Tuesday, September 16, 2008

"Too Important To Fail" Is The New Argument For Socialism

Using strict statistical methods, I have calculated that my productivity has dropped by a record 8% in the last 48 hours while I try and sort through the financial nightmare that is terrorizing some major money moguls as we speak. The latest victim is AIG, which just ceded an 80% stake to The Federal Reserve (yikes) for a barely fathomable $85 billion.

Historically, the government has identified industries that are too big or too important to fail. Amtrak and the airlines both have enjoyed government favoritism to some extent. But the financial industry is in a class by itself. The Federal Reserve came in 1913, and the FDIC came in 1933, creating a foundation for a system that now allows firms to make stupid decisions and people to obtain stupid loans.

In case you didn't realize this by now, with public goods being the notable exception, when the government gets involved in industry it screws everything up, and necessarily produces a result inferior to that of the private market. What incentive do banks have to make responsible loans if the government is going to bail them out?

As an economics student, I learned the virtues of the Fed. After all, countries need central banks. But, the Fed's purposes have evolved. Originally meant to control bank panics, it became a regulatory agency for banks, a monetary policy instrument, and a lender of last resort to banks. There has been some history of the Fed serving as a mediator and broker for emergency rescues of too-big-to-fail financial institutions, with Long Term Capital Management being perhaps the most noteworthy. But in the last 6 months, the Fed has pushed even that boundary and has acted a lender of last resort to investment banks (not regular banks), and now, today, has apparently nationalized the nation's largest insurer! Not only are we taxpayers on the hook for the first $85 billion, but I'm quite sure AIG is about to shell out infinity billion dollars to rebuild Texas from Hurricane Ike--are we going to have to pay for that too?!!!!

If that weren't scary enough, consider this: at some point, the Democrat Congress is going to realize that they now have an 80% stake in an insurance company. Democrats want national health insurance. Get the picture?

I hope to research a mega-post on this, but in case I don't, here's what I'm thinking. Most of this is the fault of Democrats, not of the free market or capitalism. Democrats created Fannie Mae and Freddy Mac, and Democrats ran those agencies into the ground while cooking the books and pocketing tens of millions of dollars. When President Bush tried to reform those agencies in 2003 (I think), Democrats blocked it. Fannie and Freddie gave millions of lobbying dollars to Democrats (Obama, Hillary, and Biden were all in the top 5 I think...McCain was #342)--which essentially means the government was lobbying the Democrat part of itself--and we can now see why.

Even so, I am not happy with the Bush administration. That itwould allow such an overt breach of free-market principles is horrible. If the Fed did this unilaterally using its independence, then we need to find limits to the Fed's powers outside of monetary policy. To borrow terminology from Warren Buffet, we the taxpayers are throwing good money after bad money, and we didn't have an ounce of say about it. Earlier in the post I announced that the latest victim was AIG, but the true victim is us.

15 comments:

Anonymous said...

According to Hank Grenberg, former AIG head who lsot 3 billion in this mess, the board that took over after he left threw out some basic rules on managing risks.
Second, he said the government is LOANING the money to get through what is essentially a cash flow crisis since the assets are worth more than the loan - just repeating what he said.
If he lost 3 billion, that's a warning not to have your eggs in one basket.

Super Patriot Master of Justice said...

The republic party is responsible for this , it has been proven again and again. But I like your conspiracy theory :

"If that weren't scary enough, consider this: at some point, the Democrat Congress is going to realize that they now have an 80% stake in an insurance company. Democrats want national health insurance. Get the picture?"

lay of the stimulants dude, reality ain't that exciting.

Anonymous said...

First of all, my interpretation of the deal is similar to the first anonymous. The Govt is offering a bridge loan. The loan is to be repaid, in the short term, with specific asset sales. The Fed isn't taking control, it's more like a Chapter 13 reorg.

Secondly, this is exactly why free markets work. These investment banks were going ways over board, and what happened, the market took them out. That the difference between companies and governments. When companies go over board and get greedy, they go out of business. When governments get greedy and raise taxes, the are rewarded by lazy voters.

This isn't a crisis, it's an opportunity to have a more efficient capital market.

Brian Gill said...

Maybe you guys have different info than me, but the article I read says that the government is taking an 80% equity stake in AIG. Usually when equity is given, it is not a loan.

I understand that the transaction is billed as a loan...but what money is going to be used to repay it? In the near-term, AIG will surely suffer negative cash flow do compensate policy holders. That would leave an even bigger hole to climb out of, and if the Fed has the majority interest in the company, do they set the business model to make that money back? If so, I wouldn't be optimistic.

I agree that this is a chance for more efficient capital markets. But they way to do this is to leave the government out of it. JP Morgan was considering a buyout for $75 billion over the weekend--if the Fed stayed out of the way, the AIG board would have had no choice but to lower its price, lest their valuation fell to nothing.

At some point, the government has to let them fail. If not now, then the next crisis will involve even more money.

Anonymous said...

Brian Link
http://www.federalreserve.gov/newsevents/press/other/20080916a.htm

24 month Loan, colateralized with AIG's assets

Anonymous said...

And Brian you have to consider this... if these companies are filing for bankruptcy protection, why would the Feds loan them money without a vested interest in their success? Let's say they loan the money and the company STILL goes out of business. AIG could then sell itself off to some other company and that $85billion loan is gone.

Basically, the Fed Reserve is covering its ass. They offering up the loan but if the company still fails, the Fed retains the assets for liquidation to recover as much of the loan as possible.

nap guy said...

Sorry for the tangent, but this is important--the shooting on Janwall. Moyer says, 'if there's anything i'm not doing...' Well, first she should start exercising, something besides her jaw, then maybe she could enforce the federal laws in our great city of Annapolis.

the cops haven't said who's responsible yet, but the best guess is it was over drugs that illegal criminals are bringing in, either a dispute between this guy and local dealers, or between him and illegal alien criminals. i suppose there's also the chance that this was a more violent version of the stabbings that occured over an illegal alien girl a few months ago. Either way, this is RIDICULOUS.

We keep getting tastes of things to come. When is annapolis going to wake up. This experiment with replacing the cheap labor force did not work in other cities and it will be just as disastrous here.

Bruce Rothchild said...

Tangent 2

The President has lead us into an economic quagmire.

Between the costly war and corporate welfare programs , our nations wealth has been drained and the American People have nothing to show for it.

I thought we were Free Market advocates.

What the hell are we doing bailing out everyone but our own people.,

I am rethinking my loyalty to the Republican Ideology

Anonymous said...

Don't re-think your alliance too hard...

http://elections.foxnews.com/2008/09/19/obama-laments-debt-but-promises-billions-for-anti-poverty-program/

bruce rothchild said...

That is not news that is Fox . Real conservative ( those that can think for themselves) read the London Financial Times.

Tender Thighs Tina said...

the root of all this mess :
http://www.liveleak.com/view?i=6a7_1221869759

Anonymous said...

tender thighs,

To blame all of this on Georege W. Bush, or on any single person, shows your ignorance of both the American political and financial systems.

Stop blindly buying in to the political propoganda you are fed. Free your mind, don't listen to politicians or the left-wing media (MSNBC, CNN, pretty much everyone else besides Fox) or the right-wing media (Fox). Get the facts, ignore the punditry trying to disguise itself as journalism and objective reporting and make up your own mind. If you were already doing this I don't think you would have posted your last comment.

Anonymous said...

Wow Bruce. You really are a snob.

Anonymous said...

This was a fascinating article:

http://www.time.com/time/nation/article/0,8599,1843168,00.html?cnn=yes

Tim

Founding father's roll said...

That's a pretty good article, in a stealthy socialist Time sort of way.

I hate to say it, but we could learn something from French patriotism. Half of the outrageous shit going on in this country right now would cause the second reign of terror if their leaders tried it. Look at them on the EU referendum: a reverberating NON! We don't even get to know about, let alone vote on, the SPP. And for their immigration problems? They are all wide awake and have cathartically broken the chains of political correctness for the sake of saving their country and their heritage. We mull around with the idea of a fence, as the globalists keep any real posibility of enforcement from ever happening in Washington, so our country can become one big cheap labor factory for them. And now the banks? 'The elite serving the elite.' Ridicule, mon ami!