people seem to be leaving it.
— Alan Jacobs · Sep 17, 12:42 PM · #
kab, that’s a good point — why isn’t Romney in charge of McCain’s market response brain trust?
— J Mann · Sep 17, 01:29 PM · #
Noah,
With regards to the question of whether or not Treasury has the authority to do this, didn’t you get the memo? 9/11 changed everything, and if we don’t bail out AIG, then the terrorists have already won. Questioning their authority in this regard simply shows your utter lack of patriotism. USA! USA! USA!
And secondly, although st’s comments show a way in which McCain, in a previous, much more serious incarnation, did show some low-level ability to think clearly about these issues, certainly the fact that he is being rewarded, at least in the polls, for running an entirely ad hominem, substance-free campaign means that neither he nor his advisors are going to spend much gray matter trying to come up with a coherent response to the issues of the day.
Much easier, really, to shout “Over-regulation! Greed! Lower taxes!” repeatedly, since very similar strategies have proven quite effective in the past few months.
Similarly, since such reduced-calorie tactics have worked, year in and year out, don’t expect Obama to stray too far into the depths of policy prescription, since most red-blooded Americans don’t have the interest or ability to keep up, especially if it keeps them from watching American Idol.
To quote Marvin the Paranoid Android “Oh God, I’m so depressed…”
— David Samuels · Sep 17, 02:12 PM · #
Why do John and Barack want this job, again?
— Freddie · Sep 17, 03:16 PM · #
David, please. I’m no fan of McCain, but at least he was on station at the root of the governments’ “moral hazard” involvement in this crisis. (Fannie Freddie).
This idea that the Republicans offer tedious tropes — mom and apple pie — while the Democrats offer sound “policy solutions” is laughable. “Low taxes” btw is a sound 1st order policy with a proven track record. Insufficient, but necessary.
What i hear from the Democrats — “powerful forces”, “BIG corporations”, “windfall profits”, “universal health care” — is all tedious tropes. Take the most policy specific — health care. What’s the rationing scheme? Whenever you make something free, that’s the FIRST question — how are you going to ration it? And, we have a federal system, 50 (not 57) states. The Democrats control plenty of them, why haven’t them implemented universal health care and any of them? Huh? (Canadian health care — often pointed to — is actually provincial health care. When i lived there i had BC health care, not canadian health care.) Why not give us a little “universal health care” preview in say … New York, before inflicting it on the rest of us?
And on the housing\financial crisis, forget Obama, even the supposed Democrat “intellectuals” like Krugman, can’t seem to face the reality of government involvment in causing the crisis. It’s precisely because we had\have Fannie and Freddie mandating and soliciting low income borrowing and providing a secondary market that private companies could unload junk to, that we have the crisis. Absent government mandates to jack up minority\low income borrowing, and Fannie\Freddie market to dump it, we’d never have had a bubble this big.
Furthermore this Fannie\Freddie debacle underlines the risks, the moral hazard, the general BAD IDEA of exactly the kind of quasi-public or “public private” partnership the Democrats always love to tout. So they can be “leading” or “growing” or managing the economy and have plenty of cushy bureaucratic jobs. (Hey! The economy does not NEED you to mess with it. It does not NEED your management. It has millions of people out there managing their pieces of it already.)
I’d say this crisis, while in some sense just underlying the emptiness of the cult of Greenspan… next bubble Alan? … has also underlined how all these government interventions just create more bad incentives and moral hazard.
Finally for empty sloganeering campaigns… with all due respect the Obama “hope”, “change” campaign is the emptiest campaign Democrat or Republican that i have ever seen. It’s all symbolism, style, “design”. It’s the “stuff white people like” version of a Nuremberg rally. All symbolism and emotional connection. Otherwise Obama? Please.
~~~
And finally, finally. This crisis: misaligned incentives. When capitalism is out of balance that — and excess leverage — are usually at fault.
People who write mortgages need to be on the hook for those mortgages.
The way to do this in a capitalist economy is to have say Countrywide be a REALLY, REALLY big stock market capitalized company. Low leverage (if any), and no loans being generated and packaged off elsewhere. It would generate loans it feels are going to be profitable — assessing borrower and real estate market AS THEY SEE FIT. (No government requirements to lend to <x>% minorities or low income or any other nonsense.) The management would have strong incentives (stock price, stock options) to see (standard compensation practices involving measurement, bonuses, etc.) that their employees are writing mortgages that will be profitable. If they do a good job — profit, high stock price. If they do a poor job — crashing stock price (worthless options). And none of this creates a financial crisis. Just like GM being in the tank creates no financial crisis. Excessive leverage, misaligned incentives and politicized government interventions create the crisis.
The government needs to stop bailing out these miscreants. But rather make it clear that it WILL NOT bail out miscreants, thus forcing them to be more prudent about dodgy, unsecure, highly leveraged investments.
— Jim · Sep 17, 03:56 PM · #
Freddie makes a good point. The argument goes that 2000 was an election that candidates would not have wanted to win, while 2004 was the opposite situation. Whether or not that’s true, is 2008 an election that people really want to win? I’d say no, but I sure hope I’m wrong.
— Klug · Sep 17, 05:09 PM · #
<i>Is it pharmaceuticals, which have developed almost nothing for a decade, despite all the talk about revolutionary new therapies?</i>
Actually, I think big pharma could make it big in a time of economic crisis—not because of any innovation, but because with the economy in the gutter, people will be more likely to turn to their dope, I mean, medications. Think about it…you have just lost out big time, and there isn’t much of anything fun to do, at least not anything that is affordable. You’re too much of a snob to get drugs on the streets. So you go to Dr. Feelgood and get scripts for Vicodin, Paxil, Cymbalta, etc. Any idiot can get a good-sized script of Vicodin (hydrocodone with acetaminophen)—including doctor visit—for not much more than $100. There’s a reason why hydrocodone w/APAP is the #1 most popular prescription drug, not Viagra or Cialis (or at least it was ca. 2004, the year my first OChem textbook came out1). Or you could just shortcircuit the process and down some Robitussin or Delsym…nice and cheap.
And damn, without a steady supply of new toys, those kids are getting rowdy. Time to put them on Ritalin. And oh, I’ve got some really bad anxiety, will my equity go down even more? Time for some Marinol or medical THC products. And gosh, I’ve been eating way too much too, and my cholesterol is way up. Probably all those other meds I’m taking aren’t helping my cholesterol either. Time for some cholesterol-lowering meds. And now that I’m taking all this stuff, my health is a mess…time for even more medications!
[1]Kind of weird to be discussing that in an Organic Chemistry textbook. There is also a question, in the same chapter, asking whether tetrahydrocannibol (THC), ie pot, or sodium pentothal is the “safer” drug. Of course the correct answer is, you guessed it, THC. Not going to say which textbook this is, because I do not want to defame the author.
— birch barlow · Sep 17, 08:13 PM · #
the incumbent will take the rap on this.
two soundbites that will play ad nauseum—
Septugenarian Guy saying he doesnt know anything about economics and that “the ecomony is sound”.
lol
a gift for Obama.
don’t you get it yet?
Brooks is right, the republicans are simply intellectually unfit.
When Bush said “go shopping” post911, the republican deregulators, the greenspan negative interest rate policy….created this huge recession bubble and pushed it down the road.
Bush was hopin hed be out of office by the time it broke.
And a lot of you morons want to elect Palin.
The Founders greatest fear was demagoguery. The election of a populist candidate with zero credentials.
The electoral college was supposed to protect us from unqualled theocons like Bush and Palin.
Let me break it down for you.
If…you…believe….in….creationism aka intelligent design…..you are STUPID.
We dont need stupid in office.
— matoko_chan · Sep 17, 08:42 PM · #
“And a lot of you morons want to elect Palin.”
At least they just want her as veep. The Dems insist on pushing their fluffy hope-and-change community organizer / almost-a-full-term-senator in the Prez slot. But I assume you have no problem with that.
— st · Sep 18, 08:12 AM · #