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September 15, 2008

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"The situation is dire," a person close to AIG said."

Or to quote former New York Knick Micheal Ray Richardson:

REPORTER: What do you think is happening to the team? RICHARDSON: The ship be sinking.
REPORTER: How far can it sink?
RICHARDSON: Sky's the limit.

Ratings agencies had threatened to downgrade the insurance giant's credit rating by Monday morning

Ratings agencies are the most prolific source of comedians in the United States.

Their downgrading of Lehman on late Monday was quite amusing.

I've been really depressed about this all (and a few other things not really connected to it but all like a storm in my mind: Palin's ascendancy, DFW's death).

I was thinking tonight of the big stories of this decade. I thought of 9-11 and the debacle of the Iraq war and the Enron-era corporate malfeasance, the incipient energy crisis, and now this mortgage and banking crisis. They all share something in common. They were all foreseeable, all arguably preventable, or at least manageable. And in all cases, no one had the will to change things, to even talk about things until it was too late to do much besides watch the horrific consequences unfold.

And this feeling crossed my mind that we've moved past where there was enough political will for our collective problems to be managed and responsibly controlled.

It is as though there are no adults left, as though they all vanished, and the world was given over to children.

I'm amazed. While all eyes are trained on the circus performers in the upcoming November election, the ship is sinking (has sunk).
To Ara, I'm not sure there ever really were any adults, at least, there haven't been any for quite some time. Certainly not in the baby boomer generation, and that means me, at any rate.
Back in the States this summer for five weeks after a voluntary 12 year absence, I was horrified at what I saw : a pseudo culture on its last legs, in spiritual (not moral...) bankruptcy, albeit the fact that there are now two banks and one church on every street corner.
More than 40 years ago (thus WELL BEFORE GEORGE W. BUSH), my grandmother fustigated Brigham Young (the second political and spiritual leader of the Mormon Church) in Salt Lake City for having his back to the Temple, and his hand outstreched to Utah's first bank. That says a lot, doesn't it ?
Personally, although I will lose my shirt in the upcoming financial crisis, I think that this system must stop. And its total indifference to everything that makes us human is about to ensure this.

We can be those adults. There may or may not be enough of us, but as citizens of a democracy, we have to try.

This (AIG) is the big one, not Lehman.

Note that Yves Smith observed that the exposure of the credit market to systemic failure is serveral times larger for AIG than it was for Bear Stearns, because AIG's business was mainly in the area of issuing protection to others, so the counterparty risk if they fail (and the effect it is likely to have on the enormous credit default swaps market) is very, very big.

We will see one of three things happen if AIG is unable to raise enough capital to deal with a ratings downgrade induced deleveraging: either (1) the mother of all Federal bailouts with taxpayer money used to recapitalize them, or (2) the largest systemic failure of the credit markets since the bank failures of the early 1930's, possibly as large as the latter event, or (3) propping AIG up with yet more liquidity - either a loan package put together by other Wall St. firms or direct intervention by the Fed, or some combination of the two (most likely IMHO), which will only kick the problem further down the road and/or weaken the other players who are involved by infecting them with additional risk dervied from AIG's shaky position. In fact if other firms issue loans to AIG, I expect they will be backstopped by the Fed in a manner similar to the Bear Stearns takeover.

We should be so lucky as to get stuck with the bill for (1) or (3), but if the authorities are not fully prepared to move quickly enough, we may get (2) even if the intent to bailout or prop them up exists.

I'm guessing option (3) is the most likely and appears to be already underway as we speak, which means that a fork in the road where we get either (1) or (2) will come later, probably after the election.

Also, what hilzoy said about being adults. Our grandparents (give or take a generation depending on how old you are) survived the Great Depression and helped to defeat totalitarianism. We will survive this.

Ben Bernacke just opted for letting AIG fail (AIG is solvent, but it's illiquid. The market is not clearing), citing moral hazard and the danger of inflation.

Bill Gross of PIMCO, the greatest bond manager since Alexander Hamilton and, I hope, Treasury Secretary under an Obama adminstration, said the decision is "other-worldly" and moves us closer to a financial tsunami.

The US Government, under Republican rule, is betting the house on an ideology.

Pol Pot didn't care for people who wore glasses and made it policy.

The Andrew Mellon wing of the Republican Party doesn't care for government altering where the chips may fall.

If the ship goes down, the gates in steerage have just been locked, folks.

But it's a love story.

We're all Donald Luskin now. Because we have to be.

One tidbit about the wonderful interconnectness of our financial world.

AIG insures the rent payments for Lehman Brothers offices in London.

How I long for the days when insurance and investment banking were so boring that nobody wanted to do them unless they were overpaid for spending the entire day engaged in an activity about as exciting as reading the telephone directory.

In further news, The FED has been pursuaded by people screaming at them over their cellphones as they step off of window ledges to cobble something together for AIG.

Let the moral hazard begin! Right, conservatives?

I'll bet rational conservatives all over the country all running down the streets feeling compelled, zombie-like, to do something, anything, financially irresponsible because the incentives-Gods are sending the signal.

Better to let the world collapse than abandon principle.

Just kidding. Pretty much.

Well, mostly.

Sort of.

O.K., I'm being sincere.

Well, I don't know what comes over me.

By the way, the market likes the news of a gummint work-out..... today.

How's Larry Kudlow going to explain this, since, you know, the market is always right?

How's Larry Kudlow going to explain this, since, you know, the market is always right?

You don't get it, do you John? For people with a Panglossian view of "the market", the proposition that "the market is always right" is a premise, not a conclusion. An axiom, not a theorem. Arguing about it is like arguing whether Euclid's 5th Axiom is "true".

--TP

The market is just like movement conservatism: it cannot fail, in can only be failed.

Here's a Bloomberg article regarding the Dance Macabre going on around AIG right now – parts of it sound almost like an English comedy of manners, which would be funny if there weren’t so many people’s livelihoods at stake.

Here's the political positions being staked out (quoted from story linked to above):

Republican presidential nominee John McCain told CNBC today that there is a ``moral hazard'' in forcing taxpayers to be responsible for the poor performance of companies.

Asked whether regulators should allow AIG to fail, McCain said, ``I think you have to.''

Senate Banking Committee Chairman Christopher Dodd warned the Fed and Treasury against a rescue of AIG without checking with him first, expressing anger about past incidents where he was only informed afterwards. He also said he was skeptical that AIG merited aid while Lehman didn't.

``Tell me why this situation is different from Lehman,'' the Connecticut Democrat said today. ``I'm willing to listen.''

Two comments:

- So does this mean that if AIG fails and the global credit markets seize up tight, that John McCain will take his lumps for being in favor of the worst financial catastrophe since 1930-32, or do you think these words will go down the memory hole?

- Since accusations are sometimes leveled at the commentariat here of never having anything negative to say regarding Democrats, let me add that I hope what Sen. Dodd means is "come explain to the general public why AIG is different from LEH, in my forum". Because if he really doesn't yet know what the difference is between the two firms he should resign his committee chairmanship for reasons of gross ignorance of the subject matter.

Anyone who has been following the financial press with any degree of care for the last 3 months should be able to tell you right off the top of their heads that both LEH and AIG were expected to fail sometime soon, and what the most salient differences between them are, which have a rather large bearing on the question of bailouts, pro- or con-, for either one of them.

If the Senate Banking Committee Chairman doesn't fall into the category of people who are thusly informed, something is seriously wrong in DC.

I'm a hopeless romantic, Tony.

Oops, my rotting nose just fell off.

TLTIA: There was an interview on the radio on Monday -- I can't for the life of me figure out what or who, since it was on a station I don't normally get (107.9, hooray wrong turns in the country) -- in which various administration apologists said exactly that, that this was not a failure of the markets but rather of ineffective regulation. Not that more regulation was needed, mind, oh no -- just "better".

Oh, and one of the guests (a woman from the Harvard Business School?) said that the correct response was not just "better", but probably not more, regulation, but -- wait for it -- a renewed sense of corporate responsibility. Yes, that was her predicted, and prescribed, cure: that everyone in the banking industry promise not to do this again.

Your Mileage May, Indeed, Vary.

Anarch- Yes, that was her predicted, and prescribed, cure: that everyone in the banking industry promise not to do this again.

How dare you impugn the honor system? We could eliminate prisons overnight if we just required criminals to promise not to commit a crime again. Now retract your statement sir!

Sounds like faith-based capitalism to me.

Or perhaps it would work if we established a rule that all the C-level officers (both current and former) have to spend 1 year in prison for every billion dollars of taxpayer bailout money issued to keep a company alive.

Screwed up? You need $25 billion in a big hurry? Sure, no problem. Here's your organge jumpsuit. See ya' about 2033 or so.

"We will survive this."

I suppose we will. But this generation and the one before it -- and maybe even the one before that -- have never had to make sacrifices for the common good.

Hooray for him since he wants to take it on. But I'm not sure even Barack Obama knows what kind of challenges await him if he is victorious.

---

Here's a scary thought: I forgot who said it last night -- maybe Maddow -- that if McCain wins you can bet that the Treasury Secretary will be Mr. Whiner himself: Phil Gramm.

Heaven help us all.

We can be those adults. There may or may not be enough of us, but as citizens of a democracy, we have to try.

Reminds me of one of my favorite quotes from E. M. Forster:

I believe in aristocracy, though - if that is the right word, and if a democrat may use it. Not an aristocracy of power, based upon rank and influence, but an aristocracy of the sensitive, the con- siderate and the plucky. Its members are to be found in all nations and classes, and all through the ages, and there is a secret understanding between them when they meet. They represent the true human tradition, the one permanent victory of our queer race over cruelty and chaos. Thousands of them perish in obscurity, a few are great names. They are sensitive for others as well as for themselves, they are considerate without being fussy, their pluck is not swankiness but the power to endure, and they can take a joke. I give no examples - it is risky to do that - but the reader may as well consider whether this is the type of person he would like to meet and to be

btfb,

There was a time earlier this year when it seemed clear to me that a Democratic President (should they win) was being set up with an intractable set of problems, so as to become the Jimmy Carter of the early 21st Century, allowing the GOP to sweep to victory in 2012 and then continue strip-mining the country for another decade or two before people got sick of it. I thought that in the long run (i.e. on a scale of decades) that it might not be so bad to have John McCain win this year and own all the failures that are likely to happen for the next four years.

Then came the Russia-Georgia conflict and the Palin VP pick. I decided that having people in the WH who don’t shrug their shoulders in indifference (or rub their hands in glee) over the prospect of war with the country holding the world’s 2nd largest nuclear arsenal was probably more important, in the greater scheme of things. I’d rather have the GOP sweep to victory in the 2012 elections than risk that there might not be any of us left alive to vote in 2012, for either party.

I’d rather have the GOP sweep to victory in the 2012 elections than risk that there might not be any of us left alive to vote in 2012, for either party.

I thought my generation wouldn't have to worry about the threat of nuclear annihilation. That was supposed to be one of the big perks of the Cold War ending. Now I'm in the market for a fallout shelter. Thanks a lot foreign policy geniuses.

Yes, LeftTurn, I don't think we can take anything for granted about 2012 when the stakes are too dire for 2008-09.

---

A general criticism of both Obama and McCain: It was a shame to see it took the Lehman/AIG crisis for the campaigns to finally focus on the economy. This truly is The Short Attention Span GE.

Fed to offer bridge loan in exchange for control of AIG.

As Atrios would say: WHEEEEEEEEEEEEE!

Here's a good point Gerard Seib makes in this Wall Street Journal article that exposes a weakness in the Palin pick:

"Had former venture capitalist Mitt Romney been the running mate, he could look comfortable doing a television interview talking about a crisis of confidence in the markets; that's a lot less likely with Gov. Palin."

IIRC consensus on the political blogs I read was that a possibility of Romney being picked as the VP nominee was "foreclosed on" as a result of (1) McCain's I don't recall how many houses I own gaffe, and (2) Obama's choice of Biden as VP (Biden is ranked 2nd to last in net worth in the Senate and only owns 1 house).

The reasoning being that against a McCain/Romney ticket, the Dems could have run class warfare ads on TV for the next 2 months bashing them as a pair of out of touch rich guys.

John Thullen's buddy Larry Kudlow continues to sing the praises of free markets.

As a rule, I find it hard to follow economics -- they speak a different language from you and me. But Kudlow isn't even grounded in reality -- well, he is, but it's his own happy reality.

What I don't get about this is if AIG is that important to the global economy that it can't be allowed to simply go bankrupt, why aren't the other central banks pitching in here? Why is it just us?

TLT, there was also the speculation that the Christian Right would have been unable to abide with a VP who was Mormon. Of course, this speculation was stronger when it appeared that Romney might be the presidential candidate, but if those observations were true (here's a Googled link as a cite), they would also apply to him being chosen as VP, something that is underlined by the fact that, as I understand it, Palin was a choice floated in a lot of Christian right circles.

Justin,
If the other central banks are doing what japan is doing, they are pouring money into their own systems so the US system doesn't drag them down with them and probably view saving AIG as throwing good money after bad.
link and a rundown of Asian governments are doing.

LJ: Thanks, and of course that makes sense. Forgot that the global stock market tanked yesterday (or Tuesday in Asia due to the holiday) and everybody's got their own problems right now.

These robot traders need to adhere to Asimov's First Law.

$85 billion.

I don't think that's enough.

How do I know that?

Because the figure three days ago was 25 billion.

Yesterday, it was 50 billion.

This morning, the free market consortium of Wall Street thugs failed to come up with 75 billion.

Tonight, the taxpayer bid $85 billion, you know, from around the kitchen table, where these decisions are made.

I say there was deliberate non-transparency by Republican design all these years, and I say $85 billion is only a partially transparent figure.

The world remade in the image of Enron.

It's Obama's fault. You watch. The black man will take the rap.


It's now a done deal - a 24 month $85 billion (which is more than the Gross State Product for my home state, i.e. more than everybody in my entire state produces in a year) loan from the Fed.

50 billion here, 85 billion there, pretty soon we'll be talking real money.

see the top article at calculated risk for details, or any of your favorite other econ blogs. I'm sure debate will be raging over this, at least until the next crisis (WaMu, is that you?) rears its ugly head.

Quoted from the Fed, by way of CR:

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

Today, we are all socialists.

50 billion here, 85 billion there, pretty soon we'll be talking real money.

Actually, any sentence that contains the word "billion" is incomprehensible to real people who deal with real money.

Let's say there are 100 million households in the US. (That's just for simplicity. The number may be 200. But the order of magnitude is right.) So, a billion dollars is $10 per household. Then, eighty-five billion dollars is $850 per household.

Now, if you asked the average head of household in the US whether saving AIG is worth $850 to them, the answer would probably be "Hell, no!" It might be an ill-informed answer, but that's not my point.

My point is that if you convince the average head of household in America that Republican policies just cost them $850, you make a whole lot more political hay than if you talk about "$85 billion." At he very least, talking per-household numbers makes it clear that when McCain caterwauls about some $85 million "earmark", he's making a big deal about 85 cents.

Exercise for the reader: the US national debt is about $10,000 billion. Do the math. The average household owes:$_____?

--TP

Today, we are all socialists.

One of the commenters at CR said the same thing, but (and please forgive me for saying this), his snark was way funnier.

Someone with some photoshop skills might consider whipping up a few of these, appropriately altered

Now if we could just find a major healthcare provider that is in terribly desperate financial straits, and take them over via a bridge loan* from the Fed, we could get socialized medicine via the back door.

*Another good piece of snark seen in CR comments: this isn't a bridge loan, it's a pier loan - it's just long enough to get AIG out to the plank that they will be forced to walk.

$850 a household. Nice number. Now, if in fact it prevents a worldwide financial meltdown, the households will in general be much better off with their $850 plowed into this effort; if anybody got to that level of subtlety in the political debate, we'd just have to go around again to the Message, that the Repugs made this expense necessary.

Speaking of 850: I read that this loan draws interest at 850 basis points above 3-month LIBOR. In English, according to a table I saw, that's like 11.3% ! Compare Prime at 5%. Compare a good 30-year mortgage, if you can get one, at 5.9%. These are current rates.

The Fed isn't giving the money away. Good for them. And AIG's situation must have been utterly bloody desperate.


Speaking of 850: I read that this loan draws interest at 850 basis points above 3-month LIBOR. In English, according to a table I saw, that's like 11.3% ! Compare Prime at 5%. Compare a good 30-year mortgage, if you can get one, at 5.9%. These are current rates.

The Fed isn't giving the money away. Good for them. And AIG's situation must have been utterly bloody desperate.

Reading between the lines at some of the econ blogs (I haven't seen a solid analysis yet), these very high rates are designed to encourage AIG to continue to seek private financing by being set so high that with luck they will be able to find other sources willing to lend them money at rates below what the Fed is stipulating.

In other words, the Fed has told AIG - here, we'll give you a loan for all you need to prevent a default (which would trigger an immediate settlement of their CDS positions - that is what is really putting the fear of God into everybody), but at terms that mean you will use as little of it as possible for as brief a period of time as you can, while continuing to look for a better offer somewhere else.

How they got AIG management to sign off on this deal (other than by threatening to line them up against a wall and shoot them) rather than just declaring bankruptcy I have no idea (since this deal is basically bankruptcy in slow motion), but under the circumstances I'll take it.

One of the commenters at CR said the same thing, but (and please forgive me for saying this), his snark was way funnier.

Haha, thanks for the link.

Another good piece of snark seen in CR comments: this isn't a bridge loan, it's a pier loan

Someone else called it the Bridge to Nowhere loan...

How they got AIG management to sign off on this deal (other than by threatening to line them up against a wall and shoot them) rather than just declaring bankruptcy I have no idea (since this deal is basically bankruptcy in slow motion), but under the circumstances I'll take it.

So, let's get this straight, TLTIABQ:
AIG = Tracy Minda
Uncle Sam = payday lender
Is that roughly what's happening here?

--TP

TP,

In a nutshell, yes.

In Wall St. terms, Libor + 850 is a mugging with serious head trauma damage. Somebody in the CR comment thread I linked to earlier actually called them (the Fed) the Federal Payday Loans.

I read elsewhere (not yet sure if this is accurate or not), that if AIG had gone into bankruptcy, the bankruptcy court might have been able to clawback the most recent bonuses received by their officers (which explains why they are all for taking this deal), and apart from that perk, this deal amounts to about the same thing under a different name.

Basically the Fed decided to shoot AIG and charge them for the cost of the bullet, just like the Communists.

Note that this comes after AIG rejected several last ditch attempts at working out a deal with potential buyers (who apparently didn't bring good enough terms to the table). It makes me wonder if the Fed is sending a message 'pour encourager les autres' to anybody else out there who is thinking of stepping up to ask for a bailout.

Or perhaps it would work if we established a rule that all the C-level officers (both current and former) have to spend 1 year in prison for every billion dollars of taxpayer bailout money issued to keep a company alive.

A billion here, a billion there... pretty soon it adds up to real jail time.

Tony P: The 2000 census quotes the figure as 105.5 million households so, well done on that estimate!

BTW, TLTIA: Ha! I hadn't realized you'd used the same quote upthread. Great minds, etc.

"In Wall St. terms, Libor + 850 is a mugging with serious head trauma damage. Somebody in the CR comment thread I linked to earlier actually called them (the Fed) the Federal Payday Loans."

Not really. Not in todays market.

A floor of 8.5% for two years is not that far out of line.

Put it in perspective with what FRE paid just a few short months ago for money. FREpZ had a minumum coupon of 7.875% for four years, and 8.735% at issue.

Granted AIG had to put up all its assets whereas FRE did not put up any, but still, the actual interest burden is not all that different.

My opinion is that AIG actually got a pretty good deal, all things considered.

My opinion is that AIG actually got a pretty good deal, all things considered.

It isn't a zero sum game in this case. AIG got a better deal than straight up bankruptcy (and the execs don't have to worry about their compensation being clawed back), while the Fed managed to keep the levees from collapsing (i.e. a CDS unwind) on terms that look pretty good under the circumstances.

For the latter, see comments at both CR and nakedcapitalism. For example, see especially the comments by Lune at 9/16 11:30pm and Anonymous at 9/17 8:09am on Yves' blog for a breakdown of the details that IMHO are getting it right.

I stick with my earlier comments.
I am learning how to grow a vegetable garden : you see, since my 1920 born parents kept my head in the clouds (they and their generation found the Depression way too depressing, even though they managed to survive it (with a vegetable garden...), I never learned how to do a lot of those really basic things that, well, a lot of people of my generation, and the next, can't manage to do.
I maintain also that for some of you out there, your noses are too pressed into the page to have perspective to see what's really coming up. And it's definitely not pretty at all.
I don't really feel like joking about it these days. There's a limit to my cynical humor, even at the best.

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