Here’s what is most infuriating: Here we are now, fully aware of how these scams worked. Yet for all practical purposes, the government has to keep them going. Indeed, that may be the single most important reason it can’t let A.I.G. fail. If the company defaulted, hundreds of billions of dollars’ worth of credit-default swaps would “blow up,” and all those European banks whose toxic assets are supposedly insured by A.I.G. would suddenly be sitting on immense losses. Their already shaky capital structures would be destroyed. A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful.
I asked Mr. Arvanitis, the former A.I.G. executive, if the company viewed what it had done during the bubble as a form of gaming the system. “Oh no,” he said, “they never thought of it as abuse. They thought of themselves as satisfying their customers.”
That’s either a remarkable example of the power of rationalization, or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean it up.
That would be us, the taxpayers.
That’s either a remarkable example of the power of rationalization, or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean it up.
They weren’t lying to themselves, or rationalizing. They were just good businessmen. They were the smart ones, who earned big money for their customers and stockholders (no doubt, many were congressmen) knowing that the way to make money today is not to have a wise business plan, but to be in bed with Washington bureaucrats. This is moral hazard Exhibit A, which I’m increasingly sure is a major cause of the current crisis. Perhaps they did all this because they knew they had all the right lobbyists and all the right congressmen and would be bailed out. And, now that we’re proving them right, many other businesses that are too big to fail will engage in risky practices bacause they also know they will be bailed out. Which is why the cure, in the long run, will likely be more expensive than the disease.
If it’s going to take $250 billion to make sure AIG doesn’t slip beneath the waves, then no amount of capitalization of its CDS positions would have prevented its insolvency. CDSs are fine instruments of risk management, but not when the entire sector they insure is collasping.
The problem wasn’t the CDSs, it was the real estate bubble they were based on.
I always wonder if AIG would have been in this mess had Greenberg not been ousted as CEO. An excerpt from his testimony (pdf):
It was recently reported that AIGFP began selling credit default insurance in 1998 and that the volume of this business exploded after I left the company in March 2005. AIGFP reportedly wrote as many credit default swaps on collateralized debt obligations, or CDOs, in the nine months following my departure as it had written in the entire previous seven years combined. Moreover, unlike what had been true during my tenure, the majority of the credit default swaps that AIGFP wrote in the nine months after I retired were reportedly exposed to sub-prime mortgages….For example, it is my understanding that the weekly meetings we used to conduct to review all AIG’s investments and risks were eliminated. These meetings kept the CEO abreast of AIGFP’s credit exposure. Earlier this year, AIG’s independent auditors, PricewaterhouseCoopers, found AIG to have a material weakness in its internal controls relating to AIGFP’s portfolio of credit default swaps. It also appears to be the case that the problem created by the additional risk AIG had taken on through these new credit default swaps may have been aggravated by the fact that the new exposure appears to have been entirely or substantially unhedged.
That was an Eliot Spitzer crusade, JGeorge, that forced Greenberg out of AIG. Unintended consequences and all.
AIG covers the DC retirement packages.