The truth behind the AIG bailout

Matt Buttell

The creation of the notion that banks are "too big to fail" is largely associated with the AIG bailout last September. But fresh reports reveal that idiom was never part of the bailout plan, sparking frustration over why the government really rescued AIG, and what its implications really mean.

Until now, when making a case for the AIG bailout, the US government has always maintained that had the financial services giant been left to fail, its credit default swap (CDS) obligations would have caused huge losses to its counterparties, resulting in all-out financial collapse.

It has long been considered a fair argument, subsequently giving rise to the belief that financial services institutions at large were simply "too big to fail" - so ingrained in nations' wider economies that governments had no choice but the bail them out.

However, according to a report by Troubled Asset Relief Program (TARP) Special Inspector General Neil Barofsky, released last week, this preconceived notion was in fact not part of the motive for the AIG bailout. In fact, according to reports from the Wall Street Journal (WSJ), the real motive goes well beyond the Obama administration's efforts to regulate CDSs and other derivatives.

Instead, argues the WSJ, it stands as one more example that the administration may be using the financial crisis as a pretext to extend Washington's control of the financial sector.

"A relevant factor"

According to the report from last week, Treasury Secretary Tim Geithner - who was actually President of the New York Federal Reserve Bank when the AIG bailout occurred - did not believe that the financial condition of the firm's CDS counterparties were "a relevant factor" in the decision to rescue the company.

Barofsky's report says that this contradicts the conventional assumption pertaining to the bailout: that a failure to follow through with the AIG bailout would have led to disastrous consequences for the wider financial services industry.

Regulation

The WSJ now reports that such an admission by the Obama Administration brings broader questions to the fore. Notably, whether the entire regulatory regime proposed by the administration, and now being pushed through Congress is based on false preconceptions. After all, as was the case with the AIG bailout, the administration has consistently used the term "large, complex and interconnected" to describe the non-bank financial institutions it wants to regulate.

This suggestions has in-turn given rise to the idea that if one bank should fail, others would undoubtedly follow: a domino effect of ailing banks.

Of course, until now many have been happy with this explanation for the state of the financial services sector; but if the New York Fed really did not believe AIG's failure would have actually brought down its counterparties—and ultimately the financial system itself—it raises serious questions about the administration's credibility, and about the need for its regulatory proposals.

The concerns over what exactly "interconnectedness" means has also given rise to further issues, too. The WSJ writes, "the administration's unwillingness or inability to clearly define the problem of interconnectedness is not the only weakness in its rationale for imposing a whole new regulatory regime on the financial system."

Notably, the claim made by both Geithner and President Obama himself that predatory lending by mortgage brokers was one of the major causes of the financial crisis.

Now though, the biggest concern of all is whether this disclosure about credit default swaps and the AIG crisis will signal a debunking of other Fed polices, promises and propaganda.

 

 

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