That didn't last long

Two days after the US authorities made much of standing firm against calls for a bailout of Lehman, the Fed has announced an $85 billion rescue of insurance company (and large-scale counterparty in all kinds of derivative markets) AIG. There’s none of the ambiguity surrounding Fannie and Freddie in this deal. AIG is not a federally regulated entity, and the insurance subsidiaries are regulated at the state level to ensure their ability to pay out on claims. This is, purely and simply, a case of a speculative financial enterprise that’s too big to fail.

Having reached this point, it’s hard to see how the US can turn back from a massive extension of financial regulation, starting with the derivative markets where AIG got into so much trouble, notably those for credit default swaps (CDS). Along with winding up the affairs of AIG, Lehman and others, the authorities will need to oversee an orderly unwinding of the transactions in these markets which they are now effectively guaranteeing. More generally, it’s time for a partial or complete reversal of the financialisation of the economy that took place after the breakdown of the Bretton Woods system back in the 1970s.

BTW, if you happen to have cash parked in a US money market fund, you might want to read this. (Insert disclaimer about financial advice)

UpdateBrad Setser has the same reaction.

47 thoughts on “That didn't last long

  1. If I ever here a white collar whining about welfare ( dependency ) for poor people again, I’ll clobber them on the spot…

  2. SO lets deal with your logic.

    On one hand
    You are upset with computer models that got the real world wrong when trying to simulate risk.

    one the other.
    You believe that climate models do in fact represent the real world, and you want a brand new financial instrument based on computer models to be implemented to cut CO2 emissions.

    So in summary, you are all in favour of one giant mess up, but have no problems with another one in the offing?

    Here is a tip, give Nassim Nicholas Taleb book on Black Swans a read and you might understand why computer models can never represent the real world and will always fail.

  3. Sorry, the unexpected happened and I made a mistake.

    “So in summary, you are against one giant mess up, but have no problems with another one in the offing?

  4. Just a few titbits I have to point out.

    1, Greenspan was never in favour of the fiat currency system that he run, the only person who has been consistent on this issue is Rep. Ron Paul

    2 Fiat currency is political in nature, it is based upon trust, when trust goes the currency eventually goes too.

    3, F May and West was not a Nationalisation in the ture sense,their debt went from being implicitly backed by the Fed, to explicitly backed by the fed.

    4, In 2003 GWB tried to reform May and West.

    In 2006 a certain john McCain, was ringing the alarm bells.

    5, Its ok to so on about new regulation, but what kind of regulation, and what kind of unforeseen consequences might arise?

    6, This whole thing could and should have been avoided with a simple directive given by politicos to the central bankers, when the economy grows make sure that credit growth does not outstrip economic growth.

    7, why did they not give this instruction? could it be that stuffing peoples pockets with cash especially poor peoples pockets is seriously good politics? for both the left and the right?

    8, History does not repeat itself, circumstances are never exactly the same, Historicism is one of the most universal discredited theories of the 20th century. The 1930s crash was a very different thing altogether, except of course it involved banks going bust as well.

  5. It certainly didn’t last long and hot on the heels of HBOS and AIG comes Morgan Stanley-

    MORGAN Stanley, which saw its stock pummeled overnight on worries it may not survive the credit crunch as a broker-dealer, is considering merging with Wachovia, or another commercial bank, according to reports.
    Morgan Stanley chief executive John Mack received a call on Wednesday from Wachovia, the fourth-largest US bank, expressing interest in a deal with the Wall Street investment bank, the New York Times reported on its website, citing sources.

    Morgan Stanley, the second largest US investment bank, is considering other options, as other banks also have expressed interest, the Wall Street Journal reported.

    Both Wachovia and Morgan Stanley declined to comment on whether it was having takeover talks, but said it was doing everything it could to help its stock price.

    “The smartest people at this firm are focused on solutions,” said a company spokeswoman.

    The Wachovia talks are in the early stages and no deal may be completed, according to the reports that cited unidentified sources.

    A number of analysts and investors, though, questioned the wisdom of combining two banks that have been burned by the spreading credit crisis that began with plunging mortgage prices and spread to commercial real estate.

    “Two wrongs don’t make a right,” said James Ellman, a fund manager and president of SeaCliff Capital. “Hasn’t Mr. Market been saying both companies possibly are going to fail? If you put them together, how does that make a better company?”

    I guess the answer to the last question is that-
    “The smartest people at this firm are focused on solutions,”
    No doubt Morgan Stanley people, having watched Lehman Bros staff clear their desks, while some are not allowed to fail, have recognised it’s time to join the latter. There’s a fallacy of composition here somewhere, but I guess when you’re up to your tits in moral hazard it’s time to seek higher moral ground from the Creator.

  6. If you want a government bailout, you have to be “too big to fail.” That is why the smartest people at the firm are looking to merge with anyone, anybody, as fast as possible. Due diligence be damned :-0

  7. Standard & Poor (S&P), one of the crucial members of the ‘financialised economy’, has made a noise (“negative”) about the MacBank on the grounds of its assessment of the MacBank business model.

    S&P had about 10 years time to examine the MacBank business model. They offered their piece of wisdom after the share price halved during the past year. Have these high-charging glorified private sector second-guessers been sound asleep behind the wheel for all this time?

    Nevertheless, ‘the market’ (short-sellers?) still seems to take notice of these second-guessers noise makers. This morning (about 20 minutes before this post), the share price fell by over $6 to just under A$27.

    If there is something ‘wrong’ with the MacBank business model then this should come out in the wash through the ‘root and branch’ review of the regulatory framework of the international financial system. Hopefully such a review leads to the conclusio that S&P and ‘core players’ in the ‘financialised economy’ have unhelpful business models.

    Disclosure: I have NO financial interest in the MacBank and I am not associated with any of its employees.

  8. AIG wasn’t “too big to fail” it was “too critical to be allowed to fail”.

    AIG “inusred” $300 billion worth of European bank loans – guaranteeing thre lender agaisnt any default.

    This was sheer economic engineering – it allowed the banks to remove the loans from their balance sheets are therefore loan more.

    An AIG bankrupcy would have resulted in credit down grades for many of those banks and could have caused another wave of defaults and forced sales.

  9. #33 That’s true but it just raises again the question of how the authorities could allow an essentially unregulate firm such a critical role in the system. In particular, why were regulated banks allowed to fiddle their books in this way?

  10. ahh McCain, you’ve done it again.
    McCain Embraces Regulation After Many Years of Opposition

    …Three years earlier, McCain had joined with other Republicans to push through landmark legislation sponsored by then-Sen. Phil Gramm (Tex.), who is now an economic adviser to his campaign. The Gramm-Leach-Bliley Act aimed to make the country’s financial institutions competitive by removing the Depression-era walls between banking, investment and insurance companies.

    That bill allowed AIG to participate in the gold rush of a rapidly expanding global banking and investment market. But the legislation also helped pave the way for companies such as AIG and Lehman Brothers to become behemoths laden with bad loans and investments.

    McCain now condemns the executives at those companies for pursuing the ambitions that the Gramm-Leach-Bliley Act made possible, saying that “in an endless quest for easy money, they dreamed up investment schemes that they themselves don’t even understand.” …

    so the guy with his name on the law is McCain’s economic advisor. he’s the same guy who recently called Americans ‘whiners’ for not thinking the economy was doing fine.

  11. JQ – the whole Basel II architecture which essentially let banks write their own prudential guidelines (sorry “risk management models”) needs to be revisited.

  12. The think with the Gramm=Leach-Bliley Act is that the barriers between different areas of finance never really applied in the other major capitalist economies (hence the European Bancassurance giants).

    It’s tempting now in retrospect to say the fundamental thrust of the bill was wrong – but other major economies have operated on that basis for decades.

    Clearly something went badly wrong – but simply blaming Gramm (tempting as it is to lefties like me) doesn’t really help us understand exactly what went wrong and how to fix it.

  13. Sept. 16 (Bloomberg) — Merrill Lynch & Co. Chief Executive Officer John Thain and trading-division head Thomas Montag may reap payouts totaling more than $47 million if they leave or are given lesser roles after Bank of America Corp. buys the firm.

    Montag, who joined in August and is a former colleague of Thain’s from Goldman Sachs Group Inc., would get $30 million in accelerated stock awards and at least $6.4 million in options if he’s dismissed or his duties are diminished after a change of control, Crystal said.

    36 million dollars for two months work that involved the failure of the company

    that is what is wrong with this system

  14. so reassuring to learn the system is fundamentally sound, but just needs a bit of tweaking and plucking of bad apples.

    otherwise i would think that a system that periodically boomed and busted, in which clever people made millions and walked away leaving lives ruined, was not a system at all. just a jungle.

    but it seems that only those profiting from the system euphemistically called capitalism are unfussed by periodic convulsions and destruction of savings, so perhaps i won’t take their word for it.

  15. To put a more positive light on the matter.

    The collapse of Lehmans and selling off of Merrill are hugely significant events. They represent the massive reallocation of resources away from failing uses toward more productive uses.

    It clearly demonstrates that no matter how large, entrenched and institution maybe it is suceptible to being annihilated by market forces.

    The cause is the total sum of all the decisions of individual players in the market place trying to get the best deal for themselves.

    These events have happened without any violence, change of government, terrorist attacks, planning committees, government intervention etc..

    In essence, the market, is the great leveler.

    The quicker we liquidate the badly allocated resources the better off we will all be.

  16. Ian Gould says, “Ikonoclast, and in those terms how “realâ€? is the money now being pumped into AIG?”

    That’s a good question and I’m not sure there is an easy answer. This money has or at least arrives with a different kind of backing to the “backing” that the lost billions had in the merry go round pass-the-debt-parcel financial system. However once these new billions are in the system, where do they go and what are they worth? Given the continuing negative reaction of the markets I’d say, “Who knows? and “Not much.”

    And another pundit says I am almost sounding like an Austrian! (Meaning of the “Austrian” Economic School I guess.) LOL. Not quite, but if there is any logic in their system I would be akin to them on those points.

  17. Every day Socialist China becomes more capitalist and capitalist USA becomes more socialist. It’s like the end of Animal Farm. Pigs started looking like men and men started looking like pigs. Puts a new slant on the lipstick on a pig line

    I would suggest a reading of “The Vanity of Human Wishes� by Samuel Johnson. Lines that caught my eye in the first 2 stanzas alone were;

    “How Nations sink, by darling Schemes oppress’d,
    When Vengeance listens to the Fool’s Request.”

    “For Gold his Sword the Hireling Ruffian draws,
    For Gold the hireling Judge distorts the Laws;
    Wealth heap’d on Wealth, nor Truth nor Safety buys,
    The Dangers gather as the Treasures rise.”

    Read the poem at

    Remember, reading good poetry is very economical entertainment and mind improving too!

  18. Being on the ATO email list, it suddenly dawned on me that many of you may be having a lot of trouble working out the value of things at present. Perhaps you sorta know what your thing is worth but need confirmation, or you have a thing and haven’t got a clue what it’s worth right now, then you need to know help is at hand (with appropriate documentation of course)-
    It’s important to remind ourselves that we can always rely on Govt in these troubled and confusing times.

  19. Ernestine. It was just a thought. On a Blog. No offence intended.

    It would be interesting to see if the funds the world banks intend to “save” our economies with are backed by anything at all ?

    If its fiat money then it would be bad money chasing after more bad money .

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