What Would Happen If We Let AIG Fail?

First of all, why was AIGFP (American Internation Group's Financial Products) division in financial trouble?

Allegations of accounting irregularities, caused AIG to be downgraded from a AAA to A credit rating. This downgrade triggered provisions in some of AIGFP's credit default swaps which requiried AIG to provide billions of dollars in collateral to their counterparties. (Counterparties are companies like Goldman Sachs which bought credit default swaps from AIGFP to insure against mortgage defaults within their mortgage backed securities.) Since AIG didn't have the money to put up this collateral, the government loaned them $170 billion. This was called a loan but there is almost no chance that the loan will ever be repaid. This is because the AIGFP division has no intrinsic worth and the has no prospects for significant future income since the real estate bubble on which it thrived on has burst.

AIG recently released a list of their counterparties who received the bailout money. Most of this American taxpayer money went to European banks.

On April 2nd, Hank Greenberg, former CEO of AIG, testified before congress that the taxpayer would have been much better off if the government had allowed AIGFP to file Chapter 11 bankruptcy. (Video of Testimony) Through this process, AIGFP would be broken up and sold off. The proceeds would go to their creditors. If this were to occur, the counterparties would have only received maybe 20% or 30% of the money that AIG owed them, but Greenberg said it definitely would not have led to systemic failure of the entire financial system.

It makes sense. For instance, Goldman Sachs received $12.9 billion in counterparty payments. That's far less than the $18 billion that they spent on executive bonuses in 2007. So the receipt of only $3 billion through an AIG bankruptcy settlement would not have broken them, but it would certainly have brought down exective compensation.

Numerous congressmen have requested the Treasury Department's explicit explanation of how AIGFP division's bankruptcy would destabalize our county's entire financial system. Naturally, the Treasury has failed to provide a description of this scenario. This, in conjunction with the fact that Goldman Sachs was President Obama's number 1 campaign contributor, should make anyone suspicious of our government's motives. In fact, Goldman Sachs has spent over $43 million on political contributions. This is a paltry sum when compared to the tens of billions they made off of the AIG bailout.

The bottom line is that the average household in America had to shell out around $2000 to make sure that AIG's counterparties (giant financial institutions) wouldn't have to accept the risk which they made when they allowed a private entity, AIG, to insure on their behalf with a public statement that they were able to evaluate. Losses are socialized and proftits are privatized. I can garuntee that each household would not have recevied $2000 from AIG had these investments turned out to be successful.

Financial Sector Costs Us More than All Food, Utilities and Construction Sectors

The purpose of the financial services industry is basically to transfer money from savers to entrepreneurs. It primarily consists of using a computer to shift money from one bank account to another. This service requires virtually no physical labor and very few material resources.

Yet, this relatively simple service cost our country more than $2 trillion in 2007. That was more than the country spent on health care, construction, food, utilities and transportation.

It's clearly unreasonable for this financial paper shuffling to cost us more than the construction of the skyscraper where the paper shuffling will then take place. How does this industry get us to spend such an inordinate amount of money on their services. Through smoke and mirrors as the recent crisis has shown us.

The free market system automatically optimizes resource allocation to satisfy society's wants and needs. The current problems in our financial sector can be seen as our economy's attempt to reduce the excessive size of the financial sector and redirect those resources to more productive purposes. Yet, the government is doing everything in its power to counteract this process. The feds have taken or committed to take over $12 trillion from the other sectors and given them to financial institution to maintain this imbalance. This works out to $42,105 for every man, woman and child in the U.S.

Why is government taking money from the paychecks of working people and giving it to AIG and Goldman-Sachs? They claim that their failure will result in the collapse of our entire economic system which would eventually lead to a dystopian Mad Max scenario. However, the presented choice between government bailout and complete financial collapse is a false dichotomy. In reality, if the government allowed these irresponsible actors to fail, they would enter a bankruptcy process and be sold off to more smaller, more responsible companies.

Correlation doesn't necessarily imply causation. However, the reason the government is so set on using tax dollars to prop up these insolvent companies as opposed to taking the bankruptcy route might be related to campaign contributions. For instance, AIG executives gave more than $630,000 during the 2008 political cycle even as the company was falling apart. President Obama collected a total of $130,000 from AIG in 2008, while McCain accepted a total of $59,499. Last year AIG and its subsidiaries spent about $9.7 million on federal lobbying, or about $53,000 for every day Congress was in session in 2008. Additionally, Obama's top presidential campaign contributor was Goldman-Sachs. McCain's was Merril-Lynch.

For all the awful investments AIG made, this political investment has produced a 1730000% rate of return.

Household Debt to GDP Ratio = 100%

The Household Debt to GDP Ratio is 100%. That means the average family has as much debt (mortgages, auto loans, credit card debt) as they earn in a year.

For a most of the 20th century, the Household Debt to GDP Ratio's been under 50%. The last time it reached 100% was 1929. Note the twin peaks in following graph.


This suggests that our current crisis is about something much simpler than credit default swaps, derivatives, or toxic assets. It might be that the significant increase in the standard of living we've seen over the past twenty five years was not brought about by an increase in the median wage. It's been brought about by an increase in the median household debt.


We can't just keep borrowing more and more forever and paying it back is painful.


Here's a link to an excellent easy-to-understand radio program on the whole banking mess:
http://www.thisamericanlife.org/Radio_Episode.aspx?sched=1285

Bailout Costs $16,000 per Worker

This is the only clear examination of the true costs of the bailouts that I've seen.

These ideas are so simple, yet so rarely ever expressed in the mainstream media.

Obama to cut deficit in half... After quadrupling it.

"Obama plans to slash deficit in half" is the title of this AP story. The attribution of fiscal responsibility to our current president is rather misleading.

Here's a graph from a Wall Street Journal article of the annual federal budget deficits over the last 30 years.



Bush’s worst deficit was less than $500 billion. Obama’s 1^st might be $2 trillion. Then in four years, he says he might decrease it to $533 billion.

That’s still the worst annual deficit in the entire history of the United States. Then that AP story tries to portray him as a fiscal conservative.

Preposterous, indeed!

Historical Examples Show Government Intervention Only Prolongs Economic Downturns

This study by the Federal Reserve examines the effects of government intervention and the absence thereof in two similar financial crises which occurred simultaneously in Chile and Mexico.

Chile liquidated the insolvent banks and instituted a new regulatory system to prevent future abuses. Mexico nationalized the entire banking system keeping the insolvent banks on life support at the expense of the taxpayer. This is what happened.



The lesson is clear. If the government subsidizes bad behavior you get more of it. If the government taxes good behavior you get less of it.

Yet that's exactly what were doing. We're taxing successful, competently run businesses to subsidize irresponsible, poorly run businesses. Until we realize this simple fact, the previous trend of increased productivity and standards of living will only be a memory.

Debt to GDP Forecast Chart

Those defending the huge budget deficit incurred by the massive federal stimulus package often say, "These are extraordinary times. We can't afford to worry about the national debt now. We'll be in a better position to deal with that later."

The falsehood of that statement is best illustrated by the following chart.


http://en.wikipedia.org/wiki/United_States_federal_budget