Thursday, March 05, 2009


Wow. The normally calm, measured, and rational-to-the-point-of-being-unemotional Barry Ritholtz lets loose on the AIG bailout. Damn, check some of this out:

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.

* * *

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.

* * *

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.

* * *

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.

* * *

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.

* * *

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.

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Anonymous Applesaucer said...

I guess this is just some more "smart politics" by Obama, right?

It occurs to me that Obama might actually turn out to be more of an economic disaster than Dumbya. I didn't think that would be possible.

"the banking system is subsidized, guaranteed, favored, and ultimately rigged."

I agree 100%. I don't think it's enough to ask for concessions, though, since banks will ultimately bankrupt us -- wait, we're already bankrupt, so make it "bankrupt us even more" -- if we subsidize and favor them.

We must cut the banks loose and let them live or die on their own. Depositors must take their chances.

It could be that every bank in the country would die, since they all lend out multiples of their reserves.

Short of that, we cannot allow banks to be public companies because they will manage themselves quarter-by-quarter, issuing options to management to cash in at bubble peaks. Also, we cannot allow them to loan more than they have in reserves.

Fat chance of any of these things happening, of course.


9:01 AM  
Blogger Smitty said...

the banking system is subsidized, guaranteed, favored, and ultimately rigged

It is how we moved from a manufacturing economy to a "service economy." But in my newly-awakening mind, the "service economy" actually means an "economy of economy." make sense? We're not based on anything but the existence of money. Our economy is based on the fact that we...have an economy, instead of labor and things. So, it seems logical to follow that the banks are and have been nationalized because our whole economy depends on it. And now we reap what a few have sewed.

Depositors must take their chances.

I'm not thrilled about the prospect of keeping money under my mattress.

Also, we cannot allow them to loan more than they have in reserves.

The only reason I see these little local-yokel banks (for instance, Dart Bank in tiny little Mason, Michigan) surviving is because that's exactly how they are operating. I'm sorry, Mr. Smith, but you need 20% down, I'm only giving you a 30-year fixed, and I can only lend out 1 more loan of this size.

9:25 AM  
Blogger George said...

subsidized, guaranteed, favored, and ultimately rigged

Isn't that true of everything that seemed to make oodles of money the last 15 years? (industrialized agriculture, say)

12:32 PM  
Blogger Weaseldog said...

Smitty, remember these simple words to success, "This time is different."

Ooops, that seems to be the, 'Gotcha' words.

Remember when America was so strong that it could ignore all of the fundamentals and pretend that it was invincible, throw away all of the things that made it strong and remain invincible forever, no matter what?

When was that anyway? 2008?

4:42 PM  
Blogger Mike said...

Depositors must take their chances.

I'm not thrilled about the prospect of keeping money under my mattress.

If it's the safety factor that concerns you, I can't argue. If it's some notion, however, of "lost interest," you really have to ask some questions. To follow Applesaucer's scenario to its logical extreme, he's contemplating some elimination of central banking/fractional reserve banking.

Remove the Fed's slow (or fast) increase of the monetary base AND the money multiplier that results from banks lending far more money than you actually have, and what do you have? Well, you have no increase in the money supply.

In other words, you have no inflation. So the pidly 1 or 2% interest that banks pay for your deposits hardly beats the mattress' 0% rate of return, and falls short of what you might get if you wisely invested that money in a security of some sort, or purchased some private debt, or put it towards some entrepreneuial venture of your own.

I admit I'm being a bit glib in this explanation, but the overall point is that in a world without constant inflation of the money supply (which is what economists I respect call "inflation"), you won't have price inflation, and the need to earn a steady rate of return in the form of BS bank interest is reduced.

There are other factors to be sure, I admit.

subsidized, guaranteed, favored, and ultimately rigged

Isn't that true of everything that seemed to make oodles of money the last 15 years? (industrialized agriculture, say)

No doubt, and it sucks. But those represent niche lobbyist worlds. Unlike the finance (or insurance) lobby, which is large and really powerful. Wall St. and the banking sector get money up-front and they get bailout money when they squander it.

The federal reserve is the lender of first and last resort for the elite.

6:26 AM  
Anonymous Applesaucer said...

Regarding federal deposit insurance: what person in his right mind would object to it? Afterall, nothing good can come from a bank run, right?

Well, here's how I see it:

(1) banks no longer have to earn depositor trust. They attract funds through things other than safety and soundness.

Knowing that, American banks don't bother with safety and soundness as much as they should; which leads to

(2) Many if not most or all American banks would go under if each of its depositors withdrew all of their deposits;

(3) the agency responsible for insuring deposits -- the FDIC -- is ridiculously undercapitalized; it can cover only a small fraction of the deposits for which it is responsible; and, so

(4) the predicable result will be a treasury infusion, which will require, a little further down the road, the Federal Reserve printing up new money. Plus, the house of cards banking system we've had for almost a century needs sustained inflation to survive since there must always be that promise of new money from the Fed -- and the ocassional delivery thereof.

So, in return for our fatuous comfort in deposit safety, we get a chronically sick currency.

It can only lead, actually, to the currency's destruction, if you think about it. And then think about what happens when the currency dies: the division of labor dies with it.

Think I'm crazy? Maybe. But it's happened elsewhere.

At the end of the day, all federal deposit insurance amounts to is a promise by the federal government to print more money -- to inflate -- when they have to.

And we can see how it corrupts and keeps us stupid.


8:02 AM  

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