AIG Bailout … Where Did The Money Go?

Wow.

AIG is some organization. Is it me, or is there nothing else going on? All the newspapers want to focus on is AIG all the time. It has become to poster child of the chaotic collapse of the Reagan era of deregulated, free-wheeling, Wall Street obsessed, ‘anything goes’ economics. Given the enormity of the errors made there I suppose it is fitting that AIG assumes this role. But let’s not forget that stupidity and hubris are the common denominator linking the entire web of financial companies, some of whom – Goldman Sachs for instance – still try to cultivate an air of superiority quite unbefitting to their record in their supposed area of expertise.

They all failed. The entire intellectual underpinning of what they were doing for twenty odd years has been exposed as an illusion. They all thought they had discovered the magic potion of perpetual risk management nirvana, and they were all wrong. Hopelessly and irretrievably wrong. This is one of those historic moments when we can look at people who previously had flaunted their expertise and the wealth it allowed them to accrue and chortle quietly to ourselves. They actually knew nothing. There pompous airs and graces – still much in evidence here in New York City I might add – are a hollow chimera. They traded and lived in what has been exposed as a delusion. Their much ballyhooed skills were so much vapid nonsense. As an elite they have proven to be worthless, their leadership, to borrow from Shakespeare, ‘signifying nothing’.

But what damage they did.

To you and me.

Their overly compensated dreamworld produced and drove asset price inflation: apartments here in New York soared in price as silly young traders flaunted their ‘wealth’. The rest of us ran faster and faster just to stay in place. I suspect a whole raft of social novels is already in production lambasting these people. None of which will wipe away the incredulous look we see on their faces as they slowly absorb the enormity of their incompetence.

There are the defiant ones of course.

Like Cassano, the former head of AIG’s toxic waste department, formerly known as it Financial Products Divisions of London and Connecticut.

This as we know was the center of the delusion. It entered into all sorts of hopelessly unnecessary financial arrangements – e.g. those ‘Credit Default Swaps’ we’ve been reading about – in order to generate vast fees for itself and the ‘traders’ who worked there. The provision of a solid business service was, it now appears, simply a flimsy excuse to justify bonuses for employees. The central business model of AIG’s toxic waste department was purely the enrichment of its employees. Satisfying a customer need or building wealth for their own shareholders were entirely secondary – if they were considered at all.

The problem with picking on AIG is that this mentality pervaded the entire system. Traders made trades to make money for themselves, not to satisfy some fundamental business requirement or to solve a problem.

On the surface Credit Default Swaps [“CDS’s”], while complicated, look as if they serve a purpose. They act as insurance policies against the loss of capital due to default by other forms of financial assets. They were one of the reasons the sub-prime mortgage mess grew unchecked: everyone thought they had insured themselves against the losses they all knew were there. CDS’s were a main plank upon which traders stood when they claimed to have solved one of finance’s great problems: how do you convert bad assets into good assets? They genuinely thought they had succeeded.

Hence the crestfallen looks.

This was case of being smart, very smart, but not thinking. In the end all they did was shift risk about a bit and, meanwhile, get paid huge fees for their efforts. As risk managers they were extraordinarily bad. Never has so much incompetence been concentrated in so few minds – in the guise of brilliance worth vast remuneration. But as illusionists they were massively successful. Never has such an act been applauded and rewarded so copiously.

The whole sad story rumbles on:

Today the New York Times gets snitty over the horrible revelation that some of the money paid to ‘bailout’ AIG actually flowed straight through to its counter-parties. In effect we were bailing them out, not AIG.

Some of those counter-parties should now wipe the smirk off their faces – I’m thinking of Goldman Sachs in particular – since they have now been exposed as stupid too. They would have suffered huge losses had the taxpayers not written the checks to AIG. They were all dumb to be involved in the illusion.

Massively and collectively stupid groupthink dominated Wall Street for decades. But the counter-parties were right to try to protect themselves. They were stupid to be in this business, but they had every right to make a claim against AIG. The story is their dumbness, not their receipt of cash.

Here’s the New York Times getting all breathless today:A.I.G.’s Bailout Priorities Are in Critics’ Cross Hairs

This is a silly story.

Under the terms of the CDS master agreement all counter-parties have certain rights. One of which is to ask AIG to put up more collateral if its credit rating goes down. This is normal. Last September AIG was downrated. Counter-parties asked for more collateral. AIG ran out of cash. And the rest is history. So in reality any taxpayer money going into AIG last year was exactly and completely for the single purpose of making payments out to the counter-parties. Many of whom are foreign banks.

There is no news in this. None. The whipped up hysteria that the bailout somehow wasn’t really to ‘save’ AIG, but to bailout, say Goldman Sachs or Societe Generale is just silly. It was those counter-party claims, made because of collateral calls, that precipitated AIG’s collapse and thus triggered the need for a bailout. Where else was the money going to go?

And the notion that the bailout was poorly targeted because some of the money went to foreign banks is even more silly.

Banking is global. It has been for decades. That AIG did business with Deutsche Bank, Barclays or Societe Generale is not exactly a shock. That it had contractual obligations abroad is perfectly normal. The suggestion that somehow these foreign claimants should get bailed out by their own governments is plain stupidity. This was an American company that collapsed. It owed money all over the place. Tough.

The populist surge against AIG and the other banks is natural enough, but I hope it isn’t allowed to lap over into xenophobic folly. The idea that the French taxpayers should bail out Societe Generale because AIG, of New York, failed is preposterous.

The US has lived off of borrowing from abroad since Reagan set us on the path of deficit spending. It is hardly in a position to boss foreign lenders about. If it owes money is must pay it back. If one of its companies is bailed out it must fulfill its obligations.

Populist rage has to be channeled and dissipated. For Congress to work itself into fury over AIG is understandable, but should produce sensible regulation, legislation and firm leadership, not a backlash against foreign banks who were once a source of the cash we needed to keep our binge going.

What a mess. I will be glad when AIG finally goes away.