Too Big To Fail

Too Big To Fail

… first part written just before the latest bailout plan was floated…

A few days after sending Lehman Bros Investment Bank to the dustbin in order to uphold the concept of moral hazard the US government reversed itself and stepped up to the plate with $85 billion in public money for AIG, the country’s largest insurance company. Lehman with a mere $200 billion in assets wasn’t too big, but AIG with a trillion evidently was - possibly because it sold a lot of insurance on those down and dirty mortgage bonds that are now tanking big time.

This all came on top of the $200 billion of capital infused into quasi-government agencies Fanny Mae and Freddie Mac, $35 billion for the Bear Stearns bail last March and at least $200 billion before that that involved the treasury exchanging, to an array of banks, solid-as-the-US Government bonds for subprime assets possibly worth pennies on the dollar; hard to say, nobody knows for sure what they are worth.

Moreover, the money already expended on Freddie and Fanny may only be a small part of what the US may ultimately be liable for on their account. All told, even without the frightening possibility of additional trillions in liability, we’re probably talking a trillion dollars coming out of the public trough. By any standard a chunk of change; easy enough to imagine the good works that could come of that much dough.

The manipulators made out like jewel thieves packaging and trading their purposely inscrutable financial instruments, but now that their tomfoolery has turned calamitous, it’s Joe Sixpack to the rescue. Fanny and Freddie were once government agencies with strict rules to work to but in the mania for privatization that’s gripped the country in the past few decades they were turned into a hybrid where profits are privatized while losses, as we now see, are socialized.

Moral hazard is the idea that business people will make greedy and foolish decisions if they know that the government will bail them out; that they won’t have to pay for their transgressions. In the case of Freddie and Fanny, the US is obligated to rescue them no matter how crassly and stupidly they were run and regardless of the idiocy of privatizing them in the first place.

Now AIG has been rescued because it’s too big to fail; it’s demise would be catastrophic, we’re told. This however brings up a question that is somehow not part of the debate: If it’s too big to fail then maybe it should never have been allowed to get that big in the first place. Furthermore, investment banks are being sold at bargain prices to other banks so large they too will be too big to go under if/when they hit hard times.

Breaking News… The Congress is preparing legislation to purchase at least $700 hundred billion of additional subprime based, mortgaged-backed, toxic (in Wall Street lingo) securities from tanking banks. In exchange for securities of unknown value, the banks will get real money. That way they can get right back to creating the next financial meltdown. And why not? It’s fun making tons of money and until it all goes bust again they can do really well. They made the money while the getting was good, now the rest of us suckers can bail them out.

So now we’re talking around a trillion and a half dollars (just for perspective that’s $1,500,000,000,000; equal to 10% of GNP) with the possibility that the number could go higher. To be fair, the government may eventually get some value for its money. Once again, impossible to say how much, real estate values are still going down.

On the other hand, it’s not certain that the bailout will do the trick. It may not solve the fundamental problems in the industry. It may be only one more stopgap measure in a cascade of calamities.

When developing countries experience economic or financial meltdowns, we insist that shock therapy is the only proper response and they should just tough it out. Especially, bailing out the little guy is severely discouraged.

When it came to helping people facing foreclosure Congress could only manage a program designed to come to the aid of but 10% of those in trouble. Now at the insistence of the bushman they are racing to the rescue of the fat cats.

With news of the massive bailout, stock markets soared. Knowing the government was coming to the rescue clearly allowed the investor class to breathe a sigh of relief.

There’s one good that will hopefully come of this fiasco: Neo-con economic ideas – deregulation, unfettered free markets - will be totally discredited. They will be as toxic and repulsive as the obscure financial instruments created in the wake of the deregulation mania of the recent past that are the crux of this crisis.

Even if the multiple bailouts are successful - if that’s the proper term - it’ll still take a decade or more for the US economy to recover from the fiasco. And because the money being thrown at the problem will all be borrowed, it’ll take at least a generation to pay it off. All in all a sordid state of affairs that’ll leave its bitter aftertaste for a long time.

Last word is that Congress may actually demand some input into the bailout plan. Well now, that would be a first: Congress asserting itself on behalf of the American people. Hard to imagine, hard to believe, but miracles do happen so stay tuned.