Bailout Nation (44 page)

That is an accurate description of what occurred with Washington Mutual (WaMu), now part of JPMorgan Chase, and with Wachovia, now part of Wells Fargo. The FDIC steps in and seamlessly transfers control of the assets to a new owner, while simultaneously wiping out the debt and the shareholders, and giving a big haircut to the bondholders.

Let's look at what these terms mean:

What emerges is a clean, debt-free bank, well capitalized, without deadly toxic assets on its books.
Why would anyone find this state of affairs objectionable?

If our choice is between going Swedish or turning Japanese, you can call me Inga.

I
n reality, the nationalization issue is moot. Miller Tabak's market strategist, Peter Boockvar, notes that the debate over nationalization is now mere wordplay:

And it could get worse. If the recession intensifies, we should expect increased layoffs, weaker retail sales—and more foreclosures. As of this writing, the United States has had five consecutive monthly Non-Farm Payrolls releases of about 600,000 job losses or worse. If that number doesn't improve soon, foreclosures are going to increase. With most of the toxic paper banks hold primarily consisting of mortgage-backed securities, the need for more bailout money may be inevitable.

T
o get a handle on just how absurd the results of our casino capitalism have become, let's take a closer look at AIG. The bailouts of the insurance giant raise a disturbing question: Why are the taxpayers making good on hedge fund trades gone bad?

AIG was essentially two companies jammed under one roof. One was a highly regulated, state-supervised life insurance company—in fact, the biggest such firm in the world. It had a long history of steady growth, profitability, and excellent management, and made money (as the commercial goes) the old-fashioned way: They earned it.

This half of the company held the most important insurance in many families' financial lives: their life insurance. When an AIG policyholder passed away, the company paid off the policy, providing monies that were used to pay the mortgage, kids' college educations, and the surviving spouse's lifetime living expenses. Given the importance of this payment, one can see why the state has a vested interest in making sure there are sufficient reserves to pay off the life insurance policies. The actuarial tables used are conservative, the accounting transparent. The policy payoffs are rock solid, utterly reliable.

AIG, this insurance company, was well run. It made a steady income and provided a valuable service to its clients. It was also solvent, and had no need for a bailout.

The other half of the AIG firm was an unregulated structured finance firm, specializing in credit default swaps and other derivatives. Most people did not learn of the darker half of the firm until AIG faltered. This structured finance half was nothing that the life insurer was. Neither regulated nor transparent, it existed only in the shadow banking world, a nether region in the financial universe. This part of the company engaged in trading with hedge funds, banks, speculators, and gamblers from around the world. Huge derivative bets were placed, with billions of dollars riding on the outcome. Other than a legal pursuit of profit, it served no societal function.

This was the part of AIG that was nothing more than a giant structured finance hedge fund. Despite the fact this hedge fund had no credit rating, no supervision or regulatory oversight, and no reserves, it somehow managed to trade off of the good name—and triple-A rating—of the regulated half. Counterparties treated it as if it were triple-A, regulated and guaranteed by the government.

AIG “exploited a huge gap in regulatory oversight” to operate a hedge fund on top of its core insurance business,” as Fed Chairman Ben Bernanke testified before Congress on March 3, 2009.

This was nothing more than a giant fraud, perpetrated by the people who were running AIG's structured products division. This side of the firm was exempt from any form of regulation or supervision, thanks to the Commodity Futures Modernization Act.

As you might have guessed by now, this portion of AIG is the insolvent half. As taxpayers, you should be asking yourself: Why have we paid $173 billion to bail out the speculation and derivative bets?

Of all the many horrific decisions that Hank Paulson made as Treasury secretary, the $143 billion to AIG may likely be his worst. And his successor at Treasury, Tim Geithner, is not too far behind, having already doled out $30 billion to AIG.

It's highly unlikely we're getting the money back. The main reason for the cash infusions so far seems to be bailing out AIG's counterparties, the firms for which AIG provided so-called insurance on collateralized debt obligations and other derivative instruments. Given that few of these CDOs are ever going to get back to par and that some of the policies have 30-year durations, we've only just begun the process of bailing out AIG and its policyholders, who have claims that some estimate run into the $450 billion range.

W
hat should have been done? When AIG was nationalized, it should have immediately spun out the good, solvent life insurance company, which is a highly viable stand-alone entity. The hedge fund should have been wound down in an orderly fashion. Match up the offsetting trades; wind down the rest. End of story.

The credit default swap gamblers had no reasonable expectation that anyone other than the firm they placed their bet with was going to make it good. If they happened to place a bet with a firm run by incompetent management, well, then, that becomes their problem, not the government's. If they selected as a counterparty another hedge fund that did not reserve for the losses and was unable to make payments, well, that was a choice they made. It certainly is not the obligation of the taxpayer to assume the risk. As of March 2009, the bill for AIG is $173 billion—every last penny of which has been a needless waste.

At least as far as the taxpayers are concerned it's a waste. To the various counterparties, it was manna from heaven:

“AIG, under pressure from lawmakers to show how its bailout cash was spent, disclosed on March 15 that $105 billion flowed to states and banks, led by Goldman Sachs Group Inc., Société Générale SA and Deutsche Bank AG,” Bloomberg reported.

“Banks that bought credit-default swaps or traded securities with AIG got $22.4 billion in collateral, $27.1 billion in payments from a U.S. entity to retire the derivatives and $43.7 billion tied to the securities-lending program, AIG said. States, including California and Virginia, got $12.1 billion tied to guaranteed investment contracts.”
⁵

Among those that have partaken of Uncle Sam's munificence were Goldman Sachs, Merrill Lynch, Morgan Stanley, Wachovia, and Bank of America. You might be surprised to learn that the rest of the charity recipients were overseas banks: Germany's Deutsche Bank and French bank Société Générale, as well as Calyon/Crédit Agricole (France), Danske (Denmark), HSBC (UK), Royal Bank of Scotland, Banco Santander (Spain), Lloyds Banking Group (UK), Barclay (UK), and Rabobank (Netherlands).

Not only are U.S. taxpayers subsidizing the bad decisions made by executives in the United States, but we are also bailing out the poor judgment of the rest of the world.

Adding injury to insult, “some of the billions of dollars that the U.S. government paid to bail out [AIG] stand to benefit hedge funds that bet on a falling housing market,” the
Wall Street Journal
reported.
⁶

In short, what looks like a government backdoor bailout of major financial institutions with AIG serving as the middleman is, in part, actually a bailout of private speculators. Hedge funds don't bear the responsibility for the collapse of our financial system, as some contend, but do they really deserve to double-dip on the real estate bust at taxpayers' expense?

H
ence, the call for nationalization is not a move toward socialism, but an attempt to prevent casino capitalism from bankrupting the country. (See
Figures 22.1
to
22.5
.)