June 10, 2010
The adults in the room have spoken. The Congressional Oversight Panel – headed by Harvard Law School professor Elizabeth Warren – created to oversee the TARP program, has just issued a report disclosing the ugly truth about the bailout of AIG:
The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.
Note the present tense in that statement. Not only did the bailout have a poisonous effect on the marketplace at the time –it continues to have a poisonous effect on the marketplace. The 300-page report includes the reason why the AIG bailout continues to have this poisonous effect:
The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America‘s largest financial institutions and to assure repayment to the creditors doing business with them.
And that, dear readers, is precisely what the concept of “moral hazard” is all about. It is the reason why we should not continue to allow financial institutions to be “too big to fail”. Bad behavior by financial institutions is encouraged by the Federal Reserve and Treasury with assurance that any losses incurred as a result of that risky activity will be borne by the taxpayers rather than the reckless institutions. You might remember the pummeling Senator Jim Bunning gave Ben Bernanke during the Federal Reserve Chairman’s appearance before the Senate Banking Committee for Bernanke’s confirmation hearing on December 3, 2009:
. . . you have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail. Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out. In short, you are the definition of moral hazard.
With particular emphasis on the AIG bailout, this is what Senator Bunning said to Bernanke:
Even if all that were not true, the A.I.G. bailout alone is reason enough to send you back to Princeton. First you told us A.I.G. and its creditors had to be bailed out because they posed a systemic risk, largely because of the credit default swaps portfolio. Those credit default swaps, by the way, are over the counter derivatives that the Fed did not want regulated. Well, according to the TARP Inspector General, it turns out the Fed was not concerned about the financial condition of the credit default swaps partners when you decided to pay them off at par. In fact, the Inspector General makes it clear that no serious efforts were made to get the partners to take haircuts, and one bank’s offer to take a haircut was declined. I can only think of two possible reasons you would not make then-New York Fed President Geithner try to save the taxpayers some money by seriously negotiating or at least take up U.B.S. on their offer of a haircut. Sadly, those two reasons are incompetence or a desire to secretly funnel more money to a few select firms, most notably Goldman Sachs, Merrill Lynch, and a handful of large European banks.
Hugh Son of Bloomberg BusinessWeek explained how the Congressional Oversight Panel’s latest report does not have a particularly optimistic view of AIG’s ability to repay the bailout:
The bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer through swaps or securities lending.
AIG owes about $26.6 billion on the credit line and $49 billion to the Treasury. The company returned to profit in the first quarter, posting net income of $1.45 billion.
‘Strong, Vibrant Company’
“I’m confident you’ll get your money, plus a profit,” AIG Chief Executive Officer Robert Benmosche told the panel in Washington on May 26. “We are a strong, vibrant company.”
The panel said in the report that the government’s prospects for recovering funds depends partly on the ability of AIG to find buyers for its units and on investors’ willingness to purchase shares if the Treasury Department sells its holdings. AIG turned over a stake of almost 80 percent as part of the bailout and the Treasury holds additional preferred shares from subsequent investments.
“While the potential for the Treasury to realize a positive return on its significant assistance to AIG has improved over the past 12 months, it still appears more likely than not that some loss is inevitable,” the panel said.
Simmi Aujla of the Politico reported on Elizabeth Warren’s contention that Treasury and Federal Reserve officials should have attempted to save AIG without using taxpayer money:
“The negotiations would have been difficult and they might have failed,” she said Wednesday in a conference call with reporters. “But the benefits of crafting a private or even a joint public-private solution were so superior to the cost of a complete government bailout that they should have been pursued as vigorously as humanly possible.”
The Treasury and Federal Reserve are now in “damage control” mode, issuing statements that basically reiterate Bernanke’s “panic” excuse referenced in the above-quoted remarks by Jim Bunning.
The release of this report is well-timed, considering the fact that the toothless, so-called “financial reform” bill is now going through the reconciliation stage. Now that Blanche Lincoln is officially the Democratic candidate to retain her Senate seat representing Arkansas – will the derivatives reform provisions disappear from the bill? In light of the information contained in the Congressional Oversight Panel’s report, a responsible – honest – government would not only crack down on derivatives trading but would also ban the trading of “naked” swaps. In other words: No betting on defaults if you don’t have a potential loss you are hedging – or as Phil Angelides explained it: No buying fire insurance on your neighbor’s house. Of course, we will probably never see such regulation enacted – until after he next financial crisis.
Ignoring The Root Cause
June 17, 2010
The predominant criticism of the so-called “financial reform” bill is its failure to address the problems caused by the existence of financial institutions considered “too big to fail”. In an essay entitled, “Creating the Next Crisis” economist Simon Johnson discussed the consequences of this legislative let-down:
One would assume that an important lesson learned from the 2008 financial crisis was the idea that a corporation shouldn’t be permitted to blackmail the country with threats that its own financial collapse would have such a dire impact on society-at-large that the corporation should be bailed out by the taxpayers. The resulting problem is called “moral hazard” because such businesses are encouraged to act irresponsibly by virtue of the certainty that they will be bailed out if their activities prove self-destructive.
Gonzalo Lira wrote a piece for the Naked Capitalism blog, explaining how the moral hazard resulting from the “too big to fail” doctrine is facilitating a state of corporate anarchy:
Good-old British Petroleum – the latest beneficiary of the “too big to fail doctrine” — can rely on its size to avoid any sanctions it considers unacceptable because too many “small people” might lose their jobs if BP can’t stay fat and happy. Gonzalo Lira’s analysis went a step further:
Mr. Lira discussed how a leadership void has been helping corporate anarchy overtake democratic capitalism:
The failure of President Obama to take advantage of the opportunity to address this “root cause” in his Oval Office address concerning the Deepwater Horizon disaster, inspired Robert Reich to make this comment:
One of my favorite commentators, Paul Farrell of MarketWatch, recently warned us about the consequences of allowing corporate anarchy to destroy democratic capitalism:
If we ever reach the point when the watered-down “financial reform” bill finally becomes law, the taxpayers should insist that their government move on to address the “root cause” of corporate anarchy by taking up campaign finance reform. That should be one hell of a fight!