The Argument Against Letting AIG Fail

Posted by: Michael Mandel on March 20

Since I argued that we should have saved Lehman and let AIG go, let me give the opposite side. Or more precisely, let me quote from a post by Mark Thoma of Economist’s View:

It may very well be that financial markets can withstand the failure of AIG, but the potential downside if that assumption is wrong is very large, larger than any policymaker wants to take the blame for. Thus, in such cases, you often observe policymakers pursuing what they feel is the safest policy that moves the ball forward rather than policies that might have a better upside, but also come with the possibility of, say, market meltdown. I’m sympathetic to the argument that we should put AIG through a carefully managed failure, but saying, as above, that letting “AIG’s derivative counterparties take a significant haircut … should not lead to … a crisis” still leaves the door open, even if only a crack, to an outcome that no policymaker wants to be responsible for.

And then he goes on to say:

How sure are we that if we let AIG fail all of the necessary pieces - all the big and little ifs above - will fall into place, how sure are we of any evidence based upon asset valuations when there’s no market price for them, and how sure are we that we’ve thought of all of the things that could go wrong?


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Reader Comments

empedos

March 21, 2009 10:43 AM

From the moment that the US "decided" to become the global banker and risk manager, one of its main assets is the globe's confidence in its ability to keep its promises. Neither Lehman nor AIG should have been left to fail. Some help from other goverments through negotiations should have been sought though by the Bush and Obama administrations, what is happening is unfair for the American taxpayer.
It was America's banking system that failed to see that investing others' money in US soil alone (housing bubble) is a dead-end. The third world (for example) offered (and still does) some significant opportunities both on the demand as well as on the supply side. Being the globe's banker requires global thinking and acting.
Becoming the world's new Switzerland could be a profitable business offering many jobs to America's citizens. To this end, one has to prove though his ability to offer sustainable yields to his clients by being openminded and not thinking "America only".

CompEng

March 21, 2009 12:42 PM

Empedos,

when did America's people and government decide to make such a decision? Some of America's banks sprung up and were successful. Then they made poor decisions... and remember that the final responsibility is always with the investor except in the case of fraud (and if some of the actions taken fall in that category, Americans still have no obligation to bail out the bank). When did all of America "decide" to be the world's banker?
Instead, America's "deciders" are attempting to be purely pragmatic. If there are N possible futures, we're trying to pick the one that has the best consequences. But I don't think if you took a poll, the honor of being the world's banker would be high on very many people's priority lists.

kc

March 21, 2009 12:46 PM

We should bail out AIG's clients exclude Goldman and foreign banks, and let AIG fail.

empedos

March 21, 2009 03:59 PM

CompEng,
America's "deciders" (i' m talking about the Fed in particular) have recently decided to buy toxic assets (mortgage backed securities) worth a huge amount of money by printing more dollars. Obviously, Mr Bernake does not want the holders of these securities to loose their money and he's helping them out (not all of them are foreigners). The Fed's message was clear and loud : we, the Fed, have responsibility for poorly regulating the market and we are now ready to take on risk to compensate for our previous failure and to maintain the trustworthiness of our financial institutions. We cherish this trustworthiness.
Obviously, you believe that this is a mistake that the Fed is making.

CompEng

March 21, 2009 07:01 PM

Empedos,

The distinction I'm trying to draw is a little more subtle than that. I think the Fed and America's bankers should not be thought to speak for America's whole economy: that's part of how we got in this mess. We should do what is absolutely necessary to avert disaster in the overall economy, and no more.

The Fed, the Treasury, and America itself have a very strong interest in keeping the majority of America's banks from going belly-up (and you can generalize it: globally we should make sure most banks globally don't go belly-up). We don't have the same level of interest in 100% guaranteeing every dollar put in them. I think *everybody* is going to wind up with a bit of a haircut, which is much better than a few of us losing our whole heads. But completely backing America's banks to the point where any investment in them is considered to be a zero-risk proposition is not in anyone's interest. The overall risk distribution should not be so centralized as you seem to be implying: that's another lesson I think this mess should have taught us.
The way risk was nominally supposed to be distributed didn't help us because no one really believed there could be any downside under any circumstances. There is simply no way at all that we can afford that kind of attitude.

Careersthatdontsuck

March 23, 2009 03:41 PM

"Too Big to Fail". I'm so sick of hearing this! It's ironic that the decentralized, unregulated free market policy-makers set out to create has turned out to be the polar opposite--a market where power and wealth is effectively centralized with a few players.

Problem is, I don't think this is some ironic coincidence. No, I don't think anyone planned the collapse of the U.S. economy, but I do believe that someone planned the centralization of power and the legal environment where financiers and the politicians who stuff their pockets with lobbyists' gifts, could do whatever they wanted without worry of legal consequences. That's exactly what we've got and why we can't do much about it--we can't put bankers in jail, we can't keep them from spending taxpayer dollars on unearned bonuses, we can't pull the plug on festering sores like AIG.

I'm not advocating Socialism, just smarter policy that incentivizes entrepreneurs to start businesses while also creating disincentives to fraud.

Perhaps, once we've found a bit of dry land in this storm, we can focus on creating smarter business policy. For now, maybe we can just admit we are all flailing in the dark, just testing and tuning.

dr Jay Veeoh

March 26, 2009 10:13 PM

Wages and bonusses had to be paid to AIG
because AIG itself is collateral for the loan and therefore must be properly
supported back to normality. Under pressure during the hearings, Geitner failed to explain and Bernacky tried to help him out by saying that the "voters" who lost 40% would have lost 70%. Can't they stand the heat ?

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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