Swindlers’ Waltz to the Sounds of a Crash

Government officials, perhaps influenced by spending too much time with bankers, forgot that if you want to govern effectively you have retain the trust of the people. And by treating the financial industry — which got us into this mess in the first place — with kid gloves, they have squandered that trust.

During the bubble years, many financial companies created the illusion of financial soundness by buying credit-default swaps from A.I.G. — basically, insurance policies in which A.I.G. promised to make up the difference if borrowers defaulted on their debts. It was an illusion because the insurer didn’t have remotely enough money to make good on its promises if things went bad. And sure enough, things went bad.
By making what was in effect a multibillion-dollar gift to Wall Street, policy makers undermined their own credibility — and put the broader economy at risk.
finishing the job has become nearly impossible now that the public has lost faith in the government’s efforts, viewing them as little more than handouts to the people who got us into this mess.
November 20, 2009
Op-Ed Columnist

The Big Squander

Earlier this week, the inspector general for the Troubled Asset Relief Program, a k a, the bank bailout fund, released his report on the 2008 rescue of the American International Group, the insurer. The gist of the report is that government officials made no serious attempt to extract concessions from bankers, even though these bankers received huge benefits from the rescue. And more than money was lost. By making what was in effect a multibillion-dollar gift to Wall Street, policy makers undermined their own credibility — and put the broader economy at risk.

For the A.I.G. rescue was part of a pattern: Throughout the financial crisis key officials — most notably Timothy Geithner, who was president of the New York Fed in 2008 and is now Treasury secretary — have shied away from doing anything that might rattle Wall Street. And the bitter paradox is that this play-it-safe approach has ended up undermining prospects for economic recovery. For the job of fixing the broken economy is far from done — yet finishing the job has become nearly impossible now that the public has lost faith in the government’s efforts, viewing them as little more than handouts to the people who got us into this mess.

About the A.I.G. affair: During the bubble years, many financial companies created the illusion of financial soundness by buying credit-default swaps from A.I.G. — basically, insurance policies in which A.I.G. promised to make up the difference if borrowers defaulted on their debts. It was an illusion because the insurer didn’t have remotely enough money to make good on its promises if things went bad. And sure enough, things went bad.

So why protect bankers from the consequences of their errors? Well, by the time A.I.G.’s hollowness became apparent, the world financial system was on the edge of collapse and officials judged — probably correctly — that letting A.I.G. go bankrupt would push the financial system over that edge. So A.I.G. was effectively nationalized; its promises became taxpayer liabilities.

But was there any way to limit those liabilities? After all, banks would have suffered huge losses if A.I.G. had been allowed to fail. So it seemed only fair for them to bear part of the cost of the bailout, which they could have done by accepting a “haircut” on the amounts A.I.G. owed them. Indeed, the government asked them to do just that. But they said no — and that was the end of the story. Taxpayers not only ended up honoring foolish promises made by other people, they ended up doing so at 100 cents on the dollar.

Could things have been different? Some commentators argue that government officials had no way to force the banks to accept a haircut — either they let A.I.G. go bankrupt, which they weren’t ready to do, or they had to honor its contracts as written.

But this seems like a naïve view of how Wall Street works. Major financial firms are a small club, with a shared interest in sustaining the system; ever since the days of J.P. Morgan, it has been common in times of crisis to call on the big players to forgo short-term profits for the industry’s common good. Back in 1998, it was a consortium of private bankers — not the government — that put up the funds to rescue the hedge fund Long Term Capital Management.

Furthermore, big financial firms have a long-term relationship, both with the government and with each other, and can pay a price if they act selfishly in times of crisis. Bear Stearns, the investment bank, earned itself a lot of ill will by refusing to participate in that 1998 rescue, and it’s widely believed that this ill will played a major factor in the demise of Bear Stearns itself, 10 years later.

So officials could have called on bankers to offer a better deal, for their own sake, and simultaneously threatened to name and shame those who balked. It was their choice not to do that, just as it was their choice not to push for more control over bailed-out banks in early 2009.

And, as I said, these seemingly safe choices have now placed the economy in grave danger.

For the economy is still in deep trouble and needs much more government help. Unemployment is in double-digits; we desperately need more government spending on job creation. Banks are still weak, and credit is still tight; we desperately need more government aid to the financial sector. But try to talk to an ordinary voter about this, and the response you’re likely to get is: “No way. All they’ll do is hand out more money to Wall Street.”

So here’s the real tragedy of the botched bailout: Government officials, perhaps influenced by spending too much time with bankers, forgot that if you want to govern effectively you have retain the trust of the people. And by treating the financial industry — which got us into this mess in the first place — with kid gloves, they have squandered that trust.

4 Responses

  1. Equitable One; well, are you not just the only light shinning around here, and you are correct very much so!!!! Just goes to show how incredibly stupid we the people are……Could the intelligence of our citizens not have anything to do with those gov. run schools now, do you think? God bless, kat and tim
    p.s. consumers, if you have the 2010 Garfield handbook that on page 311 suggest UCC does not apply to your deed of trust and or mortgage; please google UCC 3-407, Alteration and UCC 3-202 instruments negotiated. The Garfield book is wrong, UCC AND UCC Rescission does apply to your home loan!!!! Go to the law library and read and you will see these laws are better then TILA people!!!!!!! Consumer borrowers only may call us 410-257-5283

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  2. it seems that all these federal laws and agencies are worthless. They only do what’s good for them….

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  3. On a practical level, what all this means is that
    the bond and CDO market is going to collapse in the
    near future, down to pennies on the dollar.
    The Fed will have to be nationalized and turned into
    the “Third United States Bank” (ie we’re back to Alex.
    Hamilton’s solution). Federal and State debt will have
    to be the basis for a new, gold backed currency called
    US Notes, the red label kind. In the future, private banks will not be allowed to monetize private sector debt as they have been doing since 1913. (An exception will probably be made for new major
    projects which benefit the economy as a whole).
    Yes, we are living in interesting times ,indeed!

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  4. It has been my belief for several years now that our system is set up for exactly these kinds of taxpayer bailouts. G. Edward Griffin devoted a section of his 1994 book “The Creature From Jekyll Island” to this. In Chapter 1, Section 2, titled “The Name of the Game is Bailout” he expressed in rather clear language that in our system of banking the taxpayer is always the “lender of last resort” and will always be called on when private banks foul things up so badly they are about to (God forbid, can I even say it out loud) fail.

    Interesting is that laws are/were already in place to deal with the situation created. Enacted after the S&L crisis it is known as the Prompt Corrective Action Law. In a nutshell it calls for institutions either on the precipice, or already in the abyss, to be put into receivership. This can be found at USC Title 12, Chapter 16, Section 1831o

    So, not only is there no constitutional authority whatsoever for taxpayers/government to bail out private corps, there are actually some laws that prohibit doing such and mandate a completely different course of action.

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