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The Wilder View

The dark side of the U.S. financial bailout: AIG

The Federal Reserve balance sheet is quite organic, growing in size with each week that passes (unusual before 2008). A significant amount of balance sheet space is now dedicated to the direct lending to and purchase of securities from American International Group (AIG) and its subsidiaries.

fed_balance_sheet.png

The chart illustrates the Fed’s balance sheet (Table 1 Factors Affecting Reserve Balances of Depository Institutions) spanning 2008, including the various lending measures instituted since the beginning of the year (to see these measures, click on policy tools here). Notable changes in the most recent release (December 29, 2008) include:

  • Bank reserve balances are now $785 billion, which is a $779 billion increase since this time last year.
  • The Fed continues to prop up the commercial paper market with its massive $326 billion net holdings under the Commercial Paper Funding Facility (CPFF), up by $10.5 billion since just last week.
  • The Fed has dedicated no resources to the money market investor funding facility – I guess that they are holding this facility in place “just in case”?
  • Other federal reserve assets – essentially the currency swap lines opened up with various global central banks – fell $28 billion to $614 billion. I suppose this is a good sign: the $US is now more accessible to foreigners. AND
  • The Fed purchased a new $2.5 billion for a total of $20 billion in residential mortgage-backed securities from AIG and its subsidiaries (Maiden Lane II in the chart above, the Fed first announced the purchase here).
  • The Fed purchased a new $8.5 billion in collateral debt obligations on which the Financial Products Group of AIG wrote credit default swaps (see this Washington Post article about Financial Products Group).

The Fed has extended direct credit to AIG and is now shoring up assets related to AIG and its subsidiaries; this is obscene. The bottomless pit that is AIG (currently, the government has invested $152 billion) goes deeper.

Have you seen Parenthood? Steve Martin is Gil Buckman, a dedicated father, who struggles with the tradeoff between career and family. Tom Hulce plays Gil’s younger brother, Larry, who fathers a son Cool that he cannot support in his plight to get rich quick. Larry promises Frank that he will change his life after he gets a loan, but he does not. Larry leaves Cool in Frank’s care and takes the money from Frank for his scheming, and is assumed to never never pay back the loan. AIG is Larry – Larry is AIG.

I am seriously disgusted by this facet of the government’s handling of the financial crisis; it goes against everything that is good about free markets. Bad business models should fail, certainly including AGI, Citigroup, GM, and GMAC (of course they got their $6 billion). The government is barricading the healthy process of consolidation.


Originally published at the News N Economics blog and reproduced here with the author’s permission.

9 Responses to “The dark side of the U.S. financial bailout: AIG”

E BonneauDecember 31st, 2008 at 8:43 am

The author does not share with us any arguments to support his emotional state. The companies he mentioned have trillion dollars in assets which brings the amount required for the rescue into perspective.Too much we focus on a few individual companies to demontrate our anger and frustration about this financial crisis. By doing so we are distracted from looking and understanding the fundamental reasons of the crisis.The author also claim that the government is preventing the healthy process of consolidation. This crisis is extraordinary and not part of a normal economic cycle. I support the FED and government to prevent an extraordinary situation to adversly affect companies that otherwise would perform well such as the insurer AIG. AIG is a solid company that had one single (AIGFP) responsible for its misfortune.Leaving this financial crisis to freely evolve would lead us to Great Depression II in a way that would even affect everyone including the author of this article.

GuestDecember 31st, 2008 at 8:48 am

I agree with the commenter. The author is venting his frustration without any support to his arguments. But we also have to remember that having a book-value of trillions of dollars does not necessarily translate into a market-value of trillions of dollars. For example, AIG sold HSB for less than its market-value.

villagerDecember 31st, 2008 at 10:13 am

I share the same concern with Rebecca Wilder – that AIG is a “bottomless” pit. Yes, these are extraordinary times – that is why the Fed and the US government could end up bankrupt. Even Dr Roubini acknowledges that the Fed has undertaken an enormous gamble. The argument for intervention has been to stabilize financial markets and to allow the downturn in the economy to occur less precipitously and therefore less painfully. The problem now appears that the intervention is misguided and by impeding adjustment, the pain and suffering could be prolonged and even deepened.Personally, I think that the authorities have under estimated the magnitude of the financial problem in terms of the amount of deleveraging that is required. This is understandable given that there never had been any oversight of the shadow financial industry. I don’t think the authorities can “buy” (bailout) their way out of the problem. There is failure to accept that the financial industry and the economy (eg. GM) can not return to what it had been. Remember the word “gamble”. How much of America’s resources are to be gambled (wasted) before the realisation is made?

CapitalizerDecember 31st, 2008 at 10:38 am

The government’s policies (the Fed’s monetary policy and lack of regulation) created this mess. Printing endless supplies of money will not fix it. A “Great Depression II” is what this country needs. It’s a natural free market correction. When you’re sick you have to take your medicine, even if it doesn’t taste good.

CapitalizerDecember 31st, 2008 at 10:42 am

Apparently this government will do whatever it takes to keep credit flowing…at least that’s what they’re trying to do. It isn’t working well, but the government knows that our economy is 70% consumption, so if we actually STOP spending money (which we DON’T have) and actually START saving, our economy will have to go through the natural correction it SHOULD go through. The government is delaying the inevitable by printing money to keep credit markets flowing. Eventually the whole thing will collapse in on itself.

Micharel KDecember 31st, 2008 at 5:26 pm

The Fed has definitely underestimating the amount of bail-out required, which has reached twice the amount estimated initially. Otherwise, it has lied to the American public. Who is going to bail-out the Fed if all the gambles failed. Why should common Americans bailout the unaccountable and irresponsible CEOs who have taken obsence bonuses by inflating their corporation balance sheets. Has the authority taken any action to recover the ill-gotten billions. I believe it will be interesting to compute how much these failed organizations have contributed in taxes compared to the amount of money that are needed to bailout these corporations. The cost and benefit analysis may provide us a better perspective of the FED’s bailouts.

SteveJanuary 9th, 2009 at 10:25 am

AIG has operated a mega lottery and offered to pay out (if the right numbers are presented on the purchased tickets) an amount 30 times their capital. The winning tickets are now being presented. If it were a state supported lottery it wouldn’t have been able to do this but it was an insurance company and our radar wasn’t working.Now the question is what does the American taxpayer get from any additional investment in AIG and why. If the answer is that noone in the financial sector has reported their tickets as lottery entry, they’ve reported them as a reduction in exposure, then the American taxpayer has the right to ask why there wont be a central security depository to keep track of the funny accounting in the future in order to avoid absense of knowledge among regulators and financial sector participants about what is going on.

Rob MatsonFebruary 23rd, 2009 at 12:20 pm

A major point that has been overlooked in the “Big 3 Bailout” is that we are really talking about the Big One bailout. Ford is not asking for money and foresees that it can turn itself around. That leaves two – GM and Chrysler. But what about Cerberus? If we consider that this one company owns the better part of both GM and Chrysler, then our Big 3 has now become just one. When I consider the amount of funds that are being “invested” in our automakers, I have to worry. It seems that the media and as well as the government are misleading the public and perhaps themselves.So let’s take a fresh look at the current situation with this new knowledge in mind. In total, requests are for 39 billion dollars for Chrysler and GM or in truth – Cerberus. The projection is that repayment could begin in five years. In order for this to happen, the economy will have to make a huge turn around and these companies will have to enjoy sales nearing their all time highs. What if this improbable scenario doesn’t happen? Will we invest more dollars? It is likely we will and it is more likely that this company knows it. If we have made a nearly 40 billion dollar investment, would we give up on that investment in lieu of loaning an additional 10 billion? Not likely.What we have to ask ourselves is this: Could it be more beneficial to America, in the long run, to invest those dollars elsewhere? While our educational scores fall lower and lower against foreign counterparts, so do our standards of quality in the automotive marketplace. Have our automakers done anything in the last decade to show that they are willing to step up efforts to better compete globally? I don’t think so. If we, the tax payers, take a look at this investment as investors, I do not believe we would want to take this plunge. I can’t imagine any investor that would.Since we are not willing to let these companies collapse due to the number of jobs affected and the prospect of having only one US automaker left in the game, we have to consider the common factors and take some action. Ford is managing to keep it’s own head above water, the other two – or rather one is not. Just as any other investor would do, we must ask some questions and attach some conditions to our investment. Why is Ford succeeding and the other failing? What decisions and payouts are being made by and to Cerberus that have influenced the failure? What exactly does GM and Chrysler plan to do DIFFERENTLY in order to be competitive globally? If we can not get good answers and provide good solutions, then we must consider that these or THIS company will fail eventually regardless of our investment now. Would we ultimately be better served to let the nature of business take it’s course? Mismanaged companies fail, it happens all the time. Why should this one be any different?

Rob MatsonFebruary 23rd, 2009 at 12:21 pm

The word “OR” has never sounded so scary. When President Obama discusses the new economic stimulus package, it is notable that he likes to use the word or. This word may be the most worrisome choice of two letter words since Clinton’s notorious “is”. The president says the new bill “will create OR save 3 million jobs”. Wait a minute! I see a future political discussion around exactly what he promised. In an economy that has and continues to lose so many jobs, merely saving 3 million is a very insignificant thing. The first thing that comes to mind is an analysis a few years down the road of how this package prevented some 3 million more jobs from being lost. This would be VERY debatable to say the least. Further to the point is that what we need is to replace the lost jobs AND create more. The population is certainly not getting any smaller and a growing portion of this population is unemployed. The fact that Obama ensures that he uses the “or” word in every address is very scary indeed.

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