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FU AIG
Jason
God EmperorArrakis Moderator
All I have been hearing about lately is AIG. It is all over the newspapers. It is all over the radio stations. I bet if I bothered to turn on the t.v., it would there too. I had originally wanted to write a long blog expressing my thoughts on the company, the bailout and the $165 million in bonuses that were recently handed out, but since that would be like beating a dead horse, I have decided to just note a couple of things I think are important:
1. The current financial crisis could have been avoided, and so could have AIG's near failure.
It is rather complicated to explain exactly what happened with AIG, but the bottom line is that AIG's financial sector was paid by investment companies to back up securities that were in turn backed by pieces of mortgages. AIG effectively promised to make up the difference if the investments failed. So where did they go wrong?
It seems that AIG, thanks in part to Gary Gorton, the finance professor who designed AIG's risk models, figured that being paid to take on these risks was "free money" because they never thought they would have to make any payments to cover actual defaults. What they apparently did not take into consideration, however, was the potential write-downs or collateral payments to trading partners (How AIG Failed). But specific regulations dealing with these securities and mortgage default swaps could have possibly prevented all of this. This is where both the company and the government failed.
David Swensen, the person who is credited with creating derivatives or "swaps," eventually paved the way for an entire industry to be built around creating and trading derivatives based on mortgage payments of homeowners (Inventor of the "Swap" blames regulators for Financial Crisis). In the case of AIG, they basically insured these mortgage-backed securities. But the government was seemingly reluctant to regulate these derivatives and the industries that had developed around them, and traders eventually abused them to the point of financial collapse. Part of this was due to the perceived benefit of these swaps by people like former Fed Chairman Alan Greenspan. As Bob Moon notes, "... he called credit default swaps "probably the most important instrument in finance," because they were supposed to spread risk around and stabilize the market" (Banks deep into unregulated 'gambling').
The sad fact is that stricter regulations and oversight on the part of the government, plus more transparency and less greed on the part of financial institutions, could have prevented much of this from happening, including what happened with AIG. Swensen himself says that he supports "requiring swaps and other derivatives to be traded openly on an exchange" since it would reduce the risk, but surprisingly, this very proposal was "torpedoed by both the Clinton and Bush administrations." Why? Swenson theorizes that "Financial institutions that deal in these things have resisted that because it would make the market more transparent and less profitable" (Inventor of the "Swap" blames regulators for Financial Crisis).
2. Sen. Wyden deserves and honourable mention for attempting to discourage such bonuses.
The current uproar over AIG is that $165 million in bonuses was recently handed out to execs in the same sector of AIG that helped caused this mess in the first place. Everyone is up in arms about this, and there is good reason to be. But it turns out that, according to one article in the Huffington Post, Sen. Wyden (D) of Oregon and Sen. Snowe of Maine (R) introduced a provision during the crafting of the stimulus package that "would have forced bailout recipients to cap their bonuses at $100,000" and any amount paid above that "would have been taxed at 35 percent" (Wyden: My Bill Could Have Prevented AIG Mess).
Unfortunately, the same article states that, "The language made it through the Senate, but during conference committee with the House, it was inexplicably removed." But I give props to Sen. Wyden for his effort and foresight nonetheless.
1. The current financial crisis could have been avoided, and so could have AIG's near failure.
It is rather complicated to explain exactly what happened with AIG, but the bottom line is that AIG's financial sector was paid by investment companies to back up securities that were in turn backed by pieces of mortgages. AIG effectively promised to make up the difference if the investments failed. So where did they go wrong?
It seems that AIG, thanks in part to Gary Gorton, the finance professor who designed AIG's risk models, figured that being paid to take on these risks was "free money" because they never thought they would have to make any payments to cover actual defaults. What they apparently did not take into consideration, however, was the potential write-downs or collateral payments to trading partners (How AIG Failed). But specific regulations dealing with these securities and mortgage default swaps could have possibly prevented all of this. This is where both the company and the government failed.
David Swensen, the person who is credited with creating derivatives or "swaps," eventually paved the way for an entire industry to be built around creating and trading derivatives based on mortgage payments of homeowners (Inventor of the "Swap" blames regulators for Financial Crisis). In the case of AIG, they basically insured these mortgage-backed securities. But the government was seemingly reluctant to regulate these derivatives and the industries that had developed around them, and traders eventually abused them to the point of financial collapse. Part of this was due to the perceived benefit of these swaps by people like former Fed Chairman Alan Greenspan. As Bob Moon notes, "... he called credit default swaps "probably the most important instrument in finance," because they were supposed to spread risk around and stabilize the market" (Banks deep into unregulated 'gambling').
The sad fact is that stricter regulations and oversight on the part of the government, plus more transparency and less greed on the part of financial institutions, could have prevented much of this from happening, including what happened with AIG. Swensen himself says that he supports "requiring swaps and other derivatives to be traded openly on an exchange" since it would reduce the risk, but surprisingly, this very proposal was "torpedoed by both the Clinton and Bush administrations." Why? Swenson theorizes that "Financial institutions that deal in these things have resisted that because it would make the market more transparent and less profitable" (Inventor of the "Swap" blames regulators for Financial Crisis).
2. Sen. Wyden deserves and honourable mention for attempting to discourage such bonuses.
The current uproar over AIG is that $165 million in bonuses was recently handed out to execs in the same sector of AIG that helped caused this mess in the first place. Everyone is up in arms about this, and there is good reason to be. But it turns out that, according to one article in the Huffington Post, Sen. Wyden (D) of Oregon and Sen. Snowe of Maine (R) introduced a provision during the crafting of the stimulus package that "would have forced bailout recipients to cap their bonuses at $100,000" and any amount paid above that "would have been taxed at 35 percent" (Wyden: My Bill Could Have Prevented AIG Mess).
Unfortunately, the same article states that, "The language made it through the Senate, but during conference committee with the House, it was inexplicably removed." But I give props to Sen. Wyden for his effort and foresight nonetheless.
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Comments
Of course. But name an economic system that has provided more wealth and more opportunity for more people of the world.
What is happening with AIG right now is the exact opposite of free market capitalism. Adam Smith would be rolling over in his grave right now.
I disagree, KoB: this is precisely the inevitable outcome of free-market capitalism. It is the return of the 'robber barons' of your 19th Century.
Adam Smith was beguiled into believing that the marketplace was benign. It is far from benign when it rests on winners and losers. It is vital to remember that Adam Smith considered that his worlk on ethics to be more important than The Wealth of NationsI. He supported high wages for the poor which is precisely the contrary of the situation in our countries. And, despite his opposition to it, slavery underpinned the economic context within which he elaborated his theories. Capitalism has created wage/mortgage slavery far more destructive and crippling than the slave coffle.
If AIG fails, the world's economic system will collapse within 24 hours. So, like it or not, there is very little chance that AIG will be allowed to go under.
So, assuming that AIG continues to function in some way, shape, or form, the question then becomes, what happens next? And this is when things become really troubling ...
The larger point:
http://atimes.com/atimes/Global_Economy/KC20Dj02.html
What happens next is AIG (1) undergoes chapter 11 bankruptcy, which will allow it to restructure and even try to become profitable again (this is what should have happened in the first place), (2) is put into receivership or (3) gets broken up and then sold off. There are problems with all of these options, but something has to be done.
The way I see it, AIG could do one or more of these things. Even though AIG has already taken $175 billion in bailout money from the Fed, it can still file for Chapter 11, be broken up or both, but it appears that 3 is the more likely scenario, especially since CEO Edward Liddy apparently told lawmakers Tuesday that, "The dividing of AIG is exactly what we're doing so the entity that existed for 90 years as AIG will over time cease to exist" (AIG to be broken up).
I think 2 is the most unlikely option for the simple fact that it would take an act of Congress to create the authority necessary for placing a non-bank holding company into a receivership (Bankruptcy For AIG?). And considering public opinion at the moment, the government needs to be careful about anything else it does concerning AIG.
Thanks for the info.
By what stretch of the imagination? The inevitable outcome of capitalism would mean that, like it or not, AIG would either be bankrupt right now or non-existent. Either way, they probably wouldn't be getting bonuses right now.
Who are the robber barons in this case? The people who get bonuses, or the people who retroactively tax bonuses at 90% at the whim of populist opinion? I'm not even sure if it is constitutional to specifically target a group like that. But then again, it's what is to be expected when bureaucrats with no business experience try to run a business.
At least you and I can agree here. While I applaud Sen. Wyden's original effort to discourage these types of bonuses, I do not agree with Congress' effort to penalize the recipients by adjusting the tax code.
Geithner demands more power in attempt to avert second AIG catastrophe