All Your Finance Are Belong To Us
And now, back to our regularly scheduled catastrophe. So what does the AIG takeover – not conservatorship, apparently – mean?
Let’s step back a second and understand the two risks the Feds have been trying to weigh in the balance.
On the one hand, if they allowed AIG to fail, that would not only be the largest corporate default in history, it would have global repercussions that nobody wanted to risk. Just to give one example: money-market funds are big owners of AIG debt. The money market industry is already in serious trouble because of Lehman. AIG would be at least an order of magnitude bigger hit.
On the other hand, if they ponied up money, that would be a signal to the rest of the banking system not to lend. After all, if you are a bank and are terrified of lending to another bank whose books may contain toxic debt, but you’re also terrified of the consequences of a major bank failure to yourself, now you know that the government will be there to lend when nobody else will. So why stick your neck out?
So the government opted for a mid-range solution, neither allowing AIG to fail nor simply giving them a loan. They gave them a loan, but it’s a loan that structurally subordinates all other debtholders and was made on the assumption that AIG will now proceed with asset dispositions as rapidly as possible in order to pay that loan back. And the government gets 80% of the company.
There are three possible outcomes from here with AIG.
Best case, the asset sales proceed in a timely fashion, the loan is repaid, and AIG gets back on its feet. In that case, the government will make a tidy profit on its equity stake and everyone will breathe a sigh of relief.
Mid case, the asset sales go poorly, but they go. The loan is repaid, but the remainder of the company is still unhealthy. Unsecured AIG bonds are still trading below 50 cents on the dollar; the market still thinks there’s a very good chance the company ultimately fails, and bondholders don’t get back their whole principal. In this case, the government gets back its loan, and the pain in the market isn’t as bad as it would have been if AIG had failed today, but much of that pain is just deferred rather than avoided.
Worst case, the asset sales don’t happen, and the government takes over a bankrupt AIG instead of getting back its money. This is unlikely, as AIG’s operating subsidiaries in its traditional insurance businesses are generally considered to be quite healthy. But if the macro environment really takes a leg down, this case could materialize.
But before any of the above happen, we are already seeing the negative consequences of the bailout for bank lending: it has stopped. LIBOR – the rate at which banks lend to each other overnight – has gone through the roof. Expectations are growing that Morgan Stanley will need to be sold (as of this morning, we were talking about HSBC; now we’re talking about merging with Wachovia, which isn’t too healthy itself) and even teflon-coated Goldman Sachs is not immune.
I do not want the Federal Government to run America’s financial system. I’m just funny that way; I don’t think the Russian/Venezuelan model is right for America. And that’s where we’re headed with this rolling bailout – not literally in that I don’t think we’re headed for a soft dictatorship, but in the sense that waiting for critical institutions to get to the point of failure, and then debating whether they are too big to allow them to fail, is a recipe for repeated failure and ever-increasing government ownership. The alternative to buying up failing institutions is to buy up failing assets. Obama thinks it’s premature, but I’m inclined to agree with Barney Frank that it’s time to start setting up an RTC-style entity to buy up mortgages and put a floor under the market. So I guess I mind it less if Uncle Sam is my landlord than I do if he’s my banker.
Once we’ve stabilized things, then we can talk about the right kind of regulation that should be imposed. About which more later.
I think that part of the problem is a philosophical atmosphere where any criticism of bankers/investors/moneymen was somehow considered an affront to capitalism, where if you said anything critical of the actions of certain players within the markets, you were somehow an enemy of the markets, or whatever. There was a pretty successful effort to make criticism of any system within capitalism a criticism on capitalism in general. (See the average talking head on CNBC.) This attitude has always been weird to me. The big banks and investment houses has created a ton of new and strange kinds of derivatives and markets, which we have very small understanding of, even now. Is it really the case that questioning the consequences of these sorts of things is an affront to free trade? You have to take laissez faire to a really crazy level to think that, in my view. This is where, I think, capitalism becomes magical capitalism, where people take pro-market and pro-business rhetoric to such an extreme that we are supposed to believe that any criticism, skepticism or scrutiny of specific facets of the big banking and investment industries is somehow unAmerican. We have an awful lot of sorting out to do, and the idea that some of these new markets just don’t work, or are just too dangerous, has to be on the table.
— Freddie · Sep 17, 11:04 PM · #
Interesting distinction between buying assets and buying institutions, Noah, and I think I agree (not that my opinion on financial matters is to be trusted).
It seems that one way you’re pushing against the trend of recent commentary is that the issue of mortgages has dropped out—everyone knows that this whole thing was started by bad mortgages, but now everyone is focused on the big institutions.
— Justin · Sep 18, 01:25 AM · #
The issue of mortgages has not dropped out because that is the black hole eating these firms and causing banks to be afraid to lend. The problem is spreading beyond residential mortgages, though, to commercial real estate, corporate loans . . . but this stuff should be easier to value.
— Noah Millman · Sep 18, 01:55 AM · #
America would be more on board with what is happening if the CEO’s and boards, and CFO’s and other associated big wigs in “the clique” at these institutions lost EVERYTHING LIKE THE EMPLOYEES DID. But no, they havent’. Many got golden parachutes despite ruining their companies.
Why? Thats what the American public wants to know. If the CEO’s, CFO’s, Board, and the cronies lost their pants, the public would be a lot less peeved about bailing out some of these entities.
If a NFL coach fails miserably at one job, he is not offered a head coaching vacany at another team when he is fired. He has to go back to being a coordinator (or if he really stunk it up) a position coach somewhere else in the profession. This may include being the outside linebacker coach at McNeese State if he was really terrible. I remember one coach in particular (Mike Dubose) who so stunk it up down south at Alabama, that he had to coach IN HIGH SCHOOL because his reputation as a competent professional was so hindered by his performance at that school.
NOT SO in the business (or governmental beauracratic world). Indeed, sometimes execs “fail UP” and not down when they really make a mess of things.
We pretty much have to bail out AIG. I understand that. But their top execs and managers should LOSE THEIR JOBS with NO BONUSES. Their names should be DIRT in the business and they should have to GO BACK TO THE BOTTOM for wrecking a company so badly. But that wont happen and we all know it. Likely they will get to retain their jobs. At the worst, they will be offered new similar employment at other large companies.
If the city of Atlanta commissioned an artist to sculpt a large statue commemorating the war on terror (or whatever), and that artist turned out a large post-modern-un-understandable pink and organge maze or twisted rock and metal that looked like a junkyard on steroids, would Charlotte commission the guy for a “second chance”? Hell no………James Cayne SHOULD NOT BE ENJOYING HIS RETIREMENT, et cetera et cetera et cetera
— miles · Sep 18, 02:03 AM · #
Miles, I have to disagree with your analogy.
Generally, if an NFL or college coach does poorly, he gets bought out of the remaining years of his contract, becoming a rich (but unemployed) man in the process. A few years later, he takes a job for a lesser team desperate for a turnaround, and if he achieves it, all is forgiven. Under no circumstances does he have to repay the money he has already been given, often for lackluster “rebuilding” seasons that amounted to nothing.
I don’t think that’s fair for either NFL coaches or corporate CEOs, but it seems fairly closely parallel.
— J Mann · Sep 18, 04:02 PM · #
Note that the sky high LIBOR rate will make the mortgage mess even worse, as some adjustable rate mortgages are tied to the LIBOR rate. Some of those mortgage reset monthly, others quarterly or annually.
— Steve in Brooklyn · Sep 18, 07:46 PM · #
“I do not want the Federal Government to run America’s financial system. I’m just funny that way; I don’t think the Russian/Venezuelan model is right for America.”
Oh you’re hilarious. Very funny. You know what I’m funny about? Taxpayer ripoffs. Socialism for the rich, harsh free markets for the poor.
These institutions that are “too big to fail” should be bent over by the government, and reamed with regulations.
Go ahead and complain about abusive government in Venezula and Russia. We need to make sure our government is democratically accountable and we need to stop this rampant fraud in the private sector.
No one want to lend to each other because no one trusts each other. Except for the US government and Treasuries. You want sarcasm? Good going America… Bravo .. well done. Gives one faith in humanity.
— Peter K. · Sep 18, 08:06 PM · #
“Too large to fail.”
That’s the problem. The solution (albeit sans details) suggests itself.
— Julie · Sep 18, 08:29 PM · #