Since the $182 billion bailout, state regulators have said that its core business was sound, and that the problems were confined to a single high-risk unit. Uh, maybe not. David Merkel (CFA) at AlephBlog has been looking at this issue for some time now, and see the full PDF/Excel analysis. He also makes a compelling case that the bailout was unnecessary. Now, the New York Times is taking a harder look at the solvency of AIG's subsidiaries... and seems to be coming to the same conclusions as Merkel's analysis:
"...state regulatory filings offer a different picture. They show that A.I.G.'s individual insurance companies have been doing an unusual volume of business with each other for many years -- investing in each other's stocks; borrowing from each other's investment portfolios; and guaranteeing each other's insurance policies, even when they have lacked the means to make good. Insurance examiners working for the states have occasionally flagged these activities, to little effect. More ominously, many of A.I.G.'s insurance companies have reduced their own exposure by sending their risks to other companies, often under the same A.I.G. umbrella.... But A.I.G.'s companies have reinsured each other to such a large extent, experts say, that now billions of dollars worth of risks may have ended up at related companies that lack the means to cover them."
In other words, they're cooking the books. Legally, but dishonestly. Another player in a game that's harder and harder not to see as rigged. That's bad for capitalism as a whole, and bad for the country.
Maybe it's time to go through all of the "too big to fail" financials, and send them into breakup. When even Forbes Magazine is starting to float this idea, it's time for a serious look.
This smacks of the Enron scam: Lay off your liabilities on entities that are - barely - de jure independent, but in fact have no practical ability to capitalize themselves separately from the mother ship. This is less risk mitigation and more just sweeping the problems under the rug, and counting on a bailout when worst comes to worst.
People are going to scream for more regulation, but just like everything in this mess its not a question of the laws on the books, its a matter of enforcing them. The other problem with 'too big to fail' companies is that generally they are too big to slap with fines or drag into court for violating the law. They have too many congressmen on their speed dials.
The latest debates have made something clear to me- as a nation we have stopped expecting government to work, much less holding people responsible when it doesn't the way we supposedly hold those in the private sector responsible.
The right generally considers government such an inept cesspool that they have stopped even bothering with the pretext of reform, notwithstanding the fact that the generally vote for many of these programs. The left is either so hyper-sensitive about the subject politically (see above) that they turn a blind eye- or (my theory) they are for some reason ok with government being monumentally inept in a way they would never accept from the private sector. I believe this stems from a comfort in 'the plan', even if 'the plan' is horrifying (to paraphrase The Joker). This is obviously a very broad brush of psycho-analysis, but I think there is a case that the liberal mindset craves somebody being in charge in a way that doesnt exist in chaotic systems like economies and society. The idea that the self-organization of the free market will yield better results when pared to effective limited government is anathema to that mindset, no matter what history says. Consider Stalin's observation about tragedy and statistics.
What washes is out is that neither party is any longer interested in the nuts and bolts of getting the government we have to work functionally, much less efficiently. That's the worst of both worlds.
Mark, #2: What washes is out is that neither party is any longer interested in the nuts and bolts of getting the government we have to work functionally, much less efficiently. That's the worst of both worlds.
Yup. Both parties are more interested in simply playing to voters' emotions, particularly fear and anger. Bailouts and the "too big to fail" mentality are all about the fear of widespread catastrophe if some company goes under. In AIG's case there was also the fear that if they collapsed on Bush's watch before the election, the resulting anger at the GOP would not only destroy whatever slim chance John McCain may have had of winning, but cost them even more seats in Congress, and give even more momentum to the incoming Obama administration's drive for "change".
Joshua... Let's assume your analysis is 100% true. So why the lack of responsible regulatory scrutiny now?
Break it you bought it? Maybe its safer just to ignore incompetence rather than try to fix something and risk failure. Not watching money is very lucrative in Washington. Also I think the Obama administration doesn't want to acknowledge government incompetence period. Its hard to argue for bloating government further still when you demonstrably can't get what we already have to work.
My preferred reforms to this industry would be 3-fold:
1. Make Credit Default Swaps illegal (voiding all existing instruments). Credit Default Swaps are inherently fraudulent, and spread greater losses throughout the economy when a firm does fail.
2. Make High-Speed Trading Programs useless, via enforced execution delays. High-Speed Trading is now reportedly 70% of market volume. It is not even done to own stock, it's done to make the rubes without it pay more when they're buying. Which means it's a negative value arbitrage - one that can magnify downswings in the bargain, and sends false signals re: market liquidity. Haven't we been here before?
3. Put every financial institution considered "too big to fail" through forced breakup, lowering their size and influence and allowing them to specialize.
The current bailout culture is funneling billions into a part of the economy that looks more and more rigged, while fundamental value sectors and critical sectors like energy continue to erode. It's just setting the table for the next big disaster, while providing a perfect example of the insiders' chosen role in Obamanomics.
None of this is being seriously challenged, by either party. The GOP challenges the bailout approach, but it's about "the government should never interfere" instead of "our financial sector has to contribute to a productive underlying economy, to which it is subservient."
I believe these chickens are going to come home to roost. Probably sooner than most people think - we may have a few more demonstrations by the end of this year.
"3. Put every financial institution considered "too big to fail" through forced breakup, lowering their size and influence and allowing them to specialize."
Reintroducing Glass-Steagall seems like a no-brainer, the repeal of which, ironically, was sweetened with the Community Reinvestment Act, which got the ball rolling (kicked by the government naturally) on sub-prime lending.
Freddie and Fanny are troubling as well- I don't think people understand how much chaos can be introduced into a market by a quasi-government entity. You can't be kind of pregnant.
Its not just what they do, but the fact that they are doing it. And lest we forget (ahem) only AIG has taken more bailout funds... and thats SO FAR. For all the pitchforks and torches out for the private company, we've heard nary a word about Fanny & Freddie, two of the prime (subprime anyway) suspects. They may not have written most of the bad loans, but they bought up plenty, and just their ability and willingness to make dangerous loans with no real consequences for them certainly chummed the waters.
From Aleph:
I disagree.
AIG was for many Asians the face of American financial prowess. Asia holds some couple-three trillion in Treasury securities.
There was an incipient run on AIG subsidiaries in Singapore last fall.
This is strictly - but not exclusively - my opinion - letting AIG go may have precipitated a run on the dollar. At the very least, the risk was real.