Three dirty letters: "A.I.G."

When the history of the current global depression recession is written, will the three dirtiest letters be “S.E.C.” or “Fed” or “CDS” or “CDO”? (There sure are many candidates, aren’t there?)

I’m betting on “A.I.G.”

The New York Time’s Joe Nocera wrote an anger-inducing article describing how A.I.G. recklessly put taxpayers on the hook for hundreds of billions (and counting).

I thought I had a pretty good grasp of the A.I.G. nightmare, but Nocera’s article added a new chapter — “2a-7 puts” — to the book of insane heads-we-win-tails-taxpayers-lose risks A.I.G. took.

I’m too angry now to write more. Perhaps tomorrow. But please read the excellent article.

Bottom line: A.I.G. “insured” everything under the sun but didn’t put aside any capital to pay off losing bets. Governments didn’t bother to regulate A.I.G.’s financial insurance policies as either insurance or financial instruments. Ratings agencies continued to let A.I.G. maintain an absurd “AAA” (riskless) rating as it issued hundreds of billions (or trillions?) in insurance policies against losses on risky financial assets without setting aside money to pay off claims. And A.I.G. executives earned massive payouts from the (short-term) “profits” from its unprecedented gambling spree. Now we taxpayers are being forced to pay off our reprobate brother’s gambling losses.

Didn’t the sophisticated institutions purchasing “insurance” from A.I.G. realize that a thinly-capitalized institution writing hundreds of billions of insurance contracts promising to pay off losses on financial assets of all kinds was too good to be true? Of course they did!

So why are taxpayers paying off these unrealistic “insurance” policies? Capitalism has a mechanism for dealing with bankrupt companies: bankruptcy. And fear that an A.I.G. might go bankrupt is supposed to encourage those seeking insurance to buy insurance only from firms that can pay insurance claims when things go badly. By insuring everything under the sun, A.I.G. was obviously unable to pay off its policies if the economy turned down. So, why did everyone pretend A.I.G. would pay those claims? Was everyone expecting a taxpayer bailout if the economy turned bad? If so, we’re being played for suckers.

Posted by James on Sunday, March 01, 2009