by Frank Thomas and John Lawrence
Frank has eloquently argued “Yes” here in Part 2 and continued here in Part 3 of our examination of the financial crisis of 2008. Part 1 dealt with Republican economic philosophy over the last 30 years which had produced disastrous results for the economy leading up to the crisis.
This week John argues that AIG should have been allowed to fail and that this would not have affected Main Street banks or the banking activities of average Americans. But the real question is ‘If American taxpayers and the Fed had not given billions of dollars to AIG and the other large banking institutions, would they have indeed failed or would they, on the other hand, have survived quite nicely even without the bailouts?’
What’s clear in the financial crisis of 2008 is that Washington rescued Wall Street while abandoning Main Street.
The government under the direction of Treasury Secretary and former CEO of Goldman Sachs, Henry Paulson, and later Treasury Secretary Timothy Geithner (former President of the privately owned Federal Reserve Bank of New York on whose Board Jamie Dimon CEO of JP Morgan Chase sat) held the most reckless casino contracts made by rich investors inviolable paying out 100 cents on the dollar to them while considering the contracts entered into by homeowners and small business owners mere irrelevancies.
Neil Barofsky, former Inspector General in charge of Oversight of TARP, the $700 billion taxpayer funded bailout, has accused the whole Wall Street enterprise of fraud. He has said that he focused on criminal rings made up of corrupt lawyers, mortgage brokers, notaries, loan officers, appraisers, and various and assorted other insiders, virtually the whole Wall Street crowd.
Mortgage brokers lied to potential borrowers about the amounts of their payments and what they would be when their ARMs (Adjustable Rate Mortgages) reset. Brokers were paid incentives to get borrowers who qualified for a prime loan to instead take a more expensive higher-interest-rate subprime loan.
The worse the mortgage was for the borrower the better it was for everyone in the mortgage business. Regulators had abandoned any pretense of regulating and looked the other way.
When this edifice built on fraud started to collapse in 2008, Treasury Secretary Henry Paulson serving under George W Bush ran around Washington with his hair on fire and demanded that Congress pass a bill immediately giving him $700 billion to be used at his own discretion with no strings attached. In addition to taxpayer money the Federal Reserve ponied up $7 trillion of fiat money that it just created out of thin air with a few mouse clicks.
On October 13, 2008 with Bush still in office, Paulson called a meeting of nine big Wall Street banks and forced them to take $125 billion which he parceled out to them even though some of them didn’t want it and didn’t need it. Richard Kovacevich, CEO of Wells Fargo, didn’t want to take the money. Paulson forced him to take it.
Can you imagine if your banker called you in and said “We are going to pay off your mortgage whether you like it or not.” That would never happen but here was Hank Paulson forcing CEOs of big Wall Street banks to take billions of dollars. Kovacevich said “I believe the TARP decision of forcing people to take money they didn’t want or didn’t need was one of the worst economic decisions in the history of the US.”
The biggest recipient of TARP cash, Goldman Sachs, has maintained it had no exposure to AIG. Between the collateral AIG posted and other assets on their books, Goldman claimed to have fully hedged any counterparty risk.
Was it necessary to save these institutions by throwing money at them? And was it worth it not to bail out the homeowners underwater on their mortgages insuring that all contracts between homeowners and banks should be honored in order not to encourage moral hazard? Moral hazard is simply the fear that letting people off the hook will encourage shoddy behavior in the future.
As it turned out, the moral hazard incurred was on the part of the fraudsters on Wall Street who were showered with money and allowed to get right back to the business of screwing people secure in the knowledge that they would never be held accountable because they were ‘too big to fail.’
AIG was essentially a huge insurance company insuring that all the bets that Wall Street was making on derivatives were good. When these bets turned out to be bogus, AIG had to pay up and couldn’t. It was similar to a run on the bank.
Should AIG have been allowed to fail? David Stockman, Reagan’s former budget director, says that that isn’t even the point. He maintains that they wouldn’t have failed even if TARP and the Fed hadn’t bailed them out. Certain investors would have taken a haircut but AIG could have withstood those blows and remained in business. Paulson’s ‘hair on fire’ bailout at taxpayer expense had more to do with saving investors’ and speculator’s hides than in saving the banking institutions themselves.
In his book, “The Great Deformation“, Stockman says:
“For me, AIG was the skunk in the woodpile. After twenty years on Wall Street I knew that the giant, globe-spanning AIG and its legendary founder, Hank Greenberg, had once been viewed as not simply the gold standard of finance, but as sweated at the very right-hand of the financial god almighty. And then, in a heartbeat, AIG needed $180 billion – right now, this very day, to keep its doors open? Worse still, this staggering sum of money – the size of the Departments of Commerce, Labor, Energy, Education, and Interior combined – had been ladled out as easy as Christmas punch: Bernanke just hit the “send” key on his digital money machine.”
And Hank Greenberg even threatened to sue the Federal government because he didn’t think the terms for the bailout were favorable enough to AIG!
Stockman maintains that Main Street banks were never in any jeopardy. Small business loans would still have been available, and ATMs would have continued to function. Frank argued that some 400 small banks failed during this crisis, but that only represents about 5% of the total number of banks in the US. The large preponderance of banks and credit unions remained in business and would have remained in business even if no bailout occurred.
“There was never a remote threat of a Great Depression 2.0 or of a financial nuclear winter, contrary to the dire warnings of Ben S. Bernanke, the Fed chairman since 2006. The Great Fear — manifested by the stock market plunge when the House voted down the TARP bailout before caving and passing it — was purely another Wall Street concoction.
Had President Bush and his Goldman Sachs adviser (aka Treasury Secretary) Henry M. Paulson Jr. stood firm, the crisis would have burned out on its own and meted out to speculators the losses they so richly deserved. The Main Street banking system was never in serious jeopardy, ATMs were not going dark and the money market industry was not imploding.”
John Carney argued in 7 Reasons AIG Should Be Allowed To Die that insurance policy holders were protected by AIG’s insurance subsidiaries. Also losses to derivative counterparties would have been best addressed by infusing capital directly into the banks that needed it.
Serious consideration should have been given to forcing AIG’s partners in derivative transactions, which were mainly buyers of credit default swaps from the company, to take a substantial haircut. Not allowing AIG to fail created a moral hazard that as much as guarantees that any large banking institution is for all intents and purposes a branch of the Federal government.
After Lehman Brothers failed in September 2008, the government decided to draw the line at AIG which was next in line to go under. Stockman maintains that, if AIG had been allowed to fail, it wouldn’t have caused a chain reaction or a financial doomsday. “In fact, none of the bailouts were necessary because the meltdown was strictly a matter confined to the canyons of Wall Street.”
The failure of these Wall Street institutions would not have infected the Main Street banking institutions; the ‘contagion’ had no basis in fact. Moreover, Stockman maintains that even without a bailout AIG would not have gone out of business.
AIG’s assets were parceled out to subsidiaries all over the globe. Its $800 billion balance sheet consisted of high grade stocks and bonds that were domiciled in a manner that invalidated the “contagion” theory. The crisis had nothing to do with AIG’s assets i.e. its survival as an institution; it had to do with AIG’s CDSs (credit default swaps) which could have been readily liquidated in bankruptcy without affecting AIG policyholders.
Grandpa’s life insurance policy would not have been affected. The money given to AIG was not designed to save the masses from harm but in reality to save the asses of a few dozen speculators.
So the huge amount of taxpayer money given to AIG was not to protect Main Street; it was to bail out speculators 100 cents on the dollar. The evidence shows that each and every Wall Street institution that received money could have withstood the AIG hit so that the bailout was all about protecting short term earnings and current-year executive and trader bonuses.
Stockman sums it like this: “In short, there was no public interest at stake in preventing AIG’s demise. Indeed, the bailout’s primary effect was to provide a wholly unwarranted private benefit at public expense; namely the shielding of highly paid bank traders and executives who had exposed their institutions to embarrassing losses from taking the fall that was otherwise warranted.”
And even though the big speculators recouped a hundred cents on the dollar, homeowners were wrongfully foreclosed on and forced to take a settlement of as little as $300 in return for losing their homes. The TARP program was supposed to help troubled homeowners struggling with their mortgages by writing down the principals, lowering interest rates, lowering monthly payments or all of the above.
However, only a small fraction ($1.4 billion according to Barofsky) of the $50 billion allocated to help homeowners avoid foreclosure was actually spent while the funds expended to prop up the financial system totaled $4.7 trillion.
Stay Tuned – Next time – Part 5: The Role of the Federal Reserve and European Central Bank