Saturday, March 21, 2009

The AIG Bailout: Preventing a Resolution of Offsetting Claims?

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?


Jack said...

I've been thinking the same thing for a while now, and the hulabaloo
about the AIG bonus money seems to be little more than an excuse to not attend to the really important aspects of where has all the money gone. This is a copy of a comment I made on AB this morning that is pertinent to the question. It's not an answer, but I agree that our questions should be aimed in another direction.

“Has our attention been diverted by the clever manipulation of the AIG bonus fiasco? Is it just coincidental that the much ado about this issue came up at virtually the precise time that the disclosure of the co-parties was made public? What have we heard since first disclosure about two weeks ago of the several major financial institutions, here and abroad, that saw AIG's bail out funds in their on coffers almost immediately? There was a very brief outcry about the billions flowing right through AIG into the banks that had already gotten major inflows of bail out funds. Where has that story disppeared to with all the attention being showered upon the AIG bonus payments.

I don't mean to imply that the AIG bonus payments should be allowed to stand. Did it really require an act of Congress to revise the tax codes to recoup that money? I've made this point before so it may seem redundent. The bonus money could have been dealt with as a managerial decision. We seem only to have an executive with the most peculiar point of view at the helm of AIG at the moment. The bonuses were contracted, you say? What about performance on the part of the employee? Performance is the basis for all contracts. What was the performance results at AIG in the recent past? Not too good, I think. No performance, no bonus is the usual process.

It's a distraction from the big money issues. Co-parties being treated like injured parties rather than co-conspirators. Where's the Justice Dept lately? Who really believes that between Jutice, the Treasury Dept and the SEC there are not sufficiently knowledgeable people to have unwound the who did what to whom of this financial debacle? Why don't they want that to be the process?

TheTrucker said...

You ask where all the money has gone. But the fact is that that the money never existed unless you define contractual debts as money. The money never existed to cover all these counterclaims. The book value of the institutions holding the contracts inflated well beyond the supply of money needed to settle the claims.

The big boogerman and scarecrow on this deal is that the people who are actually insolvent due to their betting money they did not have are also the lenders that keep the real economy rolling along. There was a way out of this and it was for the Fed to do its job as "lender of last resort" in supporting the legitimate economy as opposed to "bailing out" the "financial sector" (the "financial sector" as defined by me does not include "commercial banks").

What we have now is the Fed trying to "make good" on the money already squandered in the bailout. It is a tar baby and a sinkhole. It may well be that the best that can be done is to blow off the 400 billion already pissed away and open some new lending institutions that serve the real economy. It may be even at this late date that the best move is, in fact, "do (whatever) requires each individual claim to be settled separately". e.g. even though we have already lost $400B it may be time to abandon the bailout project while opening some new lending institutions. The bailout money is gone and the perhaps the best way to get its value back is to pump new money into the real economy(wages). I wonder what the target is where national average home prices meet the value of the dollar? If wages rise enough then that mortgage payment does not look so bad.

Anonymous said...

Yep, the problem is that the people playing games sold some of the monopoly to people not playing, or borrowed against it, or otherwise tied it to the real world.

Anonymous said...

i heard someone on CSPAN today say rather than do a 1.2T bailout of banks, etc. just give the same amount, divided per cpaita, to all US citizens (or everyone here, for the 'without borders' crowd). That's maybe 2$M / per person. (i heard john stewart said something like this too).

i wonder if there is anything really wrong with that? perhaps some feel there might be some irresponsible uses of it. (One could put it like food stamps, so only 1$M is in lotto tickets while the rest is in other essential commodites). maybe people are worried about the pension funds? or is it just the Hamptons?

i wonder if the income distribution is changing, or whether all the money just goes towards keeping the distribution scientific (log normal or exp/pareto) to avoid a crash? (on taht theme, Bruce West had a great paper on how pareto's law is basically one of sharing or 'moral sentiment'. Another good one is on why global warming is caused by sunspots, so drive safely and happily).

Peter Dorman said...

I hate to be a stickler about arithmetic, but $1.2T is a few thou for each of us in the US. If the decimal places get gummy, just remember that our GDP is a little over 10x that number, so we're talking about a little less than a tenth of per capita income. (But knowing that Stewart is lined up against me makes me doubt everything.)

Also, I can't see how Pareto's law of income distribution (power function) has anything to do with sharing. It's rather the opposite. Extreme income inequality was one of the sources of the current madness: people whose incomes weren't going up got their "raises" by borrowing from those whose incomes were.

Anonymous said...

you must be a mathematician. somehow i divided 300 million people into 1.2 T$ and confirmed the $2 M i heard on cspan. but. i was using p-adic numbers or some nonstandard logic , which i do think should replace current GDP accounting methods.
(i guess i was thinking instead of bailing out the banks, why not just give all the people who are foreclosed the money for the house, or rent, adjusted for current prices (which are down i guess 30%. i think their are 10% of 70M houses in foreclosure, each needing maybe 200G, so that would be 1.4T).

the paper on 'sharing' by bruce west (physics, us army) with a collaborator at Duke (or UNC) actually is a joke (or rather an ideological justification of pareto's law---its neither exploitation as marx had it, or perfect competition (with cream rising to the top of the income distribution) but 'sharing'.
i like that. it could also be called socialism, or mutual aid.
they always say people benefit from sharing and giving more than taking or receiving. Bernie Madoff, milchael milen and peter ackerman have proven this.

(his one on how sunspots cause global warming appears similar (not all Real scientists agree with the ipcc). unless he means economic sunspots, recognizing from econophysics that the 'sun' is actually a social construction due to false consiousness. (see also 'the big bang never happenned' by Lerner for a similar treatment, showing that universal inflation in cosmology mostly was just a Freudian projection of psychological trauma caused by a combination of the 70'
s oil shock and the crisis of faith caused by the realization that Firedman's monetarist theory of the universe was probably wrong. god wasn't dead, rather the Fed simply couldn't create her (for womyn's month) using firedman's recipe.