Archive for category AIG

Inside the Financial Crisis

Although I have numerous ideas for posts from the travel course to Austria and Germany, I’m going to start with a book I read on the train, recommended to me by my chiropractor: The Big Short by Michael Lewis.  I’ve been intrigued by how people couldn’t see this crisis coming when the signs were clear and obvious.   When I mentioned that to Dr. Roberts, he recommended this book which I took with me and read on the train between cities.  This will be a short post — a recommendation to go and read this book.

The book itself is a good read for anyone, regardless of ones’ level of understanding in the fields of economics and finance.   It also goes beyond just the “big bad banks” (though they clearly behaved badly) and the usual blaming of de-regulation, to paint a clear story of why de-regulation and the nature of financial markets led to such a collapse.  The story was told not so much through technical explanations of how the system worked/failed, but through psychological insight into the players — in particular the players who managed to figure out that the system was doomed to collapse.   Not only did they see clearly what so many did not, but they were ignored and even ridiculed.    These stories illustrate just why the market doesn’t work like magic, and illustrate the problems inherent with any concentration of wealth and power.

Most important is psychology.   Anyone can put forth a theory, but Lewis lets the characters involved tell the story.  It can be the CEOs  or investors who are utterly clueless to what they’re dealing with, but believe because they’re making millions it will go on forever.     Both the people who refused to see the obvious, and those who feared for democracy because of how insane the mortgage markets and their derivative securities operated, show the limits of rational thought.   Humans are driven less by rationality than by other psychological quirks and a dose of wishful thinking alongside ignorance.

What to do about all this is another question.  Lewis shows us a bit of how  we got to where we are, and that it’s not a plot of evil capitalists or a conspiracy theory — though greed, conspiracies and amorality are present.  Rather, we as humans have faults, quirks, and weaknesses.   Yet we also can have honor, intelligence, and ideals.    No theory or philosophy can explain or guide human behavior, but perhaps we can at least learn from our mistakes.

Anyway, this is a short post, but the point is that if you are interested and want to understand what’s happening to the US and world economy, want a riveting and well told story that is interesting in its own right, and want to be provoked to reflect on the human condition at this time in history, read The Big Short by Michael Lewis.

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AIG and the Berlin Wall

Populism against corporate greed and Wall Street big shots is a favorite among today’s politicians on the left and right.   Thus as it became known that AIG executive (and former executives) would receive $165 million in bonuses — over 70 getting more than a $1 million each — it was time to pile on.  Senator Grassley suggested “resign or suicide,” while the Republicans blamed Treasury Secretary Geithner and the Democrats blamed the Bush Administration.  Then came the “revelation” (actually old news) that much of the money was ending up in the hands of foreign banks, creating yet another backlash.   What does all this mean?

First, despite all the political grandstanding and self-righteous prose being heaped by pundits left, right and center, this is more a symbolic issue than a real one.   In the grand scheme of things the money paid as bonuses is only a tiny fraction of the bailout money given to AIG, and the contractual obligation to pay these bonuses appears to come from April 2008 contracts, when AIG still appeared robust.   Second, symbolism matters.  A lot.  When the Berlin Wall came down on November 9, 1989 it marked the downfall of an edifice that symbolized communism.  Within months, Europe was transformed completely.

AIG had to be bailed out when it became evident that letting it fail would reck havoc on global markets.  European and Asian states were heavily involved in AIG, and if the US cut the rope on our economic partners, the pay back could have led to a world economic downward spiral.   It was, therefore, known from the start that a huge chunk of this would end up in foreign hands, that was in fact the reason a bailout was seen as necessary.

Ultimately it came down to this: there was a real panic that global credit markets would seize completely.  Credit is the lifeblood of capitalism.   The Bush administration realized that AIG failing would create a potential global meltdown and after considering “letting it fail” decided it had to save the giant.   It’s share of the bailout money is about $170 billion, a huge chunk of cash, giving the US government ownership of 80% of the company.

The bonuses were agreed to in 2008, before the bailout, and in both administrations someone no doubt read about the bonuses and either they didn’t register as something important, or they realized that AIG was contractually obligated to pay them.   Indeed, bonuses were already paid out last year, without raising the protests we’ve seen this week.  So what gives?

AIG is symbolic of a system of deregulated out of control executive compensation, whereby companies across the board found CEOs and other top officials with large bonuses and severance packages even if their performance was a failure.  Moreover, companies that appeared to be doing well gave large bonuses because officials had incentive to gain short term profits to enhance their compensation, even if it were clearly a long term risk.  The long term was irrelevant.  The fact that AIG and its executives did not seem to think the bonuses anything out of the ordinary (nor did most in Congress, though you’ll have a hard time getting them to admit it) demonstrates that the mentality is still alive.  They believe they are worth the money because they are used to getting that kind of money.  The entire system was built on the fact that extremely high paid executives fancied themselves wizards of Wall Street, navigating and plotting a global investment boom, and therefore saw the bit they took off the top as justifiable.  Unlike Madoff and Stanford, they didn’t think they were doing anything wrong, they felt they’d earned it.

That delusion was based on the belief the boom was real and would last, that investment income would keep growing, the property bubble would continue to expand, and wealth would continue to grow, and in fact feed on itself.   They would make sure that happened, and be rewarded handsomely.  Perhaps some knew it was unsustainable and thus were ‘getting while the gettins good,’ but I suspect most were so caught up in the spectacle that they fooled themselves as well as the average investor.  Moreover, since they were the inside players, making “special deals” and manipulating the markets, they knew their skill — or rather, access to inside information and secret deals — was worth a lot.    The real scandal of the AIG bonuses is how widespread that sort of thing was (and is).

The fact that the taxpayer is footing the bill arouses righteous rage, but our depleted 401K funds paid the bill for all the other bonuses and compensation packages that allowed the fat cats to maintain their high calorie diet.   Either way, they took our money, legally, benefiting from being on the inside, while deluding themselves into thinking they could stretch the good times on for the foreseeable future.

In that, AIG is the “Berlin wall” of the economic crisis.  Just as the wall symbolized the evils of communism, the AIG bonuses symbolize the delusion and gluttony of the world of high finance.   Just as the collapse of the wall led to a ripple effect throughout eastern Europe and ultimately the fall of the Soviet Union, this could lead to a massive increase in regulations on executive compensation and corporate behavior.  Never again should we let the robber barons run wild.

The Hank Paulsons and Tim Geithner’s of the world, insiders themselves, paid little attention to the compensation issue because they saw the credit crisis as a problem to be solved; they didn’t recognize this as a revolutionary change to the practice of high finance in America, or even the globe.   This should shock them out of it, and force them to recognize they are not dealing with just a crisis, but a complete revolt against the way things were done.

This particular case will pass.  AIG execs will return some bonuses, or much might be taxed back into the federal coffers.  Politicians will point fingers, and find embarrassing tidbits about who knew or should have known what when.   But as that fades, change will sweep through the regulatory structures on Wall Street and beyond, executives will face new scrutiny, and more stories will emerge of greed and avarice, funded by the tax payer.   Last week it was financial “journalism,” this week it’s the actual players and politicians under the gun.  No one will be spared.

And next, expect to hear a lot more about money AIG will be paying super rich investors in Hedge funds.   Look for radical change in that industry too.  Things will never be the same again — which, given the mess the old system brought us, is a very good thing!