By William Greider, The Nation
The government’s $182 billion bailout of insurance giant AIG should be seen as the Rosetta Stone for understanding the financial crisis and its costly aftermath. The story of American International Group explains the larger catastrophe not because this was the biggest corporate bailout in history but because AIG’s collapse and subsequent rescue involved nearly all the critical elements, including delusion and deception. These financial dealings are monstrously complicated, but this account focuses on something mere mortals can understand—moral confusion in high places, and the failure of governing institutions to fulfill their obligations to the public.
Three governmental investigative bodies have now pored through the AIG wreckage and turned up disturbing facts—the House Committee on Oversight and Reform; the Financial Crisis Inquiry Commission, which will make its report at year’s end; and the Congressional Oversight Panel (COP), which issued its report on AIG in June.
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The five-member COP, chaired by Harvard professor Elizabeth Warren, has produced the most devastating and comprehensive account so far. Unanimously adopted by its bipartisan members, it provides alarming insights that should be fodder for the larger debate many citizens long to hear—why Washington rushed to forgive the very interests that produced this mess, while innocent others were made to suffer the consequences. The Congressional panel’s critique helps explain why bankers and their Washington allies do not want Elizabeth Warren to chair the new Consumer Financial Protection Bureau.
The most troubling revelation in this story is the astonishing weakness of the Federal Reserve and its incompetence as a faithful defender of the public interest.
The report concludes that the Federal Reserve Board’s intimate relations with the leading powers of Wall Street—the same banks that benefited most from the government’s massive bailout—influenced its strategic decisions on AIG. The panel accuses the Fed and the Treasury Department of brushing aside alternative approaches that would have saved tens of billions in public funds by making these same banks “share the pain.”
Bailing out AIG effectively meant rescuing Goldman Sachs, Morgan Stanley, Bank of America and Merrill Lynch (as well as a dozens of European banks) from huge losses. Those financial institutions played the derivatives game with AIG, the esoteric practice of placing financial bets on future events. AIG lost its bets, which led to its collapse. But other gamblers—the counterparties in AIG’s derivative deals—were made whole on their bets, paid off 100 cents on the dollar. Taxpayers got stuck with the bill.
“The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America’s largest financial institutions,” the COP report said. This could have been avoided, the report argues, if the Fed had listened to disinterested advisers with a less parochial understanding of the public interest.
Fed and Treasury officials dismiss this critique as second-guessing of tough decisions they had to make in the fall of 2008, amid the fast-moving global crisis. Yet two years later, those controversial decisions remain highly relevant. Public anger has not abated. It fuels the election turmoil that this year threatens to bring down incumbents in both parties who voted for bank bailouts.
Although the AIG bailout was carried out in the waning days of George W. Bush’s presidency, the popular sense of injustice has deeply scarred Barack Obama, since he too adopted a forgiving approach toward culpable financial interests. Obama came to office intent on restoring public trust in government. His indulgence of the mega-banks led to the opposite result.
More to the point, the AIG story raises real doubts and suspicions about how the government will respond next time. Or whether the new financial reform legislation actually corrects government’s deference to the pinnacles of private financial power. Massive federal intervention was certainly necessary, the Warren panel agrees, including quick action to forestall AIG’s bankruptcy. But government declined to demand anything in return.
The AIG rescue was done in ways that had “poisonous effects” on the financial marketplace and public opinion, the report concluded. Cynical expectations were confirmed, both for citizens and financial players. Some financial firms are simply “too big to fail,” it seems; Washington will not let them collapse, no matter what the president claims.
The most troubling revelation in this story is the astonishing weakness of the Federal Reserve and its incompetence as a faithful defender of the public interest. In the lore of central banking, the Fed is awesomely powerful and intimidating. As regulator of the banking system, it has life-and-death influence over banks. As manager of the economy, it has open-ended authority to intervene in the financial system to restore stability, as the central bank did massively during the crisis.
Yet the Fed was strangely passive and compliant when it came to demanding cooperation and sacrifice from the largest financial institutions. Timothy Geithner was then president of the New York Federal Reserve Bank, the lead regulator of Wall Street’s largest banks. He briefly insisted they must accept the burden of rescuing AIG. But the bankers called his bluff and blew him off—and Geithner deferred to their wishes. The taxpayer bailout followed. The episode is relevant to the future, because Geithner is now Obama’s Treasury Secretary and in charge of preventing the next taxpayer bailout.
In the early autumn of 2008, mayhem swept through global financial markets. It engulfed AIG on Monday morning, September 15. Lehman Brothers had just failed. Panicky credit markets were seizing up. American International Group, largest insurance company in the world, was hemorrhaging capital, rapidly sinking toward bankruptcy. At the New York Fed, Geithner had the problem covered, or so he thought.
Geithner informed top executives of Wall Street’s most important financial houses—Jamie Dimon of JPMorgan Chase and Lloyd Blankfein of Goldman Sachs—that the banking industry, not the Federal Reserve, must step up and do the rescue. Geithner told them it was “inconceivable that the Federal Reserve could or should play any role in preventing AIG’s collapse.”
That Monday morning, Geithner summoned representatives from Goldman and the JPMorgan bank to Fed offices and told them to organize a private-sector consortium of major lenders to provide the emergency liquidity loans that would keep AIG afloat until things settled down. It was presumed JPMorgan would be the lead lender; Goldman, as an investment bank, could help AIG sell off assets to raise capital. Given the Fed’s blessing, other banks were expected to cooperate.
The New York Fed president did not need to threaten anyone. This was the gentlemanly way in which the central bank can invoke its informal authority, with numerous precedents in the past. Prodded by the Fed and Treasury, major banks had done something similar back in 1998 to save the hedge fund Long Term Capital Management, whose collapse threatened a chain reaction on Wall Street. During the Latin American debt crisis of the 1980s, the Fed had used its overbearing influence to make leading US banks grant concessions and write down outstanding loans—a grudging “workout” that saved Mexico, Brazil and Argentina from default but also saved some famous New York banks from imploding.
If I were American I would be seething. I lose my house while my tax dollars bail out mega rich corporations. Socialism for the rich and capitalism for the poor! Yamit, do you think the quai-public Fed is really a necessity? I think without the Fed Congress could issue currency. Instead of inflation + debt would there only be inflation?
The idea behind state intervention into the otherwise free-market economy is leveling crises. But there is another side: market participants come to expect the crises to be leveled, so they swing the market recklessly. This is especially true for huge companies: they are implicitly assured of the government’s support lest they fail, lay off many employees, and send shock waves through markets. Huge corporations can therefore assume higher risks: while they succeed, their profits are above average and they grow relative to smaller companies; when they fail, they are assured of a bailout. Such guaranteed status brings them customers and investors who seek government-like safety with market returns. They are basically a fraud: the government subsidizes the customers and shareholders of very large companies with taxpayer money. Fannie Mae and Freddie Mac’s operating profits ran into tens of billions of dollars during the years of the real estate bubble; its top officers received hundreds of millions of dollars in bonuses. The taxpayers are left with two to five trillion dollars in bad debt.
Here the interests of liberals and swindlers meet. Liberals want businesses to embrace a social agenda rather than pursue profits. Such an agenda is by definition unprofitable, or it would have been taken on and solved by the free market already. Unprofitability can be solved by raising prices or lowering risks. In the American phantasmagory, liberals tax the commoners to increase the big businesses’ profits by providing them with government guarantees. In a typical example, a black American with no credit history approaches a bank for a $150,000 mortgage. A free-market bank would have refused him on the spot simply because his risk cannot be measured. Not so in America. There, a government-backed corporation called Fannie Mae insures the risk. The black risk suddenly becomes lower than the white one: a middle-class white American can fail to make his payments, but the government stands behind its black citizens. Additionally, the bank charges the black customer a sub-prime (higher) mortgage rate even though his risk is actually lower than the white’s. Of course, every bank jumps on the bandwagon of minority mortgages. Insurance companies such as AIG join the fray: they reasonably expect that for the sake of justness the government which insures sub-prime mortgages by blacks would also act as the last-resort insurer of other sub-prime loans and over-the-conforming-limit loan balances. AIG also insured the mortgages sold to Fannie Mae: practically insured by the government, Fannie Mae paid for commercial insurance from the insurer who in the end was bailed out by the government. If that is not fraud, then what is?
Soon the scheme is expanded from those minorities who theoretically might deserve affirmative action to groups which only can claim such benefits in a socialist environment: Hispanic immigrants, single mothers, and various degraded elements.
Various scams have been devised to dress the affair in economic terms. HUD and Fannie Mae substituted rent-payment history for credit history. Never mind that mortgage payments are two to three times the cost of rent payments. Never mind their utterly different nature: failure to pay rent lands one on the street soon, while walking away from credit obligations is relatively safe. One does not acquire a habit of managing his credit obligations simply by paying rent; credit relations are much more complex than that.
The facts were there for everyone to see, but no one wanted to act. On March 2, 2000, Fannie Mae’s CEO announced at a press conference, “Fannie Mae’s policies are to expand home ownership as aggressively as possible….During the 1990s, Fannie Mae grew to become the nation’s single largest source of home financing for minority families…In the decade of the 1990s minority home ownership boomed.” Anywhere but in a socialist state this is a crime: of manipulation at least, of conspiracy at worst. In the land of tens of thousands of banks, any worthy borrower can find a loan; Fannie Mae encouraged borrowing for those who on the average were bound to fail. They have the audacity to call this, “fair lending.” What next, selling Lexuses to low-income blacks at “fair price”?
Investors wanted to believe Fannie Mae was a government-backed corporation despite the clear disclaimer in the law that established it. Liberals served that end by increasingly regulating Fannie Mae: in conjunction with HUD, they continuously pushed the corporation to ever more lax policies so that undeserving borrowers would obtain loans. The NAACP dictated many of Fannie Mae’s policies. Fannie and Freddie customers enjoy a borrower’s paradise: lenders get their money back from the government, and the government won’t push the minority home-buyers too hard to repay; the government cannot evict thirty to fifty million citizens from the houses they have defaulted upon.
What is truly bizarre is that all the racist-minority-fairness talk is a lie. The free market actually lends more to black families than does Fannie Mae. The corporation embraces not black borrowers, but rather bad ones. In doing so, Fannie Mae diverts lending resources and thus jacks up the loan cost for decent borrowers; it also bears major responsibility for the real estate bubble. Fannie Mae was among the pioneers of almost zero downpayment loans—incredibly, it provided high-risk loans to high-risk groups.
The FDIC is another culprit in the current crisis. By insuring bank accounts, it absolved depositors of any risk, and essentially welcomed them to the riskier banks which pay a bit more on deposits. Like Fannie Mae, the FDIC rewarded reckless behavior: if the bank succeeds in its wildly risky lending, everyone wins; if the bank fails, taxpayers cover the losses. Risky banks got an increasing share of deposits, and sub-prime loans ballooned.
The US mortgage crisis is greatly overstated. Liberals do so in order to push for more regulation and direct government action in the markets. Big businesses want the government to cover their losses. In fact, the defaulted money comes from big investors. The bank losses of half a trillion dollars belongs to institutional investors shoulder-deep in various collateralized mortgage securities; they have enough money to cover their losses. Banks, moreover, can always water down their shares to cover their losses.
It is only fair to let the sharks go down: they profited immensely on the real estate boom, and if the market exerts justice on them, so well. The big lenders eagerly developed the sub-prime mortgage market until it reached a whopping one fifth of the total. They gladly “accepted” the risks which, after securitization, others would buy from them. They gambled, profited, and now want the public to repay their endgame losses. Often the same entities which clamor for government subsidies continue destabilizing other markets, notably oil futures. This M3+ money flight from mortgages into commodities is largely responsible for the crisis: investors thought they would always be able to find someone to dispose of the securitized mortgages, and are stuck with overpriced paper. It’s like the promoters of a Ponzi scheme asking the government to pity them.
Only a minor small part of the debts would reach the M2 money supply relevant for common citizens. Besides, much of the debts will eventually be recovered through foreclosures.
To say that real estate prices are falling is misleading: they are simply returning to normality after a manifold increase during the preceding fifteen years. A large percentage of responsible borrowers have considerable equity in their houses and won’t walk away from them even as the prices fall.
At its roots, the crisis is traceable to the government’s fateful decision a century ago to nationalize the business of issuing bank notes. If commercial banks had been issuing competing currencies, the speculation would be drastically curtailed. Each bank will be keen to control its own currency rather than let speculators inflate the money supply with cunning monetary instruments. Acting as clearinghouses for their own notes, the banks will control the money supply tightly. As private institutions, they can limit the use of their notes in the way the government cannot. Some issuers will serve speculators in the M3 market and retail customers would shun their currency. This is the ticket: the retail and speculative currencies have to remain separate to insulate common citizens from big-time institutional gamblers.
Some bank failures there would be—many of them—but for relatively small amounts, nothing like the current defaults. State regulation prevents common restructuring crises—and paves the way to a rare mega-crises.