Michael Lewis on A.I.G.

Good article from Michael Lewis in Vanity Fair on the failure of A.I.G. – “The Man Who Crashed the World”.  Here’s the crux of the endgame:

In the beginning, A.I.G. F.P. had required its counter-parties simply to accept its AAA credit: it refused to post collateral. But in the case of the subprime-mortgage credit-default swaps, Cassano had agreed to several triggers, including A.I.G.’s losing its AAA credit rating, that would require the firm to post collateral. If the value of the underlying bonds fell, it would fork over cash, so that, for instance, Goldman Sachs would not need to be exposed for more than a day to A.I.G. Worse still, Goldman Sachs assigned the price to the underlying bonds—and thus could effectively demand as much collateral as it wanted. In the summer of 2007, the value of everything fell, but subprime fell fastest of all. The subsequent race by big Wall Street banks to obtain billions in collateral from A.I.G. was an upmarket version of a run on the bank. Goldman Sachs was the first to the door, with shockingly low prices for subprime-mortgage bonds—prices that Cassano wanted to dispute in court, but was prevented by A.I.G. from doing so when he was fired. A.I.G. couldn’t afford to pay Goldman off in March 2008, but that was O.K. The U.S. Treasury, led by the former head of Goldman Sachs, Hank Paulson, agreed to make good on A.I.G.’s gambling debts. One hundred cents on the dollar.

While he doesn’t pursue the logical question in this article (my emphasis) – why exactly did Paulson think that the taxpayers should foot the bill of this mess, particularly at 100%?

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Comments

  • oakhill193  On July 10, 2009 at 8:16 pm

    On the surface it does seem quite underhanded along with some strong favoritism. I’m sure Paulson still owned some Goldman stock and would’ve hated to see it lost. At the same time, though, I believe saving the banks and/or reducing the massive bank runs that could’ve occurred was a good thing. If there were more Lehman examples in the market, we would be living in a different world today. I probably wouldn’t be able to afford the electricity to turn on my computer to even write this response.

    It doesn’t seem fair to prop these guys up and save them so they can live to see another payday. They made greedy mistakes and don’t really seem to be suffering. BUT unfortunately WE are all tied into this and I believe the 70-80 percent drops we saw in our investments would’ve gone to zero with very little chance of recovery. And a lot more innocent people would’ve lost their jobs.

    Believe me, I’m not a fan of financial services but building up and preserving their perception of stability is quite important right now.

  • Curt  On July 10, 2009 at 11:45 pm

    I hear what you’re saying, and indeed preventing bank runs and total financial collapse had to be the number one goal. But I think it would have been far better to make Goldman and other take some kind of penalty. Now the precedent is set up that the taxpayers will bail out any big financial firm that runs into trouble, so what’s to rein them in from taking all kinds of crazy risk?

    I would wager that folks at Goldman knew that the ‘insurance’ they were buying from A.I.G. was not necessarily solid (and there are stories that they had already tried to hedge against that possibility), so why pay them out at 100%?

  • oakhill193  On July 11, 2009 at 7:54 am

    In some ways there was a penalty. Stock values dropped considerably, personal worth of employees (and shareholders) dropped considerably and the world of yesterday has completely changed for the future. A lot of people in my town have their houses on the market. In addition, the Gov’t now has oversight committees and rules are being re-written to look out for this kind of stuff. And as you can guess the new problem will be too much gov’t involvement in business (socialism). And, there will be another scheme hatched that skirts these rules and screws the market again. I think junk bonds are coming back into fashion. And, yes, everyone in the market knew this was crazy, that bubble would burst. But they were making money and all was good at the moment.

    Any interest in opening a falafel stand?

  • Curt  On July 11, 2009 at 8:33 am

    oakhill193 writes: “In addition, the Gov’t now has oversight committees and rules are being re-written to look out for this kind of stuff. And as you can guess the new problem will be too much gov’t involvement in business (socialism). And, there will be another scheme hatched that skirts these rules and screws the market again.”

    I think this is a little too pessimistic about what regulation can do. Let’s remember that in fact for many years there was much tighter regulation around what banks could do, how much leverage they could take on, etc. We seemed to avoid financial meltdown during those years, and I think those regulations were part of the reason. If we’re now in an era of ‘too big to fail’ financial companies, then I think we have to regulate them to the point where they become boring businesses, not casinos.

    Just remember that there will be no bailouts for the falafel stands!

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