Last fall, a burst of financial meltdowns scrolled across the headlines: Bear Stearns, Lehman, Merrill Lynch, Morgan Stanley (almost), Wachovia. But one of these companies will end up being more expensive to you, the taxpayer, than all of them combined: AIG, formerly one of the world's largest insurers.
Follow me below the fold to see why...
Tomorrow's NYT has an article on AIG by Joe Nocera that performs a post-mortem on AIG's continuing failure (we're coming up on bailout #3, folks). I can't recommend this article enough -- it is the clearest explanation of a financial flim-flam that has been just technical enough to escape widespread notice. Unless you're willing to wait for the Michael Moore movie, read this article!
A few key points from this article:
- When we're bailing out a company like AIG, we're not doing this to save the floundering company: we're doing it to save their counterparties. (This is Wall St.-speak meaning trading partners.) AIG wrote insurance policies [credit default swaps (CDSs)] for hundreds of billions of debt and, yep, the levees on Wall St. broke and it's time to pay up to the tune of up to $250 billion:
A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.’s dubious business practices during the housing bubble it pretty much has the world’s financial system by the throat.
If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks "will face their own capital and liquidity crisis, and we could have a domino effect." A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.
- AIG was a bad actor and we're going to pay for it (like it or not).
When you start asking around about how A.I.G. made money during the housing bubble, you hear the same two phrases again and again: "regulatory arbitrage" and "ratings arbitrage." The word "arbitrage" usually means taking advantage of a price differential between two securities — a bond and stock of the same company, for instance — that are related in some way. When the word is used to describe A.I.G.’s actions, however, it means something entirely different. It means taking advantage of a loophole in the rules. A less polite but perhaps more accurate term would be "scam."
Be sure to read the details -- the regulatory arbitrage wasn't a solo swindle by AIG: the ratings agency and all client banks were complicit in the con.
- The SEC and industry self-regulatory groups failed. No, FAILED. Think Hindenberg.
It’s not as if this was some Enron-esque secret, either. Everybody knew the capital requirements were being gamed, including the regulators. Indeed, A.I.G. openly labeled that part of the business as "regulatory capital." That is how they, and their customers, thought of it.
And that $250 billion insurance policy referred to in the title? You don't remember? You wrote that policy on AIG and didn't even know about it...