In the Wake of AIG: Obama’s First Priority

AIG is rapidly becoming a nightmarish metaphor for the Obama Administration’s problems administering the bailout of Wall Street. One central problem is the lack of transparency. According to some news reports, Treasury Secretary Tim Geithner knew weeks ago that AIG was planning to issue the bonuses to executives in its notorious credit default swap unit, and felt it was contractually bound to do so. But even if Geithner discovered all this just last week, he faces an awkward question about why he didn’t know sooner. These bonuses in fact were only the latest if a series, and were not even distributed until last Friday. But it was not until Saturday, after the story leaked to the press,that Geithner went public to express his “outrage” about them.

Meanwhile, the Treasury has been readying yet another big multi-billion-dollar payout to AIG on top of the $170 billion already provided the company, because AIG has been hemorrhaging red ink. The company’s balance sheets have been deteriorating far more quickly than the Treasury had anticipated. But there’s been no clear exit strategy for stopping the flow of taxpayer money.

What’s particularly embarrassing for the current Administration is that it had promised to undertake the Wall Street bailout far more transparently and effectively than the way the Bush administration went about it. The Obama Administration had assured the public that, among other things, taxpayer money would no longer be used to backstop Wall Street bonuses. (It’s worth noting, in this regard, that the related plan put forward by the Obama Treasury to limit executive pay in Wall Street firms that received bailouts turned out to be riddled with holes.)

We’ve also learned that much of the 170 billion has been used by AIG to pay off AIG’s putative obligations to other Wall Street banks such as Goldman Sachs. Goldman has maintained that it got no bailout money from the Treasury. But in fact it received some $13 billion through AIG. More troubling is that the original plan to bail out AIG was concocted at a meeting held last fall, run by then Treasury Secretary Hank Paulson who, before becoming Teasury Secretary, had been CEO of Goldman Sachs. Also attending the meeting was Lloyd Blankenfein, the current CEO of Goldman Sachs. Also at the meeting: Tim Geithner, then head of the New York Fed.

None of this would be nearly as awful if the Wall Street bailout were working. But here we are six months after it began and it’s still the case that almost no loans are being made to Main Street. This week the Fed is launching its own program to get loans to consumers financed by private investors, in effect by-passing the big Wall Street banks.

The Wall Street bailout is starting to look like the most expensive tax-supported fiasco in history. The problem for the Obama administration is that this bailout is near the very center of the President’s economic recovery program. It’s not possible for the economy to bounce back until credit markets are working again. Yet even though the bailout so far is a bust, Geithner still hasn’t decided — or told the public — how he’s going to use the remaining $300 billion of bailout money differently.

The President cannot afford to lose the public’s confidence that his administration is a careful steward of the public’s money. The public was willing to go along with a large stimulus package. But it won’t go along with a second stimulus, and certainly not another TARP. And until the public feels confident that its money isn’t being thrown down a rat hole, it may balk at other ambitious undertakings such as health care or education or the environment.

Bottom line: Before it can clean up Wall Street or do much of anything else, the Administration has to clean up the way it’s been trying to clean up Wall Street.


Originally published at Robert Reich’s Blog and reproduced here with the author’s permission.

7 Responses to "In the Wake of AIG: Obama’s First Priority"

  1. Robert Gerard   March 18, 2009 at 1:39 pm

    Hi Robert,I usually agree with you, but on this point you lost your focus. AIG was and is and always will be a Ponzi scheme. It is not the incumbant administration’s fault. You are mature enough to realize this. ThanksRobert Gerard

    • Turtle   March 18, 2009 at 3:01 pm

      AIG was not a Ponzi scheme/plan — wherein money from investor #2 is used to pay investor #1. AIG credit default swaps (not gambling, not insurance, not backed by anything) was a way of getting higher ratings for garbage sold by Wall Street. You could have achieved the same result with Mother Grace Ferguson’s Storm Door and Credit Default Swap Company. American International Group sounds better. Back in the 1950s Mother Grace ran an airline to Hawaii where everyone stood all the way and the first class passengers got a strap to hang onto. See and compare Shelly Berman.

    • Guest   March 19, 2009 at 8:22 am

      Gerard, you should re-read what Reich is saying. He isnt blaming the Obama gang for that, he is criticizing parts of the administration’s current handling of the bailout of AIG.I applaud Robert Reich’s realization that Geithner’s handling of AIG is a debacle. Hopefully he’ll have some influence in fixing the path we are on. Just because Obama rubber stamps something doesnt make it right..starting with those AIG bonuses on his watch that Geithner had to know were going to be distributed for weeks before they were.

  2. Garret Ihler   March 20, 2009 at 2:05 am

    When the Dutch tulip bulb frenzy popped, the courts ruled that all the contracts involving who had to pay what for a tulip bulb to be invalid. That solved the problem, to some people’s satisfaction anyway. Whether our courts will rule that swaps etc are unenforceable doesn’t matter if the primary sucker counterparty, AIG, is allowed to go bankrupt. If that destabilizes secondary sucker counterparties, banks, hedge funds, etc, then one can consider the wisdom of directly supporting the putative recipient of AIG money with taxpayer money. Maybe they won’t need it, maybe they won’t need as much money, maybe we don’t care whether they go bankrupt. AIG has been so stupid and greedy that, whatever the consequences, it is impossible to support giving them any (more) money.

  3. Tomasz Johannsen   March 20, 2009 at 4:34 am

    Thanks, Robert, I think you’re right that this is a crucial test of competence and credibility for the administration.Another Geithner blunder was his original reaction to the bonuses. He said “AIG will repay them”. In the footnote, he explained how the “repayment” would be deducted from the next $30B AIG handout. This response was insulting to all taxpayers because we the people already own AIG and are funding it. So what sense does it make to take back our own money? Does he think we’re all stupid?It is the employees/execs who need to return the money – I hope the Senate approves the 90% bonus tax legislation. After all, the AIG execs are government employees now so they shouldn’t expect compensation that’s 20x that of the average teacher. Especially since teachers know how multiplication (leverage) works.

    • JAy Larson   March 20, 2009 at 5:46 pm

      Of course he thinks were stupid. Look what we allowed to happen with our excess FICA contributions that went to the Social Security Trust Fund. The Government borrowed the surplus (the excess contributions that you and I paid in) and the only way they will ever possibly be able to pay us back is by reducung our benefits, borrowing more money from us or increasing our taxes. To date the Gov has borrowed (taken) in excess in excess of $2 trillion from the trust fund. That is $2 trillion of our money that has been in essence stolen and it was such a smoth capper that we are not even mad about it. Some refer to this as the greatest theft in history. Therefore,I have to acknowledge that we have set a pretty good precident to prove how stupid we actually are.

  4. Anonymous   March 20, 2009 at 5:40 am

    Does anyone have a total picture of the problems? I don’t think so. On Leno last night President Obama said most of what was done was legal at the time. According to Kevin Phillips, the first financial engineering instrument was created in 1973. The American love for the rich and tolerance for things unbelievable needs to return to 1950 levels. We all knew inflation was occuring, even as the market went to 14,000. The only way to keep up with the fiery pace was to be in the market. The flames are subdued and fuel in short supply. More greenhouse gas to bring on a financial ice age.