The big news of the day is unquestionably the bailout of insurance giant American International Group (AIG):
The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.
The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.
The message here is quite clear: AIG was just too big to be allowed to fail. I suspect that a particular concern was AIG’s business in insuring bonds. Increased perception of risk in the bond market could be disastrous not only for thousands of corporations but for thousands of governments.
AIG’s problem was a third level consequence of the ongoing subprime mortgage mess, resulting not because people had taken out mortgages beyond their means nor because banks couldn’t meet their margins but because AIG was a major risk mitigator in the mortgage business. Insurance companies are just the next domino to fall. I wonder what the next one will be? I’m guessing state and local governments.
I find this bailout troubling on a number of grounds. Moral hazard, ironically a term from the insurance business, is a big one. When you indemnify individuals or companies against risk, they’ll take more risks. Unless there’s some governing mechanism put in place at some point they’ll ultimately fail in that positive feedback loop and they’ll fail more catastrophically than they otherwise could have. This bailout is another instance of Keynes’s quip “When you owe the bank 100 pounds, you have a problem;when you owe the bank a million pounds, the bank has a problem.”. Only in this case “the bank” is us.
In a time of sovereign wealth funds and state monopolies competing internationally we need big institutions of our own to match. If the institutions are government-owned and -operated, we’ve become a command economy with all of the attendant problems. If we privatize profits and nationalize losses with bailouts, we continue the positive feedback loop. If the institutions are truly private, they must be allowed to fail.
However unpalatable it may be we’ve got to start developing the means for coping with mega-corporations in a way that’s consistent with our character as a nation, with our peculiar society. I have no idea what that will entail. Some sort of mandatory insurance with premiums based on the company’s size?
I continue to think that there isn’t a great deal of political hay to be made from this crisis. It’s a bipartisan mess that’s taken decades to develop and which will require a bipartisan solution. Unfortunately, we’re not in a particularly bipartisan sort of mood.
Cramer made an interesting point on MSNBC, he said (and I paraphrase) that Americans are not primarily at risk from an AIG failure, it’s the international accounts, but the Europeans are too slow and stupid to take responsibility. If this is true, then it puts an exclamation point on “too big.”
(Although IIRC in the golden age of British finance, the Bank of England would lead an intervention to prevent bank failures that would have probably hurt foreign countries worse than the British)
Yeah, I made the same observation myself over at OTB.
There are a couple of reasons for this including various sovereign wealth funds’ and foreign banks shares in AIG, AIG’s ownership of various foreign assets.