As a little kid, there was a part of my little mind that always had a big question mark on it. Like, when I was told that I was "wasting time"or entreated to "save time," I would think that those things didn’t make sense – that time marched on no matter what I did. Of course, those were just the internal ramblings of a little boy pushing back against too much outside control, but it was fun to think about. When I got older, that same part of my mind wrankled at the great worry in our house about "making money." That one came out of my mouth. "I thought counterfeiters ‘made money’," I would say to my own delight [and the annoyance of others around me]. As I grew older, that "make money" thing became something of a philosophy. "You can’t ‘make money.’ You can ‘earn money,’ or ‘take money,’ but you can’t ‘make money’." Of course, I only said it when people talking to me were getting on my nerves with this ‘make money’ thing [our financial advisor doesn’t think I’m a bit cute].
"Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?"
That reference to a Ponzi Scheme
in Krugman’s op-ed was the first time I’d ever heard the term, so I looked it up and read [with amusement] about the Italian Immigrant, Charles Ponzi
, and his antics. It was prophetic that Krugman was using this term to describe the financial crisis, just two weeks before the real McCoy showed up in the form of Bernard Madoff
[In the articles about Madoff
, he is called a "moneymaker," and, of course, that set off my childhood question mark mind].
But, when I read Krugman’s op-ed, I didn’t quite know how the flim-flam man, Charles Ponzi
, related to the current financial crisis, because I didn’t really understand the crisis itself. Now that I’ve read the series in the Washington Post
[my last post
], I feel more informed. A.I.G.
was, in effect, selling Insurance on Loans that they thought they’d never have to pay off.
For months, several executives at AIG Financial Products had pulled apart the data, looking for flaws in the logic. In phone calls and e-mails, at meetings and on their trading floor, they kept asking themselves in early 1998: Could this be right? What are we missing?
Their debate centered on a consultant’s computer model and a new kind of contract known as a credit-default swap. For a fee, the firm essentially would insure a company’s corporate debt in case of default. The model showed that these swaps could be a moneymaker for the decade-old firm and its parent, insurance giant AIG, with a 99.85 percent chance of never having to pay out.
The computer model was based on years of historical data about the ups and downs of corporate debt, essentially the bonds that corporations sell to finance their operations. As AIG’s top executives and Tom Savage, the 48-year-old Financial Products president, understood the model’s projections, the U.S. economy would have to disintegrate into a full-blown depression to trigger the succession of events that would require Financial Products to cover defaults.
If that happened, the holders of swaps would almost certainly be wiped out, so how could they even collect? Financial Products would receive millions of dollars in fees for taking on infinitesimal risk.
So it was
a giant Ponzi Scheme
, just like Krugman said. A.I.G.
was selling Insurance they couldn’t back up – billions of dollars worth of it – unregulated! That’s what a Ponzi Scheme is – the illusion of a financial instrument with nothing behind it
. In Madoff
‘s case, it was Investment Accounts that paid high dividends, though the Principle was quietly disappearing in the background. With A.I.G.
it was Insurance with no Capital behind it to back it up if you tried to collect. In both cases, there was the idea of "making money." I can "make money" by investing with Madoff
. I can "make money" loaning money to anybody, because any loan defaults are covered by A.I.G.
[who is thinking that they can "make money" because they’ll never have to pay off any defaults].
They both proved that I was right as a kid. You cannot "make money." Now, how do we explain that we bailed out A.I.G. and yet we are going to crucify Madoff?…