James Kwak admonishes us to move from the nano-picture of bonuses to the big picture of counterparty bailouts in the AIG mess. I agree. Along those lines, I have a thought: perhaps the credit default swaps we the taxpayers are making good on are part of a larger, interconnected network of transactions, whose aggregate value, if you netted them out, would be a lot less than the sum of their individual values. My understanding is that this is true in a general way for the derivatives tangle; I don’t know if the CDS’s link to this in some way. Part of cleaning up the financial gridlock is resolving these offsetting claims, of course. But an arbitrary guarantee to pay out some subset would interfere with that process and virtually require that all obligations be carried out. It is in the individual interest of AIG’s counterparties to put the clamps on the US government to get every penny they can, but it is not remotely in the public interest to do anything that requires each individual claim to be settled separately.
I admit I don’t know the detail here. If any EconoListeners have a better handle on this, can they tell me if my worries are well placed?