The Wall Street Journal published an article in its weekend edition (March 7-8) on the American International Group bailout that deserves wider attention than it has so far gotten.
The U.S. government has thus far pumped $173 billion into AIG in a series of installments that began with an $85 billion bailout last September. Officials have had to allocate ever larger sums since then as they have gradually learned of the real depths of AIG’s problems. Where have these funds gone? Thus far, the Treasury and the Federal Reserve, along with AIG, have refused to refused to say for fear of embarrassing the recipients.
The Journal has now begun to peel off the layers of the onion. Saturday’s article makes clear that the taxpayers are not bailing out AIG, but rather all of the counterparty banks here and in Europe that bought Credit Default Swaps from AIG to insure their mortgage backed securities and related investments. The following quote makes the main point:
The beneficiaries of the government’s bailout of American International Group Inc. include at least two dozen U.S. and foreign financial institutions that have been paid roughly $50 billion since the Federal Reserve first extended aid to the insurance giant.
Among those institutions are Goldman Sachs Group Inc. and Germany’s Deutsche Bank AG, each of which received roughly $6 billion in payments between mid-September and December 2008….
The names of all of AIG’s derivative counterparties and the money they have received from taxpayers still isn’t known, but The Wall Street Journal has identified some of them and is publishing others here for the first time….
In a Senate Banking Committee hearing in Washington on Thursday, Fed Vice Chairman Donald Kohn declined to identify AIG’s trading partners. He said doing so would make people wary of doing business with AIG. (emphasis added)
But Mr. Kohn told lawmakers he would take their requests to his colleagues. The Fed, through a new committee led by Mr. Kohn to discuss transparency concerns, is now weighing whether to disclose more details about the AIG transactions.
The Fed rescued AIG in September with an $85 billion credit line when investment losses and collateral demands from banks threatened to send the firm into bankruptcy court. A bankruptcy filing would have caused losses and problems for financial institutions and policyholders globally that were relying on AIG to insure them against losses. Since September, the government has had to extend more aid to AIG as its woes have deepened.
The Journal has been able to identify several of the recipient banks, in addition to Goldman Sachs and Deutsche Bank — Merrill Lynch, Barclays, HSBC, Royal Bank of Scotland, Morgan Stanley, Wachovia, Bank of America, Lloyds, Banco Santander, Societie Generale, and several others. In other words, several of the world’s largest banking institutions.
The article raises the question as to why American taxpayers — factory workers, school teachers, small business owners — are being asked to bail out international banks whose executives received extravagant bonuses in years one, two, and three for decisions that banrupted their institutions in year four? The answer given by the Treasury and the Fed is that the banks, unless they are paid, will collapse like falling dominoes and thereby bring down the entire financial system with them. This appears more and more to be an exaggerated proposition as the crisis intensifies while the bailouts accumulate. There is also the question as to why the public cannot be told who is receiving checks courtesy of the taxpayers.
There is little doubt that a public backlash is forming against the banks and the bailouts as layoffs and bankruptcies accumulate and as the stock market continues to fall. The medicine thus far prescribed by the financial authorities will have to begin to work soon or risk being discredited altogether. One suspects that this is why the Treasury has been so dilatory in coming up with an overall plan to rescue the banks — the costs are beyond comprehension, it is impossible to value their bad assets, the public will react badly when it becomes clear who is being rescued, and any failure now will preclude future measures to stem the tide of insolvencies.
When the history of this crisis is written, we may well conclude that the the bailouts were a mistake — that from the beginning the architects badly underestimated how much trouble the banks were in, that they prolonged the crisis by throwing good money after bad, that they rewarded the people responsible for it, and established a terrible precedent requiring ever more bailouts of auto companies, state and local governments, insolvent mortgage holders, and still others until we exhausted our resources on bad debts and had little left over to make provision for the future.
That is a grim scenario. Despite misgivings, one still hopes for a better outcome.
Kudos to the Journal for its reporting. Read the story.
– James Piereson is president of the William E. Simon Foundation and former executive director of the John M. Olin Foundation.