Understanding the AIG decision

By Felix Salmon
November 17, 2009
Dean Baker notes, Neil Barofsky's report on the 100% payments to AIG's counterparties is the news of the day. It's sexy stuff, revisiting the dramas of the week of Lehman's collapse, and of course going into great detail about the way in which the crisis's designated villain, Goldman Sachs, walked away with billions of dollars of taxpayer money despite saying they never asked for it nor particularly needed it.

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As Dean Baker notes, Neil Barofsky’s report on the 100% payments to AIG’s counterparties is the news of the day. It’s sexy stuff, revisiting the dramas of the week of Lehman’s collapse, and of course going into great detail about the way in which the crisis’s designated villain, Goldman Sachs, walked away with billions of dollars of taxpayer money despite saying they never asked for it nor particularly needed it.

I agree with Barofsky that, in hindsight, the payments should have been made at less than par; TED has a good explanation of how that could have happened, given sufficient aggression. After all, it’s not like Treasury wasn’t being run by a hard-charging former investment banker at the time.

But I’m maybe slightly more sympathetic to the Fed than most — or at least I understand how this happened. It shouldn’t have happened, that’s true: for the sake of putting a knife into the moral-hazard trade, some haircut — any haircut — should definitely have been imposed, even if it was only the 2% that UBS offered to accept.

But the government owned AIG, which created the situation that Germans call Anstaltslast: the fact that state-owned companies simply don’t default on their obligations. The government was also battling a major crisis using the only weapon at its disposal: enormous amounts of liquidity. When you’re putting out a fire, you don’t stop to worry that large amounts of liquidity are going to end up where you don’t particularly want them — the important thing is putting out the fire.

So yes, given a bit more aggression and foresight, the Fed could have tried to cram down a haircut onto AIG’s counterparties. But at the time, no one was particularly interested in being harsh to the global financial sector; instead, they were trying to rescue it. With hindsight, it now seems that companies like Goldman Sachs have turned out to be the biggest winners, paying out billions of dollars in bonuses even as the rest of the country struggles with an extremely nasty recession. But that wasn’t particularly foreseeable. And so although I agree with Barofsky that the Fed and Treasury should have been harsher on the counterparties, I do understand why they weren’t.

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