The federal government’s takeover of American International Group marks the end of three decades during which we have been made to worship at the altar of “free” markets and deregulation. The religion of unbridled capitalism is dead, replaced by a new theology of ad hoc intervention and selective lemon socialism.
Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke are reshaping the financial landscape with the zeal of 1920s Soviet central planners. The difference is that they don’t seem to have a five-year plan. They are rushing from crisis to crisis, making up policies as they go along.
Bear Stearns is forced to merge into JPMorgan Chase, with the Fed backing up some of Bear’s riskier investments. Fannie Mae and Freddie Mac are placed into federal “conservatorship.” Merrill Lynch is thrust into a shotgun marriage with Bank of America. Lehman Brothers is forced to file for Chapter 11 bankruptcy, paving the way for Barclays to swoop in and buy its viable assets at a bargain-basement price. AIG is given a cash infusion of $85 billion, in exchange for which the federal government becomes an 80-percent owner of the insurance company.
The “invisible hand” of the market has been replaced by a ham-handed approach that puts expedience over coherence or prudence. The desperate way in which these emergencies are being handled is indicative of just how screwed up the financial system has become.
In many ways, the crisis at AIG is the most troubling of all. Unlike Bear, Merrill and Lehman, AIG was not supposed to be part of the casino-like world of investment banking. As an insurance company, it presumably had a responsibility to be somewhat more staid. In fact, it does have units—property & casualty coverage, aircraft leasing, etc.—that are doing well and will probably be sold off to raise cash.
What brought AIG down is its Financial Services segment and particularly its “credit products,” described opaquely in its 10-K filing as “credit protection written through credit default swaps on super senior risk tranches of diversified pools of loans and debt securities.” AIG, it seems, has been insuring the esoteric financial investments being made by others. It may be a good idea for investors — especially institutions like pension funds — to arrange for some protection when putting money in risky securities. But it turned out that the party doing the insuring, AIG, lost control of the process.
Last February, AIG disclosed that its auditors had found a “material weakness” in the company’s oversight of its credit default swap portfolio. That’s a polite way of saying it might have been cooking the books in terms of its exposure to swaps relating to mortgage-backed securities that were plunging in value. It later came out that the Securities and Exchange Commission and the Justice Department were investigating whether AIG deliberately overstated the value of its swap position.
So let’s see if I got this straight. A company that was supposed to provide protection for speculators became a speculator itself and may have tried to hide how deep a financial hole it had fallen into. And the same federal government that was investigating AIG now owns it. A fitting symbol of the end of market fundamentalism.
Addendum: Here’s some coverage of one of the previous instances in which AIG faced a government takeover—when the revolutionary government of Iran nationalized its subsidiary in that country in 1979. It remains to be seen whether the current takeover turns out any better. Click on the following link to see an excerpt from the New York Times of June 26, 1979. The reference to AIG is in the last paragraph.