AIG = Ask an Idiot and Get

The word du jour right now is “rathole”, a rather ugly expletive that equates to plughole, drain, succubus, and other such unpleasantries. It may however be too polite a phrase for what is going on right now with the bailout of AIG, the government’s new pet project that looks like it’s going to hand the downpayment on fixing the nation’s health care shambles to Goldman Sachs and their ilk.

Just like everyone else in this country, I’m spitting with fury at the idea that the government is handing over money to keep these clowns out of the poorhouse. The bonuses should have been blocked way before they went public, and the fact that the President is being exposed to ye olde “What did you know and when did you know it?” game only eight weeks into his administration does not bode well.

Then there’s the irksome question of whether the meeting where it was decided to keep AIG alive in September of last year was actually a little joke played on us by Goldman Sachs. (After all the key people around that table were Paulson, ex-boss of GS, Blankenfein, current boss of GS, and Tim “someone put me out of my misery now” Geithner). We’ve known for years that Goldmans was a class above every other investment bank, but their ability to game the system seems utterly unparalleled now.

Finally, there’s this little nugget. We were told that if we’d let AIG die the global banking system would have collapsed. That the $1.6 trillion in Credit Default Swaps (CDSs) that they sold to the world’s top financial institutions who’d sunk their dough into those toxic assets would suddenly go away, leaving them totally exposed, and toppling like dominoes. Makes sense, right? I mean, if the insurance company backing those toxic assets goes belly up then the world’s banks are left holding the bag. Stands to reason.

Or does it?  With the caveat that I really don’t know what I’m talking about, I’m not so sure. And here’s why.

Let’s start with what everyone knows. We know that the slice and dice mortgage derivatives that the best and the brightest of the world’s financial institutions got suckered into buying because of their AAA ratings (purchased AAA ratings it should be noted) went really, really bad. We know that this stuff has been written down all over the world, but there’s an awfully long way to go.

We know that financial institutions and hedge funds bought AIG’s Credit Default Swaps to the tune of $1.6 trillion (AIG’s own numbers) as a way to insure themselves just in case these investments went bad. We know that AIG didn’t have to back the CDSs with assets like they have to with regular insurance. And if we know that, I’m guessing the guys who are holding these CDSs knew it way before we did. They also knew that there was no way AIG would be able to find more than a fraction of the $1.6 trillion in the “very unlikely” event the assets went bad. In short, as soon as the rats started leaving the sinking ship when Bear Stearns went down everyone knew most of the Credit Default Swaps were worthless.

Wait. Rewind that. “Everyone already knew most of the Credit Default Swaps were worthless.” Far from being the keystone holding the system together, AIG might in fact have been utterly irrelevant to the future of the world’s financial system, except to elite banks like Goldman Sachs. Goldmans, it turns out, were one of the first counterparties out and got paid back in full for their bad bets – by the US taxpayer. Which goes a long way to explaining the scare story that Paulson and Blankenfein (let’s call them the Goldman boys) worked on poor, put-upon Tim Geithner. Paulson signed the check over to AIG, the rathole was dug, and the payouts were readied. Goldman Sachs didn’t want to take the PR hit of taking TARP funds direct, but by instigating “Operation Chump”, ie filtering the TARP funds through AIG first, was a fine and dandy idea. Ka-ching for Blankenfein and Paulson. Ka-ching for the top banks on the planet who didn’t want to face the music. Ka-pow right in the keester for the rest of us.

One could be pardoned for suggesting all this doesn’t pass the smell test. That perhaps AIG could have been left to wither on the vine, and bypassed entirely in favor of the bad bank plan that’s on the cards now, which would have saved us that health care down payment. Or that perhaps the AIG bailout (or “Operation Chump”) might well have been a ruse to salvage the reputation of the top banks.

There are three very painful ironies at the heart of all this. Here’s number one. What made AIG critical to the world economy was the act of saving it.  If AIG had failed, its mainly worthless CDS contracts would have continued to be, well, worthless. But once we made the decision to prop up the company, the world’s banking system knew it had found a sucker to back those contracts again and again. That sucker would be….us.

The second irony is this, If we’d let AIG fail, we would have been forced to price the toxic assets at the heart of the credit crisis, which is the only true way that recovery from the crisis can be quantified. But backing AIG’s CDS’s undermines that vital requirement. Now all we have to do is bilk the US taxpayer for billions upon billions more to honor Credit Default Swaps of banks all over the world at the asking price.

Finally, irony number three. The public is readying a lynch mob. Congress wants blood. Even President Obama is mildly indignant, but it’s all for naught. Because bailing out AIG is the biggest example of moral hazard imaginable. When it comes to punishment, actions speak louder than words. All the feiry rhetoric about AIG execs falling on their swords means nothing if Uncle Sam’s still signing the checks to bail these clowns out. Big banks made really bad bets, then bought snake-oil insurance to back them. Two awful decisions for which they should pay the price. Except that we’re paying it for them.

Someone, please tell me I’m wrong about all this.

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when the insurers need insuring to insure the economy doesn't go totally belly up, that's what i call insurance

Joe Nocera of the New York Times wrote a great post today which adds more grist to the mill on the price discovery issue relating to AIG’s credit default swaps (CDSs). Not only does the government end up propping up the most destructive derivative behavior around, but it does so while allowing AIG to maintain the confidentiality of their shady transactions.

And guess who that protects? You’re spot on. It shields AIG’s counterparties, banks, investors, and lenders who were looking for a way to ‘insure’ themselves on the quiet while they pigged out at the trough just before the fall. Nocera makes the point that this doesn’t sit well with the President’s call for transparency and he’s right. But it’s yet another example of the contradictions that Obama seems to be displaying. High principle on the one hand and almost Bush-like duplicity with the status-quo on the other. It’s becoming increasingly clear that Tim Geithner is lurching from crisis to crisis just like his predecessor. But the situation is far worse now. Paulson was a stooge and everyone knew it, a placeholder and agent for the Street. Geithner is supposed to know better. But he doesn’t seem to be able to escape the shackles of hide-bound “group-think”. Wasn’t the President supposed to put a stop to this kind of thinking?

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Firstly, either the government should have let AIG die and backed their Credit Default Swaps, or else let the CDW’s lapse and allow legitimate price discovery for the CDOs on that basis. The CDWs prop up fictitious value at our expense which is exactly what we shouldn’t be doing. Secondly, last week Congress removed billions for education spending. This week it gives that money to AIG? We’re about to try and overhaul the healthcare system. The $150 billion that we’ve committed without accountability to a dead company could have been a useful downpayment on the single biggest drain on the US economy. Is Tim Geithner trying to be Hank Paulson, because his leadership at Treasury shares the same “making it up as he goes along” characteristics.

Obama is getting all squirly on us. First he signs up a centrist cabinet and give progressives like Robert Reich and Howard Dean the cold shoulder. Then he dumps bipartisanship in favor of a progressive budget. And now he gives yet another handout to the street by protecting their crazy CDOs. Who is he? The answer is we still don’t know.

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here's a plan. panic first. solve problems never.

Who came up with the cockamamie idea of the ‘economic stimulus’? The Bushies. During the post Bear-Stearns policy meltdown, when Paulson and his merry band of idiots put together policy on the fly, all we heard was how we needed to stimulate the economy. Well, we did an awful lot of stimulating but we’re in deeper trouble now than we were then.

And yet, Obama, continuing his annoying tendency to shape policy through a Republican prism, is continuing with this absurd “got to rush through the package now before its too late” rubbish. Many of the changes in the package are going to take months or years to be seen but that doesn’t stop him from giving the poor, downtrodden American people hope (remember that word) that this is a quick fix. It isn’t, and by branding it as one, Obama is only setting up problems for himself.

We all know the reason that this heavyweight bundle of measures was called a “Stimulus Package” even though it’s nothing of the kind – and the reason is that if we created what we really need – which is an “investment package” everyone would say “what about my job, now?”.   But the truth is that trying to stem the tide of a systemic depression is pointless. Instead of seeing economic policy as a series of bandaids, we need to take the panic out and replace it with a cool, patient approach. We need to invest in our future, not rush to plug the dykes. Part of the reason we anointed Obama is because he was so damn unflappable.

So stop flapping Mr. President and show us that America can take a long term view of its problems. Because doing so might just lead us to better solutions.

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a brand new bridge. this one's in france

Things are turned way around when Liberals are agreeing with quirky, flat-tax Steve Forbes, but when called Hank Paulson the “worst Treasury Secretary in living memory” there are few diehard progressives that would disagree.

But old Hank has at least done us one big, big favor. By steamrolling through the TARP at a cost of $700 billion and then doing precisely squat with it, he turned $700 billion into the new $7 billion. Suddenly, with the exception of the bailout for the once mighty now hopeless auto industry, fears of excessive spending seems petty next to the cost of TARP, the Citigroup, AIG, and Fannie and Freddie bailouts. We’re awash in borrowed money, and nobody seems to care. Another day, another dollar, or a hundred billion of them. Whatev.

So when Obama announced his massive public works program (let’s call it the New New Deal or NND) and didn’t even bother to mention a pricetag, the only Cassandra was the ever-predictable American Enterprise Institute. With the economy losing half a million jobs a month, the American people are ready for it. So don’t expect the whining from Club for Growth knuckle-draggers in Congress to be anything more than mumbled griping at worst.

America’s been crying for infrastructure changes for years, but the Bushies, bless ‘em, could hardly spell the word. Result, we’re way behind most other developed countries. And America being America, we wait until disaster is at the door before we do something about it.

But that moment has arrived, and thanks to the TARP and other blank checks, there’s no such thing as a pricetag we can’t afford anymore. It was Dick Cheney who said “deficits don’t matter”, and boy was he right. Of course he was referring to financing fruitless no-end-in-sight wars, but hey, that’s just a detail. The bottom line is that we’ve got way more important fish to fry than worry about making the numbers add up. The reason is simple. A T-Bill is still the safest debt around. Everyone wants ‘em, and as long as they do, hell, we can print ‘em. In a potentially deflationary environment, a little inflation goes a long way.

Businesses run on credit. It’s called investment, and you expect a return on it. America will be rebuilt on the same principle, brick by brick, schoolbook by schoolbook, hospital bed by hospital bed. You get the idea.

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it's always xmas on wall street

Today, a distinguished board of economists said the country had been in a recession since December ‘07, a statement that normally the markets would have discounted, because, yeah, like we knew that. But no, the market’s took a massive swoon, again, giving back all the hard earned gains of the past week’s rally.

Call it rank cynicism, but it just can’t be helped. It’s just too tempting a thought not to consider all this just a tad convenient. Last week the long guys had a party to celebrate a completely predictable new Secretary of the Treasury. This week the toilet beckons because we were told what we already know, and the short guys make a bomb. Coincidence? Perhaps. But if there was collusion between the traders, who after all work either a drink after work or a few desks apart, one could hardly be surprised. After all they’re just trying to make a buck or two with someone else’s money. Right?

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you're getting sleepy...

The Dow Jones Industrials are widely regarded as a pretty poor indicator of where the overall equity markets stand, let alone the real economy. As one hedge fund manager suggested, “equity markets are a zit next to the bond markets.” And let’s not even mention the vast trillions in the derivative markets which have damaged the global economy so profoundly.

And yet at the end of every radio newscast, on every Yahoo home page, on the ticker on every cable network, thereis the DJI, it’s not so shiny brand dancing around at the whim of some very silly people playing monopoly with other people’s money. It’s going up, it’s going down, it’s barely moved. Blah, blah, blah.

The truth is we’re worshipping a zit.

As a nation, we’ve very prone to hypnosis. We love numbers compared to other numbers. It’s easy news. Big movements in numbers equal big news. Little movements are news too. You can always eke some pathetic meaning out of them. Let the long term be damned, when we can be happily transfixed like a two month old baby by bright lights.

There are other examples of bouncy number fixation. The box office reports of the weekend’s receipts, for example. They tell a fraction of the story of film economics, but boy, do we love ‘em.

Why do we love numerical gyration so much? Is it because we’re bored or stupid? Is it some kind of Pavlovian thing? Is it because the news media is too lazy to try and analyze a long term trend, or because the past and future are so much less important than the here and now.

Would the world be any different if we were made aware of the Dow Jones Industrial Average only once a day, rather than once a minute, or once a web page?

Of course it wouldn’t. But without it what would we fixate on?

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eahhh. i've seen better.

So what exactly is Obama thinking with his cabinet picks?

Everyone from Joe Lieberman to Pat Buchanan is delighted with Obama’s top job choices. Joe says they’re “perfect”, which suggests Obama is doing something very, very wrong. Pundits are torn. Is Obama a closet centrist who sold us a bill of goods with all that ‘change’ stuff? Or is he a progressive who’s going to browbeat all his experienced Clintonians into doing his bidding.

My guess is the answer is neither. Obama said today that the ‘change’ is going to come from his desk and filter downwards, but that’s easier said than done. If Obama truly is a progressive (and he really needs to be to define this historical economic moment), a more likely outcome is that the cabinet could quickly descend into ideological squabbling as the President talks up real change, and the cabinet talk up real caution. Obama is known as a consensus builder. If the cabinet is moderate, the consensus will be moderate, and real ‘change’, well that will have to wait.

It would certainly help the President’s ‘change scenario’ that at least one of his major cabinet picks was someone, well, new. But there isn’t really one guy in the top team that offers a totally new perspective on anything at all. So far moderation and predictability has been the order of the day, except in the case of HRC for State, which strikes me more as either fear or plain stupidity.

Time will tell, of course. But there’s one word that definitely wouldn’t be used to describe the new cabinet.

And that’s transformative.

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feed me

There’s something diabolical about a creature that consumes itself. It seems so profoundly irrational, so utterly insane. We file stuff like that in some ‘unspeakable’ part of our minds.

Except that we live it every single day.

Capitalism is a great system in many ways, but it has a tendency to destroy itself if left unchecked. We’re seeing that all too clearly right now. There are two areas where capitalism is profoundly cannibalistic.

The first is how it handles credit.

The flow is pretty simple. Institutions offer cheap credit, which consumers and companies snap up. But at a certain point their ability to pay is reduced, and the value of the debt drops into the toilet. The institutions respond by raising rates, further reducing consumer and companies’ ability to pay. That starts a feedback loop which destroys both sides of the equation.

The second is in the real economy.

Let’s call this “The Walmart Syndrome”. Strong companies control costs, and grow. Large consolidated companies with efficent cost structures want to keep costs down, and demand more for less from their suppliers. This creates globalization, forces labor costs overseas, and jobs are lost at home. As the domestic economy weakens, the ability to afford goods is reduced, causing further cost reductions, and reinforcing the feedback loop which cripples both sides of the equation.

The two feedback loops begin to combine. Weak credit leads to a weak real economy, and downard costs. That’s how world depressions begin.

To restore equilibrium will require a massive ‘brake’ from government in the short term which will have to be deficit financed, and in the longer term, a new economic paradigm. Social Democracy, a mixed economy, strong regulations, and personal and corporate responsibility.

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hi, i'm the system

Back in the eighties there was an awful lot of talk about the nefarious “system”, a deep and dark conspiracy of the powerful to keep down the powerless. Before resentment became a tool of the right, it was a clarion call of the unreconstructed left, a youthful, incoherent, but somehow meaningful rallying cry that drove many a drunken, sophomoric conversation. You don’t hear too much about “The System” these days. Nobody seemed to care anymore, when “The System” was delivering them flat screen TVs and great opportunities to flip condos.

But it seems to me that it’s time to revive talk about “The System” because it’s become very clear what it is.

Undiluted socialism for the rich and influential, and the legal and enforcement system to protect it.

Let’s take a very real world scenario. A couple in Henderson, Nevada, struggling to make ends meet had built up a crushing credit card debt that they want to consolidate. They had tried to be responsible, but stagnant wages had forced them to finance their own personal deficit with credit. To pay that debt that they need collateral, i.e what’s left of their savings. With great effort and sacrifice they start to pay off their debts at the cost of their childrens’ college fund. Much of this couple’s debt is on credit cards owned by Citigroup, which pushed up fees and interest rates as the fortunes of the economy began to falter, further undermining the couple’s ability to pay.

Citigroup had made billions in the good times. It seemed like a detail that it had failed to inform its shareholders and government regulators that its out of control traders had created upwards of a third or a trillion dollars worth of hardly traceable, unpriced, and worthless collateralized debt obligations, tranched out all over the world in an orgy of profiteering. They had paid the ratings agencies for the all important AAA ratings to help them move these CDO’s. These shadow assets had now gone bad, leading to a potential writedown that would destroy the bank. That is the definition of irresponsibiilty.

During the good times, Citigroup had expanded dramatically, its counter-party tentacles creating a web of interdependence that was now a very useful insurance policy. “Too big to fail”, said the government, so they invested nearly $50 billion in the bank with minimal control in return, and offered to guarantee the hundreds of billions in CDO junk. Among the millions bailing out the crushingly irresponsible Citigroup is the responsible couple from Nevada, who continue to pay their taxes on time, or are forced to pay penalties, and face jail time.

That is “The System”

The vicious spiral for the family feeds a virtuous circle for the bank.

At the risk of sounding sophomoric, it occurs to me that “beating the system” really wouldn’t be that hard.

If everyone boycotted making their credit card and mortgage payments for say three months, the banks would fail, and there’s nothing the government could do about it, except for calling out the National Guard to arrest us all. A very American Revolution. Of course, that won’t happen. We’re all too afraid of the law enforcement system put in place to protect “The System”, so we continue to feed it as it sucks us all dry.

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