1 Boring Old Man

Senators Ask Who Got Money From A.I.G.
New York Times
By MARY WILLIAMS WALSH
March 5, 2009

Trying to draw a line in the sand, a Senate panel told the vice chairman of the Federal Reserve to identify all the parties made whole by the bailout of the American International Group or forget about coming back to ask Congress for more rescue money. “You will get the biggest no you ever got,” Senator Jim Bunning, Republican of Kentucky, warned Donald L. Kohn, vice chairman of the Fed board of governors, in a hearing on Thursday. “I will hold up the bill.”

The hearing, led by Senator Christopher Dodd, Democrat of Connecticut and chairman of the Senate Banking Committee, was called to examine the regulatory patchwork that had allowed huge risks to build up at A.I.G. Since the insurance conglomerate’s near collapse in September, the federal government has committed $160 billion to keep it afloat.

Tens of billions of those dollars have merely passed through A.I.G. to its derivatives trading partners, shielding them from losses. The Fed has refused to provide the names of those financial institutions, and senator after senator, Democrat and Republican, said that was an outrage. “We need to know who benefited, and we’re going to find out,” said Senator Richard C. Shelby, Republican of Alabama and the ranking member of the committee. “The Fed can be secretive for a while but not forever.”

Mr. Kohn said the Fed believed that the only hope of recovering the taxpayers’ money was to get A.I.G. back on its feet, doing business as usual — and that meant respecting its customers’ privacy…

Under our new improved system, the lending institution sold the loans to larger institutions who repackaged them as mortgage backed securities, ranked them according to some [arbitrary] level of risk and sold them as Securities called CDOs [Collateralized Debt Obligation], passing on the risk with the asset. Even larger financial institutions bought the CDOs and insured them against loss by purchasing Credit Default Swaps – a quaisi-Insurance that assumed the risk. A major seller of the Credit Default Swaps was AIG-FP [American International Group – Financial Products]. They sold these quaisi-Insurance Products on the Unregulated Derivatives Market using AIG‘s AAA Rating and neglected to have any Capital to back up their quaisi-Insurance since they thought they’d never have to payoff anybody.

So, since the bigger financial Institutions could hedge their risks with CDSs, they bought CDOs like crazy. And since the financial institutions could sell their risk as CDOs, they bought Mortgages like crazy. And since the lending institutionscould sell their risk, they gave loans to anyone who wanted them. And since the property buyers could get a loan in a heart beat, they bought property they couldn’t really afford getting absurd sub-Prime Loans with balloon payoffs. Property values escalated to the sellers delight, creating a financial bubble – easy loans, corrupted CDOs, unsecured CDSs. The fraud in the system operated at every level as the risk rode up the chain. Then one day… 

The Big Dither
New York Times
By PAUL KRUGMAN
March 5, 2009

Last month, in his big speech to Congress, President Obama argued for bold steps to fix America’s dysfunctional banks. “While the cost of action will be great,” he declared, “I can assure you that the cost of inaction will be far greater, for it could result in an economy that sputters along for not months or years, but perhaps a decade.” Many analysts agree. But among people I talk to there’s a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern.

Here’s how the pattern works: first, administration officials, usually speaking off the record, float a plan for rescuing the banks in the press. This trial balloon is quickly shot down by informed commentators. Then, a few weeks later, the administration floats a new plan. This plan is, however, just a thinly disguised version of the previous plan, a fact quickly realized by all concerned. And the cycle starts again.

Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets, often referred to these days as “toxic waste,” are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away…

This is the same A.I.G. that, unable to honor its promises to pay off other financial institutions when bonds default, has already received $150 billion in aid and just got a commitment for $30 billion more. The truth is that the Bernanke-Geithner plan — the plan the administration keeps floating, in slightly different versions — isn’t going to fly.

Take the plan’s latest incarnation: a proposal to make low-interest loans to private investors willing to buy up troubled assets. This would certainly drive up the price of toxic waste because it would offer a heads-you-win, tails-we-lose proposition. As described, the plan would let investors profit if asset prices went up but just walk away if prices fell substantially. But would it be enough to make the banking system healthy? No…

… officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable. But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.