WHEN IT'S TIME TO ASK "WHY?"
When AIG first faltered, there were two companies jammed under one roof. One was a highly regulated, state supervised, life insurance company. In fact, the biggest such firm in the world. The other firm was an unregulated structured finance firm, specializing in credit default swaps and other derivatives. The first firm was Triple AAA rated. They had a long history of steady growth, profitability, excellent management. They made money (as the commercial goes) the old fashioned way: They earned it. This half of the company held the most important insurance in many families’ financial lives: Their life insurance.
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The other part of the firm was none of the above. It was neither regulated nor transparent. It existed only in the shadow banking world, a nether region of speculation, and of big derivative bets. This part of the company engaged in the most speculative of trading with hedge funds, banks, rank speculators, gamblers from around the world. Huge derivative bets were placed, with billions of dollars riding on the outcome. It served a far more limited societal function than the Life insurance portion, other than a legal pursuit of profit. This part of AIG was nothing more than a giant structured finance hedge fund.
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It was exempt from any form of regulation or supervision, thanks to the Commodities Futures Modernization Act. This ruinous piece of legislation was sponsored by former Senator Phil Gramm (R), supported by Alan Greenspan (R), former Treasury Secretary (and Citibank board member) Robert Rubin (D), and current presidential advisor Larry Summers (D). It was signed into law by President Clinton (D). It was the single most disastrous piece of bipartisan legislation ever signed into law.
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Here is the question that every single taxpayer should be asking themselves: WHY AM I PAYING $1000 TO BAIL OUT THIS GIANT HEDGE FUND? Of all the many horrific decisions that Hank Paulson made, this may be his very worst. That is a very special description, given his track record of incompetence and cluelessness. What should have been done?
Simple: When we nationalized AIG, we should have immediately spun out the good, solvent life insurance company. It is a highly viable standalone entity. The hedge fund should have been wound down in an orderly fashion. Match up the offsetting trades, the rest go to zero. End of story.
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Right now, we are into this clusterfuck for $166 billion — every last penny of which is a needless waste. Taxpayers should not be bailing out hedge fund trades. This insanity must cease immediately.
Again, wow. Not much to add, since Ritholtz says it better than I ever could. At the core of my opinion (since I have different thoughts from him about what "deregulation" is, what it means) is the belief that if you get governmental protection, if you're first in line for cheap loans, if your industry is subject to loopholes and access the rest of us schmucks don't get, then we damn well have the right to make the rules that you play under.
But from what I understand about what Clinton and Gramm and Greenspan and Rubin and Summers did, huge banks and other companies got to have it both ways: all the perks with none of the rules.
And the acolytes of these enablers (Geithner learned his craft at the lap of Rubin, Bernanke served on the Fed Board of Governors under Greenspan), if not the active perpetrators (the utterly loathsome Larry Summers), are continuing to roll out the gravy train.
At our expense.
And as Ritholtz says, "every single taxpayer should be asking themselves: Why am I paying $1000 to bail out this giant hedge fund? ... Taxpayers should not be bailing out hedge fund trades. This insanity must cease immediately."
Update (Of sorts): This post by Steve Randy Waldman at Interfluidity (H/T Naked Capitalism) is somewhat on-point with the concept I tried (clumsily) to explain at the tail end of this post. I haven't thought enough about what he's actually advocating, and the post is a bit arcane for non-financial types like me. That said, he makes the larger point that:
Private-sector banking has not existed in the United States since first the Fed and then the FDIC undertook to insure bank risks. There is no use getting all ideological about keeping banks private, because they never have been.
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I don't think we should give much deference to traditional banking, on the theory that we know it works. On the contrary, we know that it does not work. Banking crises are not aberrations. They are infrequent but regular occurrences almost everywhere there are banks. I challenge readers to make the case that banking, in its long centuries, has ever been a profitable industry, net of the costs it extracts from governments, counterparties, and investors during its low frequency, high amplitude breakdowns. Banking is lucrative for bankers, and during quiescent periods it has served a useful role in financial intermediation. But in aggregate, has banking has ever been a successful industry for capital providers? A "healthy" banking system is arguably just a bubble, worth investing in only if you're smart enough or lucky enough to get out before the crash, or if you expect to be bailed out after the fall.
Again, I haven't thought about this enough to say I agree with whatever it is that Waldman favors (assuming he has something in mind). I'm just throwing some kindling on the fire I'm trying to stoke: that our collective understanding of "free markets" and "laissez faire" and "deregulation" will forever be skewed unless we come to grips with the fact that, in America, because of the Federal Reserve system and the financial industry's leverage on Capital Hill, the banking system is subsidized, guaranteed, favored, and ultimately rigged.
And if it wants continued largesse, we need to extract some real concessions.