AIG a bailout or Safe Sex?

I think we need to be a little careful in the words we use to describe the events that have unfolded with the demise of AIG (American International Group). I’m also very conflicted in how I see the US government’s actions as I almost always prefer strictly hands off approach that most of us libertarians prefer. AIG is a huge firm and was involved in a host of things that goes to the core of Main Street. A disorderly liquidation could have proved even more disastrous without the “intervention”.

Rightfully so, in my opinion, the Fed was greatly concerned with the mess the liquidation would cause to the financial system and they took action.

The terms the US Fed extracted from AIG were absolutely punishing. AIG is borrowing the money at 850 basis points over Libor (3.3%). Importantly the FED ranks ahead of all the other creditors which means the the Fed has first bight at the money cherry. The Fed has also forced out senior management and installed its own people. Both Morgan Stanley and Goldman Sachs are the Fed’s advisors and I presume their representatives are acting as temporary management.

I would call this action something else- perhaps a punishing intervention, but I certainly wouldn’t call it a bailout in the traditional sense. It appears to me that the US taxpayers done a great deal. The Fed ranks first and the receives a 10% margin over Fed funds (2%) and there is a great betting chance they get all their money back plus the huge spread.

Loan Sharks would be salivating at the deal in the back streets alleys of Brooklyn.

Perhaps…… It definitely was sex but the Fed seems to have used a condom.


Right now Morgan Stanley and Goldman Sach’s stock is down 45% and 25% respectively (on the day). This after they both reported profitable quarters with Morgan Stanley beating street estimates. What does this mean? It means to me that we are seeing the end of Glass Steagall– the enormously stupid regulation going back to the 30’s that separated stock broking business from regular banking that was finally repealed in the late 90’s. It looks like these two firms won’t survive in the present structure and are likely to be merged with commenrcial banks. I guess the Macquarie model is also gone.

29 thoughts on “AIG a bailout or Safe Sex?

  1. I think that it is time to put a gallows on Wall St and start hanging these bastards that ripped off investors of the whole world. China would do it, has done it.

  2. MarkL – this a libertarian site not Socialist Weekly. it was the US govt regulation forcing mortgage lenders to make loans available to people with minimal chance of repayment that got us into this mess.

    jc – truly momentous events. BankWest here in Australia now has a new owner (Lloyds). If anyone has cash sitting with an Aussie bank, make sure it’s one of the Big 4 – otherwise you could lose the lot.

    it’s hard to see how the world will avoid a deep recession now. hunker down and keep liquid.

  3. I am very willing to stand corrected, but I didn’t think the Fed was owned by the taxpayers ?

    The conspiracy-sphere postulates, as far as I can gather, that the US Treasury issues debt instruments to the privately held Federal Reserve bank, and the Fed prints greenbacks ( IOUs ) in return.

    So unless this understanding is wrong, and please help me out here, unless the Fed is passing the interest premium back to the Treasury on the US Govt debt, then the Fed has all the potential upside and Joe and Jill Schmuck taxpayer are presumably carrying all the risk ? Or not ??

  4. Technically i think you’re correct, Kev. The structure of the Fed is a little complex, however there is a direct link back to the Treasury and the federal government.

  5. Kev is right. It would be better if such interventions were done explicitly by the treasury or some other government agency using taxpayers money and if the central bank and it’s printing press powers were abolished. That would dispense with a lot of ambiguity and unaccountability.

    JC makes the point that the executives have been dismissed and that the fed stands first in the queue for repayment. Hopefully this diminishes some of the moral hazard. However the mere fact that creditors may be saved by this action means that moral hazard still prevails. If banks are too big to be allowed to fail then if they end up being bailed out by the government then the government should seek to have them split up. It would not be quite the same as letting the big hollow trees fall to the forest floor but it would at least ensure they don’t continue to suck up all the sunlight.

  6. I’m of the view ( and I know it’s not popular) the the only reason we will get out of this is the fed can add liquidity to the system as the leveraging unwinds. The gold standard prevented this happening in the 30s.

    There is a limit, the USA is in a very week position ( war with tax rates that don’t come close to covering it) and they run the risk of trashing there currency. If China and Japan continue to hold US debt it’s ok, but there will come a point where those two will do a France and say enough is enough.

    As there wasn’t an interest rate cut I’d say that point is getting close.

    And as for Glass Steagall, at this rate there will be no private commercial bank left in the US to regulate.

    Interesting times.

  7. However the mere fact that creditors may be saved by this action means that moral hazard still prevails.

    True which is why I’m really conflicted on this one. We live in interventionist places so as far as this intervention goes it wasn’t bad. In fact it’s pretty good in the sense that the US government – ok the Fed – is getting its a few kilos of flesh. As I said those are loan shark terms. The Oz government ought to ask for a piece of the action and put the surplus to some use.

  8. Andrew Mellon, Secretary of the U.S. Treasury in 1929,

    “Liquidate the banks, liquidate the farmers, liquidate Wall Street…”

    a man after Terje’s heart.

  9. Pom:

    there are starting to appear a few juicy morsels if you can wear the pain without having to borrow. I bought a few stock today. I bought a little macquarie airports and touched the edge of BHP.

  10. Hang on jc, how can you see that taxpayers have a great deal on their hands ?

    AIG was a failing institution, nobody else got the money together to buy it out, so why should tax payers feel like they won a prize ?

  11. Jono

    The total asset side of the balance footings is about US1 trillion. The Fed has first claim on all assets sales which means they rank ahead of the other creditors. On top of that, just to make sure the shareholder doesn’t run a free ride the Fed also received a warrant for 75% of the stock issued, which mean the current stockholder has been massively diluted to the size of that warrant which was issued at the money and basically free.

    I wish i could get that deal.

    Why didn’t other people lend on those terms? dunno. Ask them.

  12. JC,

    What do you reckon is the cheapest way to buy gold if you’re planning on holding it for at least 5 years as insurance?

    ETFs are one option but the management fees look like they’d add up over 5 years, plus you never know if the issuer is about to go belly up.

    Depository services like the Perth mint look interesting and more secure.

  13. It’s good to see from the comments that in Australia there are some pragamtic libertarians; would that we had more in the U.S.

    To date, the American citizen is on the hook for some $300 billion in ‘interventions,’ and letting Lehman fail might not see the end of more “bailouts.” There will, as always, be intense political pressure for lower interest rates to help ease the situation, but the Fed is ‘trapped’ by a rate already down to 2%. Anything approaching 1% will unleash a firestorm of warnings that the U.S. is headed for the twenty-year debacle of Japan: zero interest, zero flexibility, collapse of the sector.

    Despite the drop in U.S. rates during the past year to help ease the meltdown, the size of the crashing has escalated, highlighting that the fundamental problem isn’t the higher interest rates on the refunded mortgages: It is the mortgages themselves.

    The mortgages have been issued by banks (at the “behest” of the egalitarian national government) in a feeding frenzy of loan fees, to people who have no ability to pay once their ‘introductory’ lower interest rate rises. The banks made the loans betting on rising home values to re-finance the renewed mortage (more fees!); when home values instead fell, the roller coaster ride began a plummet.

    Housing prices are collapsing, as they should when supply overwhelms demand. An entire cottage industry has grown to counsel people how to successfully walk away from their homes, without any penalty. The government created the original distortion in the housing market, and it will be the government which will be blamed for not ‘protecting’ low income people colluding with their bankers’ greed. The eventual total cost of te meltdown is utterly unknown.

    Gold at $2,000 doesn’t sound at all impossible.

  14. JohnZ – you’ll only lose if the issuer goes belly up and acts fraudulently. The Perth mint is interesting because you can buy ‘unallocated’ gold for which there are no storage charges. otherwise ‘gold’ ticker on the asx shd be good enough.

  15. Pommy,

    I was under the impression that ETF holders are creditors without legal title to the underlying asset?
    Or are you saying that this protection is good enough for all intents and purposes?

  16. Z

    I just buy gold spot and hold it paying the interest rate differential against the US dollar which at 2% is an okay deal.

    You could look at futures which essentially does the same thing

    I really don’t like the idea of holding the stuff physically s you don’t have to own it to “enjoy” its value as your only interested in the movement of the price of gold.

    Gold stocks: well you have to worry about management and quite honestly I can’t quite figure the embedded price of gold in a stock.

    for you I would suggest futures and keep rolling the position over prior to expiry.

    Call me if you need help. Let Jason know to give you my email address.

  17. Z:

    are you predicting the end of the financial world? Not a trick question by the way.

    I’m just seeing that you’re worried about the credit risk.

  18. Not the end of the financial world, but it seems prudent to hedge against a wider financial meltdown.

    What’s your estimate of the counter-party risk with the futures contracts?

  19. JohnZ

    from the ASX website,

    A GOLD security consists of a gold bullion share of nominal value and a beneficial interest in approximately 1/10th of one fine troy ounce of gold bullion held on trust for the holder of the security.

    The gold is held in London vaults by a custodian. A trust deed establishes a separate trust for each holder of GOLD so that the holder is absolutely entitled to the gold bullion held in the vaults.

    The important point to note is that the Gold is held in trust for you. hence you are not a creditor.

  20. What’s your estimate of the counter-party risk with the futures contracts?


    I believe the futures broker would be the counterpart.

  21. “I’m of the view ( and I know it’s not popular) the the only reason we will get out of this is the fed can add liquidity to the system as the leveraging unwinds. The gold standard prevented this happening in the 30s.”

    Get out charles. This is just socialism for the rich.

    The gold standard didn’t stop it at all. It simply meant people didn’t overpay for shit assets.

  22. Pommy – are you against personal responsibility. Just wondering given your comment to me. 😉

    The great depression was caused by a massive hike in US trade barrier and a massive retaliation from the rest of the world. The gold standard in the USA neither caused it nor exacerbated it. However the gold standard in Commonwealth countries (such as Australia) was a serious burden due to Churchills monetary cockup in 1925 and there were many economists and commentators at the time describing the burden of the gold standard. Essentially the whole Commonwealth was already burdened by Churchills deflation at the time that the Smoot Hawley tariff struck. The market anticipated the tariff (and the recession it would cause) which is why we had the crash of 1929. However if Britian had stayed on the gold standard during WWI, or if Churchill had returned to the gold standard in 1925 at a more realistic price then there would have been no deflation.

    In short it is stupid to blame the gold standard for the great depression. And it was stupid to think inflation would fix the great depression.

    A gold standard, where gold is the unit of account, only causes a decline in liquidity when there is a fall in the demand for liquidity. Which is in fact the whole point of the system and one of the ways in which it automatically stabilises the price level. And unlike our modern artificial stabilisers (central banks) the gold standard manages to stabilise not only consumer prices but also currency prices and commodity prices. Gold used properly is the great stabiliser. Like polaris it is not perfectly stable but like polaris it is pretty damn fine none the less.

  23. p.s. Just to be clear. Different actions by Churchill could have avoided deflation across the commonwealth but not the contraction brought on by US trade policy.

  24. I just don’t understand how this could have happened, Freddy and Fanny were subject to oversight by the Banking, Housing and Urban Affairs Committee which is chaired by Sen. Christopher Dodd (D-CT) who is held in high regard by them.

    Such high regard in fact that they have donated $133,900 in campaign contributions to him. This is $28,000 more regard for him than they have shown for Obama.

  25. Pingback: skepticlawyer » Banking bailout or economic bailout? Guest post by Joe Cambria

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