AIG has insured $1.6 trillion in derivatives


And you thought AIG's $62 billion quarterly loss last month was bad -- turns out that the company has a further $1.6 trillion in outstanding derivatives exposure, according to this leaked memo that AIG sent to the US Treasury in order to beg for another $30 billion. Aig Systemic 090309 (via The Dynamics of Cats)

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  1. OK, we are F*#%ed.

    This is not going to end well. It’s like watching an episode of “Intervention” with the US Treasury as the hopelessly codependent enabler to an arrogant Wall St. in denial, and we are ALL part of the god damned family…

  2. Just glancing over it, the thing looks legitimate, and they know they’re financial terminology. I had our head analyst brush it over and told me, “As real as this looks, I’m going to ignore it to feel better.”

  3. TAKUAN,

    We got two going now, and it ain’t helping much….

    Good time for an alien hostile takeover. Perhaps some intergalactic private equity fund will swoop in and pick us up on the cheap while our planet is in cyclical decline…..

    Don’t you dare steal that idea you William Gibson wannabes…….

  4. Well, at least now I can pay off my student loans with a couple of US$10,000 bills…

  5. I saw the prime minister of Belgium buying yellow cake at the store the other day. Sounds like regime change time to me.

  6. We’d be better off if we just accepted that these institutions have failed and just let shareholders take the hit. The bailout money would be much better spent creating NEW banks that aren’t saddled with fantastical amounts of bad debt.

  7. Having skimmed it, I think I can summarize it for anyone who wants to save time.

    “We’re too big to fail. More money, please. Thanks!”

  8. Which is why insurance is only good for medium-size things. Little things, like dental insurance? Useless (you pay in as much as you get out). Big things, like a hurricane that takes out a city? Useless (insurance co folds or tells its customers to screw off or leeches off the taxpayers). Medium bad things, like a flood that submerges half a dozen houses, or a rogue saw that severs a few fingers? That’s what it’s good for.

    The only good insurance policy for big-scale bad things happening is the kind that’s not maintained by an insurance company. Like having multiple residences in different parts of the world, or stocking up a bunker in Idaho. Or a significant enough diversification of skills such that you can get by on a radically different set of circumstances.

  9. The geniuses that came up with credit default swaps and the executives that let them multiply should be pushed. All they’ve given the world is new and easy ways to go into debt.

    Maybe they could be allowed to not jump by giving up everything. Set ’em up as migrant laborers.

  10. The time has come to slaughter this pig, bleed it dry, cut it up and sell the pieces. The sooner it is disposed of and the sooner that the whole CDS structure and selling thereof can be destroyed and outlawed, the better.

    For a market to work properly, there must be risk and punishment for failure. This failed idea that all risks can be insured against and avoided has destroyed us.

    The real world contains risks.

    Pooling resources to help rebuild after a tornado is not the same thing as covering bets, which the base for our whole financial system under “the Roving Cavaliers of Credit”.

  11. @#9:

    We’d be better off if we just accepted that these institutions have failed and just let shareholders take the hit. The bailout money would be much better spent creating NEW banks that aren’t saddled with fantastical amounts of bad debt.

    It’s not that easy. The shareholders of AIG are already wiped out, the stock is worth essentially nothing. Everyone who owned AIG stock has lost that money now. They’re not the ones in trouble.

    The thing is, when you sell insurance, like AIG has, there is someone on the other end buying it. That buyer is counting on getting that money back if worse comes to worse (after all, they did pay for it, so they have a right to it). If AIG goes under, suddenly all of those people who are counting on that money if things go bad, will no suddenly not have that protection. They will not be able to pay back their dept, and they will go under along with their creditors.

    Add to that the peculiar way credit default-swaps work. Say company B bought CDS protection from AIG on company X. You pay $2 million a month, and you get $60 million from AIG if X defaults. Two months later, X looks much shakier than it did when you bought protection, so now you can sell protection on $60 million for $4 million instead of 2. So you sell that protection to company C.

    Now, every month, company C pays you (company B) $4 million, and you pay AIG $2 million, and you pocket the difference. But notice that you’re completely hedged, you’ll never have to pay nothin’. If X defaults, you’ll owe $60 million to C, but you’ll get that from AIG, so there’s no worry there!

    These chains can get very long, and if there’s even one break, the whole thing collapses. If AIG can’t pay you the $60 million, you can’t pay C their $60 million, and C can’t pay D their $60 million, and so on. If AIG defaults, it would bring down a huge number of companies, and would not unlikely completely destroy the financial system.

    We can’t let AIG fail. I know, it sucks, but that’s simply reality.

  12. @OSKAR 17 – but there’s only $60M missing from the equation.. Everyone but the last person in the chain already sold their shot at the payout. Where I have trouble is figuring out what the $1.6T is: is it the $60M in your example, or the sum of all the $60M which really is just a lot of arm-waving when it really comes down to it?

  13. We can’t let AIG fail. I know, it sucks, but that’s simply reality.

    No. The reality is it already has. All that wealth people thought they had? All that insurance? Doesn’t exist.

    A lot of people are still in denial about this, and they want the government to support their denial by handing them money to make the illusion “real”. But the government can only do that by transferring the money from someone else, or – more likely – by devaluing all money. Which is ultimately just another form of wealth transfer, affecting those on the bottom rungs of society the most.

    The illusion will be pierced, but not before our government manages to shift the worst of the consequences onto those had nothing to do with creating it.

  14. We can indeed let zombie AIG, that financial black hole, fail. Feeding the monster will only make the situation worse. Kill to cure. Ugly? No doubt. Painful? Yes. Options? Can’t think of any.

  15. From what I have read, there were between $60 – $75 TRILLION dollars worth of credit default swaps issued, which was approximately the gross domestic product of the entire globe in 2007! And, like with AIG, few (if any) of the other issuers have any reserves to pay on the CDSs.

    I am not sure if people truly understand the depth of the current financial crisis. The more I learn, the more I wonder how we are going to get out of this mess.

  16. @#18 Anonymous:

    In my example, the original $60 million is the $1.6 trillion dollars that this story is about (or rather the 1.6 trillion is the sum of all those insurances that AIG sold). It’s important here to say that AIG never actually had $1.6 trillion. They never expected to have to pay up that amount of money. In my example, it’s not like they put aside $60 million every time they sold a CDS, they simply sold them expecting that the economy wouldn’t collapse. But it did, and now we’re in deep do-do.

    So no, the 1.6 trillion is not the sum of the chain, it’s the sum of the CDSs that AIG alone sold (but if they can’t pay that back, the losses will multiply as they travel down the chain). And to be clear, it’s not like they have to pay up the entire amount, it’s not like every company in America is gonna fold under this crisis. Presumably, Apple and Microsoft and Boing Boing are going to be able to ride this crisis out, so if AIG sold any CDS-protection on those companies, they will not have to pay up that money.

    @#19 Ernunnos:

    No ones in denial about the fact that AIG is a failed company. When you start counting your stock price in cents instead of dollars, that means that everyone knows that as a company, it’s dead.

    But that’s different thing from actually having AIG default on their debt and go into bankruptcy. That would be a cataclysmic event, and it would make plunge the world into Great Depression 2: Electic Boogaloo, the sequel that everyone thought was unnecessary.

    It’s fine to say in blog comments “those people were idiots, and they deserve to go into destitution!” and shake your virtual fist, but we live in the real world, and letting AIG default on their debt is simply not an option. If it costs the government 200 billion more dollars (which is not, like, a completely unreasonable scenario), it’s still something they have to do, because the alternative is so much worse.

    No one is saying that AIG isn’t a failure and no one is saying that it was a good idea to let them get that big, but we are where we are now, and we have to deal with the situation in front of us. If someone invents a time-machine, that would be great, we could go back to the year 2000 and stop the Commodity Futures Modernization Act from being passed. But we don’t have a time-machine, so we have to deal with what’s happening right now.

    Real life is messy, and sometimes you have to do stuff which you don’t like because of the bigger picture. That’s just life.

    1. we are where we are now, and we have to deal with the situation in front of us.

      How……reality-based.

  17. Many of these CDS are contacts between third parties that are not directly (or many cases completely unrelated) to the risk/liabilties being insured. Why can’t these CDS be completely regulated? Isn’t there a way to pull the plug on them if they should not have been underwritten in the first place? Why isn’t this transparent?

    I canceled my auto insurance ages ago with AIG because they were unfair. I never thought they could still reach out and touch me again.

  18. I know nothing about economy, so my question is:
    Given that shit is happening, as these companies were too big to be allowed to fail, should not we prevent and regulate the size of any company to prevent it to become that big and screw us all?
    And maybe impose a cap on maximum income.

  19. @#25 Eclectro:

    The problem is that all these CDSs already exist. There’s no going back now, you can’t just nullify them, people have payed good money for them, and they are legal and enforceable contracts. If I bought CDS protection (although as you rightly point out, the vast majority isn’t protection, it’s speculation) I payed good money for them! In my previous example, I payed millions of dollars a year for them, you can’t just take that away from me!

    Also, these contracts are now on thousands of companies balance sheets. If the government would wave a wand and proclaim that they were null and void, the next day thousands of companies would be insolvent (and the day after that, we’d all be living in caves).

    Not that you’re making a bad argument. It’s an excellent argument, just one that should have been made a decade ago.

  20. Stuff reality. I’m off to my happy place.

    La la la laaaaa, la la laaaaa, la la la la laaaaaaa, got my fingers in my ears, can’t hear what your saying, la la la laaaaa.

    Oh look! Kittens!

  21. It’s hilarious that the Republicans who championed the TARP giveaway, are suddenly counseling fiscal responsibility: “No, let the banks fail! Doing otherwise would be socialism!”

    At least Ron Paul is consistent. Well, compared to the rest of them, anyway.

  22. I disagree that the existing CDS already exist and can’t just be cancelled. Why not?

    As I understand it, there are two general types of CDS – the first is insurance protection that a bondholder purchases to protect his investment in a bond. The second is a speculative bet by a speculator that does not actually own the bond that is being insured.

    The second type of CDS outnumbers the first type by a factor of ten. I believe.

    So my question is why can’t you declare the speculative CDS null and force the insurers to just return the premiums that the speculators paid for the CDS. This way the speculators have not lost anything (they hads their payments returned). The only thing they lost is the huge payday that they might have made – that would be paid for by the US taxpayers.

    I bet AIG and others have enough capital to return these premiums even without a taxpayer bailout.

    But even if they don’t, wouldn’t it be preferrable to bailout just the premiums ( approx 1-2% of the value of the CDS market ) and let all the companies de-leverage themselves from this insanity?

  23. @ Oskar:

    If you invest more in a single CD than FDIC insurance will cover (normally $100K but currently $250K) you made a leap of faith that the company you entrusted your money to knows what they’re doing. If you bought CDs from AIG you were clearly wrong. (Though you still have $250K, which is too much to get sympathy from me.)

    No question, a lot of people will be royally screwed if the Feds abandon AIG but that’s the way it’s SUPPOSED to happen. Otherwise there is no incentive for anyone to make sure that our financial institutions follow the due diligence they are supposed to.

  24. @Toneman:

    No, it’s simply not feasible to completely eradicate all CDS contracts, even those used only for speculation. They’re far to deeply engrained. If you were to do that, the economy would collapse.

    A simple example. Say I’ve sold a CDS to someone else, and I get a nice stream of money from it, a few million dollars a year. It’s been going for a few years, so all in all I’ve collected maybe ten million dollars.

    That income stream is on the “asset” side of my balance sheet. That income is guaranteed, and I need that income to be able to pay off my debts. I’m counting on it. If that income disappears, I’m done, I’m insolvent and have to go into bankruptcy.

    Your scheme would not only remove my asset of a few million dollars per year, I would turn it into a liability many times greater since I would be forced to pay all the money back! But I already spent that money! I don’t have it anymore, no company collects that cash and keep it in a mattress, it invests it in other things.

    This would very likely turn many companies insolvent, and they would collapse, and be unable to pay back their debts.

    Now, look at it from the perspective of the buyer. What do I gain? Well, nothing. If the person I bought the CDS from collapses because he can’t afford to pay me and the other people he owes money, I get nothing. My CDS, which I payed dearly for over several years, is suddenly not worth the paper it’s written on. I’ve thrown money in the lake for nothing. And what has society as a whole gained? Nothing.

    You can’t just go in and say by law that stuff people have payed for is worthless. You can’t do it. Lets say you buy a car, a really nice car that you took out a loan to pay for. What if the government went in and by fiat declared that all cars where to be collected in and thrown away, and every car seller had to pay back every cent that they had gotten for selling those cars. No car dealer could pay for that, they’d all become insolvent, so now you’re stuck with a gigantic loan and nothing to show for it. Who does this benefit? It hurts the car-dealer and it hurts you, everyone is worse off.

    And lest we forget, no one actually did anything illegal here. In hindsight, it may have been a monumentally stupid way of running a business, but it was perfectly legal and accepted way of doing things.

  25. These chains can get very long, and if there’s even one break, the whole thing collapses.

    Why do people say this about a complex system like an economy like it’s some kind of revelation?

    When GWB said something like, “turns out the economy is complex”, Jon Stewart lampooned him as quoting from a farcical GWB economics book “Supply and Demand?”

    Given that shit is happening, as these companies were too big to be allowed to fail,

    It’s just a ruse; there’s actually no such thing as “too big to fail”; economies unhindered by imposed rigidities are extremely resilient at adapting to dramatically new circumstances. In fact, adapting to uncertainty is exactly why markets exist and work.

    But that’s different thing from actually having AIG default on their debt and go into bankruptcy. That would be a cataclysmic event

    No, that’s just a scare tactic, ike “Iraq has WMDs”, to make the public stupid and complicit while the government-business partnership pillages and subjugates you.

    In the past, politicians promised to create a better world. They had different ways of achieving this, but their power and authority came from the optimistic visions they offered their people. Those dreams failed and today people have lost faith in ideologies. Increasingly, politicians are seen simply as managers of public life, but now they have discovered a new role that restores their power and authority. Instead of delivering dreams, politicians now promise to protect us: from nightmares. They say that they will rescue us from dreadful dangers that we cannot see and do not understand. … But much of this threat is a fantasy, which has been exaggerated and distorted by politicians. It’s a dark illusion that has spread unquestioned through governments around the world, the security services and the international media.

    The Power of Nightmares: The Rise of the Politics of Fear

  26. @Brainspore:

    Saying “a lot of people will be screwed” is so underestimating the problem that it’s ridiculous. And when you say that $250,000 should be enough for anyone to live on, you’re not understanding the scope of what we are talking about.

    These things aren’t bought by regular people. The people that buy these things are enormous institutions. We’re talking huge banks, pension funds, hedge funds, investment companies, even central banks. Without these things, the modern economy cannot function. And every single one of them would be hit hard if AIG defaulted on its debt. It would be a financial earthquake that would rock every company there is. Unemployment would skyrocket to 20-25% at least. It truly would be the Great Depression once again.

    And for what? For some vague sense of “incentives”? This is taking the moral hazard argument to absurd lengths. First of all, as I’ve repeatedly said, as a company, AIG is dead, it’s trading at 35 cents. So AIGs investors have already payed dearly, in that they have been completely wiped out. And it’s the same for the people who bought these contracts, they are now sitting on tons and tons of extremely risky assets which no one will buy, and their stock-price are taking massive hits too.

    And by the way, do you honestly think that anyone twenty years from now will be pondering whether they should invest in these toxic assets will be thinking “hey, if I buy this, I might be a contributor to a massive collapse in credit and world markets, our stock price will plummet and my company will be publicly humiliated and never do business again. On the other hand, if that happens, the government will nationalize us, and the police will protect us from the raging hordes of angry people who’ve been layed off”.

    The people who caused this crisis have suffered enormously from it. I certainly agree that from a moral perspective, I’d like to see them suffer even more, but they’ve certainly suffered enough to fulfill any condition of some economic condition of “moral hazard”. We have to stop thinking in terms of “these fuckers need to pay!” and start thinking in terms of “what is the best thing for the economy right now”. And clearly, bailing out AIG is by far better than the alternative.

  27. General comment: Oskar here clearly gets it on the scope and details. Generalized agree in depth with his comments.

    However:

    You can’t just go in and say by law that stuff people have payed for is worthless. You can’t do it.

    Actually, you can. The market has done that, to stocks, a lot of bonds, property values, and by some companies failing to some CD swaps and other actions.

    The problem is, if you just wipe that out by government fiat (which could legally be done), then you wipe out assets on all the companies books who bought the CD swaps. Which they presumably relied on. So they’re out large chunks of money, may now be in default or bankrupt themselves, etc.

    Wiping it out by fiat lands the damage across a wide swath of other industries and types of companies and organizations. As AIG points out in that presentation, the side effects of that (an AIG failure) are severe. Many other companies are only liquid now because they bought CD swap contracts on business they did with other parties. If that suddenly goes away, people who paid good money to be insured against a catastrophe in the economic markets (a smart thing to do, the same as life insurance and flood insurance and auto insurance are smart) is now told “sorry, you’re out of business anyways”.

    Fundamentally, the problem was that AIG and others were allowed to sell that type of insurance in the first place. They were accepting risk (of catastrophic economy-wide meltdown) that they couldn’t pay for in the case of that catastrophic meltdown. In accepting that risk, they then encouraged companies and investors to make larger bets on investments in the last decade than they would have without CD swap insurance. Part and parcel of the whole economic system bubble, as it were.

    What the US Government and AIG are doing is to unwind gently – accept that AIG got screwed by this and that the US Government is now screwed by this, but unwind it one transaction at a time and come to agreement with those holding the contracts, and get it all settled cleanly. If you don’t unwind it, and void the transactions by fiat, 1.6 trillion more dollars just disappears overnight out of other company balance sheets, and over the next week or so thousands of companies are and have to declare bankruptcy.

    Same thing would happen if a major bank (Citi, Wells Fargo, etc) goes down hard. See Lehman Brothers and multiply by 10 to 100.

    Large bubbles create recessions. We’re having a horrible recession now, worst in many decades. Allowing or forcing the tottering giants to collapse (as declaring AIG gone by fiat would do) is the sort of government misstep similar to Roosevelt’s actions that turned 1929 into the great depression.

    To clarify and personalize: one in ten of us is now unemployed. A depression, which is credibly the direct and inevitable result of any major missteps now, is one in three or one in four of us unemployed. It is most of your money in IRAs and 401ks going away as the markets hard crash, and your ability to retire on anything more than social security going with it. It’s your parents and children and siblings having to move into the house of the one person still working who makes enough to pay their mortgage. It’s people who made stuff for export to the US starving elsewhere in the world, chaos and disaster in places that didn’t have the sort of safety net that 75 years of relative boom times without major hiccup brought to the US.

    There are a lot of anarchists yelling “Stick it to the man” right now. You’re fools – if you win, you starve, and lots more people starve and die with you.

  28. And by the way, do you honestly think that anyone twenty years from now will be pondering whether they should invest in these toxic assets will be thinking “hey, if I buy this, I might be a contributor to a massive collapse in credit and world markets, our stock price will plummet and my company will be publicly humiliated and never do business again. On the other hand, if that happens, the government will nationalize us, and the police will protect us from the raging hordes of angry people who’ve been layed off”.

    Yes. That’s exactly what the moral hazard is.
    (If you succeed, you privately profit. If you fail, you get bailed out by the public.)

    It’s the Commonize Costs – Privatize Profits Game (CC-PP)
    aka “socialism for the rich and capitalism for the poor”

  29. “what is the best thing for the economy right now”. And clearly, bailing out AIG is by far better than the alternative.

    Clearly not, actually. This is just Business Cycle 101 playing out.

  30. I thought I understood that by holding one of these impossible-to-redeem insurance thingers that AIG sold, lots of corporations guaranteed their debt ratings. Take away AIG and you take away all the debt ratings, and suddenly everything’s a junk bond, credit markets freeze completely… and yeah, the caves. Silly that anyone still pays attention to the ratings agencies, but money is just trust in the form of paper anyway. Unfortunately, we’re just about fresh out of trust.

  31. Zulu @38 wrote:

    Yes. That’s exactly what the moral hazard is.
    (If you succeed, you privately profit. If you fail, you get bailed out by the public.)
    It’s the Commonize Costs – Privatize Profits Game (CC-PP)
    aka “socialism for the rich and capitalism for the poor”

    The whole finance industry and government financial sectors right now are learning something horrible, that the weapons of mass destruction / geopolitics crowd learned from careful introspection into a number of crisies that didn’t blow up that badly.

    Geopolitics: Normally, weapons on alert are destabilizing. In a crisis situation, however, the perceptions and mindset of the leaders and militaries involved shift around – weapons on alert are seen as a deterrent rather than a destabilization, and leaving them off alert is seen as a vulnerability which encourages the other side to jump off and try a disarming surprise attack. There is a stabilization inversion in the early phases of a crisis: if you do not change your response, sometimes if you do not change your response entirely 180 degrees around at that time, you destabilize the situation and increase the chances that the other side launches a war.

    Economy: Normally, moral hazard is entirely right and proper, we don’t want investors to go around assuming they get bailed out by the fed if things go south. Moral hazard is a major part of the social contract between the government and people on one side and the business community on the other. However, in a major economic crisis, if you let everyone implode, then they do – and all your jobs go away, everyone’s out of work, all their houses are foreclosed, etc. Imposing moral hazard in a major recession teetering on depression forces the depression, and destroys your economy.

    Economies are confidence games – not in the criminal fraud sense, but in the sense that I employ Joe to work on the assumption Joe’s work product is something I can sell, and Joe buys a house on the assumption that Joe will continue to work and get paid, and Joe’s mortgage company loans him the value of the house on the assumption that Joe will pay the mortgage. If I stop employing Joe, because nobody bought his stuff, everyone is screwed on down the line.

    When Joe is one guy, and his output was just suboptimal, that’s market forces. Joe can go work at a lower paying job, or otherwise support himself. Margins in the system keep the mortage company liquid and still lending to people who aren’t out of work, etc.

    When Joe is everybody collectively, then what happens is that we all starve, collectively. Our retirement savings go away, our equity in our houses goes away so we can’t even sell those, our jobs go away, etc.

    That’s a depression or a collapse.

    Frankly – as offensive as it is to anarchists, radical libertarians, and theoretical economists – essentially any price is worth it to avoid a depression or systemic collapse like that. The wealth and income lost in a depression or systemic collapse make what happened so far look like a picnic. If the bailout ends up taking ten times what Obama and Bush have spent or proposed spending so far – it’s probably still the right thing to do. Because the alternative is a 40-60% decline in the economic value of western civilization, and that is far far more damaging in the short, mid, and long term than governments borrowing or printing a trillion or ten trillion dollars now and using it to avoid collapse.

    This hasn’t been well articulated “to normal people” – and a lot of people haven’t seen the analogy with the destabilization inversion in geopolitics / deterrence theory yet. But it’s exactly a model for what’s happening now. Moral hazard is great and a keystone for a modern market economy and its role in society … EXCEPT for in true crisis situations, then it’s a suicide pact. The key economists realize this and are working their asses off to avoid someone pulling the trigger on the gun pointed at our collective foreheads.

  32. I thought I understood that by holding one of these impossible-to-redeem insurance thingers that AIG sold, lots of corporations guaranteed their debt ratings. Take away AIG and you take away all the debt ratings, and suddenly everything’s a junk bond

    Yes, that’s called reality… rather than perpetuating the delusion.

    When you’re falling, pretending that you’re flying only delays the required actions.

    credit markets freeze completely… and yeah, the caves.

    Credit is no substitute for capital.

    Silly that anyone still pays attention to the ratings agencies, but money is just trust in the form of paper anyway. Unfortunately, we’re just about fresh out of trust.

    That “confidence” (in a house of cards) crap.
    Buy gold, or some other commodity-based money.

    (Even electronic money that uses a cryptographic seed to preclude any debasement would be preferable to fiat currency.)

  33. However, in a major economic crisis, if you let everyone implode, then they do – and all your jobs go away, everyone’s out of work, all their houses are foreclosed, etc.

    No, at some point the “sharps” start buying when they believe the prices have finally bottomed out at their true value and start buying. Just like at some point people take the plunge to buy a computer, even though they know one that’s twice as fast and half the price will be out a year later.

    Economies are confidence games

    No, they’re epistemological calculations of prioritizing diverse individual human action towards the mitigation of scarcity. Anyone making the claim you have is using it “in the criminal fraud sense”.

    I employ Joe to work on the assumption Joe’s work product is something I can sell, and Joe buys a house on the assumption that Joe will continue to work and get paid, and Joe’s mortgage company loans him the value of the house on the assumption that Joe will pay the mortgage. If I stop employing Joe, because nobody bought his stuff, everyone is screwed on down the line.

    And then you adapt by changing your priorities and using your resources differently. Maybe Joe loses his house and someone else buys it instead.

    You’ve essentially made the broken window fallacy.

    The wealth and income lost in a depression or systemic collapse make what happened so far look like a picnic.

    The wealth isn’t lost during the depression / correction. It was already lost in the malinvestment of the boom phase of the cycle.

    People aren’t “losing value” of their homes as prices drop; their houses were overpriced because of a glut of artificially cheap credit. Same with your 401k investments and everything else. You “lost” something that never really existed to begin with.

  34. Zulu @43 writes:

    The wealth isn’t lost during the depression / correction. It was already lost in the malinvestment of the boom phase of the cycle.
    People aren’t “losing value” of their homes as prices drop; their houses were overpriced because of a glut of artificially cheap credit. Same with your 401k investments and everything else. You “lost” something that never really existed to begin with.

    This is a semantics argument, and more importantly misses the point.

    A lot of “funny money” equity (value of homes, stocks, bonds, etc) is now gone – it’s just gone, yes, so sorry. It wasn’t really there to start with, and it’s not coming back. Nobody with any business sense or economics background disputes that.

    The value of the ongoing economy – how many people are employed, what is consumer spending like, etc – is the key to recession vs depression.

    What happened has happened and is water under the bridge. The government can’t prop up the stocks, bonds, and home prices – you can print money and give it to people, but the value of the dollar then shrinks proportionally due to inflation, and so it goes back out. Things are worth what people will pay for them.

    Zulu’s fundamental mistake is thinking that the recovery plan is in any way aimed at propping up home values or stock prices. It’s not. The important point is that the economy not collapse. People need to remain working. For that to happen banks have to be able to issue credit to businesses for operating capital, etc.

    It offends a lot of anarchists, radical libertarians, and die hard free market types that the government has to help with those things. But it does, ’cause it’s all screwed up now.

    If you would prefer to let it fall and fall into a depression, you’re a fool, and if you think that’s not a real risk right now you’re doubly the fool…

  35. human purpose or operation of pure system? Is there factual/functional error in Zuzu’s logic?

    Why do we have an economy?

  36. relax; next week Pyongyang launches their satellite, a few hundred miles up, the USA knocks it down, NK immediately launches a crappy squib of a nuke that’s still enough to EMP Tokyo and ruin the exchange,while simultaneously the Nork junta suicide charges south since they couldn’t work out the succession. China grabs the chance and invades Taiwan and also starts a Blitz-Holocaust in Tibet – which also starts an Uighyur revolt and creates distraction for mobs in Beijing to attack the central government over unemployment. Meanwhile Israel sneak attacks Iran’s nuclear sites and triggers an Iranian blocking of the Straits of Hormuz, cutting off most Mid East oil flow. The Mexican government falls to a carefully executed drug-lord coup and Chavez invades Colombia. India nukes Pakistan in a decapitation attempt and mobs in London attack parliament. Who’s going to be worried about money?

  37. @ Oskar:

    I’m not arguing that the government doesn’t need to step in to avert an incredible crisis in the financial industry, or that we don’t need these kind of companies for a modern economy to function. I’m just saying we don’t need to protect the EXISTING companies when we could replace them for far less expense to the taxpayers. Protecting the economy is not the same thing as protecting existing wealth (or more accurately, the illusion of existing wealth.)

    At the very least we should temporarily nationalize AIG and fire all the people that have been running things up until now.

  38. If you would prefer to let it fall and fall into a depression, you’re a fool, and if you think that’s not a real risk right now you’re doubly the fool…

    You say that like we have a choice. It is already falling, and there’s nothing you can do to stop it. Attempting to delay the inevitable only leads to malinvestment and prolongs the suffering.

    If Jim Rogers is a fool, I’ll take that as high praise.

  39. “What happened has happened and is water under the bridge. The government can’t prop up the stocks, bonds, and home prices – you can print money and give it to people, but the value of the dollar then shrinks proportionally due to inflation, and so it goes back out. Things are worth what people will pay for them.”

    Funny, you don’t think the same about all the Credit Default Swaps AIG sold. The price of those, apparently, the government can and must prop up.

  40. The value of the ongoing economy – how many people are employed, what is consumer spending like, etc – is the key to recession vs depression.

    No, the purpose of an economy is not to move money around or full employment; it’s to reduce scarcity through real increases in the supply of goods and services that people want (i.e. demand).

    you can print money and give it to people, but the value of the dollar then shrinks proportionally due to inflation, and so it goes back out. … People need to remain working. For that to happen banks have to be able to issue credit to businesses for operating capital, etc.

    Credit expansion is inflation. If I’m reading you correctly, here is your fundamental mistake: you can’t offset unemployment with inflation (like the proverbial see-saw). That’s just another form of malinvestment (in diversion of labor from productive to unproductive action under the aegis of “full employment”).

    It offends a lot of anarchists, radical libertarians, and die hard free market types that the government has to help with those things. But it does, ’cause it’s all screwed up now.

    It’s all screwed up because of exactly this government “help” — namely, artificially cheap credit, which is the cause of the boom-bust cycle. Moreover, it’s not about “offending” anyone because it’s not about preference, any more than someone can prefer how gravity or photosynthesis occur.

    “A man who chooses between drinking a glass of milk and a glass of a solution of potassium cyanide does not choose between two beverages; he chooses between life and death. A society that chooses between capitalism and [economic planning] does not choose between two social systems; it chooses between social cooperation and the disintegration of society.” — Ludwig von Mises, Human Action p. 680

    (Yes, I substituted out “socialism” because it’s too loaded of a word, especially in this mixed context. LvM used it with specific academic meaning in 1949; while Republican pundits used it in 2008 as empty rhetoric with “Obama the socialist” — as if Military Keynesianism under 8 years of GWB wasn’t also socialism for the military-industrial complex.)

  41. I think that what we really have here is a failure to compromise.

    On one side, we have people with a strong preference for ethics (free market libertarians and the like) who feel that filthy bankers must not be allowed to steal thousands of billions from the common man in a “too big to fail” blackmail scheme. If you ascribe to these ideas, I’ll describe you in terms of Watchmen: you are Rorschach — no compromise, even in the face of Armageddon!

    On the other side, we have people with a strong preference for self-preservation (realists and pragmatists) who feel that letting filthy bankers get away with epic-scale theft is a better outcome than a grinding depression with 25% unemployment and children starving in the streets. If you ascribe to these ideas, you are Silk Spectre II: you may not like it, but if it means saving the world, you’ll go along with it.

    I feel that both positions are equally valid in their own way, and both reflect a deep sense of justice among those who side with each position. Really, the only difficulty here is that everyone has been working under the assumption that each position is mutually exclusive. With a little effort though, I’m confident that both sides can come together rationally and without discord. To that end, let me make a modest proposal:

    First, we shall “bail out” companies such as AIG, to prevent systemic collapse of the banking sector. This will be done with strict government control of these organizations, and where appropriate, misnamed insurance contracts (CDS’s) which are clearly against the public interest will be invalidated and closed down. If executed with restraint, this should mitigate the worst aspects of systemic collapse. In addition, the government will roll out revised food stamp and subsidized housing programs to help soften the widespread catastrophe.

    Second, to prevent the “moral hazard” of letting bankers steal this money from the public, we will institute a system of reforms meant to properly de-incentivize the banker class from undertaking this sort of activity in the future. To begin these reforms, we will hire a number of French carpenters and blacksmiths to construct a great many units of a fine invention of France. This invention, thought up by one officer Laquiante based on the notes of the highly esteemed Dr. G, allows a properly run agency to conduct a thorough operation which will leave no doubt about the seriousness of the problem.

    Combining these two compromise positions together, we are left with a very comprehensive plan: bankers who have created insolvent institutions that are “too big to fail” will be removed from their positions and asked to participate in a public demonstration of the Laquiante invention, while their banking and insurance corporations are calmly and deliberately managed on a non-profit basis by the federal government until such time as this crisis is over.

    Does anyone have any objection to this modest plan? Truly, could anyone have any objection? I believe it is really a great real-world example of a plan which is a “win-win” for every relevant person involved.

  42. @52 Elladan

    You’ve posited a false-choice.

    Delaying the necessary corrections will cause longer-lasting and more severe problems, such as even higher unemployment, later.

    It’s not about ethics; it’s about cause and effect.

  43. Here are some of the known benificaries of the US taxpayer bailout of AIG (Source: WSJ research)…

    Goldman Sachs
    Deutsche Bank
    Merrill Lynch
    Société Générale
    Calyon
    Barclays
    Rabobank
    Danske
    HSBC
    Royal Bank of Scotland
    Banco Santander
    Morgan Stanley
    Wachovia
    Bank of America
    Lloyds Banking Group

    Just to allay your fears that the money is not going to worthy recipients.

  44. What I don’t understand is that if AIG has already failed in the marketplace, being traded for cents instead of dollars, how can the US government hope to bail them out? It’s meant to keep them solvent, so the chain of trust does not collapse. I understand this. Isn’t part of the problem that there was no money to underpin the insurance to begin with? Is that what this money is for?

    But if that’s true, how will you break the chain? AIG doesn’t have enough money to pay out all the insurance it offered. Now let’s say they get this money, it would be equally bad for all the companies to collect that insurance, as noted in the above comments. The CDS are assets to too many companies in the chain.

    What would happen if AIG had to pay some of this insurance because the company insured against would default? That would also cause the entire chain of companies A-D to lose the CDS asset. The more this happens, the worse off everyone is.

    The way I see it, you’re damned if you do and damned if you don’t. I understand the need to fence off a full blown depression, but this just maintains the status quo without any future relief. I guess that’s what Zuzu is debating against.

    ———————————————-

    On a completely different tangent, our economical/global footprint is too large to sustain. We, the western world, have no more space left. See the ridiculous amounts of oil we consume, the insane amounts of food lost either through left-overs or feeding cattle, dependence on ultra-cheap labor, the pollution, the overpopulation, the infighting. All this was made possible by our economy, propping up our way of life, blowing up the bubble. We rode that wave and now it’s crashing on the beach.

    To make matters far worse, China is on the rise. There are a bazillion Chinese to every one of us. Not to sound all Red Scare-y, but when all those people decide they want the same luxury that we’ve grown accustomed to, we’re dead.

    How do we cope with this? How can we fix this? We have Oskar’s caves and Takuan’s war we could try.

  45. @55 Reginald

    Don’t forget to add all the pension funds, universities, school districts and municipalities that bought CDOs and are depending on AIG to cover their losses. And while you listen to Zuzu shouting ‘stick it to the man!’, think about what it will be like when your trash isn’t being picked up and when your kids school teacher isn’t getting a paycheck anymore.

  46. If George Bailey was worried about going to jail, then the motherfuckers at AIG should have to sweat, too!

  47. @57 Stuckinkiel

    I don’t think it’s as much “stick it to the man” as “we’re pumping air into a leak tire.”

    We’re riding on an air bubble. There’s a hole in there somewhere, which means it will deflate. Regrettably, the bubble includes the trash men and the teachers, not just the bankers who speculated and lost. Arguably, it will hit the trash people and teachers harder than the bankers, so we should bail the bankers out.

    The problem with a bail out is that you’re pumping money into a dead company. There’s a pump to get the water out of the ship, but the hole in the hull is too large. The money you lose now by bailing out AIG could be invested in a better way.

    I think we can all agree on the moral bankruptcy of bankers and investors in this particular case. This is nothing new. The mitigation of responsibility is nothing new either. We’re not arguing that.
    The point is that this bail out money will eventually cost you as well. It will keep the boat afloat for a while longer, but the cash has to come from somewhere. Basically, the US government is doing a big Credit Default Swap of its own: to keep the chain intact, it’s putting up money to back up the final link (in this case AIG.)

    If AIG can fail, so can the US government; if the economy can collapse on CDS overload, so can the dollar. Will that lead us into the great depression as well? What does the tax payer buy with these billions when that happens?

  48. Is there anybody left that doesn’t think that capitalism, in its current form, is illogical, inefficient and just plain schtoopid?
    Answers on a 50 billion Mark note please.

  49. Bailing out AIG with public means is a brave symbolic gesture. Like pissing on an oil silo fire. Too big to fail is too big to succeed.

    F**k it. Let’s go bowling.

  50. I still don’t understand the problem. This “too big to fail” supposition is false. Let’s just accept (for now) that it’s true, that if AiG folds, thousands of companies will follow.

    Day 1: The government decides it’s not worthwhile saving AiG, and lets it fall.

    Day 2: 10,000 big companies are badly affected by AiG’s bankruptcy. 4000 are seriously affected, but not enough to cause them to fail. 6000 says they will fall as well.

    Day 3: The government goes through the list of 6000, deciding which should be saved. It decides to let 2000 of them fail, and rescues the other 4000; taking shareholdings in exchange for the injection of funds. In many of these companies, the government ends up with more than 95% of the shares.

    Day 4: The government now has partial ownership of 4000 companies. Over the next several years, it gradually sells off these shares.

    Contrast this with: The government gives money to AiG. AiG passes it on. The government ends up with a huge bill. All those people down the chain from AiG, how exactly are they suffering from their bad investment decisions?

  51. Again, I ask:
    Should not we regulate that no company gets this big again and screw us all? Should not we regulate the maximum size and income? We humans fail, that is innate, so we know companies will screw it up eventually.

    Should not we regulate maximum profits? Our current system selects people with gambler mentality and endless ambition. Is that the kind of people we want to have in charge of the very blood of our system? Do we really have to accept that bullshit that no one will work if they cannot have the possibility of their private Island and one different jet for each day of the week? I know that I do not work for money, I work because I love what I do and I can contribute to others through my work, improve things using science. I still need to pay my rent and buy food, but I do not need to eat caviar, neither do I need to have my own private jet, or even my own car, as long as I have public transportation. The people that makes my life possible fixing roads and picking up the trash never are going to have a private jet. The ones that create the tech that I love, a lot of times won’t become so rich. So, we base our system on the possibility of becoming part of a tiny minority so vastly rich that they cannot spend all their money? Progressive taxation to the nth, I say, or a cap on maximum income and assets. Say, a billion dollar per person. That way we also prevent them to become so rich that they will buy the whole system, lawmakers included.

    I am speaking with rage, and i know I may be babbling stupidity, this is not my area. SO I ask, Why not?. Please do not scorn at me, just try to explain me why this cannot or would not work. As far as I know, this has been tried in Scandinavia and Finland to some extent, maybe not as draconian as I depict here, but certainly very different to the American system, or the Venezuelan, even if Chavez claims to be a socialist. And certainly not the soviet system.

    Yes, maybe some people will stop innovating once they reach their billion, but with more resources for others and more niches open, may others would work harder. And many of us do not give a fuck about money as long as our basic needs are covered and we can have a decent life.

    I can agree that the companies might have to be bailed out, but what I cannot agree is that the system is going to be kept, not major changes.

  52. Personally, I hope the Singularity comes soon and ends scarcity completely. Then we won’t have to put up with foolish capitalist games. :)

  53. whatever system you make law, Guido David, some one will game. But i think you are moving in the right direction. Taxes are accepted already,the principle is the same. In another vein, I think I might prefer to be a Venezuelan subsistence farmer over an America city dweller, come the Crash.

  54. Day 1: The government decides it’s not worthwhile saving AiG, and lets it fall.

    Day 2: 10,000 big companies are badly affected by AiG’s bankruptcy. 4000 are seriously affected, but not enough to cause them to fail. 6000 says they will fall as well.

    Day 3: The government goes through the list of 6000, deciding which should be saved. It decides to let 2000 of them fail, and rescues the other 4000; taking shareholdings in exchange for the injection of funds. In many of these companies, the government ends up with more than 95% of the shares.

    There are so many things wrong with this scenario, I can’t believe it.

    First of all, if we let AIG fail, the losses they take aren’t limited to what they owe. They will rapidly, rapidly multiply. Saving the 4000 companies will be VASTLY more expensive than just saving AIG. Simply asking “what’s the cheapest option”, clearly saving AIG is it.

    Second, are you seriously proposing that we should nationalize 4000 fucking companies??? Are you insane? The US Government would essentially be the only employer IN THE ENTIRE COUNTRY!!! Does this remind you of any sort of failed economic system that gained some currency in the 20th century but basically disappeared by 1990?

    Third, you’re being way to shortsighted here. You don’t see the massive consequences of taking this action. Unemployment would skyrocket, easily into the 20s and probably even higher. The government would have to vastly expand things like unemployment benefits, and it will have to inject a stimulus that dwarfs the current one. And lets not forget, this recession would drag on for half a decade longer at least (that’s not good for tax revenues…), and there’d probably be pretty heavy deflation.

    Can you imagine how much just these things will cost? Several trillions, at least. All this, just to avoid a $200 billion bailout of AIG.

    Guys, I know you all hate AIG with a passion (and so do I), but please, can we keep some perspective here? Because you guys are crazy!

  55. Oskar:

    If the government is unwinding AIG, why does it need massive shareholder injections? Why is it accepting new business? Why does it have hundreds of thousands of employees still? Winding it down would be having the government insure the existing contracts, and closing the shutters on AIG.

  56. First of all, if we let AIG fail, the losses they take aren’t limited to what they owe. They will rapidly, rapidly multiply.

    Why does it multiply? Does the loss not reduce as you go down the chain? Company X has a $100M claim against AiG. If AiG folds, X loses the $100M it would have got. It too folds. Unless, the government rescues it. Say it needs $30M to stay afloat. The government gives it $30M, in return for equity. The amount the government would have spent has reduced from $100M to $30M.

    Second, are you seriously proposing that we should nationalize 4000 fucking companies???

    No. You only supply enough money to keep the companies from going under, so the government will not end up with 100% of the shares.

    1) government gives money for nothing
    2) government gives money for equity
    3) government gives money as a loan

    If there’s no chance of (3) being repaid, it essentiallly converts to (1). Is it not better to go for (2)?

  57. @63 GuidoDavid
    About your two proposals to make sure this doesn’t happen again in the future. I understand you said some stuff in haste and in anger, two ingredients not conducive to rational decision making, but I would like to address your solutions anyway.

    1) Some kind of cap on income – I don’t think the level of income of bankers and financiers is the root cause of the problem. It seems reasonable to believe this crisis could have occurred in exactly the same way, even if bankers incomes had been capped. I’m not saying that the rich shouldn’t be taxed or anything like that and I’m not shedding any tears for financiers, I’m just saying that I don’t think exorbitant incomes are the root cause of the problem.

    2) Limit the maximum size of companies – I’m not sure if this is the problem either. I think disaster could have happened even if the companies involved were somehow forced to be smaller (but were correspondingly more numerous). By size, I assume you are talking about the size of the capital assets.

    I think the crux of the current financial crisis is that everything is so interconnected that it is impossible to disentangle the players. I think any solution proposed would have to deal with that. It would be best if we could let companies that made bad decisions fail without taking the rest of us with them.

    One thing I don’t understand, and maybe someone can answer: Why was AIG, and the other companies offering CDS, not required to hold enough assets to cover their liabilities like any normal insurance company is supposed to do?

  58. OSkar:

    If AIG fails, the financial system fails. Probably. But it should fail. Most of those financial companies are already insolvent or very close.

    And we don’t need them. What we need is someone lending on reasonable terms to consumers and business. Prudently. If private investors aren’t willing to set up banks that will do that, the government can, at least until everyone calms down.

    The financial system failing would bring it home to everyone concerned that they didn’t have the wealth they thought they had. Which includes just about everyone who owns a house, a pension or an investment. The sooner everyone wakes up to what they really have, the sooner we can get back to a sensible economy with sensible levels of growth (i.e., not much).

  59. Remmelt @56 wrote:

    What I don’t understand is that if AIG has already failed in the marketplace, being traded for cents instead of dollars, how can the US government hope to bail them out? It’s meant to keep them solvent, so the chain of trust does not collapse. I understand this. Isn’t part of the problem that there was no money to underpin the insurance to begin with? Is that what this money is for?

    We effectively aren’t bailing out AIG. We’re bailing out its customers.

    The stockholders of AIG lost 80% of their equity to the government buyout (USG now owns 80% of the outstanding stock) and about 95% on top of that by the stock price having fallen to the floor. They’re out their investments. That’s not going to come back.

    The *customers* of AIG, people who bought insurance (mostly credit default swaps, somewhat life and business insurance) are the ones getting the bailout. AIG is unwinding that business – paying off the CD swap liabilities by working it out with customers. What they intend to do is wrap that all up and leave a pure insurance company.

  60. @oskar

    I’m with Daniel here. If 4000 companies are only solvent because they’re expecting AIG to make good on their financial debts, then it seems to me that choosing whether to give the money to AIG to give to the companies, or giving the money to the companies directly, amounts to the same thing.

    It would be even cheaper, since some companies would prefer to take as small a chunk of the AIG-bucks as they can afford, to minimize the amount of government ownership.

    As for your red-baiting, Daniel’s plan is nothing like Communism. The government ownership in this case would be temporary, partial, and in most cases non-voting.

    What I don’t understand here is how giving AIG $200B — as you’re proposing — is going to suffice, when they’re on the hook for eight times that amount.

  61. I think a big group of independent actors saw (throughout the morally and fiscally bankrupting War on Terror) the inevitability of a return to the income tax levels of the past (90%+ for the highest earners) and they ALL decided to get theirs now, so their kids could be the Rockefeller’s of the next generation. And now they don’t want their medicine.

  62. does this crisis mean government finally did triumph as the system we will live under? As opposed to everyone become chattels of corporations as “shareholder serfs”? Or is that around the corner?

  63. This “report” is not a report at all. It is a slide show used (probably) at the recent presentation where AIG was begging for additional cash.

    There is a lot of exagerated crap in this presentation. Note in particular the claim life insurance written ($1.9 trillion). They suggest a possible disasterous “bank run” on life insurance, with many policyholders left out in the cold. Note however that they do not separate term and whole insurance. This is bull. You cannot have a run on term as there is no value to run and any other life insurer would be more than happy to aquire this new business. More importantly, the amount of term that is written (way, way more) vs. the amount of whole that is written makes this claim of a possible run almost rediculous. It simply would not be for that much even if it did occur.

    And this is just from a brief glance at this document. No doubt there are additional exagerations. Remember, they are begging for money, and fear is all they have to sell.

    In fact, I suspect that the release of this document was DELIBERATE and INTENTIONAL, and not at all as ABC portrayed it (though I think ABC believed what they were reporting was true. They were simply used by AIG in this case.)

  64. ZUZU: Many excellent, rational arguments. However, why try to differentiate the process of ethical deliberation from examining causes and effects? The latter exercise cannot be done free of values and perspectives.

  65. A strategically leaked memo from a corporate-government linked source meant to silence bailout detractors. Wise to keep in mind that AIG & Treasury Dept are simultaneously conspiring to keep the public from knowing which investment banks received how much in the trillions of government bailout dollars that were funneled to them through AIG.

  66. George @73:

    We effectively aren’t bailing out AIG. We’re bailing out its customers.

    The *customers* of AIG, people who bought insurance (mostly credit default swaps, somewhat life and business insurance) are the ones getting the bailout. AIG is unwinding that business – paying off the CD swap liabilities by working it out with customers. What they intend to do is wrap that all up and leave a pure insurance company.

    So we’ve given up on the old AIG, focusing instead on the companies it insured.

    The problem I see is in the chain of companies relying on income from these CDSs. It was described above that there can be long chains of companies who have CDSs as assets on their balance. They cannot afford to lose these assets.

    If AIG collapses, they lose the asset. If AIG does not collapse but reforms and shuts down the CDS operation, they still lose the asset. As I understand it, only the last link in the chain is going to see any money from these 200B.
    All other companies in the chain lose the assets and might fall over depending on their reliance on this type of income.

    Is it even possible to peacefully unwind the CDS situation?

  67. i just emptied my waste over the heads of the rioting masses on the street and am i not too sure how too feel.
    i guess that is just the system

  68. Why not give the bailout to the people? Fertilize the grass instead of the tree. The desired result of the bailout is to prevent 25% unemployment, starving children in the streets, and people living in caves. How is rewarding the companies and execs responsible for this mess going to accomplish anything but ensure that they retain their wealth?

    By definition, you can’t prop something up from the top.

  69. We are consuming too much and trying to organize into too-large power-structures. It doesn’t work. The monkeys can’t handle it.

    Once “we” admit this, we can move on with better ideas.

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