Sunday, March 08, 2009
Editorial: Making sense of the AIG mess
Some financial wizards weren't as smart as they thought. Thanks to their overconfidence, American taxpayers are on the hook for billions.
From the RoundTable blog
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How's it feel to be in the insurance business? What's that, you say? You didn't know you were in the insurance business?
Every American taxpayer, like it or not, is in the insurance business now. Multiple bailouts of global insurance giant AIG have given the American people ownership of about 80 percent of the troubled company.
So far, it's not working out real well for us. AIG announced the largest quarterly loss in history late last month: about $60 billion. That led to an announcement of yet another government transfusion, bringing the total to around $180 billion.
How does an insurance company lose that much money? More important, why does the United States keep pouring more money down that particular drain? When does the government decide that enough is enough and simply allow AIG to collapse?
All good questions. Many of the answers can be found in a Feb. 27 New York Times column by Joe Nocera (tinyurl.com/bkaf37).
The story of how this happened is distressingly familiar. Financial industry hotshots got a little too creative and a little overconfident about risks they were taking. And by a little creative and overconfident, of course, we mean massively so.
As Nocera explains it, as the housing bubble inflated, AIG engaged in what they referred to as "regulatory arbitrage" and "ratings arbitrage."
In both cases, what that meant was exploiting loopholes to charge large fees to make mortgage-backed securities held by banks appear to be virtually risk-free.
AIG extended "credit-default swaps" -- exotic financial instruments that essentially insured banks against losses in mortgage-backed securities, but without any of the inconvenient regulatory requirements of genuine insurance, such as reserve requirements to cover potential losses.
In return, the banks got the sweet cover of AIG's AAA bond rating, which helped them sell the securities. Banks also transferred the risk of loss to AIG, which lowered their own capital reserve requirements.
Everything would have been golden if the housing market had defied gravity and history and continued to climb forever.
That didn't happen, of course. The bubble burst. As the mortgage-backed securities it had guaranteed grew more toxic, AIG's exposure grew exponentially. Its losses have continued to mount.
So why not let AIG collapse? Because, as Seamus P. McMahon, a banking expert at Booz & Company, told Nocera, doing so would force AIG's partners-in-idiocy -- a distressingly pervasive host of other financial institutions -- to "face their own capital and liquidity crisis, and we could have a domino effect." According to Nocera, practically the entire Western banking system would be at risk.
That could completely lock up the credit market -- the lifeblood of the economy.
U.S. taxpayers don't know who AIG's partners in stupidity are. Despite the 80 percent ownership and the billions of dollars in bailouts, such information remains private. Several Democratic lawmakers are choking on that lack of transparency. Perhaps they'll be able to force some sunlight onto the situation.
In the meantime, Congress should turn taxpayers' anger into regulatory action to ensure they aren't made the hapless marks of a bunch of overeducated scam artists ever again.
